May 2012invisible

Laufenberg Economic Quarterly

Daniel E. Laufenberg, Ph.D.

The views expressed here reflect the views of Daniel Laufenberg as of the date referenced. These views may change as economic fundamentals and market conditions change. This commentary is provided as a general source of information only and is not intended to provide investment advice for individual investor circumstances. Past performance does not guarantee future results.

Executive Summary - Déjà vu all over again

  • To quote Yogi Berra, investors seem to be concerned that “it’s déjà vu all over again.” In particular, they have increased the likelihood that the U.S. economy hits another soft patch over the remainder of 2012 and into 2013, similar to what happened over the four quarters starting in the fourth quarter of 2010. The Laufenberg Quarterly (LQ) forecast is more optimistic.

  • The primary concerns seem to be the spill-over effects of the ongoing debt debacle in Europe, as well as the so-called “fiscal cliff” anticipated to occur here when many of the Bush-era tax cuts expire at the end of this year. Although both may detract from U.S. economic growth at times over the next two years, I doubt either will be meaningful. Indeed, there is a chance that these events will be a net positive for the U.S. economy in the longer term.
  • The LQ forecast for 2012 continues to include solid real growth, still relatively mild inflation, a declining unemployment rate, unusually low interest rates and corporate earnings growth, despite the many perceived headwinds facing the U.S. economy.
  • The key to the LQ’s more optimistic forecast is further improvement in real final sales growth, led by solid gains in consumer spending, an uptick in business fixed investment, less drag from the government sector and a better housing sector.
  • The anticipated improvement in consumer spending is expected to be driven by real income growth, a slightly more favorable wealth effect, and the increased capacity of consumers to borrow. These positive factors should more than offset the negative effect from higher taxes in 2013. Whether taxes do increase next year is still unclear. But if they do, they may not be as problematic as some contend.
  • Record corporate profits and real final sales growth will drive businesses to add capacity in the months ahead. Government spending is expected to stop detracting from growth, probably in the second half of this year, and residential investment should continue to improve as pent up demand for housing finally spills over into new construction.
  • I continue to expect the Fed to raise short-term rates earlier than its commitment of 2014. At the moment, my best guess is early 2013.

Forecast at a glance

chzrt 1 - 4


Forecast details

Forecast Details

Déjà vu all over again

Yogi Berra’s quote, “déjà vu all over again,” comes to mind with regard to
financial markets at the moment. The “sell in May and go away” trade is underway again
and nothing apparently can stop it except maybe June. If it is a repeat of 2010 or 2011,
then the correction is only at its midpoint and may continue through much of the summer;
the S&P 500 index fell 16 percent from peak to trough in 2010 and nearly 18 percent in
2011. As of May 17, the S&P 500 is down 8 percent from its peak on April 2.

This correction notwithstanding, earnings continue to surprise to the upside,
most U.S. economic data reported so far in May have been better than suggested by the
consensus, the long-anticipated severe recession in Europe that has weighed on financial
markets for more than two years has failed to occur, and the slowdown in economic activity
in China has been relatively mild. Of course, there is always a chance that corporate
earnings will disappoint, the U.S. economic data will deteriorate, Europe will slip into a
severe recession, and China’s economy will collapse. Indeed, such concerns are fueled by
events like JPMorgan’s hedge-gone-wrong that resulted in a loss of $2 billion or more for
the bank, the allegation of bribes paid by Walmart, and the widely advertised and politically
charged “fiscal cliff” at yearend caused by the scheduled expiration of the Bush tax cuts. In
other words, there are always plenty of things for financial market participants to worry
about. I worry about many of them too but I also try to be realistic about them. As such,
the difference between my more optimistic view and the current consensus view seems to
be that I have assigned much lower probabilities to the worst case scenarios.

