COVID-19 Timeline

December 31, 2019, China alerted the WHO to several cases of unusual pneumonia in Wuhan, a port city of 11 million people in the central Hubei province. The virus was unknown.

January 1, 2020, several of those infected worked at the city’s Huanan Seafood Wholesale Market, which was shut down. As health experts worked to identify the virus amid growing alarm, the number of infections exceeded 40.

January 7, 2020, Chinese officials announced they had identified a new virus, according to the WHO. The novel virus was named 2019-nCoV and was identified as belonging to the coronavirus family, which includes SARS and the common cold.

January 11, 2020, China announced its first death from the virus, a 61-year-old man who had purchased goods from the seafood market. Treatment did not improve his symptoms after he was admitted to hospital and he died of heart failure on the evening of January 9. 

January 13, 2020, the WHO reported a case in Thailand, the first outside of China, in a woman who had arrived from Wuhan.

January 15, 2020, a US man returned from Wuhan on Jan. 15, two days before passenger screening was instituted at three major airports in the United States, but he had no symptoms at the time.

January 17, 2020, as a second death was reported in Wuhan, health authorities in the US announced that three airports would start screening passengers arriving from the city.

January 20, 2020, the US man who returned from Wuhan on Jan. 15 tested positive for the virus in Washington State.

January 21, 2020, United States confirmed its first case in Washington state, a man who traveled to the Wuhan area.

January 23, 2020, Wuhan was placed under effective quarantine as air and rail departures were suspended.

January 30, 2020, the WHO declared coronavirus a global emergency as the death toll in China jumped to 170, with 7,711 cases reported in the country, where the virus had spread to all 31 provinces. The WHO declares the coronavirus outbreak as a Public Health Emergency of International Concern (PHEIC). The United States issues a Level 4 travel advisory for all of China.

February 5, 2020, CDC began shipping diagnostic test kits to more than a hundred labs in the United States.

February 12, 2020, United States confirmed fourteenth case. Some U.S. states found testing kits distributed by CDC deliver “inconclusive” results.

February 21, 2020, mainland China, the death toll reached 2,236 as the confirmed cases of the infection rose above 75,400. In Italy, the region of Lombardy reported the first local transmission of the virus with three new cases bringing the total in the country to six infections.

February 25, 2020, U.S. senators received a classified briefing on the Trump administration’s coronavirus response. U.S. CDC warned that spread to the United States is likely and that people should prepare. San Francisco became the first U.S. city to declare a state of emergency over COVID-19.

February 29, 2020, the United States reported its first death, a man in his fifties with an underlying health condition. Washington state declared a state of emergency.

March 3, 2020, Italy announced the death toll in the country reached 77. U.S. Federal Reserve cut its benchmark interest rate by half a percentage point.

March 7, 2020, the coronavirus killed nearly 3,500 people and infected another 102,000 people across more than 90 countries. China’s Health Commission reported 99 new cases, down from 143 cases the day before, with a total of 80,651 cases nationwide. Official data, meanwhile, showed China’s exports plunging 17.2 percent in the first two months of the year after the outbreak brought much of the country to a halt.

March 11, 2020, the WHO declared the coronavirus outbreak a pandemic, as Turkey, Ivory Coast, Honduras and Bolivia confirmed their first cases. 

March 16, 2020, New York Mayor Bill de Blasio ordered the city’s bars, theatres and cinemas to close down, as the number of cases continued to rise in the US.

March 17, 2020, Italy reported 345 new coronavirus deaths in the country over the past 24 hours taking its total death toll to 2,503 – an increase of 16 percent. The total number of cases in Italy rose to 31,506 from a previous 27,980, up 12.6 percent – the slowest rate of increase since the contagion came to light on February 21.

March 18, 2020, Italy, meanwhile, recorded 475 new deaths, the highest one-day toll of any nation, taking its total to 2,978. The total number of infections in the country reached 35,713. For the first time since the start of the epidemic, no new domestic cases were reported in China. 

March 19, 2020, Italy overtook China as the country with the most coronavirus-related deaths, registering 3,405 dead compared to 3,245 in China.

March 21,2020, Europe remains the epicenter of the coronavirus with Italy reporting 793 new fatalities, its biggest daily increase, bringing the total number of deaths to 4,825 amid 53,578 cases. Spain is the second worst-hit country in Europe with more than 21,000 infections and at least 1,000 deaths. To help each European country to contain the pandemic, the EU has taken the unprecedented step to suspend rules on public deficits, giving countries free rein to inject spending into the economy as needed.

March 25, 2020, The White House and Senate leaders of both parties struck an agreement on a sweeping $2 trillion measure to aid workers, businesses and a healthcare system strained by the rapidly spreading coronavirus outbreak.

March 26, 2020, the total number of coronavirus cases globally surpassed 500,000. 

Important Disclaimer

Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. Callan Capital outsources to lending and financial institutions that directly provide our clients with, securities based financing, residential and commercial financing and cash management services. For more information, please refer to our most recent Form ADV Part 2A which may be found at http://www.adviserinfo.sec.gov.

CORONAVIRUS UPDATE

What began with a handful of mysterious illnesses in a market in Wuhan, China has since turned into a pandemic that has traversed the world. First detected on December 31, 2019, the novel coronavirus has infected tens of thousands of people. It has triggered unprecedented quarantines, a stock market upheaval and historical government intervention. As the country and its health-care system prepares, much is still unknown about the virus now named Covid-19. As a continuation of our update on the new government aid packages released today, the following is a brief on several topics we believe are key to our recovery from the pandemic.

TRUMP AND FAUCI
President Trump’s latest call to reopen the United States economy by Easter has put him at odds with public health officials. The potential downside if we open too soon is enormous. Public health experts and even some Republican lawmakers have been uneasy about the idea of rushing to boost a lagging economy before the virus is fully contained. They have warned of potentially catastrophic consequences, including a spike in infections and deaths that could lead to overrun hospitals, and argued the health of the nation should be the priority. In a tweet, President Trump said “We can do two things together. THE CURE CANNOT BE WORSE (by far) THAN THE PROBLEM!” 

Dr. Anthony Fauci, the head of the National Institute of Allergy and Infectious Diseases and a prominent member of the White House’s coronavirus task force, added that a timeline for the lifting of restrictions on parts of the country by Easter Sunday should be “flexible.” “You may not want to essentially treat it as just one force for the entire country, but look at flexibility in different areas,” Fauci said. “So I think people might get the misinterpretation you’re just going to lift everything up. . . .That’s not going to happen. It’s going to be looking at the data. And what we don’t have right now that we really do need, we need to know what’s going on in those areas of the country where there isn’t an obvious outbreak.” 

