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One of the critical differentiating factors at Corestates Capital Advisors is our strategic view of investing. Our mission is to sustain acceptable portfolio growth with limited risk. To accomplish this we believe portfolios can no longer be guided by predominantly domestic strategies because they tend to be overly-influenced by US Monetary Policy and US Foreign-Policy. Our 20/20 Global Vision encompasses the 20 critical global issues that will influence portfolio performance over the next 20 years. Listed below are the current 20 issues that we think will have enormous influence.

This YouTube video provides excellent reinforcement for our 20/20 Global Vision philosophy.


Click Here to watch on YouTube

Beyond California: States in Fiscal Peril

The Pew Center on the States recently released a report entitled “Beyond California: States in Fiscal Peril”. The report examined the impact of the recession on the finances of the states, highlighting nine other states facing similar stresses to California. This report received
widespread press coverage, including both the Inquirer and the Wall St Journal. Below are brief comments regarding several states where we have client concentrations.

The full report can be found at http://www.pewcenteronthestates.org/

Pennsylvania: We have previously distributed positive comments regarding PA’s relative position among the states. It is gratifying to see the Pew Center list PA among the 10 states “least like California”. PA’s revenue decline of only 5.5% is well below the national average of 11.7%. The budget deficit of 18% of the general fund is close to the national average of 17.7%. The increase in unemployment has been 3%, compared to the average of 4.4%. PA was particularly cited for having established and funded its rainy day funds. Several states had set up such funds but never really deposited any money into them.

Maryland: MD’s revenue decline of only 1.2% was among the smallest drop of any state. Despite that, its budget gap is 18.7%, above both PA and the average. Similarly to PA, its real estate market had neither run up nor collapsed as much as the national averages. General financial management and employment levels are also above average. MD scored just outside the 10 best states.

Delaware: DE also had a modest drop in revenues of only 3%, well better than average. Its budget gap at 17.6% was close to the national average. The 3.6% increase in unemployment was better than the national average but worse than its regional peers. The financial management was scored very high. DE’s overall score was slightly behind MD.

New Jersey: NJ scored as one of the 10 worst states, most like California. Pressured by several factors, its revenue declined 15.8%, well above the average. The budget gap at 29.9% was among the worst. The 3.7% increase in unemployment was not as bad as the average. However, only 2 states scored worse than NJ regarding financial management and practices. We continue to believe that NJ residents should diversify some of their municipal holdings outside the state in order to lessen risk.

Virginia: VA scored very highly regarding its financial practices. Unemployment has only risen 3.2%, well better than average. The budget gap of only 10.9% also reflects well. A revenue decline of 19% is probably the only reason VA scores just outside the 10 best states and even with MD’s score.

Florida: FL’s ranking among the 10 states most affected by the recession should not be a surprise as its real estate difficulties have been well documented. The foreclosure rate of 2.72% is effectively twice the national average of 1.37%. The revenue drop of 11.5% is better than might have been expected. The unemployment increase of 4.4% is at the national average. The state has mixed scores on political and financial management issues. FL does not have a state income tax, so client portfolios are national portfolios, already diversified outside the state.

Ohio: Perhaps surprisingly, OH fares better than many of its Midwestern neighbors. Unemployment has increased at the national average of 4.4%. Despite that, revenues fell a less than average 9%. The budget gap is a better than average 12.3%. OH also scores well regarding financial practices. Its overall score is equal to DE.

Stocks For the Long Term? Why Bother?

Stocks got pummeled in 2008 and early 2009. Although most markets have since shown good recovery, the message lingers – stock returns are much more volatile in the short-term and much less dependable over the long-term than most investors were led to believe.

In fact, as 2009 began, the average annual return from stocks over the entire preceding decade was negative (S&P 500 average annual return -1.36%) – a loss! For the same 10-year period, “no risk” US Treasury Bills provided a 3.16% average annual return. And, long-term Treasurys led them both with a 6.59% return (all figures courtesy of Ibbotson).

Now, as 2009 comes to a close and stocks have rebounded some 60% from their March lows, astute investors are wondering if investing in equities is worth the agony. Why don’t we just cash out what’s left of our stock portfolios and settle for the 3% to 6% returns provided by bills and bonds?

Our answer – we would if they (bills and bonds) could. But, regrettably, the confluence of factors that allowed bonds to provide this level of returns over the last decade, actually the last few decades, is highly unlikely to occur in the coming decade. The environment is more likely to be just the opposite.

It’s different this time . . . really.

The return earned on a bond portfolio consists primarily of the interest payments received on the bonds – the portfolio “yield.” The level of yield is determined by the types and quality of bonds owned in the portfolio, and by market interest rate levels prevailing when the bonds are bought – initially and ongoing as interest payments and proceeds of maturities are reinvested. A much smaller but still important component of a bond portfolio’s return is any change in price of the bonds owned – the “appreciation or depreciation.”