For that reason, the core features of the Laufenberg Quarterly (LQ) forecast
are little changed from February, including solid real growth, still relatively mild inflation, a
declining unemployment rate, unusually low interest rates and corporate earnings growth,
despite the many perceived headwinds facing the U.S. economy. To be fair, this is not that
different from the current consensus forecast. According to the Philadelphia Federal
Reserve Bank’s Second Quarter 2012 Survey of Professional Economists, the participants
have revised upward their estimate of the probability that real gross domestic product
(GDP) growth on a year-average basis will be in the range of 2.0 to 2.9 percent in 2012 and
2013. I agree, although my estimate of real GDP growth on this basis for 2012 is 2.6
percent, which translates into a 3.0 percent growth rate over the four quarters of 2012. In
other words, the LQ forecast is a bit more optimistic than the consensus.

Consumers to the rescue

The LQ forecast is above consensus in large part because consumer spending
should surprise on the upside for all of 2012. In particular, the consumers’ wherewithal to
spend has increased and should continue to improve as job growth translates into solid
income growth. In this regard, the March and April employment reports were perceived to
be disappointing. I disagree. Indeed, I thought they were consistent with my forecast of
3.0 percent real GDP growth this year.

The concern was that nonfarm payroll jobs in March and again in April did not
increase as much as expected by the consensus. In March, the expectation was for a gain
of 201,000. It was estimated initially by the Bureau of Labor Statistics to be up only
120,000. More recently, the March gain was revised upward to show a gain of 154,000,
which was better than the initial estimate but still shy of the 201,000 consensus. Moreover,
the April data provided a similar scenario. The consensus was for a gain of 165,000 and it came in a mere 115,000. Apparently two consecutive months of disappointing job gains
raised concern among investors and triggered the safe haven trade. As a result, equity
prices fell and Treasury bond prices rose.

Needless to say, I think this concern is misplaced. My forecast for nonfarm
payroll jobs is a gain of 2.5 million for all of 2012 (or roughly 210,000 jobs a month), which
is more than the 1.8 million new nonfarm payroll jobs for all of 2011. Through April,
nonfarm payroll employment has increased an average of 200,000, very much in line with
my estimate. As shown in Chart 1, the monthly change in nonfarm payroll employment has
always been uneven, so the changes so far this year are not unusual. More importantly to
the outlook is that the monthly changes in jobs continue to be positive. So far this year,
they have and I expect that they will continue to be positive over the remainder of the year
but at a very uneven pace.

chart 1

In addition, market participants seemed to dismiss the fact that the
unemployment rate slipped lower by another 0.1 of a percentage point to 8.1 percent in
April. The commentary around this development was that the unemployment rate fell for
the wrong reasons—the labor force declined more than employment in the household survey
data—for the second consecutive month. First, recall that the household survey is not
designed to provide employment data from month to month but rather to generate an
estimate of the unemployment rate only. In other words, the only meaningful statistics in
the household survey data worth considering in any one month are the unemployment rates
and not the level of employment or unemployment.

Over a longer period, thanks in large part to revisions around benchmarks,
payroll jobs in the establishment survey and total employment in the household survey
generally track in the same direction if not at the same pace. For example, over the
twelve months ending in April, the labor force has increased 1.0 million, while the number
of employed persons increased 2.3 million. In the establishment survey, total payroll jobs
were estimated to have increased 1.7 million over the same period. Remember, the
household survey is designed to generate ratios and not levels.

Second, as shown in Chart 2, the unemployment rate for adults (age 25 years
and over) in April was 6.8 percent, down from 7.6 percent a year earlier. Unfortunately, the
unemployment rate for teenagers was a whopping 24.9 percent in April, equal to where it
was a year earlier. Indeed, the unemployment rate for 20-24 year olds also was still
elevated at 13.2 in April, but was down from 14.9 percent in April 2011. It appears that
any hesitation on the part of employers to hire has been in large part aimed at teens and
young adults.