Fauci has openly tempered expectations for a quick coronavirus vaccine and an end to the epidemic on the press conference stage with Trump, even as the president promised everything was under control and a vaccine would be ready soon. But Dr. Fauci also said there was a limit to what he could do when Mr. Trump made false statements. “I can’t jump in front of the microphone and push him down,” Dr. Fauci said. “OK, he said it. Let’s try and get it corrected for the next time.”

POSSIBLE VACCINES AND TREATMENTS

There are currently no FDA-approved drugs specifically for the treatment of patients with COVID-19. Based on data from China, Fauci said about 80% of people who get infected “do really quite well” and recover without any medical treatment. But about 10% to 15% get seriously ill, particularly those in high-risk groups such as the elderly or patients with other medical problems. Currently, clinical management for those who have COVID-19 includes infection prevention, control measures and supportive care such as supplementary oxygen and ventilatory support in the most severe of cases.

According to the CDC, the US Food and Drug Administration cleared the way for New York to experiment with different treatment drugs. The CDC notes that there are a number of drugs that have been approved for other ailments as well as several investigational drugs that are being studied in clinical trials taking place across the world. The World Health Organization said on March 6 that it has received applications for 20 vaccines in development and many clinical trials of therapeutics are underway.

Earlier in the week, President Trump and members of his Cabinet met at the White House with executives of 10 pharmaceutical companies to discuss ways to speed the development of a vaccine for the coronavirus. In China, scientists have been testing a combination of HIV drugs against the new virus, as well as an experimental drug named Remdesivir that was in development to fight Ebola.

President Donald Trump has pledged to “slash red tape like nobody has even done it before” to accelerate the development of a coronavirus vaccine. But his push could backfire if the government moves too fast. Testing a vaccine must proceed in stages, not only to make sure that it works but to make sure it is safe. This is a process that can take months, if not over a year, according to Dr. Anthony Fauci. Testifying before the Senate on Tuesday, he made it clear that neither a coronavirus treatment nor a vaccine can be ready quickly. Fauci has said it could take 12 to 18 months to make a vaccine available, but even that timetable could be overly ambitious. The most promising technologies haven’t been tested on massive groups of people and public health officials typically take their time when vetting vaccines targeted at millions. In some cases, a vaccine that hasn’t been properly tested could make people sicker. And if there are complications, the public relations problems could mount, spurring an anti-vaccination sentiment. Fauci indicated potential treatments may come before a vaccine.

OUR HEALTHCARE SYSTEM

Healthcare officials battling the coronavirus are making the difficult decision to limit testing to conserve critical resources, even as more test kits become available. The balancing act means that despite an increase in drive-thru testing sites and point-of-care tests that deliver results in minutes, some of the hardest-hit areas are still restricting evaluations to health care workers and the most vulnerable patients.

Instead of broad, community-wide testing, cities in California and New York are focused on making sure only the sickest people and health care workers get tested. Doing so also slows the use of personal protective equipment (PPE) like masks, gowns and gloves, which are facing a nationwide shortage. “We’re in a much different place than we were two weeks ago, and we’ll be in a much different place in a week. The supply chain just isn’t there at the moment, so you do have to make those tough decisions about prioritization.” said Scott Becker, CEO of the Association of Public Health Laboratories.

According to the Harvard Global Health Institute, the coronavirus could end up causing between 10 million and 34 million hospital visits and about a fifth of those patients will require intensive care. “The risk to our health-care workers is one of the great vulnerabilities of our health-care system in an epidemic like this,” he said. “Most ERs and health-care systems are running at capacity in normal times.”

In light of the fact that there isn’t enough space in hospitals to deal with an explosive outbreak, it’s important to do what can be done to slow transmission. As Aaron Carroll, professor at Indiana University School of Medicine summed up “A crucial thing to understand about the coronavirus threat — and it’s playing out grimly in Italy — is the difference between the total number of people who might get sick and the number who might get sick at the same time.”

In Italy, which has been particularly hard hit, doctors and hospitals have become so overwhelmed that the Italian College of Anesthesia, Analgesia, Resuscitation and Intensive Care has published guidelines calling for doctors to approach patients with a wartime triage sensibility; and it has discussed a potential age limit for access to care. One advantage the U.S. has over the Italian health care system is a greater number of intensive care unit (ICU) beds. But while the US has more ICU beds than European countries do on average, the availability of those beds is still deeply concerning. “It’s estimated that we have about 45,000 intensive care unit beds in the United States. In a moderate outbreak, about 200,000 Americans would need one,” said Carroll.

Public behavior is going to play a big factor in determining if and when there’s a huge surge beyond the health care system’s capacity. Experts say social distancing and hygienic practices like methodically washing one’s hands and cleaning potentially infected surfaces could slow the pace at which coronavirus spreads through the population, if enough people observe these practices. This in turn could “flatten the curve” of new coronavirus cases, ensuring that hospital capacity isn’t dramatically exceeded.

The strategy is seeing some results in Washington state, the first state to test positive for the virus. Washington state Gov. Jay Inslee says number of cases is still rising, but not as steeply as before. “It is a glimmer of hope,” he says. “It’s suggestive that some of the things we are doing together is having some modest improvement,” Inslee says. But for every note of optimism, the governor adds caution. “We shouldn’t be within ten thousand miles of champagne corks on this,” he says. “Because if we do not continue to increase [the downward pressure on the infection rate], a lot of people are going to die across the state of Washington.” It’s a delicate balance for governors right now, as they try to show the public evidence that the disruption of social distancing is working, without giving people reason to lower their guard.

THE ECONOMY

Financial markets have moved swiftly and are now pricing in a global recession, with the S&P 500 falling into bear market territory and both investment grade and high yield bond spreads widening significantly. This recession, however, should be treated differently than the recession triggered by the 2008 financial crisis. The areas affected by social distancing (leisure, hospitality, retail and transportation) represent a larger percentage of overall employment, but a smaller share of GDP than the finance and construction industries did in 2008. From an earnings perspective, industries impacted by social distancing represent a smaller portion of overall S&P 500 earnings than financials did in 2008.  While early indications suggest that this could be a deep recession, experts agree that much of the recession and subsequent recovery will be determined by how long the pandemic lasts and whether the policy response rises to the challenge. “The question is: How long does it last, the social distancing,” said Louise Sheiner, policy director for the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution. “Nobody really knows. We’re all flying blind here. This is something really different than we’ve ever seen. . . the longer it lasts, the more staying power it has. The more businesses go under, the more people lose their jobs. . . .If we’re lucky on the medical front, then yes it could bounce back very quickly. And if we’re not lucky it could be much worse.”

