4th Quarter 2011 Commentary

7/31/2019 4th Quarter 2011 Commentary

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ECONOMIC OvEvIEw

The Yo-Yo Year

If you like volatility, then you surely loved 2011. TheS&P 500 was up 8% in late April, then declined 21%

through September and nally rallied back 14.5% in

the last quarter to nish the year where it started. Interest

rates fell precipitously in mid-summer as Greeces

troubles dragged on and the US government irted

with technical default. Ination continued to rise, with

the CPI increasing from 1.1% at the end of 2010 to

3.3% currently. Lastly, the US dollar almost mirrored

the stock market. It fell 8% through April, then rallied

back to end the year where it started.

For most of the year concerns about European Union

nancial problems overshadowed the markets. Meanwhile,

the US economy plodded along. Job creation was just

strong enough to keep unemployment steady and

companies saw their prots rise due to careful cost

control. In aggregate, companies of the S&P 500 posted

solid revenue growth of 8.0% and earnings per share

growth of 12.37%. As a result, the stock market valuation

is even more attractive today with the P/E ratio now at

13 times earnings. This is equivalent to an earnings yield

of 7.7%.

Politically, 2011 was a year of worldwide unrest driven

fundamentally by the difference between the haves and

the have-nots. The year began with the Arab Spring as

a wave of popular uprisings starting with revolution in

FOUTH QUATE 2011QUARTERLYCommentary

nsidethis Issue

CONOMIC OvEvIEw

: The Yo-Yo Year

ASSET MANAGEMENT

: A Wild Ride to Nowhere

EATUED EQUIT

: Paychex

IXED INCOME

: If It Sounds Too Good

to Be True

PECIAL TOPICS

: At Your Own Peril:

Online Banking

www.nelsonroberts.com | 650.322.4

Tunisia spread to Egypt and Libya. Civil uprisings alsooccurred in Bahrain, Syria and Yemen and major protest

occurred in Algeria, Iraq, Jordan, Kuwait, Morocco an

Oman. The rising cost of food (which accounts for 40

of the average citizens expenditures in these countrie

was often cited as a root cause of the unrest.

The summer brought us The Greek Problem: The

Sequel, with organized strikes and government shut

downs. The Arab Spring inspired the beginning of the

Occupy Movement with the protest on September 17

in New York Citys Zucotti Park. This spread to major

cities across the US and the developed world with the

cry of we are the 99% adopted after the Congression

Budget Ofce (CBO) reported that over the last 30 years

the after-tax income of the top 1% income earners h

tripled. This winter we are beginning to see the sprea

of protests and unrest in both Russia and China.

INDEX PEFOMANCE Q411 TD

Dow Jones Industrials 12.74 8.34

Standard & Poors 500 11.80 2.09

EAFE (international stocks) 3.40 -11.68Russell 2000 (small stocks) 15.46 -4.19

Barclays Interm. Gov/Credit 0.84 5.80

Barclays Municipal 2.13 10.70


2/6

1.45

1.40

1.35

December 31, 2010 December 30, 20111.50

JAN FEB MAR APR MAY JUN JUL AUG OCT NOV

1.2945

SEP

S&P 500 VERSUS EURO

1.30

2011 Bloomberg Finance L. P.

DEC

1100

1150

1200

1250

1300

1350

1257.6

out of control and nothing will be done in Congress

about either problem. Behavioral economics tells us th

people hate losing something more than they like receiv

something. Additionally, it is a human tendency to

want to keep what we already have even if the

replacement may be equivalent. These two principles

make entitlement reform extremely challenging under

the most auspicious political circumstances. In an electio

year, there is no chance at all of reform.

The Euro Unions problems will fade in and out of view

without a permanent resolution,

but should gradually show improv

ment. It will take a long time to

install the scal constraints for

which leaders in Germany andFrance are advocating. The Occu

Movement will strengthen in the

spring and become a vocally shrill

part of the election year rhetoric.

Unrest in the Middle East, Russia

and China will continue. In short

we see 2012 as a continuation a

strengthening of the trends

in 2011.