chart 2

Jobs will grow, the unemployment rate will fall and average hourly earnings
will increase. As a result, consumers will continue to acquire the wherewithal to increase
spending. Although personal income grew a mere 3.2 percent over the year ended in
March, it was not because of sluggish gains in the wages and salaries component of
personal income. This component, which represents over half of all personal income,
increased 4.4 percent (5.3 percent for the private sector alone) over the same period. In
addition, personal dividends and rental income of persons, both additional components of
personal income, increased rather sharply (6.2 percent and 11.8 percent, respectively) over
the last year ending in March. What did not do well was personal interest income, which fell 2.3 percent. Such a drop in interest income should not be a surprise given that interest
rates have been at historically low levels for a considerable time. By now, most debt
obligations that paid a high coupon have been called, have matured, or have been
refinanced. For this reason, my more optimistic assessment is that interest income may not
fall much further, as investors tire of zero interest on cash and start to stretch a bit more
for return.

In addition to more income, consumers now seem to have the capacity to
borrow again. According to the Federal Reserve Board, the share of income used to service
household financial obligations has plunged to a level last seen in the early 1980s (see
Chart 3). This suggests that the household sector’s relative cost of servicing its financial
obligations, including mortgages, consumer debt and leases, currently is less than it has
been anytime in the last 30 years.

chart 3

This increased capacity to borrow notwithstanding, the amount of borrowing
has been limited. As shown in Chart 4, households continued to cut back on mortgage debt
outstanding in 2011 through foreclosures or accelerated mortgage payments, albeit less
aggressively than they did in 2010. After all, even with the tax deduction of mortgage
interest payments, the cost of servicing existing mortgages is higher than the after-tax
return on most relatively safe investments. Therefore, the incentive is to reduce mortgage
debt outstanding, if possible. Nevertheless, that does not mean that consumers cannot or
will not borrow. According to the Federal Reserve Board, consumer credit outstanding at
the end of the first quarter was up 5.0 percent from a year earlier, including a 10.2 percent
jump in March (see Chart 4). This is not the most tax efficient or cost effective way for
homeowners to borrow, but it may be the only option available to many at the moment.

chart 4

Finally, household net worth has improved slightly over the last three years,
following its collapse in 2008. According to the Flow of Funds data reported by the Federal
Reserve Board, household net worth at the end of 2011 was $58.4 trillion, up from $52.4
trillion at the end of 2008 but down from $65.2 trillion at the end of 2007. As such, the
wealth effect on consumer spending in recent years has turned from a huge negative to a
slight positive; that is, consumers now feel slightly better about their household finances
than they did at the end of 2008 but still well below the euphoria they felt at the peak in the
housing and equity markets. This slight improvement in wealth may not add markedly to
consumer spending in 2012 but it should mean that wealth will no longer be a substantial
drag on consumer spending. A positive wealth effect tends to encourage consumers to
spend by saving less or borrowing more. Either way, it does not bode well for the personal
saving rate in the months ahead.

The bottom line is that consumer spending is expected to support solid real
GDP growth in 2012 and probably again in 2013 despite some potential policy and
international headwinds. Clearly the key to this outlook will be jobs, but probably not as
many as most seem to suggest are needed.

First-quarter GDP—private versus public

According to the Bureau of Economic Analysis’ advance estimate, real GDP
expanded 2.2 percent in the first quarter, which was mildly disappointing when compared to
the LQ forecast of 2.4 percent in February. Nevertheless, financial markets participants
were not impressed. Possibly contributing to this disappointment was the fact that the whisper number just prior to the release of the first-quarter GDP data was for a surprise to
the upside and not the downside. For the most part, the slight shortfall in real growth in the
first quarter was due to much larger than expected decline in government spending more
than offsetting a much better than expected increase in consumer spending.

Real government spending on consumption and investment declined 3.0
percent at an annual rate in the first quarter, marking the sixth consecutive quarterly
decline. Both federal and state and local spending contributed to the decline, with federal
government spending plunging 5.6 percent and state and local government spending falling
1.2 percent. Together they detracted 0.6 percentage point from real GDP growth in the first
quarter; in other words, excluding the government sector, private real GDP grew 2.8
percent in the first quarter. Recall that government spending as defined in GDP does not
include transfer payments, such as Social Security, Medicare or unemployment benefits,
paid by the various levels of government. Most of what is included is the so-called
discretionary spending by governments. I doubt that discretionary government spending
will continue to decline at such a rapid pace over the remainder of 2012.