While virus containment is seen as determining the duration of the recession, another key factor is whether job losses are temporary or permanent. While a lot of businesses will not recover from this, the ones that do are anticipated to be able to recover relatively quickly. “It’s very hard with any recession to know if it’s a V [shaped] or a more gradual [U shaped] recovery,” said Michael Graetz, former Treasury official under George H.W. Bush, “But this is a resilient economy and it seems to be a time-limited problem,” he added. “The key is to marshal all the resources to get out of it as soon as we can.”

CONCLUSION

Even in the midst of the crisis, all of this is worth considering for long-term investors. The last few weeks have seen sharp declines in risk assets in very volatile trading. There may well be worse to come for markets, as numbers on both fatalities and the economy still have the potential to shock investors. In any crisis of extreme uncertainty, risk assets tend to fall well below long-term fair values so now is the time to stay disciplined. Expect sharp ups and downs in the markets until our healthcare policies begin to turn the tide on the coronavirus. There are a lot of unknowns—these conditions call for patience and avoiding giving in to panic. Selling investments out of fear right now could potentially lower diversification benefits and prevent investors from experiencing gains when coronavirus-related volatility ultimately subsides, and economic activity begins to recover.

Click HERE to view a timeline of the virus.

Important Disclaimer

Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. Callan Capital outsources to lending and financial institutions that directly provide our clients with, securities based financing, residential and commercial financing and cash management services. For more information, please refer to our most recent Form ADV Part 2A which may be found at http://www.adviserinfo.sec.gov. The S&P 500, or simply the S&P, is a stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices, and many consider it to be one of the best representations of the U.S. stock market.

UPDATE-STIMULUS PACKAGE AND FED MEASURES

As the country and the world grapple with a still-expanding global pandemic, international economic activity has been disrupted and markets have been wildly volatile in recent weeks. While staying safe and healthy is of utmost importance in everyone’s mind, people are also understandably concerned about the long-term effect the virus may have on the economy, markets and their own financial lives. One thing is clear—we are living in unprecedented times.

As a follow up to our last communication, below is a summary of the most recent government measures to stabilize the economy and the market.

The White House and Senate leaders reached a deal early Wednesday morning on a massive stimulus package. The proposal will inject approximately $2 trillion into the US economy, providing tax rebates, four months expanded unemployment benefits and a slew of business tax-relief provisions aimed at protecting individuals, families and businesses impacted by the novel coronavirus. It’s the third piece of bipartisan legislation to address the pandemic this month, with two emergency stimulus bills already signed into law. But this latest deal eclipses the earlier packages in scope and spending and amounts to what could be the most ambitious economic rescue effort in American history.

THE NEW STIMULUS PACKAGE

Senate Majority Leader Mitch McConnell, R-Ky., described the legislation, known as the CARES Act, as necessary emergency relief and vowed to put partisanship aside to get it done. “No economic policy can fully end the hardship so long as the public health requires that we put so much of our commerce on ice,” McConnell said in a speech on the Senate floor on Wednesday. “This isn’t even a stimulus package. It is emergency relief. Emergency Relief. That’s what this is.”

The deal includes $500 billion for a major corporate liquidity program through the Federal Reserve, $367 billion for a small business loan program, $100 billion for hospitals and $150 billion for state and local governments,. $30 billion in emergency education funding, and $25 billion in emergency transit funding. It will also provide $25 billion in direct financial aid to struggling airlines and $4 billion for air cargo carriers, two industries that have taken a big hit in the economic downturn.  The house was expected to vote to approve the law today and President Trump has already said he would sign the bill. This morning, news of a possible delay hit the markets, but the bill has since passed.

Payments to Individuals and Families:

The Senate bill will provide a one-time $1,200 check for individuals making up to $75,000 AGI per year or $2,400 for married couples filing jointly who earn less than $150,000 AGI. There is a phase-out between $75,000 and $99,000 in income, those with incomes greater than $99,000 will not receive a check. The bill also provides an additional $500 per child. 

Taxes:

The Treasury announced this week that it would also grant a 90-day extension for filing federal taxes. Initially, only the payment due date for the 2019 tax year was delayed past the traditional April 15 deadline. Now both the delayed filings and payments are due July 15. Taxpayers are still able to file for an extension after July 15.

Unemployment:

Unemployment benefits will be extended to four months and the maximum unemployment insurance benefit will be raised by $600 per week. Unemployment hit 5.5% today (up from a historic low of 3.5% in February) and most economists predict the rate will increase to between 8% and 13% in the coming months as a result of the virus. U.S. Treasury secretary Steve Mnuchin has predicted unemployment in the US could reach 20%. Even with the additional funding in the bill, the unemployment system isn’t designed to handle the surge of new applicants for jobless claims and how they plan to get money into the hands of those who need it is still unclear.

Stock Buybacks:

The bill bans stock buybacks for any corporation that accepts government loans during the term of their assistance plus one year. Democrats also added a provision to ban businesses owned by the president, vice president, members of Congress and the heads of federal executive departments from receiving loans or investments through the corporate liquidity program. The prohibition also applies to their children, spouses and in-laws.

Border Wall:

The Senate bill prevents the Pentagon from shifting $10.5 billion in coronavirus funding to a counterdrug account it has been using to fund the U.S.-Mexico border wall.

Student Loans:

The bill would defer payments for federally owned student loans for six months, through Sept. 30, 2020. Previous versions of the bill included forgiveness of between $10,000 and $30,000 in loans per borrower; however, those provisions were ultimately cut from the final bill.

Small Business Loans:

The bill creates an employee retention tax credit for firms hurt by the coronavirus to allow deferral of payroll taxes for two years and $350 billion for small businesses impacted by the pandemic in the form of loans. The bill also dramatically expands the Small Business Administration’s ability to guarantee loans, but millions of companies could seek these guarantees all at once, putting enormous pressure on the system. The bill also creates a Treasury Department Special Inspector General for pandemic recovery and a Pandemic Response Accountability Committee to oversee loans to businesses.

THE FEDERAL RESERVE PLAN

The unfolding market shock and economic crisis wrought by the coronavirus has the Federal Reserve busy. “While great uncertainty remains, it has become clear that our economy will face severe disruptions,” the Federal Reserve said as it revealed the plans to stabilize the economy. “Aggressive efforts must be taken across the public and private sectors to limit the losses to jobs and incomes and to promote a swift recovery once the disruptions abate.”