To understand why bonds aren’t likely to provide the level of returns of the last few decades, consider the current state of each of the factors noted above.

1. Beginning market yields – The level of interest rates at the time a bond portfolio is initially assembled is the primary factor in determining a portfolio’s ultimate return, at least through the first several years. And, as this table shows, we’re starting from much lower levels than 10, 20 or 30 years ago.

Interest Rate Levels – United States Federal Reserve

2. Direction of change in market yields – The above table also shows that market rates have been steadily declining. This means yields on existing managed portfolios would have steadily declined as interest payments and proceeds of bond maturities were reinvested at ever-lower rates over this period. Over the last several years, this made bond portfolio returns decline relative to their beginning yield levels. And, with interest rates now virtually at half-century lows, most bond portfolios’ yields should continue to decline until market interest rates begin to rise.

3. Current or ending market yields – Market values of bonds vary to reflect changes in the general level of interest rates. If market rates are generally lower than when a bond portfolio was initially purchased, the bonds’ prices will have gone up, and vice versa. (This might sound backwards, but think of it this way – declines in available yields make bonds bought earlier at higher yields more valuable, and vice versa.) So, looking back over the last few decades, bond investors have benefitted greatly from price appreciation as interest rates steadily declined. Going forward, with rates already near zero, such declines are simply not possible (unless our bankers decide to pay borrowers to take their money, which, we suppose, may not be all that unreasonable to expect now that the government is running the banks!).

4. Types of bonds in the portfolio – The final factor influencing bond portfolio returns is the composition of the bonds in the portfolios. Managers can increase yields by investing in lower quality, longer maturity, and more price volatile bonds. In recent months, however, the additional returns to be gained by such increases in risk have shrunk dramatically. And, should such spreads widen again, the bonds could suffer significant price depreciation, more than offsetting the riskier bonds’ initial modestly higher yields.

So, what of stocks?

Even if bonds can’t be expected to do as well as in the past, can stocks be expected to do better? We think so, based on a similar evaluation of their yield and appreciation prospects. The S&P 500 currently provides a dividend yield (which for most investors is taxed more favorably than interest income) in excess of 2%. Many individual stocks of sound companies provide twice this level of yield or more.

As for appreciation prospects, stocks represent ownership in their underlying economy, and history has shown that as that economy grows, the economic value of stocks generally grows at a similar or greater rate. The 3.5% US GDP growth reported for the third quarter of 2009 may falter in the coming quarters, but should average at least 3% over the next few years. The resulting 5+% theoretical return is twice the current yield of the highest quality bonds.

In regard to valuations, the S&P 500 at 1100 is trading at approximately 15 times current annual earnings of the underlying companies. Said differently, stockholders currently earn back about 1/15th of the cost of the index annually. So, the “earnings yield” of the index is currently 1/15 or 6.7%. And, that’s before any growth in earnings in the years ahead.

To us at CoreStates, these measures qualify stocks as a worthy investment – with this core return expectation in excess of 5%, current earnings return of 6.7%, and good prospects for additional return from increasing earnings and expansion of valuations as the world economy stabilizes and growth resumes its historical patterns. Bonds also have a role in many portfolios, but a reduced role relative to that of the last few decades given their much-reduced future return prospects.

But, the key to investment success for 21st century investors will be to diversify well beyond these two traditional asset classes, carefully select managers capable of taking both long and short positions, and actively manage allocations among the several asset classes based on relative evaluations of the type summarized here for stocks and bonds. Our 8-Cylinder portfolio engine, SCORE manager evaluation process, and 20/20 Global Vision asset allocation perspectives are designed to provide our clients with exactly these capabilities.

They are the foundation of our overarching commitment to clients – to protect their lifestyles and preserve their legacies throughout their investing lifetimes.

Our favorite allocation as of November 17th, 2009:

Stocks 45% Bonds 25% Cash 5% Real Estate 5% Currency 8% Energy 2% Gold & PM 2% Managed Futures 8%

20/20 Global Vision is Right on Target

One of the critical differentiating factors at Corestates Capital Advisors is our strategic view of investing. Our mission is to sustain acceptable portfolio growth with limited risk. To accomplish this we believe portfolios can no longer be guided by predominantly domestic strategies because they tend to be overly-influenced by US Monetary Policy and US Foreign-Policy. Our 20/20 Global Vision encompasses the 20 critical global issues that will influence portfolio performance over the next 20 years. Listed below are the current 20 issues that we think will have enormous influence.

