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2011-5-16 Lederer PWM Portfolio Strategy Update

2011-5-16 Lederer PWM Portfolio Strategy Update

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Published by brett9949

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Published by: brett9949 on May 18, 2011
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Portfolio Strategy Update: May 2011
 Providing customized solutions for long-term financial objectives
For the past several weeks, I have been altering the composition of client portfolios, transitioning them to a more defensive posture. This piece discusses the reasons for the changes and detailsthe specific investment decisions.
Issues / Concerns
1)The broader economy and the stock markets may lose momentum with U.S. fiscaland monetary stimulus being scaled back.
In developed economies such as the United States, the economic recovery from the GreatRecession has been mediocre at best. One would expect this weaker growth following a financialcrisis. For the past year and a half, I have cited empirical data from studies performed by McKinsey Global Institute and Reinhardt/Rogoff (in their book 
This Time is Different 
, to whatsome have referred as “The Bible for analyzing financial crises”). The data indicate how a lengthy deleveraging (i.e., debt reduction) period nearly always follows a banking crisis, creating asignificant headwind to vibrant economic growth.Since almost every financial crisis results from an excessive build-up of debt, it is common toobserve declining credit growth after a crisis because: i) debtors are unable to borrow against less valuable assets (think home prices), and ii) banks are unwilling and/or unable to lend becausetheir balance sheets contain a higher proportion of delinquent loans.In the United States, negative private sector credit growth has constrained the strength of theeconomic recovery. As Table 1 illustrates, this post-recession credit growth is in stark contrast tothat during the typical post-World War II recovery, during which time borrowers and banks werein much better financial shape.
 Table 1 The Role of Private Sector Credit Growth in Post-WW II Recoveries
GDP DECLINEGDP GROWTHPRIVATE SECTORDURINGIN RECOVERYCREDIT GROWTHRECESSION(FIRST 18 MONTHS)(FIRST 18 MONTHS)Q4 1969Q4 1970-0.2%8.8%15.4%Q1 2001Q4 2001-0.3%2.7%12.7%Q2 1960Q1 1961-0.5%9.7%13.6%Q3 1990Q1 1991-1.4%4.8%5.5%Q4 1948Q4 1949-1.6%16.7%23.4%Q1 1980Q3 1980-2.2%1.4%17.0%Q2 1953Q2 1954-2.5%9.9%19.5%Q3 1981Q4 1982-2.6%11.7%18.6%Q3 1957Q2 1958-3.1%9.8%16.7%Q4 1973Q1 1975-3.2%7.5%11.9%
Q4 2007 Q2 2009 -4.1% 4.5% -6.2%
Data Sources
: U.S. Bureau of Economic Analysis and U.S. Federal Reserve
 To try and counteract the private sector credit decline, the federal government has increasedspending by nearly 25% since early 2007. However, because of lower tax revenues due to themore-sluggish economic conditions, the higher spending has led to sizable fiscal deficits and arun-up in the national debt. At the same time, the Federal Reserve (Fed) has attempted to stimulate more credit growth by:i) cutting its short-term target interest rate to virtually zero and ii) expanding its balance sheet atan unprecedented scale via two rounds of “quantitative easing (QE),” where it has createdadditional reserves out of thin air (essentially printing money) and purchased U.S. Treasury andmortgage-backed debt securities in an effort to drive down longer-term interest rates.
Figure 1Fed Balance Sheet & Federal Government Spending: Q1 2007 – Q1 2011
     Q     1     0     7     Q     2     0     7     Q     3     0     7     Q     4     0     7     Q     1     0     8     Q     2     0     8     Q     3     0     8     Q     4     0     8     Q     1     0     9     Q     2     0     9     Q     3     0     9     Q     4     0     9     Q     1     1     0     Q     2     1     0     Q     3     1     0     Q     4     1     0     Q     1     1     1
Federal Reserve Bank Credit (LHS)Federal Government Spending (RHS)
 An unprecedented amount of monetary and fiscal stimulushave been deployed to offset theprivate sector deleveraging.
     Q  -     4     Q  -     3     Q  -     2     Q  -     1     E    n     d     Q    +     1     Q    +     2     Q    +     3     Q    +     4     Q    +     5     Q    +     6     Q    +     7
Figure 2Current Economic Recovery vs. Average of Prior Post-WW II Recoveries
Even with the huge doses of stimulus, the current recovery has lagged the average post-WW II recovery by a wide margin.
Data Sources
: U.S. Bureau of Economic Analysis and U.S. Federal Reserve
 Avg Post-WW IIRecoveryCurrentRecovery
     J    a    n  -     0     7     M    a    r  -     0     7     M    a    y  -     0     7     J    u     l  -     0     7     S    e    p  -     0     7     N    o    v  -     0     7     J    a    n  -     0     8     M    a    r  -     0     8     M    a    y  -     0     8     J    u     l  -     0     8     S    e    p  -     0     8     N    o    v  -     0     8     J    a    n  -     0     9     M    a    r  -     0     9     M    a    y  -     0     9     J    u     l  -     0     9     S    e    p  -     0     9     N    o    v  -     0     9     J    a    n  -     1     0     M    a    r  -     1     0     M    a    y  -     1     0     J    u     l  -     1     0     S    e    p  -     1     0     N    o    v  -     1     0     J    a    n  -     1     1     M    a    r  -     1     1
Case-Shiller Housing Price Index (LHS)U.S. Unemployment Rate (RHS)
Despite the flood of fiscal and monetary stimulus, the economic recovery has beenmediocre at best
(see Figure 2 on previous page), with unemployment remaining stubbornly high and the housing market still well off 2007 levels.
Figure 3Housing Prices & Unemployment: 2007 - Present
 The flood of monetary andfiscal stimulus has done littleto improve U.S. housing prices and unemployment.
 While the Fed’s highly accommodative monetary policy has been unsuccessful driving downunemployment and increasing housing prices, it has helped spur a dramatic rise in commodity prices, particularly food and energy prices. As a result, inflationary expectations have risen sincethe implementation of QE2 last November (see Figure 4 on next page). Although the Fed does not appear eager to raise interest rates to address the risk of rising inflation, Chairman Bernanke has signaled an end to QE2 in June, with the program expected tocompletely wind down toward the end of the year. In addition, Bernanke has explicitly said therisks of implementing QE3 outweigh the potential benefits at this time. The bottom line is thata major source of monetary stimulus is ending within the next few months.Meanwhile, federal, state, and local government spending will either have to be cut and/or taxes will have to be raised if lawmakers want to avoid a looming fiscal debt crisis. When Standard &Poor’s placed U.S. sovereign debt on negative watch last month, it was a painful reminder thatfiscal austerity measures may have to be enacted in short order. Since U.S. governmentexpenditures (including transfer payments) currently comprise roughly one-third of U.S. GDP,cutbacks and/or higher taxes will likely create a near-term drag on economic growth.
Data Sources
: U.S. Bureau of Labor Statistics and Standard & Poor’s

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