The Federal Reserve says it will buy bonds and mortgage-backed securities “in the amounts needed” to keep markets working smoothly, unveiling a plan that also includes measures to make sure credit is available to businesses and consumers. The open-ended plans escalate an earlier emergency move that called for the Federal Open Market Committee to buy at least $500 billion in Treasury securities and at least $200 billion in mortgage-backed securities.

Federal Reserve Chairman Jerome Powell admitted Thursday that the U.S. economy may be slipping into a recession but said the long-term outlook will depend on how quickly the coronavirus pandemic is contained. “We may well be in a recession,” Powell said on NBC. “But I would point to the difference between this and a normal recession. There is nothing fundamentally wrong with our economy. Quite the contrary. We are starting from a very strong position.” The Fed introduced a wave of unprecedented stimulus measures this month, including slashing interest rates, pledging to buy unlimited bonds, and instituting credit programs for companies as businesses struggle to remain afloat while the coronavirus outbreak slashes economic activity around the country.

CONCLUSION

While no one has seen a situation quite like the mass global shutdowns spurred by the Coronavirus, history does speak to the importance of staying invested through severe market turbulence as best days often follow the worst. Diversification can show some of its greatest benefits in the most difficult times. Staying disciplined through all of the volatility is critically important—now more than ever.

Click HERE to read more about the economic impact of the virus.

Click HERE to view a timeline of the virus.

Important Disclaimer

Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. Callan Capital outsources to lending and financial institutions that directly provide our clients with, securities based financing, residential and commercial financing and cash management services. For more information, please refer to our most recent Form ADV Part 2A which may be found at http://www.adviserinfo.sec.gov. The S&P 500, or simply the S&P, is a stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices, and many consider it to be one of the best representations of the U.S. stock market.

January 2018 Market Update

In 2017, investors relished in solid economic growth, combined with abnormally high market returns, low unemployment and low market volatility. For the year, the S&P 500 increased 21.8% and the FTSE All World Ex-Us Index was up 24.40%. Investors watched as the Trump administration completed its first year in office, hurricanes ravaged parts of the country, and a tax reform bill was passed. In 2018, we expect GDP growth to accelerate, unemployment to decrease, interest rates to rise and inflation to increase slightly as the Tax Cuts and Jobs Act of 2017 takes effect.

 

Capital Markets Review

January 1, 2017 – December 31, 2017 index returns[1]:

 

S&P 500 (U.S. Large Cap): 21.8%

Russell 2000 (U.S. Small Cap): 14.6%

MSCI EAFE (Developed International Markets): 25.6%

MSCI EME (Emerging Markets): 37.8%

Barclays Capital Aggregate (U.S. Fixed Income): 3.5%

Barclays Global High Yield Index: 10.4%

Bloomberg Commodity Index: 1.7%

 

U.S. Economy

The U.S. economy has been steadily expanding for 9 years.  In the third quarter of 2017, real GDP increased at an annual rate of 3.1%. Total nonfarm payroll employment increased by 148,000 in December, and the unemployment rate was unchanged at 4.1%. In December, the ISM Manufacturing Index rose to 59.7, from 58.2, leaving it close to a 13-year high. We believe the Federal Reserve, with new Fed Chair Jerome Powell, will likely raise rates a few times in 2018 as the global economy continues to improve. The Fed estimates about 2.5% growth in 2018, which we believe is conservative.

In 2017, most major currencies appreciated against the U.S. dollar, which has a positive impact for investors with international investments. The yield on the 10-year Treasury is 2.5%, and we expect this to rise, however at a slower rate than short term interest rates. As a result, the yield curve will likely flatten.

Right before Christmas, President Trump passed the Tax Cut and Jobs Act of 2017, which gives various tax cuts to individuals and corporations in addition to other tax related changes. For a comprehensive review of the changes, and implications for the economy, portfolios, please see the Callan Capital Guide: Tax Cuts and Jobs Act of 2017.

 

Global Economy

Globally, growth and manufacturing is strong. In the eurozone, GDP growth and earnings are solid. Both reflation and rejecting the populist movement have been instrumental in sustaining the recovery that is ongoing. We see this as a tailwind to eurozone financial markets and international returns. We are keeping an eye on Brexit negotiations and the elections in Italy in the first quarter of 2018. As mentioned in prior communications, we increased international exposure in 2015, and our portfolios have benefited.

The Asia Pacific region had a good year, with solid growth and Chinese demand. We see a need to be cautious with China, as they are dealing with high debt levels. Hopefully, they will be able to de-lever by gradually tightening credit. However, China has a goal of doubling GDP per capita, and moving towards a consumption led economy, which will benefit many countries in the region[2].

 

What to Expect in 2018

We expect the U.S. economy in 2018 to benefit from the Tax Cuts and Jobs Act of 2017, but the benefits could be short term. Eventually, we feel that the increases in our federal deficit resulting from the tax cuts and increased spending will hinder growth in future years.

In 2018, we see unemployment decreasing to below 4% for the first time in 50 years and a boost in profits and earnings for corporations around the globe. It will be interesting to see how companies deal with tax cut savings, and where they allocate their funds.

This economic backdrop bodes well for stocks and is typically a headwind for fixed income given higher interest rates.  We feel much of this story is priced into the stock market and expect more muted returns and higher volatility as we move into the later stages of our U.S. recovery.  We are more optimistic about the opportunities overseas given the relative valuations.

Market performance in 2017 reminds investors that it is important to align with an investment philosophy based on discipline and diversification, rather than timing and prediction. To be able to predict the market, investors would have to both accurately forecast events and how markets will react to those events.  We believe that this is risky, and not possible on a consistent basis.

We continue to monitor the global economy and seek opportunities to invest in certain sectors and geographic regions given the current market environment. In our view, a long-term investment horizon, asset allocation, diversification and discipline remain crucial to portfolio success. If you are a client and would like further detail on these topics or anything else, please call or email us. If you are not a client, but would like more information on Callan Capital’s wealth management services, please contact us at (858) 551-3800 or www.callancapital.com.

 

[1] JP Morgan, Guide to the Markets, December 31, 2017, www.jpmorgan.com

[2] 2018 Global Market Outlook, Russell Investments. January 2018.

 

Important Index Descriptions and Disclaimers

PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS

INDEX DESCRIPTIONS:

The following descriptions, while believed to be accurate, are in some cases abbreviated versions of more detailed or comprehensive definitions available from the sponsors or originators of the respective indices. Anyone interested in such further details is free to consult each such sponsor’s or originator’s website.

The past performance of an index is not a guarantee of future results. Each index reflects an unmanaged universe of securities without any deduction for advisory fees or other expenses that would reduce actual returns, as well as the reinvestment of all income and dividends. An actual investment in the securities included in the index would require an investor to incur transaction costs, which would lower the performance results. Indices are not actively managed and investors cannot invest directly in the indices.