On the other hand, real personal consumption expenditures (PCE) grew 2.9
percent in the first quarter, well ahead of the 2.0 percent gain shown in the February LQ
forecast. Much of this upside surprise was due to spending on durable goods, especially
motor vehicles. More importantly for the outlook, real PCE was at a level in March that
suggests considerable momentum at the end of the first quarter. In fact, very small gains
in the next few months are needed to achieve the LQ forecast of 2.5 percent growth for real
PCE in the second quarter.

Business fixed investment was not as strong as anticipated in February,
reflecting in large part a sharp drop in spending on structures, as well as a slower than
anticipated increase in spending on equipment and software. Some of this may be a
payback for accelerated investment in 2011 to take advantage of temporary tax provisions
that offered bonus depreciation on property and elevated expense limits on tangible
business equipment acquired before 2012. Both temporary tax provisions continue in 2012
but at substantially lower levels. I expect business fixed investment to rebound over the
remainder of 2012 but for economic reasons more so than for tax reasons.

In the first quarter, residential fixed investment and net exports were very
much in line with the LQ forecast in February. Residential investment jumped 19.1 percent
compared to the 21.5 percent shown in the last LQ. Housing should continue to improve,
given that housing affordability is at a record high and household demographics are starting
to put some strain on the available housing stock. Net exports were neutral in the first
quarter, as the increase in exports matched the increase in imports. Given the stronger
dollar and slower growth elsewhere in the world, net exports probably will be a drag on real
GDP growth in the U.S. over the remainder of the year, as the gain in imports outpaces any
possible gain in exports.

On balance, I continue to expect real GDP to deliver solid growth over the
four quarters of 2012 and again in 2013, led by solid gains in consumer spending, good
business fixed investment, better housing data, and less drag from the government sector.
The implication is that I doubt that the numerous headwinds for the U.S. economy
frequently discussed in the financial media will be as problematic as most contend. Indeed,
a careful examination of the most popular headwind, the so-called “fiscal cliff” at the end of
this year when many of the Bush tax cuts are scheduled to expire and the Obama tax
increases are scheduled to begin, suggests that maybe it will not be as troubling as many
now claim.

Expiring and new federal tax provisions: Will it be a “cliff” or a bump?

Emotions continue to run high about the scheduled expiration of the Bush-era
tax cuts at the end of 2012. However, a number of significant tax provisions have already
expired, without much fanfare in the process, and the ones that remain to expire are
unlikely to be as devastating as many claim.

Among the provisions that have already expired are the temporary “fixes” to
the alternative minimum tax (AMT) and the elimination of election to deduct state and local
general sales taxes in lieu of state and local income taxes. So unless Congress decides
otherwise between now and the end of the year, there will be a substantial increase in the
number of individuals subject to the AMT in 2012 and individuals not subject to a state
income tax will be denied the alternative deduction of general sales taxes paid. The
expiration of the temporary bonus depreciation and expense limits for small business fixed
investment was discussed earlier.

That being said, most political and economic commentators are focused on
the provisions scheduled to expire, especially the reversion back to higher income tax rates,
higher capital gains tax rates, and the tax treatment of qualified dividends as ordinary
income rather than long-term capital gains. Without a doubt, the higher tax rates on
income will damp after-tax income as reported by the BEA but could actually boost adjusted
gross income as reported to the Internal Revenue Service (IRS). The reason for this is
because in anticipation of a higher tax rate on capital gains, many investors with
investments that have appreciated substantially will realize these gains before the end of
2012 to avoid a higher tax. However, capital gains are not included in the BEA measure of
personal income but are included in the IRS measure of adjusted gross income. Moreover,
the taxes paid on capital gains are captured in the after-tax measure of personal income by
the BEA. In other words, consumers most likely will have more income (on an IRS basis)
than the BEA measure of after-tax personal income suggests. The question then is do
consumers spend in response to after-tax personal income or in response to after-tax
adjusted gross income. Although somewhat convoluted, this may be a modified version of
the income effect versus the wealth effect on consumer spending. In other words, they
both matter but to different degrees.

