June 2011

Shower the People You Love with Love

My wife and I went to a James Taylor/Carole King concert last year. It was one of the best dates we have had in some time. It was a warm summer night, and my lovely bride and I were at the Seattle Center, along with thousands of other folks like us who grew up in the 70s. My wife and I and the rest of the audience sang along with almost every song of two of the best singer/songwriters of that generation. We were awash in memories as we enjoyed some of the favorite music of our younger years. The highlight of the concert for me was when James Taylor and Carole King sang a duet of an all-time favorite, Shower the People. The chorus tells the whole message of the song, "Shower the people you love with love,

Tell them the way that you feel. Things are going to be much better if you only will.
To make a rather abrupt and crass allegorical jump, Ben Bernanke, the head of the Federal Reserve must have also listened to James Taylor in his youth as he seems to have crafted his US monetary policy based on JTs lyrics. Although in his case he is showering the people with US dollars in hopes that things will get much better. Quantitative Easing (QE) is one of the principal ways that the US economy is being showered with money. I wrote in detail late last year about QE and its potential impact on the US economy and markets. In an update to clients earlier this year we noted that the US government now owes more money to itself (via the Fed) than it does to any other single country, as the Federal Reserve recently passed up China as the largest owner of US debt . (If you need a refresher on QE, attached is, QE Will the Feds Financial Experiment Work? our original November 2010 e-mail explaining the subject in more detail.) You can see from this chart that QE, which started in early 2009, has caused an astonishing jump in the money supply in the US. More money has been created in the last 24 months than was printed since the beginning of the last century! This is a monetary phenomenon that is unprecedented in our country's history, and almost incomprehensible in magnitude.

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QE2 is Ending
The Fed just made an announcement about QE that is likely to be very impactful to our portfolios and the economy. The current phase of QE is scheduled to end on June 30th. In other words, the Federal Reserve has indicated that they will stop making purchases of new issue US Treasury bonds at the end of June just a few short weeks from now. One of the Feds money printing schemes will end when QE stops. What will the impact of this change in monetary policy have on us? No one knows, and we dont have any historical precedent to look at, as this has never been done before in the history of our country. In a very real sense we are all living through a grand monetary science experiment whose outcome is unclear and unknown. Economists have suggested several scenarios that might ensue as a result of the scheduled termination of what has been very excessive money printing through QE. Let's walk through each of these scenarios.

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1. Wishful Thinking Scenario

A first and perhaps least probable scenario is that the Federal Reserves policy of money printing has succeeded in fixing the economy. The Fed can then pat themselves on the back, shut down the printing presses, and the good doctor Bernanke can heave a sigh of relief that the US is back on track again. In order for this to occur, we need to see a significant improvement in employment patterns and an upswing in US housing, the two biggest drivers of the US economy. Unfortunately both of these vital areas are faring poorly. The US job situation is bleak and may even be detoriarating further. The official unemployment rate has been hovering at around 9%, the highest it's been in a generation. The unofficial rate however (Bureau of Labor and Statistics U6) pegs unemployment at closer to 16+ %, the highest level since The Great Depression. You don't need to be an economic student to understand that if there are lots of folks out of work or under-employed, that there is less money to buy cars, houses, or other goods, and in general generate the economic activity that makes the US economy go around. Housing is still very troubled. I don't need to repeat the many gloomy real estate related headlines that the newspapers carry every day, but in a country where foreclosures are still piling up, and where it has been estimated that almost 30% of every home in the US with a mortgage is under water, it is hard to see a recovery in the housing sector. In fact, recent reports indicate that prices are still dropping country wide and may continue to do so. The most skeptical and cynical of the economists point out that after two years of massive government stimulus of at least a trillion and a half dollars, that unemployment has barely budged an iota, housing prices are still dropping, and suggests that is a sign of how weak the US economy really is. The wishful thinking scenario is perhaps just that. It would be nice to believe that QE has produced a successful outcome and that the economy is getting better and perhaps no one hopes for that as much as me, but the probability of that occurring, especially in the next few months, is quite low.

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2. Stormy Weather Scenario

A second scenario is that the end of QE might produce stormy weather in the investment markets. The question many observers have posed is what if the gains in the markets over the last two years are due not to an actual recovery, but to the massive amount of money injected into the US financial system? If that is the case, then with the cessation of QE, we could se turbulence in our investments. It's possible that with the end of QE, interest rates will rise, which may cause bond prices to suffer. It's also possible that stock prices may increase in volatility and could drop in value. It is also quite likely that the weak dollar/inflation friendly investments we have in our portfolios (commodities, oil, and gold) may also suffer. The mildest outcome in this scenario might be what Bill Gross at PIMCO has dubbed "the new normal," a rather permanent environment of higher unemployment, lower growth rates, a continuation of de-leveraging, or paying off of debts, by consumers, businesses, and the US Government, resulting in a low-growth and low return environment for an extended period of time. The most extreme and violent outcome might be a retracement of the last two years of gains back to the beginning of QE in Spring 2009 a highly unpleasant thought.

