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Yoshikami: 7 Issues That Matter Most

Each midyear I think it's important to review the critical issues that impact investors. What follows are my thoughts on headlines that affect the economy and investment strategy.

1. Deficit ceiling

Politics once again rules the day as the deficit ceiling is used as a political football to push legislative philosophical agendas. If the United States does not increase the debt level ceiling, there will be a technical bankruptcy potentially impacting the payment of Social Security as well as Treasury interest. A scary headline indeed.

Of course, the reality is United States is already bankrupt which is what a deficit is; not have enough revenue to cover your current expenses. The United States has the luxury of having a currency that is still in demand and, for that reason, a technical bankruptcy has not occurred. I expect that the debt ceiling level will be raised at the last minute after much finger-pointing. It might be at 11:45 PM right before the expiration of the current debt level figure, but cooler heads will prevail. Okay…… maybe the heads are not so cool but instead pragmatic as neither party wishes to be labeled as a Social Security check killer.

The overhang in the markets based on this issues is significant as this uncertainty floats and the politicians just seem to be completely ignorant that sentiment is influenced by the unknown. Politics…….sigh.

2. Quantitative Easing 3

Quantitative Easing 2 just ended in June and in this week's Federal Reserve testimony, the point was clearly made By Ben Bernanke that additional easing and stimulus measures might be taken by the Fed if unemployment remains stubbornly high. What, you might ask, can the Fed possibly do if interest rates are already at zero?

Ben Bernanke, Federal Reserve Chairman
AP
Ben Bernanke, Federal Reserve Chairman

In truth, the Fed can do a great deal.

Regulations, in terms of reserve requirements, and interest rates charged to member banks can be adjusted. Other changes can be implemented so that loans will be more profitable for the financial institutions. The Fed can flood the system with money by buying instruments. The Fed can use its bully pulpit to talk up the markets. Shockingly, this can have a significant effect on investor and consumer sentiment. Consumer companies like Apple and Coach benefit when sentiment is strong.

Right or wrong, we have an activist Fed. And you can expect that the Federal Reserve will be interventionist in its leanings and do everything in its power not to have a repeat of 2008. "Not on my watch"is the operable phrase and mantra of Chairman Bernanke.

Is this a good strategy for the long-term? It remains to be seen. Many of the techniques currently being discussed have never been used in US history and so the results and benefits are theoretical at this point. But get ready for these measures anyway; we expect the economy to remain weak and, for that reason, the Fed will insert itself into free-market activity.

3. Dollar weakness

The dollar is weak due to sentiment as well as low interest rates. Investors around the world are not fond of earning virtually nothing and are flooding countries outside of the United States with investment dollars. This is problematic on the long-term for the United States as a weaker dollar tends to lead to lower standard of living levels and this is a real risk for the United States on the long-term.

Of course, dollar weakness has its benefits. In particular, exports are cheaper for foreign purchasers and therefore help the manufacturing sector in the United States. Even services, which make up a significant part of the US economy, benefit from a weak dollar. Technology consulting companies, for example, are paid in stronger currencies and that tends to help in selling services outside the United States. Caterpillar and IBM quarterly results demonstrate that benefit of non U.S. sales.

I expect the dollar on the short-term to strengthen as interest rates begin to trickle upward. Still, longer-term, the US Dollar as well as the Euro is a flawed currency as deficits never make for great long-term fiscal fundamentals. For that reason, emerging markets will continue to gather strength as surplus nations capture more of global economic growth.

4. Market Fluctuation

Yes, the market is fluctuating. It's crazy to see a market rise of 100 points for no reason and the next day drop 100 points based on a whisper of a rumor. But get used to it; fluctuation is part of investing going forward as technology allows investors to panic on a real-time basis. Additionally, global investors can now trade around the world and that increases the number of investors buying and selling securities. Volatility is here to stay.

5. European Fiscal Drama

First Ireland. Then Greece. Now Italy and maybe Spain, Portugal, and maybe others. Yes, Europe is having issues and it is surely impacting European GDP. Imagine what happened in the United States with banks and you have a reasonable comparison for what is occurring in Europe with countries. It's a troubled zone to be sure.

I do not expect that the Euro will go away; there is simply too much time and money invested by Germany, France, and other stronger countries for this trading currency to evaporate. Likewise, all of Europe is not going to collapse. But I do expect that you will continue to see headlines declaring more problems. It’s coming; watch.

The European Central Bank led by Claude Trichet is much less activist than Ben Bernanke and the United States Federal Reserve. For that reason, expect the European Union to be more involved in trying to shore up finances in the region. Action will be taken but likely on an incremental basis; the Europe drama will likely drag on for not months but years.

6. China Inflation

China this week reported GDP growth stronger than many analysts expected but in line with our estimates. With growth still hovering approximately 9%, China is still a rapidly economy despite the slowdown in exports. There is a spillover effect for other countries around China as the entire region participates in a shifting of global GDP growth.

Inflation in China is problematic as it is greater than 5% and China ‘s central bank continues try to rein in inflation. The results have not been completely effective. Real estate prices are still frothy and there is excess euphoria in the real estate market. So there are issues that cannot be ignored.

I believe China growth will continue and that the middle class will expand faster than many expect. But the days of 15% growth are likely over. If your best customers are struggling (the United States and Europe), exports are sure to struggle as well and that will mean growth rates of sub 10% going forward.

7. Energy Prices

Oil prices have stabilized and we can now celebrate only paying $3.75 per gallon for gas in the United States (a sarcastic hooray for sure). Still, prices stabilizing rather than continuing to rise is a positive for the economy. We will take the good news where we can get it.

I find it difficult to imagine a scenario where oil drops down to under $80 a barrel on a consistent basis; higher energy prices are likely here to stay. This will be a further headwind for GDP growth and is one of the reasons why we forecast subpar US growth; energy prices will hinder economic expansion. Of course, Exxon and Chevron will benefit for any price above $80 a barrel. While some companies are hit because of high energy prices, energy companies are reaping a massive windfall.

Unfortunately, $90 to $100 a barrel oil prices are not high enough to cause a strong rush towards alternative energy. While our earth needs renewable resources to be a bigger part of the economy, financial constraints could very well limit aggressive development of alternative energy technology. This would be a bad move in our view. The United States needs to find its next big growth engine and alternative energy could fit the bill quite nicely

Change is Here To Stay

There is no shortage of headlines and drama. And maybe it's me, but it seems like it's been that way for years. Credit the rapidly changing global environment and the distribution of information at the blink of an eye. Change is here to stay and with hyper-speed transmission of information, the headlines will come fast and furious.

Such is the world we live in; there's no turning back. The information age is here with all of its resulting negative consequences. Adjust as needed; you really have no choice.

Michael Yoshikami, Ph.D., CFP®, is CEO, Founder and Chairman of YCMNET's Investment Committee at YCMNET Advisors. Founded in 1986, YCMNET is a San Francisco Bay Area-based independent money management firm that provides fee-based wealth management services to institutional investors and individual investors. The firm works with clients around the world. Michael was named by Barron's as one of the Top 100 Independent Financial Advisors for 2009 and 2010. He oversees all investment and research activities of the firm and is actively engaged on a daily basis in the firm's securities analysis activities and determines the macro tactical asset allocation weightings for client portfolios. He works with YCMNET's investment team in integrating behavioral investing strategies with the firm's core fundamental perspective. Michael holds a Ph.D. in education, other advanced degrees, and holds the Certified Financial Planner® (CFP) designation.

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