With regard to dividends being taxed as ordinary income, it too will require
some adjustment on the part of investors and corporations. I am a firm believer that all
income should be treated the same in the tax code. In other words, there should be no tax
incentive for businesses to prefer issuing debt over equity, nor should there be a tax reason
for investors to prefer equity over debt. On the other hand, if you tax dividends and
interest income the same for individuals, then they should be taxed the same for
corporations. In other words, if dividends and interest income are both taxed as ordinary
income to individuals, then both dividends and interest paid by corporations to individuals
should be deductible on the corporate tax return. At the moment, dividends are not a
deductible expense on corporate returns, whereas interest payments are. It seems
reasonable to expect that if the after-tax return on dividends goes down because of a higher
tax rate, corporations will be encouraged by investors to increase the dividend to offset the
higher tax. And given the historically low dividend-payout ratio at the moment,
corporations have room to increase dividends.

The final aspect of the tax provisions in 2013 are the new Medicare-related
taxes created by the health-reform legislation passed in 2010. Effectively there will be a
two-tiered rate for the hospital insurance portion of the payroll tax, 1.45 percent on the first $200,000 of earned income ($250,000 for married couples filing jointly and $125,000 for
married individuals filing separately) and 2.35 percent on anything exceeding the various
thresholds. In addition, there will be a Medicare “contribution” tax imposed on the
unearned income of some high income individuals. This tax will be 3.8 percent on the lesser
of your net investment income or your modified adjusted gross income that exceeds
$200,000 ($250,000 for married couples filing jointly and $125,000 for married individuals
filing separately). In other words, if a single individual had a modified adjusted gross
income of $210,000 in 2013 and his/her net investment income was $50,000, then the 3.8
percent tax would apply to the $10,000 in excess of $200,000, which is less than the
$50,000 of net investment income. Another example would be a single individual with a
modified adjusted gross income of $190,000 and net investment income of $100,000. This
individual would not be subject to the new tax, since his/her modified adjusted gross
income did not exceed $200,000. Net investment income would include interest, dividends,
annuities, royalties, rents and capital gains, as well as income from a business that is
considered a passive activity or a business that trades financial instruments or commodities.
Interestingly, interest on tax-exempt bonds, veterans’ benefits and excluded capital gains
from the sale of a principal residence are not considered net investment income. Also,
distributions from qualified retirement plans and IRAs are not considered investment

This is just another way for the government to add progressivity to the
funding of Medicare. They have already incorporated progressivity in the premiums paid by
Medicare recipients through the increased use of income-related-monthly-adjustment
amounts (IRMAAs), which is nothing more than a premium tax on high-income retirees. I
would not be surprised to see this feature expanded in the future.

If the decision by Americans is to have its government provide a service at a
price below market, then it should be prepared to have a larger share of its resources
inefficiently devoted to providing that service and for taxes to be imposed to pay for it. At
the moment, health care spending represents 11 percent of the U.S. economy. If nothing
changes, I would not be surprised if this share increases over the next decade because of
changing demographics but also because the overall economy will not grow as fast as
demand for government subsidized health care.

The good news is that higher taxes represent an effort to pay for government
services rather than to borrow against the future to do so. Given the nature of the services
being provided, it seems appropriate to have a pay-as-you-go process in place. In other
words, it should be treated as part of the federal government’s operating budget, which
should balance over a four year period. Federal borrowing authority should be reserved for
its capital budget. Unfortunately, it is difficult to separate operating expenses from capital
expenses at the federal level like they do at the state and local levels of government. I
contend that this distinction is especially important now that the Federal Reserve seems to
be in the business of monetizing federal debt.