With recent developments regarding the Swine Flu Virus #19 best describes the value we bring with the 20/20 Outlook.

Economic Issues

1. Accelerating globalization
The process of globalization will accelerate as expanding communications, development of transportation infrastructure, and more favorable trade policies encourage individuals worldwide to pursue a better economic life. The world will move closer to being one economic community.

2. Leveling of living standards
Differences in standards of living among most of the world’s economies will shrink as developing areas see rapid increases in the wealth of their citizens. At the same time, the populace of developed nations will suffer the impact of increasing global competition.

3. Moderation of economic cycles
Normal economic cycles will moderate as the major central banks become more adept at tempering inflation and managing their economies. But, this tampering with otherwise free markets could also contribute to infrequent but severe economic super-cycles.
4. Growth of the “BRICs”
Developing countries — led by Brazil, Russia, India, and China — will play larger and broader roles in the world economy and geopolitics. And, will occasionally suffer serious growing pains.

5. End of disinflation
After declining for most of the last 25 years, the global rate of inflation will begin to rise, but continuing productivity increases and global competition will moderate price increases for many goods and services.

6. Increasing petro-power
Oil and gas reserves will become an even more formidable source of power – with economic, political, and cultural impacts. Those with control of these reserves will be flexing their strengths in more and different ways, to the general detriment of the more developed economies.

Political Issues

7. Spread of capitalism
Capitalism and free markets will continue to spread. Economies that for generations relied on central planning will loosen economic constraints, allowing their citizens to profit from their ideas, initiative, and industry.

8. Creeping socialism
As capitalism displaces socialism and communism in developing economies, socialistic programs will become more pervasive in traditionally capitalistic economies as they adopt policies and programs that reward their less productive citizens at the expense of the most productive.

9. Some nationalization
The route to national prosperity through expanded personal freedoms and free markets will be readily apparent, but not all nations will choose to participate. Some natural resource-exporting countries will even move in the opposite direction, implementing broad nationalizations of resources and industries within their borders, to the detriment of world trade, as well as to their own economies.

10. National fiscal (un)fitness
Some of the world’s major representative democracies will suffer continued financial decline from the inherent lack of incentives for politicians to limit spending or raise taxes. This will raise their borrowing costs, furthering their fiscal decline.

Demographic/Social Issues

11. Diverging demographics
With the pace of natural deaths exceeding that of births, populations of the developed economies will stabilize and become older on average while populations of developing economies increase and grow younger. This will further strain the national balance sheets of developed countries, aid those in developing regions, and foster increased immigration in both directions.

12. Widening wage gaps
For low-skill jobs, wage differentials among countries will decrease, but productivity-related wage gaps will grow. This will create increasing friction between perceived “haves” and “have-nots,” which history has shown can be damaging to even well-established civilizations.

13. Rise of virtual communities
Heredity and geography no longer define an individual’s community or even family. The Internet, cell phones and other technologies give people worldwide the capability and anonymity to redefine themselves and their worlds. As the behavior-moderating effects of the family and community dissipate, the resulting individual freedoms will allow both the best and the worst of each of us to be displayed.

14. Intercultural friction
Peoples of different ethnic backgrounds, religions, and economic values will increasingly find the need to interact, often resulting in some form of cultural conflict. The ideal of melting-pot-merging of cultures will continue to be elusive.

Natural/Scientific Issues

15. Alternative energy sources
Heavy dependence on oil will continue as long as oil is readily available. When new energy sources are developed, however, the changes are likely to be significant and abrupt, to the betterment of high energy consumption nations and to the detriment of today’s energy producers

16. Mobility of production
Information technologies will continue to become faster, cheaper and more accessible. This will accelerate the movement of both industrial and knowledge-based business to the lowest-cost global providers, regardless of their locations.

17. Demand for natural resources
Just as demand for energy will outpace supply, so will demand for other natural resources like metals, timber and even water and food. This will create additional scientific challenges and global tensions, including finding ways to shelter poorer nations from the resulting price inflation.

18. Climate change
The growing worldwide demand for energy will collide with increasing pressure to address the risks of climate change. The need for energy will prevail in developing nations, accelerating their growth, while efforts to limit harmful emissions dominate in industrialized nations, restraining their economic growth and global competitiveness.

19. Global interdependence
Greater interconnectivity of the world’s peoples and economies will mean greater interdependence. This can amplify the impact of acts of terrorism such as dirty bombs or electronic jamming, and of natural disasters like viral pandemics, asteroids, or tidal waves.

20. Accelerating space exploration
As the earth becomes more vulnerable and less capable of supporting its burgeoning population, the push to accelerate space exploration will intensify, ultimately leading to discoveries that have the potential to radically change life on earth and beyond.