S&P 500®: Standard & Poor’s (S&P) 500® Index. The S&P 500® Index is an unmanaged, capitalization – weighted index designed to measure the performance of the broad US economy through changes in the aggregate market value of 500 stocks representing all major industries.

Russell 2000 Index: An index measuring the performance approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. The Russell 2000 serves as a benchmark for small-cap stocks in the United States.

EAFE Index: An index created by Morgan Stanley Capital International (MSCI) that serves as a benchmark of the performance in international index has been in existence for more than 30 years.

EME Index: An index created by Morgan Stanley Capital International (MSCI) that serves as a benchmark of the performance in global emerging markets. It is a float-adjusted market capitalization index that consists of indices in 21 emerging economies.

Barclays Capital Aggregate Bond Index: An index maintained by Barclays Capital, which took over the index business of the now defunct Lehman Brothers, and is often used to represent investment grade bonds being traded in United States. It is an unmanaged index considered representative of fixed-rate, noninvestment-grade debt of companies in the US, developed markets and emerging markets.

Barclays Global High Yield Index: An index maintained by Barclays Capital.

Bloomberg Commodity Index: A broadly diversifiedcommodity price index distributed by Bloomberg Indexes.  It tracks prices of futures contracts on physical commodities on the commodity markets. The index is designed to minimize concentration in any one commodity or sector. It currently has 22 commodity futures in seven sectors.

DISCLAIMERS:

Nothing contained herein is intended constitutes accounting, legal, tax advice or investment recommendations, or the recommendation of or an offer to sell, or the solicitation of an offer to buy or invest in any investment product, vehicle, service or instrument.  Callan Capital does not provide individual tax or legal advice. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. For more information, please refer to our most recent Form ADV Part 2A which may be found at adviserinfo.sec.gov.

Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without previous notice. All information presented herein is considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect to any error or omission is accepted.  This information should not be relied upon by you in evaluating the merits of investing in any securities or products mentioned herein.  In addition the Investor should make an independent assessment of the legal, regulatory, tax, credit and accounting and determine, together with their own professional advisers, if any of the investments mentioned herein are suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation and investors may not get back the full amount invested. Both past performance and yield may not be a reliable guide to future performance. The information presented herein is for the strict use of the recipient and it is not for dissemination to any other third parties without the explicit consent of Callan Capital LLC.

Second Quarter Economic and Market Update

Overview

The start to 2015 was characterized by modest returns and increased volatility across most capital markets. Headlines focused on low oil prices, a rising dollar, quantitative easing abroad, the humanitarian crises in the Middle East and Africa, and renewed fears of a Chinese slowdown.

Undoubtedly, low oil prices have not only hit the energy sector, but they have depressed corporate earnings in the U.S. and hurt emerging market economies dependent on commodities. The unexpectedly sharp increase in the dollar was a drag on corporate earnings and U.S. economic growth. However, these are short-term reactions and likely will correct themselves over the longer term: low energy prices benefit the global economy more than they hurt it and a strong dollar helps U.S. consumers and foreign nations dependent on exports, such as the Eurozone. Despite this short-term volatility, a well-diversified portfolio posted gains in the first quarter.

Capital Markets Review

1st Quarter Index Returns[fusion_builder_container hundred_percent=”yes” overflow=”visible”][fusion_builder_row][fusion_builder_column type=”1_1″ background_position=”left top” background_color=”” border_size=”” border_color=”” border_style=”solid” spacing=”yes” background_image=”” background_repeat=”no-repeat” padding=”” margin_top=”0px” margin_bottom=”0px” class=”” id=”” animation_type=”” animation_speed=”0.3″ animation_direction=”left” hide_on_mobile=”no” center_content=”no” min_height=”none”][1]:

  • MSCI EAFE (Developed Foreign Markets): 5.0%
  • Russell 2000 (U.S. Small Cap): 4.3%
  • MSCI EME (Emerging Markets): 2.3%
  • Barclays Aggregate (U.S. Fixed Income): 1.6%
  • S&P 500 (U.S. Large Cap): 1.0%
  • Barclays High Yield (U.S. High Yield Fixed Income): 0.6%
  • Dow Jones-UBS Commodities Index: -5.9%

Most of the major indices posted positive returns for the first quarter, with foreign markets leading the way – a turnaround from disappointing returns in 2014. The S&P 500 went from leader to laggard, with small caps beating large. In general, small cap stocks have less multinational exposure, and therefore were not as impacted by a strengthening dollar and other global headwinds, such as muted demand[2]. Surprisingly, Treasuries also outperformed the S&P 500, likely due to continued demand for U.S. bonds over lower-yielding foreign sovereign debt. Commodities continued to be dragged down by low oil prices, low inflation, over-production and decreasing global demand.

The U.S. Dollar

The dollar has been slowly moving upward over the past 4 years after a steady decline following the tech bubble, but jumped about 20% in the past 8 months[3] on an aggregate basis against foreign currencies.

USD Picture for the Q2 Market Update
Value of USD

The forces of supply and demand fundamentally determine the value of the dollar. The supply of the dollar is no longer increasing as the Fed’s easy money policy, known as quantitative easing (QE), has ended, and the demand for U.S. dollars has gone up for a number of reasons. First, the U.S. has been one of the strongest economies in the world and is attracting lots of foreign capital. Second, increased oil production here means we are importing less oil and fewer U.S. dollars are flowing abroad. Finally, domestic fiscal policies to reduce government spending and increase tax revenue have improved federal finances, and QE initiatives abroad have reduced the yields on foreign sovereign debt; investors seeking safety are flocking to the U.S. Treasury market, which increases the value of the dollar[4]. 

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Is This the Beginning of the Next Bear Market?

Many investors fear another bear market is looming with the most recent pullback off the stock market highs in September. A bear market is typically defined as a market decline of 20% or more. There are many factors that could signal the start of a bear market – but bear markets typically happen in and around recessions, rather than in the middle of economic recoveries, such as the one that we believe we’re in now. We feel current market activity is more indicative of a classic correction within an ongoing bull market, rather than the start of a new bear market. Corrections are different from bear markets in that they start sharply (think triple-digit daily declines in the market), are usually based on sentiment-based fears rather than fundamentals, and are short in duration. Bear markets tend to start more slowly and are usually a result of deteriorating economic fundamentals, which is not the environment we are in right now.