Also, the tax changes coming in 2013 have been hanging over us for three
years, creating considerable uncertainty about what the tax rules will look like. I am
confident that the U.S. economy can win but we need to know the rules of the game. As it
becomes clearer what the tax code will look like in 2013, the less uncertainty there will be.

Inflation is subdued—for now

Inflation, as measured by the consumer price index (CPI), is expected to slow
to 2.3 percent over the four quarters of 2012 from 3.3 percent over the four quarters of 2011. Core CPI inflation (CPI less food and energy) should be little changed this year from
last year—2.2 percent over the four quarters of each year. Hence, the bulk of the difference
in overall CPI inflation last year and this year is expected to be energy prices. For example,
overall inflation jumped markedly most of last year, reflecting a surge in energy prices as
well as a noticeable increase in core prices (see Chart 5). Since late last year, overall CPI
inflation has retreated considerably and core CPI inflation has leveled off at about 2.2
percent. The LQ forecast expects this both measures of inflation to be relatively stable on
average over the remainder of this year and most of next year.

chart 5

This being said, changes in the overall CPI are likely to be far more volatile
than changes in the core CPI, in large part due to large swings in energy prices. For
example, monthly changes in the overall CPI through the first four months of this year have
averaged 0.6 percent, with a range from down 1.7 percent to up 3.2 percent. It is no
surprise that huge swings in energy prices accounted for much of this volatility. On the
other hand, the monthly changes in the CPI core index through the first four months of this
year have averaged 0.2 percent, with a range from up 0.1 percent to up 0.2 percent.
Clearly, the core measure of CPI inflation is far less volatile than the overall measure. This
does not mean that consumers should ignore food and energy prices. It means that for a
better assessment of the underlying inflationary pressures in the economy, it may be helpful
to look at the core rate rather than just the overall rate of inflation.

In this regard, core CPI inflation rebounded in 2011 from a level in late 2010
that was so low that it threatened deflation. Indeed, this threat was the catalyst to the
Federal Reserve engaging in several rounds of quantitative easing (QE), which is essentially
a policy to monetize debt. It seems to me that the deflation threat has been removed and as such has removed any chance of another round of quantitative easing by the Fed. In
fact, it could be argued that the removal of the deflation threat begs the question of
whether the Fed should unwind its earlier QE measures.

Europe: Lessons from other financial crises

Greece continues to struggle with its debt problem, which in many ways is the
result of a structural problem for the economy, which is one of the reasons it is so difficult
to fix. In Greece, the public sector accounts for about 40 percent of GDP and the per capita
GDP is about two-thirds that of the leading euro-zone economies. Tourism provides 15
percent of GDP and immigrants make up nearly one-fifth of the work force, mainly in
agricultural and unskilled jobs. Greece is a major beneficiary of EU aid, equal to about 3.3
percent of annual GDP. The Greek economy grew by nearly 4 percent per year between
2003 and 2007, due partly to infrastructural spending related to the 2004 Athens Olympic
Games, and in part to an increased availability of credit.

The problem was that Greece borrowed to finance this spending, which did
very little to add productive capacity to the economy. In other words, Greece accumulated
a lot of debt with very little to show for it. In 2009, the economy went into recession as a
result of the world financial crisis and tightening credit conditions. And since past deficit
spending was not on investments to add productive capacity to the economy, it was
extremely difficult for the Greece economy to recover. As a result, the economy contracted
by 2.3 percent in 2009, 3.5 percent in 2010, and 6.0 percent in 2011. Unfortunately,
nothing has changed, which complicates the situation in Greece. What it needs now is to
rework its health-care and pension systems, and reform its labor and product markets.
Only then will Greece have a chance to make the investments needed to get the economy
growing again.

