The Big Bounce UP... From What Looked Like the Bottomless Pit!

US stock indexes are some 25% higher than on January 1, and more than 60% above their March lows. Some technology sectors are up nearly 60% year-to-date, having more than doubled from their March lows.

Similarly, industrial metals are advancing strongly, and precious metals are hitting all-time highs. Even good quality corporate bonds have gained some 20% year-to-date while high yield indexes are up more than 50%.

Obviously, these markets are reflecting burgeoning confidence in economic recovery. TARP, the stimulus package, buyer incentives for homes and autos, and the Federal Reserve’s persistence in keeping interest rates low are having an impact!

...the yellow flag is out!

In fact, they’re having a dual impact. First, they appear to be helping pull us out of recession. Home sales have turned around, industrial capacity utilization is improving, and the unemployment rate has ticked down for the first time in several months.

These are the hoped-for results, and are certainly part of what is being reflected in the investment markets. But, it’s the unintended consequences that may be having the greatest impact, pushing not just stocks, but also bonds, precious metals and other assets to what can only be called inflated levels. And, not just in our domestic markets. Investors worldwide are doing exactly what should be expected from such governmental largesse, whether or not it is what those governments intended.

How the game is played.

And, what, exactly, is it that investors are doing? It’s merely the latest version of the “carry trade.”
1. They borrow (dollars in this instance) at the near-zero interest rates set by the Federal Reserve,
2. They use those borrowed dollars to invest in assets that appear undervalued, or at least capable of being bid up in price, and
3. They ultimately sell the assets, hopefully at sizeable gains, and repay the loans with “cheaper” dollars that are almost certain to have resulted from the ballooning Federal deficits.


Where does this leave investors like us here at CoreStates? We choose not to play this game. We never subject our clients to the risks of this form of “borrowing short and investing long,” having seen far too often (most recently in housing) how asset prices can suddenly drop when interest rates begin to rise and the throngs of debt-burdened “carry-traders” all stampede for the exits. But, we do have to deal with the volatile markets these traders help create with their high-risk games.

Our strategies in today’s environment of increasingly inflated prices are intended to participate in a good portion of any continuing run-up in asset prices, but to gradually lighten exposures as prices inflate. This investment approach is almost certain to mean that, unlike the extremely favorable performance we have been able to deliver through the market recovery to date, our clients may not fully participate in the latter stages of such an extreme market advance, but nor will they be fully exposed to the risks of a market collapse.

The way we look at it, the possibility of realizing modestly lagging returns if asset prices continue to inflate is simply the price that must be paid to assure better preservation of values when the bubble eventually bursts. And, this is the best way we know to fulfill our commitment to clients – to protect their lifestyles and preserve their legacies for as long as their investment assets are under our care.
We wish everyone a wonderful Holiday Season, and a safe and secure New Year!


The information provided above reflects the viewpoint of Corestates Capital Advisors, LLC and is subject to change. This article was prepared for general informational purposes only, without respect to the investment objectives, financial profile, or risk tolerance of any specific person or entity who may receive it.

Catch CoreStates on CNBC in December!

Be sure to catch Bill Spiropoulos, President and CEO of CoreStates Capital Advisors, on CNBC on the following dates in December:

Thursday, December 3rd at 5:00 AM on World Wide Exchange
Wednesday, December 9th at Noon on Power Lunch
Tuesday, December 22nd at Noon on Power Lunch
Wednesday, December 30th at Noon on Power Lunch

15 Signs that it’s Time to Call CoreStates

Each question is worth 1 point (OR worth 2 points if you answer, "Heck yes!"):