The U.S. Economy

The U.S. economy rebounded nicely in the second quarter after a disappointing first quarter decline, posting 4.6% annualized GDP growth. As we’ve mentioned in prior communications, the decline in the first quarter was largely attributed to the severe winter weather on the East Coast and as a result, did not cause a lot of market volatility. Though the third quarter GDP numbers won’t be available for a few weeks, economic analysts believe the economy will grow at approximately 3% (annualized) over the next few years.[fusion_builder_container hundred_percent=”yes” overflow=”visible”][fusion_builder_row][fusion_builder_column type=”1_1″ background_position=”left top” background_color=”” border_size=”” border_color=”” border_style=”solid” spacing=”yes” background_image=”” background_repeat=”no-repeat” padding=”” margin_top=”0px” margin_bottom=”0px” class=”” id=”” animation_type=”” animation_speed=”0.3″ animation_direction=”left” hide_on_mobile=”no” center_content=”no” min_height=”none”][1]

Importantly, all of the leading economic indicators point to a continued recovery. For example, auto sales are well above average at 17.5 million units per year, and pent-up demand in housing will likely drive housing starts above the current 950,000 homes per year. Capital goods orders continue to climb as companies deploy more of the cash that’s been piling up on their balance sheets, and there will likely be no additional austerity measures put in place by the government.

The U.S. Bureau of Labor Statistics’ latest jobs report shows that 248,000 jobs were added during September and the unemployment rate decreased again, to 5.9% – both were better than expected.  We’re now close to the Fed’s target for full employment: 5.4% unemployment. Many Americans don’t realize we are now below the historical unemployment rate of 6.1% and we’ve added 10.3 million jobs in the past 5½ years – more than the 8.8 million jobs that were lost during the recession. The percentage of part-time workers (of the total labor force) has declined from 6% in 2010 to 4.7% today, and average hourly earnings are up 2.5% year-over-year. However, labor force participation has declined from 67% of the population in 2000 to 63% of the population today and will likely not recover for many years. This is attributable to a shift in demographics, as Baby Boomers exit the workforce and the overall population ages.

 

Job Growth (total non-farm employees)

Job Growth Chart
Source: http://research.stlouisfed.org/fred2/series/PAYEMS/ (as of 10/03/2014)

 

As we approach full employment, inflation risks increase. This is a classic result of supply and demand forces at work: as the supply of available and desired labor decreases, workers demand greater compensation. Higher wage growth is one of the factors that leads to increasing prices, which leads to inflation. The Fed will have a difficult balancing act in the coming years of increasing interest rates fast enough to mitigate inflation, but not too fast to detract from economic growth.

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Preparing For More Tempered Returns as the Federal Reserve Ends the Quantitative Easing Program

As we enter the second half of 2014, we have a more tempered outlook on our market return assumptions. We feel volatility will increase as the Federal Reserve transitions from a provider of liquidity to a retractor of liquidity by ending their quantitative easing program and ultimately raising interest rates in 2015. While this may sound counterintuitive, we believe the economy will continue to improve. Although volatility and the risks of corrections have increased, we feel a highly diversified portfolio will continue to significantly outperform cash over the next several years.

In 2014, U.S economic growth faced an uneven start. The weakness was attributed to one of the worst winters in decades, low capital spending by corporations, reduced government outlays and depressed consumer activity. Fortunately, as we anticipated earlier this year, each of these trends has begun to improve, which should benefit economic growth for the remainder of the year.

Domestic Economy Shows Signs of Strength

Corporations are reaching higher levels of capacity utilization and employment, both of which should increase investment spending. As a result, we have seen a dramatic uptick in merger and acquisition activity.

Thanks to a boom in domestic energy production, our country has become more energy independent and imported goods have slowed. This reduction in imported goods should help lift domestic economic output.

With the federal budget deal in place, another fiscal cliff or similar Washington slowdown appears unlikely. In 2013, falling government spending was a significant drag on our economy, but this challenge is largely behind us in 2014.

Unemployment Falls and Consumer Spending Increases; Housing Market Temporarily Slows

In more good news, the unemployment rate has fallen faster than the Federal Reserve anticipated and is now within one percent of their long-run target for full employment. Part of this fall can be attributed to decreasing labor force participation, but job creation has been the main driver. Approximately 8.8 million jobs were lost in the 2008 downturn, while 9.4 million have been created in the recovery. These jobs will continue to help drive the economy through consumer spending.

On the subject of consumer spending, U.S. consumers have reached new records of household net worth which provides fuel for consumption. In addition, low interest rates have provided an opportune time to lock in fixed rate financing—another key that could help propel spending for years to come.

The June housing starts report showed a 9.3 percent drop month-over-month to 893,000, while building permits fell to 963,000. Although this was a disappointment, we predict the trend will reverse itself thanks to low home inventories and mortgage rates. In addition, home construction and purchases that were delayed due to weather in the first quarter will likely occur later in the year.

Quantitative Easing (QE) Program Nears End

The Federal Reserve has stated they will stop their controversial quantitative easing (QE) program by ending the bond purchase program later this year. This should put upward pressure on interest rates, but the trend could be slower than most anticipate as the Fed continues to reinvest their current portfolio while bonds mature. The Fed has indicated that they will begin to increase the overnight lending rate approximately six months after the end of the QE program, which would be sometime between the first and second quarter of 2015.

Critics have suggested that the Fed’s QE program has fueled the market rally over the past several years. We agree that some of our recovery was due to increased liquidity, but perhaps more significantly, strong earnings have been the most important factor. Even during the first quarter of 2014, which had one of the worst economic growth rates since the recovery began, profits rose six percent year-over-year. With the second quarter earnings season under way, 76 percent of those companies that have posted results have beat their analysts’ forecasts for earnings and 67 percent have exceeded their sales forecasts, according to data compiled by Bloomberg.

Valuations Invite Tempered Expectations

Although the U.S. economy seems likely to slowly improve in 2014, it is difficult to get excited about valuations of marketable securities. Whether you use the price earnings multiple or any other valuation metric, the markets in general are clearly not as cheap as they once were. That said, they do not appear to be particularly expensive either. Given current valuations, investors should temper their expectations for meaningful returns in the U.S markets over the next 12 to 24 months.

Global Economic Health Warrants Cautious Optimism

Looking overseas, emerging markets remain attractive long-term investment opportunities, but there are some short-term concerns. Long-term growth is driven by growth in the labor market and increased efficiency. With a young workforce, high levels of investment, and lower debt loads, the emerging markets remain attractive in each of these areas. In addition, valuations of emerging market stocks are more favorable than in the majority of the developed world.