Of course as noted several times in the financial media, the transition process
for Greece is far more complicated than it was in other financial crises around the world.
Some have suggested that Greece follow Mexico’s example in 1994 on how to respond to a
financial crisis. Unfortunately, Greece lacks several advantages Mexico had in reversing its
decline. In large part, Greece cannot devalue its currency to promote exports, assuming it
has something to export. Mexico devalued its currency but had the added benefit of a
strong U.S. economy in which to export. A weaker euro most likely benefits exports from
Germany, France and Italy more so than Greece.

In my view, it is not a question of whether Greece goes or stays but whether
the entire euro-zone can survive under its current structure. If Europe wants to be a union
then it needs to be united in more than just a common currency. Until then, debt crises will
continue, financial responses from the rest of Europe will be slow, and it is unclear that the
aid when it does come will address the needs for the economy to recover.
And while Greece has suffered a severe recession, the euro zone has not. I
continue to expect the euro zone to show signs of recovering from its economic malaise
sometime in the second half of this year, but at a more subdued pace because many of the
17 countries in the union will not participate in the recovery to the full extent. This is not
too dissimilar from recoveries and recessions in the U.S. in the sense that not all states are
expanding or contracting, respectively, at the same pace all of the time.

From the U.S. perspective, financial crises that originate in the U.S. quite
understandably have proven to be devastating to the U.S. economy as the 2007-2009 crisis
demonstrated. However, previous financial crises that have originated elsewhere have proven to be buying opportunities for U.S. consumers and businesses. In the wake of the
Tequila crisis in 1994 and Asian financial crisis in 1997, most economists warned of a
recession spilling over into the U.S. when in fact it was just the opposite. From 1994
through 1999, the U.S. economy grew an average of 4.0 percent a year, as the rest of the
world seemed to be on sale. I contend that at the moment, it looks as if the rest of the
world is on sale once again, albeit not to the same degree as in the 1990s because the euro
has not retreated as much as the local currencies in other financial crises.

Investment implications

As I noted in February, the “stretch for yield may generate some interesting
new financial products. Of course, given that the tax and interest rate incentives favoring
activity in the shadow banking industry are still in place, financial regulators will need to
be particularly vigilant to guard against bad behavior. Unfortunately, it is difficult for
regulators to identify bad behavior until after the fact. But this is a subject to be
discussed another time.” The report of a trading loss of $2 billion or more at JPMorgan
provided an example of this much sooner than I expected. Fortunately, at least for now,
it appeared to be a one-off event.

I continue to believe that the economic and financial fundamentals in the U.S.
are positive and, more importantly, improving. In this regard, I continue to favor
overweighting equities in a balanced portfolio. Over the last couple of months, the S&P 500
price index has fallen about 8 percent. Although it could go lower in the near term, I
consider the recent stock market correction a buying opportunity more so than the start of a
new bear market.

Also, I dislike long bonds of any kind but especially Treasury longer-term
notes and bonds. As I noted before, investors seem to feel safe from interest-rate risk
because they think the Federal Reserve will provide advance warning of higher rates. They
most likely will be sadly disappointed. The Fed may warn them but by then it will be too

One aspect of my investment implications has changed since February. I no
longer favor buying high-yield bonds. If you already own high-yielding corporate and
municipal bonds, I would hold on but I would be very selective about buying more. The
credit spread has narrowed to the point where in many cases the investors’ exposure to
interest-rate risk outweighs the credit premium they are being paid.


The views expressed here reflect the views of Daniel Laufenberg as of the date referenced. These views may change as economic fundamentals and market conditions change. This commentary is provided as a general source of information only and is not intended to provide investment advice for individual investor circumstances. Past performance does not guarantee future results.

Mid-term updates to the Quarterly Reports


November 2009 - LEQ (PDF)
February 2010 - LEQ
May 2010 - LEQ

August 2010 -LEQ
November 2010 - LEQ
February 2011 - LEQ
May 2011 - LEQ
August 2011 - LEQ
November 2011 - LEQ
February 2012 - LEQ