"Kee" Points with Jim Kee, Ph.D.

Global data points: In Europe, second quarter GDP for the European Union rose .3 percent (or about 1.2 percent annualized), technically ending recession there. Of course, nobody sees Europe as being even remotely out of the woods yet, including me. Great progress has been made on the monetary side (European Central Bank) of the integration equation since the European debt crisis began. But it is the fiscal side that both requires more integration yet has too little to show thus far. Nevertheless, the data suggests some stabilization is occurring in Europe. And frankly, I calculate Europe’s average annual GDP growth rate over the last 20 years at 1.5 percent per year, so my expectations aren’t that high to begin with. In Japan, preliminary second quarter GDP growth data came in at an annualized rate of 2.6 percent, a bit below expectations of 3.6 percent. Here again, Japan’s average annual GDP growth rate over the last 20 years has been .83 percent, or less than one percentage point per year, so I find my expectations consistently below consensus.

US: It was a typical week of mixed data in the US, with decent retail sales and jobless claims data offsetby lower than expected housing permits. As for stocks, the Dow was off 2.2 percent last week, largely due to a combination of earnings reports and concerns over Fed tapering because of stronger than expected jobless claims reports (claims for unemployment benefits, that is). These are the periods in which investors either make (by sticking with their plan) or break (by deviating from their plan) their long-term investment goals. Most investors desire some of the long-term benefits of being invested in the stock market, and it is pretty easy to stay with your stock allocation when the market is going up. But it is during the numerous pullbacks and corrections that patience gets tested, and that’s usually when long-term goals are sacrificed due to short-term angst. As I’ve mentioned before, peer-reviewed studies of actual investment behavior as measured by trades in retirement accounts show that actual investors average around 1 to 2 percent per year, not the longer-term 9 to 11 percent average annual returns of the broader market. That’s because of the well-known tendency of people to get too active at the wrong times. In the words of Nobel Laureate Paul Samuelson, “That’s a trap. It makes you too active. You churn your portfolio. You listen to stories, and most of the stories are not worth listening to.”

I mention this because September looks like it will be a month filled with headline events. These include (1) another debt-ceiling debate as the [BS1]government runs out of funding beyond September 30th, (2) the September FOMC (Federal Open Markets Committee) meeting in which the Fed is expected to discuss tapering plans, (3) in Europe, the important German federal election on September 22nd, (4) in Japan, Prime Minister Shinzo Abe’s decision on September 9th (when fresh economic data is available) on whether to go through with a controversial 3 percentage point increase in the sales tax.

Finally, bonds: Interest rates continue to ratchet up (from extremely low levels), depressing the price of existing bonds. That’s because, for example, nobody will buy a $1000 bond that pays (earns) 3 percent if interest rates – and hence newly issued bonds- pay 5 percent. So the price of the old $1000 bond has to drop until the buyer “yields” the higher current rates. In other words, bond prices and interest rates move inversely. Looking back over the past 20-30 years, interest rates have trended steadily downward since the double digit levels of the late 1970s/early 1980s. Consequently, bonds did extremely well, and any strategy that had a lot of bonds, like most of the so-called “couch potato” strategies, did pretty well. Obviously that period can’t repeat itself because interest rates are near rock bottom. Recognizing this, many strategists are arguing for a reallocation of balanced accounts from, say60 percent stocks and 40 percent bonds, to 70 percent stocks and 30 percent short-term bond funds. If bond funds are your only option in the fixed-income area, you really have no other choice. But if you can buy individual securities (which is generally what we do at STMM), you can own individual bonds in a “laddered” strategy that ensures bonds maturing periodically. So as the principle gets repaid, it can be invested at higher and higher rates (assuming interest rates rise). In other words, a rising rate environment is toughest on bond funds, and best navigated with a strategy built upon owning individual securities. I apologize for this redundancy to Kee Points readers, but it is very important to keep in mind, given the press!