1. You’ve been waking up at night worrying about whether you’re worrying about the right things.
2. You got scared out of the stock market earlier this year (near the bottom), and are now scared to go back in (near the top?).
3. You’re convinced the dollar is going to tank, but have no idea what to do about it.
4. Your children are actually turning into responsible young adults, and you hope there’s some money left for them when you die.
5. So far, all your “precious metals” investments have been in the form of golf clubs and jewelry, but you’re thinking this probably isn’t how the pros do it.
6. Your father keeps saying he hopes his last dollar will go to pay for his burial, but you’re thinking it might have to be your last dollar.
7. Your daughter recently announced that she’s just not enjoying Law School, so she is dropping out and applying to Med School.
8. After so many years of investing for the long term, you suddenly realize... it’s now here!
9. You are noticing more and more how the things you’ve accumulated restrict your day-to-day freedom and peace of mind, and how liquid investments do just the opposite.
10. After years of focusing on investment returns, you’re beginning to think you should have been paying more attention to investment risk.
11. Charity may begin at home, but you’re concerned your legacy may end at home and your charitable aspirations go unfulfilled.
12. You’re wondering if your 401(k) will be okay, or will it be KO’d by the next market decline . . . right when you plan to retire.
13. It recently dawned on you that the medical profession has done a much better job of extending life expectancies than your investment professionals have done in extending the life of your nest egg.
14. Your long-held vision of retirement seems to be taking on a decidedly rose-colored hue.
15. You can’t stand another minute of Jim Cramer or Larry Kudlow (or your current advisor, for that matter), and need to find someone you can trust to help you do what is right for you.

SCORING

0 to 5 – Good for you! But, give us a call sometime so that you know us when you need us.

6 to 9 – Not bad, but you could benefit from our help. Call soon.

10 to 12 – This is serious! Make an appointment today.

13 to 15 – What have you been waiting for!? Call an ambulance and get straight over here!

CoreStates Capital Advisors, LLC
267-759-5000
http://www.corestates.us/

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.

CoreStates 2009 3Q Review & Outlook

At CoreStates, a foundational belief is in the unpredictability of the future. Few would argue with this simple truth. Yet, few in the financial services industry honor this fact in the design of their services to clients. Most, in fact, tout their ability to predict the future as a key reason to entrust your assets to their supervision and management (and fees).

At the current time – three-quarters of the way through 2009 – we would ask these companies and their clients, “So, how is this working out for you?”
Many, we suspect, would lament the fact that they became net sellers of stocks during the first quarter decline to the March lows, then stood by as stocks gained 15% to 30% through the second quarter and repeated that performance in the third quarter.

Now, as the fourth quarter begins and they still struggle to predict the next quarter’s market moves, they look around and see:

1. The increasingly euphoric outlook of stock investors, who have driven domestic and international markets to valuation levels well above their historical averages,
2. The serious fears of the gold bugs as most “safe haven” precious metals are hitting record high prices, and
3. The self-contradictory actions of bond investors as interest rate levels and inflation expectations reflect serious economic concerns, while shrinking interest rate spreads on lower quality bonds indicate increasing confidence in economic recovery.
   

As these conflicting market actions indicate, the current investment outlook is highly uncertain. This is very unusual – not that the future is highly uncertain, but that investors as a group (though still not individually) are recognizing this fact and reflecting it in their investment activities.

And, it is why we do what we do:

• We don’t attempt to predict economic or market moves month-to-month or even year-to-year. But, we do seek to identify the key long-term forces that will be driving economies and markets worldwide via our 20/20 Global Vision.

• And, we provide our investors with a diversity of investments – our 8-Cylinder Portfolios – that assures to the greatest extent possible exposure to whatever areas of the market “are working” at any time, including both long and short exposures so they aren’t dependent on market gains for gains in their portfolios.

Looking ahead, we believe the great uncertainty reflected in current investment markets is appropriate. The outlook has rarely if ever been this clouded by changing international economic forces and domestic governmental redefinition of the economic landscape. But, we remain confident in the CoreStates approach and fully expect to continue providing our clients with services and results that move them toward their long-term financial objectives and life goals.

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%

An 8 Cylinder Approach to Investing

WATCH OUR V8 DVD As You Read Along!

