Endowment Wealth Management-Weekly Market Update as of November 15, 2013 by Prateek Mehrotra

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Weekly Market Highlights:


•Domestic stock prices posted gains once again this week. Stock prices climbed on Fed chairman nominee Janet Yellen’s statement that the central bank should not withdraw stimulus too quickly. The S&P 500 has gained about 25% on a year-to-date basis, its best showing in a decade.
•Global markets were somewhat higher for the week. World markets posted a mix bag of performance, with European equities lagging due to slower-than-expected GDP growth during the third quarter. Germany’s growth slowed, while France unexpectedly contracted. Emerging markets stocks halted a 10-day slide on Thursday after Yellen’s remarks. Asian markets were mainly soft following last weekend’s China plenum, which disappointed investors looking for stronger reform measures.
•Treasury prices were little changed this week. The yield on the benchmark 10-year U.S. Treasury was modestly lower following a mixed bag of data.
•Commodity indices were mixed on the week. Crude oil slipped slightly, but natural gas rose; gold softened, and grains were little changed.


A Macro View – Do the Value and Small Cap Premiums Remain?

Over the past three decades there has been a significant amount of academic research done on various “risk premiums” that appear in data on stock returns. Eugene Fama and Ken French published in 1992 what is probably the best known study identifying factors that explain stock returns over time. Their research showed that small cap stocks tend to outperform large caps, and value stocks outperform growth stocks. The so-called Fama-French three-factor model shows that these two factors, combined with market exposure, explain more than 90% of stock returns. Since the Fama-French paper was published, numerous other studies have confirmed the results and have even identified other potential factors such as momentum and liquidity.

While the existence of the small cap and value premiums is evident, the reasons why they occur is much less apparent. One school of thought proposed by efficient markets adherents is that small cap and value stocks present additional risks that result in higher returns. The primary alternative view is espoused by the behavioral finance camp, and that is that the  excess returns are really anomalies resulting from investor behavior: investors tend to overvalue “glamour” companies (growth stocks) and higher market capitalizations. The question as to which theory best explains the small cap and value premiums is still up for debate.

One logical question that arises is whether these premiums should be expected to be arbitraged away over time. After all, knowing these premiums exist, wouldn’t investors bid up the prices of both small cap and value stocks such that the excess returns would disappear? Based on data obtained from Ken French’s data library, the average annualized value and small cap premiums from 7/1926 through 12/1992 (the year the Fama-French study was published) were 4.5% and 2.3%, respectively. Since that time, the premiums have declined somewhat, but still exist: from 1/1993 through 9/2013 the respective value and small cap premiums were 2.8% and 2.1%.

The table and graphs below indicate that the premiums have existed after the Fama-French research was published, so that it doesn’t appear that the anomalies are likely to be arbitraged away. One of the implications for investors is that an orientation of the portfolio toward these factors may provide superior outcomes.

Style Premiums

Value-Rolling 36 Month Excess Return

Small Cap-Rolling 36 Month Excess Return

Has the U.S. Household deleveraged fully post the 2008 crisis?

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U.S. household debt climbed 1.1 percent during the third quarter as borrowing for mortgages, education, car purchases and on credit cards all increased, according to a Federal Reserve Bank of New York survey.

Consumer indebtedness rose $127 billion to $11.28 trillion, the biggest increase since the first quarter of 2008, according to a quarterly report on household debt and credit released today by the Fed district bank. Mortgage balances climbed $56 billion, student loans increased $33 billion, auto loans were up $31 billion and credit-card debt rose by $4 billion.

“We observed an increase of household balances across essentially all types of debt,” Donghoon Lee, senior research economist at the New York Fed, said in a statement. “With non-housing debt consistently increasing and the factors pushing down mortgage balances waning, it appears that households have crossed a turning point in the deleveraging cycle.”

Americans have slashed their debt from a peak of $12.68 trillion in the third quarter of 2008, according to the New York Fed.

Delinquency rates continued to drop in the third quarter, with 7.4 percent of outstanding debt in “some stage of delinquency,” down from 7.6 percent in the second quarter, the New York Fed said. There were about 355,000 new bankruptcies during the period, about the same as in the comparable timeframe in 2012.

Is Quantitative Easing responsible for higher stock prices?

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There is no evidence that the Federal Reserve’s massive bond-buying effort has led U.S. stock prices higher, according to a report released on Wednesday by the economics research arm of McKinsey & Company. Instead, study co-authors Richard Dobbs and Susan Lund found that the biggest impact of quantitative easing by the world’s major central banks has been the cost-savings delivered to governments. Since 2007, bond-buying programs in the United States, the UK and the euro zone have reduced costs for governments by a total of $1.6 trillion. The finding will come as a surprise to many investors who attribute the rise in stock prices in the United States and elsewhere since the 2007-2009 financial crisis at least in part to easy central bank policies. All told, major central banks have added $4.7 trillion to their balance sheets over the past five years in an effort to push down long-term borrowing costs while keeping short-term interest rates low. The findings are sure to resonate among central bankers as they debate when and how fast they may be able to scale down the monetary stimulus they have used to keep deflation at bay and try and pull ravaged economies from the depths of recession.

