Blog Site: July 2013

Risk assets were off to a decent start in the second quarter but then retreated after Federal Reserve Chairman Ben Bernanke’s testimony to Congress on May 22 laid the ground work for a reduction in monetary policy accommodation through tapering their asset purchases as early as September. While the U.S. equity markets were able to end the quarter with decent gains, developed international markets were relatively flat and emerging markets experienced sizeable declines. Weaker currencies helped to exacerbate these losses.

After starting to move higher in May, interest rates rose sharply in June and into early July, helped by the fears of Fed tapering. The yield 10-year U.S. Treasury has increased 100 basis points over the last two months to a level of 2.64% (through 7/10). The increase in rates was all in real terms as inflation expectations fell. Bonds experienced their worst first half of the year since 1994, in which we experienced four short-term rate hikes before June 30.

While we have seen these levels of rates in the recent past (we spent much of the 2009-2011 period above these levels), the sharpness of the move may have been a surprise to some fixed income investors who then began to de-risk portfolios. In June, higher-risk sectors like investment-grade credit, high-yield credit and emerging market debt, as well as longer duration assets like TIPS, fared the worst. With growth still sluggish and inflation low, we expect interest rates to remain relatively range-bound over the near term; however, we do expect more volatility in the bond market. Negative technical factors like continued outflows from fixed income funds could weigh on the asset class. Our portfolios remain positioned in defense of rising interest rates, with a shorter duration, emphasis on spread product and a healthy allocation to low volatility absolute return strategies.

After weighing on the markets in June, investors have begun to digest the Fed’s plans to taper asset purchases at some point this year. Should the Fed follow through with their plans to reduce monetary policy accommodation, it will do so in the context of an improving economy, which should be a positive for equity markets.

We continue to approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds as we move into the second half of the year. A number of factors should continue to support the economy and markets for the remainder of the year:

Monetary policy remains accommodative: The Fed remains accommodative (even with the scale back on asset purchases short-term interest rates will remain low), the ECB has pledged to support the euro, and now the Bank of Japan is embracing an aggressive monetary easing program in an attempt to boost growth and inflation. This liquidity has helped to boost markets.
Fiscal policy uncertainty has waned: After resolutions on the fiscal cliff, debt ceiling and sequester, the uncertainty surrounding fiscal policy has faded. The U.S. budget deficit has improved markedly, helped by stronger revenues. Fiscal drag will be much less of an issue in 2014.
Labor market steadily improving: The recovery in the labor market has been slow, but steady. Monthly payroll gains over the last three months have averaged 196,000 and the unemployment rate has fallen to 7.6%. The most recent employment report also showed gains in average hourly earnings.
Housing market improvement: An improvement in housing, typically a consumer’s largest asset, is a boost to net worth, and as a result, consumer confidence. However, a significant move higher in mortgage rates, which are now above 4.5%, could jeopardize the recovery.
U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash that could be reinvested or returned to shareholders. Corporate profits remain at high levels and margins have been resilient.

However, risks facing the economy and markets remain, including:

Fed mismanages exit: If the economy has not yet reached escape velocity when the Fed begins to scale back its asset purchases, risk assets could react negatively as they have in the past when monetary stimulus has been withdrawn.
Significantly higher interest rates: Rates moving significantly higher from here could stifle the economic recovery.
Europe: The risk of policy error in Europe still exists. The region has still not addressed its debt and growth problems; however, it seems leaders have realized that austerity alone will not solve its problems.
China: A hard landing in China would have a major impact on global growth. A recent spike in the Chinese interbank lending market is cause for concern.

We continue to seek high conviction opportunities and strategies within asset classes for our client portfolios. Some areas of opportunity currently include:

Domestic Equity: favor U.S. over international, dividend growers, financial healing (housing, autos)
International Equity: frontier markets, Japan, micro-cap
Fixed Income: non-Agency mortgage backed securities, short duration, emerging market corporates, global high yield and distressed
Real Assets: REIT Preferreds
Absolute Return: relative value, long/short credit, closed-end funds
Private Equity: company specific opportunities

Asset Class Returns

In a recent study, 40% of consumers responded that they don’t have enough life insurance to meet their families’ long-term needs.¹ This concern raises an obvious question: How much life insurance is enough? What might be appropriate for a family with two young children and a stay-at-home spouse could be significantly different from the needs of a working couple whose children are grown.

Do the Math

Rather than using the oft-recommended formula of replacing eight to ten times your annual income, a better tactic might be to calculate the life insurance benefit amount that could provide the income to meet your family’s long-term needs and goals.

In the hypothetical example below, the family’s living expenses were $70,000 and the surviving spouse would have access to $40,000 of income, leaving $30,000 of annual income to replace. The next step is to determine the life insurance death benefit that could replace this annual income.

In order to do this, you estimate an average annual rate of return that might be achieved if the death benefit amount were invested in income-producing financial vehicles, without reducing the principal. For this example, a 5% rate of return is used. Of course, this rate of return is not representative of any specific investment; actual circumstances and results will vary.

Dividing $30,000 by 5% (.05) equals $600,000. A $600,000 life insurance benefit earning a 5% average annual rate of return could yield a $30,000 annual income.

Although this worksheet is a good starting point, for a more accurate result you should include all the potential expenses that might enable your family to live the way you want them to live. For example, you could include funds for your child’s college education. If health insurance is paid for by your employer, your family may need replacement coverage. And don’t forget final expenses such as funeral and burial costs.

The cost and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased. Before implementing a strategy involving life insurance, it would be prudent to make sure that you are insurable.

As with most financial decisions, there are expenses associated with the purchase of life insurance. Policies commonly have mortality and expense charges. If a policy is surrendered prematurely, there may be surrender charges and income tax implications.

Life insurance could be a key step toward providing security for your loved ones. It’s important to review your coverage regularly to make sure you have sufficient protection for your family’s situation.

1) financial-planning.com, September 26, 2011

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by TravelInsuranceCenter.com.

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Economic News, Outlook & Notable Numbers - July 2013

How Much Life Insurance Do You Need?

Do the Math

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