In today’s global, event-driven economy, everything that happens, everywhere it happens, can and will affect us directly, immediately and unpredictably. Markets in the United States are increasingly reacting to domestic and global events. To survive in this volatile new market, investors require more information, more education, and more qualified expertise than ever before. Unfortunately, many investors continue to be influenced by self-appointed financial gurus. Popular culture has positioned financial expertise as a self-served commodity for the masses. Investing in financial products has become the consumer equivalent of choosing a movie based on a good review.

For traditional investors, another negative influence has been group think or the herd mentality. This can lead to vastly overpriced stocks and huge bubbles that always burst eventually leaving many people with far less wealth. This is not strictly the result of malice or criminal intent or even stupidity. More often, it’s just human nature at work; good people of average ability playing with fire and getting burned. More astute investors relied on traditional investment principles. These principles taught that the stock market can be a solid investment over the long term. We were taught that time in the market, not timing the market, was critical. We were also taught that diversification can reduce portfolio risks. These principles remain true. But after living through several major declines and the havoc they can cause in our lives, we all learned the hard way that over the long term protecting and growing assets is more complicated than these principles.

These investment principles were improved by a group of economists back in the 1970’s. They developed a revolutionary concept, an investment engine designed to mitigate the inherent ups and downs of the stock market. They called their theoretical engine modern portfolio theory and it revolutionized the way investors would view the importance of the different domestic market classes of their day. Stocks, bonds, cash, and real estate were thought to be four completely separate markets. It was thought that each investment in one of these classes had very little to do with the other three. What modern portfolio theory conveyed was an understanding of how allocating assets across all of these domestic markets rather than diversifying within any one category could enhance the stability and performance of a portfolio. Through research these Nobel prize winning economists prove there was a natural balancing that typically occurred between the fluctuations of separate markets. They noted that when one class of investment was up, another was usually down much like the piston movement of a four-cylinder engine. The frequent probability of these opposite effects occurring at the same time is called a negative correlation and skilled financial advisors would quickly learn to use negative correlation to serve their investors in a positive way. The idea is that gains will mitigate losses helping to maintain the stability of the overall portfolio.

Powered by four markets instead of just one, the four cylinder engine gave investors enough power to manage the risk of individual domestic markets over the long haul. Over the past 30 years many professionals have agreed this four cylinder engine has served investor’s needs for managing risk while enhancing return potential in a portfolio. These asset classes should always play a dominant role in portfolio management; however, given the events in our recent past, we must now acknowledge the significance of global markets and economies and the influence they have on our traditional investment strategies.

In times like these, where news from far away places can affect markets around the world, how does one maintain relative returns while managing ever-increasing risks? Today’s forward-thinking advisors believe they have an answer, a new kind of investment strategy designed for a new kind of investor. They contend that the time has come for the traditional four cylinder engine to be rebuilt. They call this innovative investment strategy global asset allocation. The theory behind global asset allocation doesn’t abandon the four cylinder domestic model. It expands on its strengths by adding four more cylinders to our engine, each chosen specifically for its global presence as an asset class; raw materials and commodities, the energy complex, precious metals, and foreign currencies. These are the same asset classes where some of the world’s wealthiest investors and institutions have made and typically protected their fortunes. Raw materials and commodity prices, like stocks, move in alignment with supply and demand. For most investors, there are ample opportunities to take advantage of price trends in raw materials and commodities. And interestingly, these trends typically have no correlation to the trends in traditional markets. It is well-known that many of these raw materials and commodities have higher volatility than blue chip stocks and are much riskier. But the trading managers who manage these positions seek to take advantage of both negative and positive trends. Overall, they believe this asset class is an excellent alternative investment where trading managers have the potential to profit on trends independent of the equity market. In the energy complex, some savvy oil and gas managers take advantage of daily price changes and longer-term trends betting on price fluctuations in the energy market. Other experienced managers are able to strategically position themselves long or short because they monitor the capacity of supply reserves and increases in global consumption, yet other managers take advantage of opportunities presented in owning companies that benefit from the use of energy commodities. These companies may include the travel, tourism, transportation and plastics industries. Investment advisors may recommend precious metals to provide capital appreciation potential, liquidity, and a hedge against conventional paper assets. Because precious metals have a negative correlation to paper assets, the intention of diversification into gold, silver and platinum is to reduce the total risk within the overall portfolio and preserve wealth. Because the characteristics of gold, silver, and platinum differ substantially and because each metal reacts differently to economic and world events, some managers build positions in all three.