European equities look very attractive relative to the Unites States. Europe had a double-dip recession and, as a result, has had a much slower recovery. The unemployment rate in Europe recently peaked at 12 percent, which is a lagging indicator of economic growth. Earnings in the United States are 18 percent higher than the peak of 2007, while European earnings are 25 percent lower. The eurozone is in the early innings of economic expansion relative to the United States. As a result, the equities have greater potential to outperform. Therefore, we have reduced our United States equity exposure in favor of Europe.

Conclusion: Economic Fundamentals are Slowly Improving, Return Expectations are Moderating

The probability of a bear market still seems remote, barring an economic shock from a geopolitical or other unexpected event. Bear markets typically emerge from tight liquidity, deteriorating fundamentals and investors’ extreme euphoria, none of which are present today.  Although we are entering into an era in which the Fed will be reversing course and could potentially raise rates in 2015, there are no signs of significant tightening of liquidity. Instead, there are now signs that private sector credit growth could start to replace the Fed as a supplier of liquidity. Economic fundamentals seem to be slowly improving and we do not see signs of extreme euphoria in the investment community as many people remain nervous.

Still, market volatility is likely to increase and total returns are likely to fall as equity valuations rise and the Fed adopts less-accommodative policies. On average, market corrections of 10 percent happen every year and we have not experienced a decline of this magnitude since 2012. Investors should stay focused on long-term market fundamentals and broadly diversifying their portfolios.

 

First Quarter U.S. Stock Returns and Ongoing Fed Policy Changes Point To Continued Importance of Diversification

By: Tim Callan

In this year’s first quarter, growth in the stock market slowed significantly. The S&P 500 rose just 1.8 percent over the past three months, following a year in which the S&P 500 rose more than 32 percent. Recently, the most common question we hear from investors is, “Is the stock market overvalued?”
A decent-sized pullback would not be a surprise, given the past four years of upward momentum. After tremendous growth in equities, valuations by virtually every measure are back to long-term averages. The forward price-to-earnings multiple is 15.2 times forward earnings, while the 15-year average is at 16. We can no longer make the case that stocks are cheap on their own; however, when compared to competing asset classes like bonds, they remain attractive in the long term. When interest rates are low, stocks tend to have higher-than-average valuations because bonds are not paying investors enough yield. On a positive note, there is $10 trillion in cash sitting on the sidelines, which should help fuel further equity growth. Still, our expectation for stock market returns over the next three to five years is in the mid single digit range, below the historical average of 11 percent.

Though the overall economy continues to grow at a very slow pace, we are approaching five years of economic growth, which makes this the fifth longest economic expansion since the Civil War. There is very little evidence of economic growth being derailed in the near term. Overall household net worth has never been higher, which continues to drive consumer spending. Meanwhile, with the sequestration subsiding, government spending is expected to increase as well. However, we expect first quarter GDP growth to be around 1 percent, well below our 3 percent expectation for the year primarily due to weather-related effects.

Unemployment continues to trend lower, confirmed by the March report of an additional 192,000 jobs and an unemployment rate of 6.7 percent. We have now made up all of the 8.8 million jobs lost during the recession, an important milestone. Full employment is considered 5.4 percent so we still have a little ways to go. Our expectation is that we will reach a level of full employment by 2016 and that, until then, the Fed will keep the short-term federal funds rate extremely accommodative.

The Fed has already reduced the bond-buying program known as Quantitative Easing to $55 billion per month and we expect the program to end this year, putting additional downward pressure on bond prices and causing long-term interest rates to increase. We remain defensive in our bond portfolios and think this trend will continue for several years. Diversification outside the United States in fixed income securities is important to help protect against higher domestic interest rates.

Emerging markets remain attractive long-term investment opportunities, but there are some short-term concerns. Long-term growth is driven by growth in capital stock, growth in the labor market, and increased efficiency. With a young workforce, high levels of investment, and lower debt loads, the emerging markets remain attractive in each of these areas. In addition, valuations of emerging market stocks are the cheapest they have been in a decade. There is good reason for cheap valuations: China has been increasing its debt at about twice the rate that its economy is growing and has an overvalued housing market. However, valuations will eventually revert back to the mean, which will equate to a significant rally in emerging market stocks.

European equities look very attractive relative to the Unites States. Europe had a double-dip recession and, as a result, has had a much slower recovery. The unemployment rate in Europe is at 12 percent, which is a lagging indicator of economic growth. Earnings in the United States are 18 percent higher than the peak of 2007, while European earnings are 25 percent lower. The euro zone is in the early innings of economic expansion relative the United States. As a result, the equities have greater potential to outperform. Therefore, we have reduced our United States equity exposure in favor of Europe.

Growing Global Economy and U.S. Market Corrections Create Opportunity for Investors

By: Trevor Callan
Last week was another down week for Wall Street which led the U.S. stock market to its largest monthly loss in more than a year. After five straight years of stock market gains, many observers question whether the climb can continue in 2014. With the 2008 credit crisis still fresh in investors’ minds, skepticism has been further fueled by concerns over China and other emerging markets. We predict, however, that market corrections and the growth of the global economy will create opportunities for investors during 2014.

While no market is without areas of concern, we remain optimistic about U.S. economic prospects for the upcoming year, though rises may be less dramatic when compared with the record gains of the past year. After the recent run in prices, a correction in the equities markets is healthy and should be viewed as an opportunity to rebalance portfolios. We expect the major trends during 2014 to be very similar to those of 2013, with one exception: lower returns. Analysis of current market dynamics suggests that 2014 will be a year of continued global growth, higher stock prices, and generally lower bond prices as interest rates slowly rise. Global economic growth is expected to accelerate in the coming year, driven by accommodative central bank policies abroad and a reduction in the pace of austerity both at home and in markets throughout the world.

In the U.S., several indicators point to faster economic growth in 2014. Sales of housing and cars are climbing, and companies are increasing capital expenditures and hiring workers to meet increased demand. The average net worth per capita broke records in 2013, and housing affordability is at historic lows, which fuels spending. Given these positive signals, we believe 2014 will be very similar to 2013, favoring equities at the detriment of fixed income securities. Interest rates should slowly drift higher, and we will most likely experience higher corporate profits. Inflation should remain relatively low, though higher than in 2013. During the past year, valuation expansion drove abnormally high returns in riskier asset classes, including stocks and lower quality bonds, at the expense of high quality bonds and cash reserves. Over the next five years, we believe the days of valuation expansion are largely behind us, and equity returns will be driven by earnings growth resulting in much lower returns, likely less than 10 percent. Of the 251 S&P 500 companies that have reported fourth quarter results, 74 percent have beaten earnings expectations and 67 percent have beaten revenue expectations. After the weaker-than-expected December jobs report, the Federal Reserve cited “growing underlying strength in the broader economy.” Then, as expected, the central bank announced another $10 billion per month cut in its asset purchase program. We believe the Federal Reserve will continue to taper and ultimately end the controversial quantitative easing program, which will result in higher yields placing pressure on high-quality bonds. As a result, we will continue our strategy of holding short-maturity, high-quality bonds with some exposure to below-investment-grade bonds.

