March 2011

Kreitler Financial:

More Uncertainty

"Although we continue to be cautiously optimistic that we have been through the worst, we need to recognize we are still in uncharted waters and it could be several years before things settle down. We could still have unpleasant surprises that upset the global markets as we move to a new balance for the world that will be different from where we came from." Thus we wrote in our January newsletter. Little did we know the next surprises would come from an earthquake in Japan and revolutions in the Middle East. In this newsletter, we will discuss these developments and their implications. Although risks are more heightened than we have recently observed, not everything is bleak.


The gigantic earthquake in Japan shows how powerful and disruptive nature can be. The Japanese had taken massive efforts to protect against earthquakes, but not for the scale they experienced. Their efforts probably saved hundreds of thousands of lives. Japan's economy has been hit, but it is too early to say how hard. Japan is a very strong country and we have no doubt it will recover. The tsunami caused most of the damage; however the nuclear reactors received much of the press coverage. The reactors were designed to prevent the environmental problems that Chernobyl caused in 1986. We expect it will be some time before we know whether the engineering changes passed or failed.

As we write this newsletter, Japanese stocks have dropped dramatically as investors try to factor in the financial damage. At least one of the managers that we use has been using this as an opportunity to aggressively buy Japanese companies that have fallen sharply. Short term the Japanese economy may experience output disruptions, but longer term it may receive a boost from rebuilding. Time will tell.

Middle East

The blow up in the Middle East also came as a surprise. There are many different directions the region can go (both good and bad) and we have no idea what will be the eventual outcome. Some have posited this could be 1979 (Shah of Iran), 1989 (fall of the Berlin Wall) or 1956 (failed Hungarian uprising). In the short term, the biggest economic impact is potential oil supply disruptions and higher oil prices. GaveKal, one of the premium services we receive, reports that the developing markets receive 40 percent of their oil supplies from this region. They are likely to receive the largest impact from any shortfalls. Some of these markets already are over-heated so this adds an additional challenge. Other than the impact on oil and gold prices, the markets' reaction to the Middle East events has been surprisingly modest. One worry is a jump in oil prices could risk the US recovery if it reduces spending on other goods/services.


We still do not know how and whether European countries will be able to solve their debt problems. Flexibility is limited because countries using the Euro, each with their own fiscal policy, are locked into a single currency. Member states can not devalue their currency. Devaluation is the traditional way for a country to get out of excessive debt without pushing the country into a major recession, but is not an option for European countries. (Default on debt does not seem to be an option for those dependent on ongoing borrowing to finance their current expenses.)

Another less publicized concern is that European authorities and the US Federal Reserve have very different monetary policies. Europe is increasing interest rates while the US is keeping them artificially low. The imbalance could lead to additional financial shocks.

State Problems

There has been a lot of change at the state government level. Most states now recognize they have huge budget and future liability problems. The political maneuvering in Wisconsin is the most publicized example of states beginning to come to grips with the imbalance between what they spend (or promised to spend) and their ability to raise money to pay for these expenses. Each state seems to be tackling the problem in a different way.

Bob had the opportunity in a Chamber of Commerce meeting with Connecticut Governor Malloy to ask whether the Governor's budget proposal dealt only with the current year's $3.5 billion shortfall or whether the Governor's proposal included steps to cover the unfunded mandates (mostly for government retirees), which reportedly are around $70 billion. Malloy's answer was not clear, which Bob interprets as once we have dealt with the $3.5 billion problem, we still have another $70 billion to go. Politicians in Washington are telling the states not to expect a federal bailout.

The eventual outcome has implications for the municipal bond market.


Change in Washington continues at a very fast pace. There are many moving parts and politicians are going in different directions. One of the hot questions is when and how will the Federal Reserve end its "quantitative easing" and return to a more normal monetary policy. QE 2 is scheduled to end in June. Currently the Federal Reserve has been keeping short term interest rates close to zero. A lot rests on the return to normal interest rates.

Big changes frequently happen quietly, behind closed doors. The Wall Street Journal recently reported that Democrats and Republicans in both the House and Senate have begun serious discussions to deal with the long term deficit problems. Apparently, under discussion are changes to Social Security and the government health care programs, all of which are "sacred cows", meaning politicians concerned about keeping their jobs are reluctant to discuss fixing them. The more public debate, reported by most of the press, has been about making changes to "discretionary" programs. However, the long term debt problem cannot be solved without reforms in Social Security and health care.

One of the risk scenarios we track is whether these fiscal and monetary issues can lead to problems with bonds or the dollar.

All is not bleak

The above sounds pretty bleak and is only a summary of a few of the issues we follow; however, there really is good news. The US economy continues to recover. Consumers have done a great deal to reduce their personal debt. Having just passed the two year anniversary of the March 9 lows, the US markets are up approximately 100% from that date. Major corporations continue to have large cash reserves. Employment is beginning to gradually improve and housing is no longer in a freefall. To us the real positive is that people are talking about the deficit problems and beginning to offer solutions.

At Kreitler Financial our investment strategies continue to assume a very uncertain world. We continue to be defensive, which we feel has worked well. Our planning for the downside has made it more likely our clients will achieve their lifetime goals. After an approximate doubling in the US stock market, a correction would be quite normal. Portfolios' values don't increase in even steps and aren't guaranteed to go up over the long term. We continue to monitor what is happening in the world, but at this time we think our clients' portfolios are reasonably positioned to deal with the unexpected - from Japan to the Middle East, to whatever comes next. We will continue to monitor the situation and should we see a reason to make changes we will be in touch.

We continue to move through challenging times and we will do our best to help. Please call if you have questions.

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Robert Kreitler and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. This information is not intended as a solicitation or an offer to buy or sell any security referred to herein. Investments mentioned may not be suitable for all investors. Past performance may not be indicative of future results. Diversification does not assure a profit or protect against a loss. The S&P 500 is an unmanaged index of 500 widely held stocks that's generally considered representative of the U.S. stock market. Individuals cannot invest directly in any index. Precious metals including gold, are subject to special risks, including but not limited to: price may be subject to wide fluctuation; the market is relatively limited; the sources are concentrated in countries that have the potential for instability; and the market is unregulated. International investing involves additional risks such as currency fluctuations, differing financial and accounting standards, and possible political and economic instability. Also, investing in emerging markets can be riskier than investing in well-established foreign markets. There is no assurance any of the trends mentioned will continue in the future. Investing involves risk and investors may incur a profit or a loss, including the loss of all principal. Dividends are not guaranteed and must be authorized by the company's board of directors.
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