Currencies are unique because they form the largest capital market in the world yet most U.S. investors have little knowledge of the trading of currencies or how they are viewed globally as a separate asset class. There are several hundred managers who specifically trade currencies as an asset class based on technical trends and fundamental data. As an example, in its simplest form, a portfolio manager may believe the U.S. dollar will gain against the yen because of interest rate differentials and price trends. That manager will purchase the dollar versus the yen in the cash market. Currencies are typically traded by every large multinational institution; banks, central banks, and government. Combined with the original domestic asset classes, these four additional cylinders make use of alternative investment classes to create a stronger, more responsive engine, an eight cylinder dynamo that finally brings to personal investing the one thing it has sorely lacked, global equilibrium. Investments are balanced across eight areas instead of four with the intention of further reducing risk and increasing stability. The natural balancing effect of negative correlation is actually magnified giving investors increased potential for a positive return by actively managing risk. Global assets allocation is more than a common sense theory. It has already been put into action over long- and short-term financial periods. Consider what might have happened to an investor from the end of 1996 through the end of 2002 if that investor had diversified his portfolio using global asset allocation theory. Through this period, the most widely held investments for most Americans were in the S&P 500, the Nasdaq, U.S. government bonds and cash. A moderately aggressive investor who is willing to take on the normal risks associated with an allocation in those indexes would have seen $1 million dollars grow to over $2.4 million by March 1999, and sadly, just as quickly, given most of that profit back. By December 2002, the value of that portfolio had fallen by over $1 million dollars. The worldwide events that affected and influenced the equity, fixed income and money markets during that market cycle had far-reaching impact, but during that same period of global volatility, investments in currencies and multiple alternative strategies performed very differently. Had the investor in our example incorporated a global asset allocation strategy during the same period of time by including a 25 percent allocation of alternatives to his existing asset mix, the outcome of two critical indicators would have changed very favorably.



While at first glance this change does not seem to be dramatic, a closer look at the outcome actually shows a 27 percent increase in the rate of return on his investment and most importantly, a 25 percent reduction in the risk he has taken to achieve this enhanced return. Many professionals believe that alternative assets, by their very nature, tend to be less sufficiently priced than traditional marketable securities offering the potential to exploit market inefficiencies through active management. When applied with the appropriate expertise, the intention of global asset allocation is to not only protect wealth but also advance growth even under the worst short-term market conditions as our example has shown.

Fortunately, there are portfolio engineers who understand and embrace the significance of global asset allocation. They are dedicated, even driven, to manage risk, preserve wealth, and help their clients face the future with confidence again. Quick to read trends, look forward, and rebalance investments as needed, this new breed of professional is using the power and diversity of the eight cylinder global asset allocation engine in their quest to succeed in today’s volatile global marketplace.

Today’s economic landscape forces us to challenge traditional thinking and acknowledge one cold hard fact; changing the way we invest is no longer an option, it is a necessity. As Americans, we will continue our dream for a better future. With confidence we will take command of our financial course. We will prepare ourselves to overcome inevitable challenges and we will answer the hard questions that the world will continue to throw our way.

Am I prepared for the impact of world events on today’s markets? Will I have the strength to weather the next decline? Will I have enough time to recover my losses? Am I confident my dreams will come true? But most important, will I take action to protect my dreams?

For more information, contact: CoreStates Capital Adivsors