There is also good news for European and emerging markets. Experts predict that Europe, which is showing signs of a recovery, will emerge into a growth cycle for the first time since 2011. Equity valuations are still attractive and look similar to U.S. equities one year ago. The manufacturing index has shown Europe emerging from a recession, and their recovery is only just beginning. The European Central Bank will most likely continue to provide liquidity as the Federal Reserve in the U.S. slowly withdraws liquidity from the system. As confidence builds in Europe’s recovery, we expect to see valuations rise, making European equities attractive over the next three to five years. As a result, we are increasing our exposure to international equities and more specifically, European equities, in 2014.

In Japan, the world’s third largest economy, Prime Minister Shinzō Abe has long campaigned to end deflation and revive the country. The prime minister’s policies have led to a falling yen, rising earnings, and rising asset prices. These trends should continue over the short term but longer term risks remain over their enormous accumulated deficit.

Emerging markets should continue to grow as well, albeit at a slower pace than in 2013. Emerging markets are expected to shake off their 2013 slowdown and grow by 5.3 percent per year over the next two years. In the short term, emerging market equities will likely struggle due to weak governance and volatility associated with the U.S. continuing to taper, but they offer reasonable valuations for investors with a longer-term outlook. Chinese GDP growth slowed to 7.7 percent in the fourth quarter of 2013. Meanwhile, purchasing managers’ indexes for the country indicated that the fourth quarter slowdown may have extended into 2014, as Chinese manufacturing activity contracted during January. Risks remain as emerging markets are vulnerable to a major dollar upswing and falling commodity prices.

In general, we favor the same asset classes that showed strength in 2013: equities; high yield bonds; and real estate. Equities should benefit from faster global economic growth, low inflation, accommodative central banks, and low but rising interest rates across the globe. We expect this year’s correction to provide an opportunity for investors to rebalance their portfolios into the asset classes that performed well in 2013. Although we expect the economic trends of 2013 to continue in 2014, we expect much lower average returns, as the valuations have increased dramatically. Overall, a growing global economy and healthy market corrections will create an opportunity, not an obstacle, for investors this year.

Economic Update and the Political Standoff in Washington

The S&P 500 had a great 3rd quarter—up 5.2% and 19.8% for the year—as the economy continued to show signs of improvement. As a result of the growth in stocks and real estate, along with the reduction of interest rates, overall household net worth hit a new record of $76 trillion, surpassing the high set in 2007 by $8 trillion. With the tremendous growth in equities, many investors question their valuation.

Stocks closed the quarter at a 14.3 times price to forward earnings multiple. That’s a slight discount to the average since 1985 of 14.9 times earnings. It’s rare that the market would peak at historical average valuations, as investor optimism generally pushes equities significantly higher before they fall. However, with earnings growth slowing and the equity markets approaching fair valuation, we do not anticipate the robust equity growth we’ve experienced in the last 3 years.

Bonds, particularly treasuries, remain expensive despite a selloff in the 3rd quarter. The yields on treasuries bottomed at 1.7% early in the year and have increased nearly a full point to 2.61%. This has caused the housing refinance market to slow considerably, as many homeowners locked in record-low long-term rates. However, there continues to be a housing shortage in the U.S.; the number of homes for sale is at 2.3 million, among the lowest in 30 years. In addition, housing starts are at 891,000, well below the average of 1.4 million. As a result, we continue to believe real estate will appreciate, albeit at a much slower pace as mortgage rates increase.

We expected the Federal Reserve to taper the quantitative easing program in September, which it did not do. The Fed continues to buy roughly $85 billion of bonds per month from banks in an attempt to keep rates low and keep the economy growing. We do have concerns long term about this program and its ability to increase inflation and deflate the value of the dollar. However, with core inflation at 1.8%, the risk will not likely present itself until the economy shows much higher growth.

The unemployment rate continues to decline as the economy adds roughly 180,000 jobs per month; it’s now at 7.3%, down from a peak of 10% in October 2009. In addition to added job growth, we’ve seen the overall labor force decline from 66% in 2007 to 63.2% today. Part of decline is disgruntled workers and young Americans staying in college, but the vast majority of the labor force decline is due to a demographic shift. The Baby Boomer generation is reaching retirement age, putting downward pressure on the labor force. We expect the labor force to increase in the coming years at a slow pace. If the addition of jobs continues, we should be at a 6.5% unemployment rate by mid-2014, the rate at which the Fed indicated it will likely end the quantitative easing program.

What’s Happening Now

There are significant risks to economic growth that have emerged in the last two weeks that can possibly derail the economy. House Republicans and Senate Democrats have not reached an agreement on the budget, causing non-vital areas of the government to shut down and the markets to sell off about 4% from the peak. This political gamesmanship has the potential to cause devastating economic effects, particularly if the debt ceiling is not raised by October 17. The news today is a proposal by House Republicans to extend the debt ceiling for another six weeks but keep the government shutdown in place. The White House insists that Republicans must also agree to end the government shutdown. Stocks rallied on the news, but this is far from a done deal.

The U.S. government has a projected borrowing amount of $642 billion for fiscal year 2013 or about 19% of its total spending budget of $3.5 trillion. If the government doesn’t raise the ceiling, it will have to immediately reduce spending to match the level of tax receipts—which will have potentially devastating consequences. In that scenario, the treasury will likely prioritize spending and continue to pay the interest on government debt to appease bondholders and maintain stability in the U.S. debt market. After all, interest payments to bondholders represent less than 10% of tax receipts. However, under this scenario, it will likely not have the funds to pay the full amount of Social Security obligations to seniors and veterans benefits on November 1. Given the fact that foreign countries own about half our government debt, the headlines would see that as favoring foreigners over seniors and veterans.

We feel some agreement will be reached close to or shortly after the October 17 deadline, perhaps to extend the implementation of parts of Affordable Care Act short term in exchange for funding the government and increasing the debt ceiling. However, the longer this plays out, the more damage it can cause. We feel risk assets such as stocks will have downward pressure until an agreement is reached, at which point they will rally.

We believe the best antidote for volatility and uncertainty is diversification, and ultimately, common sense will prevail. Unfortunately, the road toward a solution will be volatile and frustrating. We remain cautious short term in light of the current political pressure.