While the entire study is over 70 pages long, the rather counter-intuitive findings regarding QE and stock prices can be found on pages 32-36 of the PDF:

The impact of ultra-low rate monetary policies on financial asset prices is ambiguous. Bond prices rise as interest rates decline, and, between 2007 and 2012, the value of sovereign and corporate bonds in the United States, the United Kingdom, and the Eurozone increased by $16 trillion. But we found little conclusive evidence that ultra-low interest rates have boosted equity markets. Although announcements about changes to ultra-low rate policies do spark short-term market movements in equity prices, these movements do not persist in the long term. Moreover, there is little evidence of a large-scale shift into equities as part of a search for yield. Price-earnings ratios and price book ratios in stock markets are no higher than long-term averages.

Social Security and Medicare Figures for 2014 by Rob Riedl, CPA, CFP, AWMA

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New figures announced

The Social Security Administration (SSA) has announced that Social Security and SSI beneficiaries will receive a 1.5% cost-of-living (COLA) adjustment for 2014. According to the SSA’s announcement, after the COLA adjustment, the estimated average retirement benefit will rise from $1,275 in 2013 to $1,294 in 2014.

The Centers for Medicare & Medicaid Services (CMS) has also announced next year’s Medicare costs. The standard monthly Medicare Part B premium will be $104.90 in 2014, the same as in 2013. However, beneficiaries with higher incomes (individuals with taxable incomes of more than $85,000 and couples with taxable incomes of more than $170,000) will pay more than $104.90 per month because they must pay an income-related surcharge.

Other important Social Security and Medicare figures are listed below.

2014 Social Security figures

  • The amount of taxable earnings subject to the Social Security tax (called the maximum taxable earnings limit) will increase to $117,000 from $113,700 in 2013.
  • The annual retirement earnings test exempt amount for beneficiaries under full retirement age will increase to $15,480 from $15,120 in 2013. If a beneficiary has earnings that exceed the exempt amount, $1 in benefits will be withheld for every $2 in earnings above the exempt amount.
  • The annual retirement earnings test exempt amount that applies during the year a beneficiary reaches full retirement age will increase to $41,400 from $40,080 in 2013. If a beneficiary has earnings that exceed this amount, $1 in benefits will be withheld for every $3 in earnings above the exempt amount.
  • The amount of earnings needed to earn one Social Security credit will increase to $1,200 from $1,160 in 2013.

2014 Medicare figures

  • The Medicare Part B deductible will be $147, the same as in 2013.
  • The monthly Medicare Part A premium for those who need to buy coverage will cost up to $426, down from $441 in 2013. However, most people don’t pay a premium for Medicare Part A.
  • The Medicare Part A deductible for inpatient hospitalization will be $1,216, up from $1,184 in 2013. Beneficiaries will pay an additional daily co-insurance amount of $304 for days 61 through 90, up from $296 in 2013, and $608 for stays beyond 90 days, up from $592 in 2013.
  • Beneficiaries in skilled nursing facilities will pay a daily co-insurance amount of $152 for days 21 through 100 in a benefit period, up from $148 in 2013.

U.S. Endowments return 11.7% on average in Fiscal Year ending June 30, 2013

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According to preliminary data from the 2013 NACUBO-Commonfund Study of Endowments, U.S. educational endowments returned an average of 11.7% net of fees in the fiscal year ended June 30, 2013., which is a significant improvement over the -0.3% return in the prior fiscal year. The average 3 year trailing return as of June 30 was 10.4% for the 206 surveys received  to date, while the average five-year trailing return was 4.3% and 7.1% for the 10-year period. Returns are net of fees and annualized.

Source: Pensions & Investments

Endowment Wealth Management-Weekly Market Update as of November 8, 2013 by Prateek Mehrotra

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Weekly Market Highlights:

Domestic stock prices ended up gaining ground on the week. Stock prices advanced this week in the wake of the strong IPO of Twitter. The S&P 500 posted its largest loss in two months on Thursday as the government reported that GDP grew faster than expected in the third quarter, but rebounded on today’s stronger-than-expected jobs report. Twitter jumped 73 percent in its first day of trading.

Global markets were mixed for the week. World markets were modestly higher overall, with European markets gaining on the European Central Bank’s unexpected announcement that it would cut interest rates to a record low of 0.25%. Asian stocks were mostly lower on concerns that this week’s positive GDP report would result in the Federal Reserve (Fed) scaling back its quantitative easing program sooner than expected.

Treasury prices were lower this week. The yield on the benchmark 10-year U.S. Treasury climbed as today’s jobs report indicated the employment situation is on the mend.

