2012 was a good year for both the stock market and PIMCO in the bond market. The S&P 500 was up 16.0% and your equity managers were by and large up more. The Barclays Aggregate bond index was up 4.2%, and PIMCO was up 10.4%. PIMCO was coming off of an average year for them in 2011 when they got out of Treasuries at the wrong time. They more than made up for that mistake in 2012.
Monroe Vos continued to recommend a moderately conservative allocation in 2012 of 40-50% in equity because PIMCO was more than doubling the Barclays index in the bond portion of the portfolio.
As you know we are recommending an increase in the equity allocation this year and reducing the allocation to bonds. For several years market pundits on TV and in the press have been saying that the bond market was not the place to be because interest rates are so low and we could see inflation and/or a rise in interest rates at any time. They, of course, primarily manage equities and are biased against bonds.
We did not buy into this argument, and we were right if you had PIMCO managing your bond portfolio. We have, however, at long last come to the conclusion that going forward it will be more difficult, but not impossible, for PIMCO to deliver double-digit returns in the Total Return Fund. This is why we are recommending a reduction in fixed income. We believe that PIMCO will still beat its index, but we want to find ways to deliver consistent returns that accomplish our clients’ actuarial rates or spending goals plus inflation.
We believe that, in spite of the lunacy in Washington, D.C., the stock market can rise in 2013 for a number of reasons. First, the stock market is not overpriced at a P/E of 13-14X. Second, even if we do not see the earnings growth we have seen the past four years, we can see multiple expansion of the P/E ratio. Third, the U.S. economy is in good shape relative to the rest of the world. Fourth, Europe has now embarked on a Quantitative Easing program through the European Central Bank (ECB) which buys time for governments to try to repair their balance sheets by reducing their debt-to-GDP ratio. This lowers the possibility of a crisis for now. They are kicking the can down the road again. Fifth, in spite of our growing debt in the U.S., we are still nowhere close to defaulting on our debt. Sixth, we have not and will not experience inflation any time soon. There is no velocity of money because of the “Elephant in the Room”, which is the huge debt that consumers and the government have accumulated. The combined debt (private and government) is 350% of GDP. Seventh, China and the rest of the world will continue to buy our debt because we are still the “cleanest dirty sheet in the hamper” as Bill Gross of PIMCO says.
The Elephant in the Room
The “Elephant in the Room” is the huge amount of debt that still hangs over the economies in the U.S., Japan and Europe. This is the developed world. Europe is trying to tackle this problem, but the U.S. and Japan are increasing their debt-to-GDP. The pundits keep talking about how the economy should take off with unemployment falling and corporate earnings growing. They keep referring to history, citing the 1960s, 1970s and 1980s. We didn’t have the high debt during these periods. They ignore this basic problem. The last time we had this high debt to GDP was in the 1930s, and we all know what happened then. In 1937 Roosevelt and Congress imposed the first FICA tax, boosting the tax rate from 56% to 62%. The economy, which had made some recovery from 1934 to 1936, fell back sharply in 1937 and 1938. This tax increase prolonged the Great Depression. Are we repeating history?
I have once again attached the Hoisington Investment Management Company Quarterly Review and Outlook. Lacy Hunt and Van Hoisington spell out the consequences of the so-called American Taxpayer Relief Act, as well as the even more egregiously named Affordable Care Act. They conclude that the real effects of the tax increases on both individual taxpayers and the overall economy will be much greater than media reports have suggested. These guys know what they are talking about.
As you know we are recommending an increase in equity exposure depending on each client’s risk tolerance and goals. We will also be talking with you about alternative investments that make sense in the current market and economic environment.
There are always issues in the market and the economy to worry about. In the investment world we call this “climbing the wall of worry.” We seem to have more to worry about today than normal. That doesn’t mean that we can’t make our money grow.
Chairman & CEO
Released: January 31st, 2013 08:15 AM