In the US, we expect the economy to continue to plod

forward, slowly building momentum. All the negative

listed above constitute the wall of worry which stock

prices will eventually climb, albeit not in a straight line

To us, the stock market is becoming more attractive

every day.

With the incessant focus on events in Europe and

elsewhere, the markets seem to have forgotten that

corporate earnings are what matter most. (Please see

our fall white paper The Euro Crisis in which we point

out that exports comprise 13% of the US economy,

only 2.6% of which go to Europe. This is truly a case

of the tail wagging the dog.)

We expect that rational thinking will eventually return

to drive stock prices but it may not return as early as

2012. A dysfunctional US government will become even

more so as we move closer to the November election.

Rhetoric will rise and compromise will fall throughthe year. We will probably see another scal cris is as

Republicans and Democrats use the federal debt

limit as a jousting tool in their political tournament.

Medical care and pension costs will continue to spiral

With the incessant ocus on Europe athat corporate profts are what ma

top

FiFteen Holdings

iShareS MSCi eMerging

MarketS

Chevron Corp

iShareS S&p SMallCap 600

Diageo plC-Sp aDr

verizon CoMMuniCationS

royal DutCh Shell plC

utilitieS SeCtor SpDr

CoStCo WholeSale Corp

payChex inC.

J.M. SMuCker

oraCle Corp

iShareS MSCi eaFe inDex FunD

varian MeDiCal SySteMS

Colgate palMolive

eMerging aSia paCiFiC SpDr

ECONOMIC OvEvIEw

The Yo-Yo Year (contd)


3/6

-2% -15% 0

JANUARY 1, 2011 DECEMBER 31, 2011S&P 500 SECTOR PERFORMANCE

19.96%

-1% -5% 5% 1% 15% 2% 25%

Utilities

Cons. Staples

Healthcare

Telecommunications

Cons. Discretionary

Energy

Technology

Industrial

Basic Materials

Finance

13.99%

12.73%

6.31%

6.23%

4.71%

2.43%

0.59%

-9.65%

-17.03%

sewhere, the markets seem to have orgottenhe most.

ASSET MANAGEMENT

A Wild Ride to Nowhere

been more focused on managing inventory, which

ultimately leads to a higher cost of product for

discounters like TJ Maxx who benet from relative

inventory mismanagement. Economic indicators on

the heels of the holiday shopping season have been

consistent with that thesis.

We also exited Illumina, Inc., at a loss. While we remain

condent in Illuminas products and execution, the

company receives the majority of its revenues from

government funding. Uncertainty surrounding the

stability and amount of this funding going forward

made us decide that we would look for a re-entry

point when there is more clarity.

Finally, the army of 100,000 brown trucks and 500

airplanes delivering goodies around the world did not

go unnoticed by us during the holidays. We purchased

UPS for our client portfolios. UPS benets directly from

the fact that not everything can be delivered digitally

and it has developed an impressive infrastructure to

make delivery efcient and cost-effective. It also pays

its shareholders a 2.9% dividend.

For those who check the stock market returns only once

at calendar year-end, it would appear to have been

a very calm year. The price change of -0.03% is the

smallest change in over forty years. For those of us

who watch the market every day, the stomach-churning

volatility of the last twelve months was anything but

tame. Daily swings in the S&P 500

in August averaged 2.2% and the

DJIA saw 400-point moves four

times in that month alone.

Early returns were encouraging.

On April 29, the S&P 500 had risen

8.4%, almost a three-year high.

Five months later, the S&P was

19% lower on heightened worries

over rising debt levels bothdomestically and internationally.

The volatility was not equally

shared. The best-performing sector,

utilities, was up 19.96% while

nancial stocks fell 17.03%. Traditional defensive

investments in utilities, consumer staples and health-

care stocks posted solid returns while those companies

sensitive to economic growth were challenged by

worldwide economic uncertainty. 85 of the 500 companies

in the S&P 500 saw their share prices decline by more

than 20% in 2011.