Commodity indices were sharply lower on the week. All three major complexes – energy, metals and grains – declined on reports of increased supplies.

A Macro View:

In an indication that the employment situation seems to be improving, the Labor Department today reported that non-farm payrolls grew by 204,000 in October, and September’s gains were revised upward to 163,000. At the same time, the unemployment rate ticked upward slightly to 7.3% from 7.2% the prior month. The gains in October exceeded even economists’ most optimistic forecasts, as consensus estimates called for a gain of only 120,000 jobs in October. Today’s employment report follows yesterday’s better-than-expected third quarter estimate of GDP growth, which came in at 2.8%, providing further support that the economy may finally be showing long-awaited signs of acceleration.

Stock prices shrugged at the positive economic news, as most market indices were lower on the week. Investors seem to have interpreted the data as giving the Fed support to scale back its bond-purchase program (quantitative easing) sooner than anticipated, perhaps as early as next month. By tapering its bond purchases, the Fed would be ever-so-slightly reining in the aggressively accommodative monetary policy it has been following for much of the past five years. At some point the market needs to come to grips with the fact that the Fed will need to end its program, and perhaps the economy is at just such an inflection point where growth is self-sustaining.

Despite the market’s struggles to post gains on this week’s encouraging economic news, it is unlikely we have seen the top in stocks and that a material decline is imminent. Part of the reason is that even though stocks have posted strong gains so far this year (the S&P 500 and Nasdaq Composite are up more than 22% and 27%, respectively), the asset class still is attractive relative to bonds. Stock multiples have expanded, causing valuations to be stretched, but the positive outlook for the economy makes the environment more favorable for stocks than for bonds. We have already seen an uptick in real interest rates, and investor rotation from bonds to stocks is likely to accelerate.  So, with economic growth projected to pick up next year, corporate profits should also be on the rise, which is a positive for stocks but a negative for bonds. In such an environment, despite the run-up in stocks this year, equities should be overweighted and bonds underweighted in a portfolio. Within the fixed income allocation, given that Treasury yields have declined 40 basis points or so from their peak, the outlook for the economy would warrant a shortening of duration and an underweight to Treasury securities.


ETF/ETP assets continue to grow…

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October marked another month of strong inflows with global ETFs/ETPs. Combining the US$32.6 billion of net inflows with positive market performance during October global ETF/ETP assets reached a new record high of US$2.3 trillion, according to preliminary findings from ETFGI’s October 2013 Global ETF and ETP industry insights report.

Year to date (YTD) through end of October, global ETF/ETP assets have increased by 19% based on positive market performance and net inflows of US$202.2 billion, which is in line with the level of net inflows at this point in 2012. Equity ETFs/ETPs gathered the largest net inflows with US$193.9 billion which is significantly higher than the US$112.7 billion at this point in 2012, followed by fixed income ETFs/ETPs with inflows of US$21.4 billion which is less than half the US$56.2 billion gathered YTD in 2012. Commodity ETFs/ETPs experienced outflows US$33.0 billion which is a reversal of the US$20.1 billion net inflows at this point in 2012.

Equities have been the preferred area to invest new assets in 2013 with net inflows of US$193.9 billion. North American equity ETFs/ETPs have gathered the largest net inflows YTD with US$117.7 billion, followed by developed Asia Pacific equity with US$32.8 billion, and developed European equity with US$20.7 billion, while emerging market equity ETFs/ETPs experienced net outflows YTD with US$6.3 billion.

YTD, Vanguard ranks first based on net inflows of US$51.6 billion, iShares is 2nd with US$51.3 billion, WisdomTree is 3rd with US$12.8 billion, PowerShares is 4th with US$12.6 billion and SPDR is 5th with US$9.5 billion.

Where J&J $2.2B Settlement Fits Among Biggest?

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Johnson & Johnson’s (JNJ) agreement to pay $2.2 billion for off-label marketing of the anti-psychotic drug Risperdal brings to more than $11 billion the amount of penalties pharmaceutical makers have been assessed for getting doctors to prescribe drugs for purposes other than approved by the FDA.

Known, as off-label marketing, the practice has helped boost drug sales over the years but frustrated regulators and law enforcement officials.

J&J’s settlement is huge, but not the largest. Here’s a not-entirely-comprehensive list, onto which J&J would become No. 2.

1. Pfizer (PFE) – $2.3 billion, 2009
2. Abbott (ABT) – $1.5 billion, 2012,
3. Eli Lilly (LLY) – $1.415 billion, 2009
4. Merck Sharp & Dohme – $950 million, 2011
5. TAP Pharmaceuticals – $875 million, 2001
6. Serono, S.A. – $704 million, 2005
7. Purdue Pharma – $634 million, 2007
8. Allergan (AGN) – $600 million, 2010
9. AstraZeneca (AZN) – $520 million, 2010
10. Bristol-Myers Squibb (BMY) – $515 million, 2007