3. Whoops, Maybe We Shouldnt Have Stopped Scenario

The third scenario is that sometime after the June 30th ending date of QE, we might experience the stormy weather in the investment markets previously mentioned. The Federal Reserve, which has demonstrated a fondness and a propensity for printing more money anytime something goes awry, might announce that they intend to come to the rescue again and re-start the money printing. The Feds rationale might be that they should have never stopped QE, and the problems in the markets are a confirmation of that. A few observations on the possibility of this occurring. Fed President Ben Bernanke has clearly articulated his foundational and dogmatic belief in the philosophy of printing more money as the key strategy for economic salvation. He has a number of supporters inside the Fed, most notably Janet Yellen, the president of the New York Federal Reserve Bank. Yellen was recently interviewed and said in very emphatic terms that she believed that the Fed must continue printing money until there are clear signs that things have improved. The biggest critic of Dr. Bernankes excessive money printing policy has been Kansas City Fed president Daniel Hoenig. Hoenig has stated that QE is a bargain with the devil. and has been the most outspoken detractor of the Fed's policies. Hoenig has announced his retirement which might remove some of the barriers for QE3 to continue. Additionally, 2012 is a presidential election year. The Fed has typically been very accommodating during presidential cycles, and they may want to preserve the status quo because of the elections. If the government does resume its egregious money printing policy by continuing QE, what might be the result? Again, no one really knows, but some knowledgeable market observers have suggested that an environment where billions of dollars are being forced into the economy on a monthly basis may

Shower the People You Love with Love Gevers Wealth Management, LLC Page 5 very well result in higher gold and commodity prices as well as being a favorable atmosphere for stock prices to also increase. We are walking through unknown territory in the investment markets, and it will be important to watch how these events unfold. As a point of clarification about QE2, the Federal Reserve is ending purchases of new US Treasury Bonds after June 30th. However, they have indicated that they will continue to reinvest their current holdings of treasuries as they mature. The bottom line is that there will be a continued, but smaller, stream of Fed money purchasing new treasuries even after June 30th, at a level estimated of perhaps 20% of the current rate of QE. In essence the Feds money-printing activities are not really ceasing completely, but they are slowing down dramatically. Another point to note is that although the rate of new money printing will slow dramatically after June 30th, that doesn't affect the tremendous amount of money that has already been injected in the economy and is still sloshing around the system with the potential for major impact.

How Does the US Budget Deficit Affect QE?

The US 2011 annual deficit is projected at about $1.5 Trillion dollars. To help put that into some kind of perspective, the entire US debt in 2000, that had taken decades to accumulate up to that point, was $5 Trillion. A deficit or shortfall of that magnitude causes the mountain of total US debt to increase very rapidly (It is currently $14.2 Trillion and rising.) The US government funds its deficit by borrowing (selling treasury bonds.) The larger the deficit, the more treasury bonds that needs to be

Shower the People You Love with Love Gevers Wealth Management, LLC Page 6 sold. If there are not enough buyers for the treasury bonds that means trouble as the US government needs to sell those bonds in order to obtain the money to keep going. The Federal Reserve started QE in order to help the US government fund the deficit. The Fed is currently buying about 70% of all treasury bonds being sold in other words the Fed is lending the US most of the money it needs to pay its monthly bills. If you find that confusing and difficult to understand you are not alone. So what happens after QE ends? And who will be buying all of those US treasury bonds in the future? And even more importantly, how come our leaders are not doing more to cut the deficit?

What about Gold?

Gold is the canary in the coal mine in the sense that a rising gold price is a signal that something is amiss with a countrys monetary system and currency. Gold prices were up about 30% per year in 2009 and 2010, and up about 8% year to date. A permanent cessation of QE might be negative for gold prices, while a resumption of QE might help fuel a continued rise in the yellow metal.

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http://research.stlouisfed.org/fred2/

Remember that although we have a significant gold exposure in our portfolios, we would like to see gold prices eventually drop permanently as that might be the canary singing that all is again well in the US financial system. I look forward to that day!

What Should We Do?

So what is the application for the retiree investor in the light of the uncertainty facing us after June 30th? It may be wise to revisit our cash and income needs, discuss any withdrawals that we will require in the near term future, and then follow up with a rebalance of our portfolio to create liquidity to fund those income needs. It is always smart investment planning to regularly revisit the risk levels in our portfolio and try and ensure we have an allocation that we are comfortable with or might at least tolerate if we do face some stormy weather. For those folks who are adding new money into investments, dollar cost averaging can be a friend in the face of uncertainty. Systematically adding to our investments every month may allow you to buy more shares when the markets are down. Remember that dollar cost averaging will not protect against loss, but may help an investor to weather volatility and acquire shares that are more favorably priced as the portfolio is built up and fully invested over time.

Shower the People You Love with Love Gevers Wealth Management, LLC Page 8 A fully and well diversified portfolio plan is more important than ever in times like these, and it may be especially significant to keep a weighting of weak dollar/inflation friendly assets in light of the state of the U.S. dollar. I look forward to reviewing the end of QE with you at our next review meeting. In the meantime, have a wonderful summer and please consider taking James Taylors words to heart and shower the people you love with love.

Warm Regards,

William R. Gevers Financial Advisor PS: If you happen to be a JT fan, the concert looked like this: http://www.youtube.com/watch?v=bteG4A1uptU

PPS: We have been repeatedly asked by clients if they could share these e-mail notes with their friends or neighbors. Please feel free to forward this with the stipulation that it may only be forwarded if done so in its entirety with no portions omitted. We would be delighted to share our comments and opinions with your friends, and welcome your comments and feedback. If you received this and would like to be included on our newsletter list, please email us at wgevers@geverswealth.com

Copyright 2011 William R. Gevers. All rights reserved.

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The views are those of William Gevers, Gevers Wealth Management, LLC, and should not be construed as individual investment advice. All information is believed to be from reliable sources; however, no representation is made as to its completeness or accuracy. All economic and performance information is historical and not indicative of future results. Investors can not invest directly in an index. Please consult your financial advisor for more information.

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