At Nelson Roberts, exposure to international markets

and smaller, growth-oriented companies weighed down

our returns. International stocks fell -11.68% and small

caps were down 4.19%. After adding to some of our

large cap, dividend-paying companies in the third quarter,

we trimmed the position of one of our best performing

names of the last three years, TJ Maxx. We took the

prot because we think that retailers in aggregate have


4/6


FEATUED EQUIT

Paychex

Despite difcult headwinds for its core service of payroll

processing, we believe Paychex has positioned itself for

future success. The unemployment rate has remained

stubbornly high since the nancial meltdown in 2008,

but has recently shown glimmers of improvement.

Additionally, historically low interest rates have nearly

wiped out Paychexs interest earnings on client funds, a

traditionally protable source of revenues. The companys

management team has navigated these challenges well

while providing attractive dividends to shareholders.

Paychex was founded in 1979

when seventeen payroll processing

companies merged. It is now

the second largest company in

the payroll processing market.Paychexs business is built around

the concept of making payroll

outsourcing easy and affordable

for small businesses. The company

now services over 500,000 small

to medium-sized businesses nation-

wide. Switching costs are substantial,

so Paychex is likely to hold onto

this sizable client base. 80% of its

clients employ fewer than 20 staff.

The company has expanded beyond payroll processinginto human resources, including Retirement Plan

Services, HR Solutions, Insurance Services and Time and

Attendance Services. This expansion has given Paychex an

opportunity to develop deeper relationships with both

new and existing clients. The HR services have grown

50% in the last four years and now comprise nearly

30% of total rm revenues.

Paychexs share price will benet from economic stabilityand an improved employment rate. We are encouraged

that unemployment has fallen to a 2 year low of

8.6% in November. Management notes that there has

been an increase in the number of checks it is issuing

per client, an optimistic sign for employment at small

companies. This company has weathered the volatility

of the last few years while maintaining a dividend rateof over 4%. As the economy continues to improve,

Paychexs business and stock price should outperform

the market.

35

25

DECEMBER 31, 2007 DECEMBER 30, 2011

MAR J UN

30.11

SEP

PAYCHEX STOCK PRICE

20

2011 Bloomberg Finance L. P.

DEC

2008 2009 2010 2011

MAR JUN SEP DEC MAR JUN SEP DEC MAR JUN SEP DEC

Vv a l u e

How do we measure value?

By producing it in the growth of assets, in how our clients view us,

in how we create partnership.

[val yoo] n. a quality having intrinsic worth


5/6


FIXED INCOME

If It Sounds Too Good to Be True

With money market rates near 0% and yields from US government bonds, corporate bonds and CDs at

historic lows, it has been another tough year for income-seeking investors. To make up for falling returns,

more and more investors are being drawn to alternative xed income products that promise interest rates

of 7, 8 or even 10%. Many of these products have serious underlying risks and should come with warning

labels reminding investors that if the yield sounds too good to be true, it probably is.

Before investing in alternative xed income products, investors should ask three questions:

1. Why would someone pay these signicantly higher yields?

2. What are the fees and/or commissions?

3. Is the investment liquid? (can you get it back quickly?)

Here are a few examples we have seen advertised recently.

Structured notes: These hybrid securities combine equity and xed income securities with derivative

contracts. They usually offer some degree of principal protection in addition to a chance for higher returns

but there are big drawbacks. In exchange for limiting losses, the notes cap the upside, which can be

signicantly less than the markets actual gains. The underlying fees are high, often 3% or more, and

the guaranteed backing is only as good as the institution issuing the note. Also, these investments aretypically illiquid, meaning that they do not trade on the secondary market. The institution issuing the

note will often promise to repurchase it, but only at a deep discount.

High-yield bonds: These bonds are issued by organizations that do not qualify for investment grade

ratings by one of the leading credit agencies. Those issuers with a greater risk of defaultnot paying

interest or principal in a timely mannerare rated below investment grade. The issuers must pay a higher

interest rate in order to convince investors to buy their bonds. In addition to the risk of default, high yield

bonds are less liquid than investment grade bonds.

Charitable Gift Annuities: These annuity contracts are established between a charity and a donor. Cash,

stock or properties are gifted to a charity in exchange for a stream of lifetime income. The rates of return

are higher than those available with traditional bank deposits, but the donor must be charitably inclined

in order to achieve the full benet. Once the gift is made it becomes irrevocable. Income payments areguaranteed by the charity, so selecting a charity that is nancially sound is critical.

The reality is that in order to make money, you must take risk. However, considerably higher yields should

be a strong indicator that the risks are high indeed and investors need to understand what those underlying

dangers are before investing. High quality, dividend-paying stocks are a better alternative for most investors.

: : Trust what is simple and can be understood at a glance. Anything

more elaborate, investigate carefully and thoroughly; if its too

convoluted for you to grasp, pull back. Remember, in nancial

matters the object of complexity is all too often to conceal the truth....

Paul Johnson, British historian and author


6/6

1950 University Avenue, Suite 202

East Palo Alto, CA 94303

tel 650-322-4000

eb www.nelsonroberts.com

email [email protected]

Past performance is not necessarily a guide to future performance. There are risks involved in investing,

including possible loss of principal. This information i s provided for informational purposes only and does

not constitute a recommendation for any investment strategy, security or product described herein. Please

contact us for a complete list of portfolio holdings.

For additional information on the services of Nelson Roberts Investment Advisors, or to receive our

Newsletters via e-mail or be removed from our mailing list, please contact us at 650-322-4000.

2012 Nelson Roberts Investment Advisors

Managing bill payment and banking has never been easier. We can pay all of our bills from any computer, setting up

many of them to be paid automatically. With a smart phone, you can now deposit checks by simply emailing a picture

of the front and back of a check.

At the same time, privacy regulations and security protections have become more stringent. For example, if you have

an account at a brokerage rm registered in the name of your revocable trust and you wish to transfer funds to yourpersonal checking account which is not registered in the name of your trust, the brokerage rm requires that you submit

a written letter of authorization to transfer your money to you. This is a sensible precaution. Technically, because the

account registrations are not exactly the same, the transfer request is treated by the brokerage rm as if it were going

to a third party such as an escrow account at a title company. By requiring your signature, the custodial rm is protecting

your assets from unauthorized third party withdrawals.

One might assume that the same level of scrutiny and diligence is applied to online banking transactions; however, that

would be a very wrong assumption. Making a withdrawal from any account that has checks or has set up automatic

clearinghouse (ACH) transactions (sometimes known as moneylinks), requires only that someone has the routing and

account numbers. This applies to both bank and brokerage accounts.

The routing and account numbers are on every unsigned, signed and cancelled check that you have in your possession

and in circulation. These numbers are also in the system of every merchant, bank and credit card company with which

you have done banking business. Anyone with this information can set up an online transaction to debit funds from

your accounts. Should a fraudulent transaction actually hit your account, you have less than 60 days (and maybe as few

as 31 days) to notify your bank or brokerage custodian. If you do this within the allowed time limit, you will then have

to le a fraud claim with the nancial institution, which will in turn reverse the transaction. If you do not notify them

within the required time limit, then your only recourse is to le a report with the local police department. This demon-

strates that you are attempting to reclaim your property. If the police cannot recover it for you, then you can deduct

the transaction as a theft or casualty loss (at $100 per theft eventsubtract 10% of your adjusted gross income). 1

For most of our clients, this means that there will be no tax benet from fraudulent transactions that are not caught

within the notication time limit.

Unfortunately, institutions will not give investment advisors sufcient information to see where funds are going. The

only information that is provided to us is the amount of the debit or transfer. Therefore, it is essential that each of you

regularly monitor the activity in your accounts on which you write checks or process ACH transactions.

SPECIAL TOPICS

At Your Own Peril: Online Banking

Investment Team

Brooks Nelson, CFA

Brian Roberts, CFA, MBA

Steve Philpott, CFP, MBA

Dennistoun Brown, MD

Ann Oglesby, MD, MBA

1www.irs.gov Topic 515-Casualty, Disaster, and Theft Losses

Documents

4th Quarter 2011 Commentary