Economic Perspective (Q4 2012)

The stock market is in a delicate precarious position between attractive relative valuation and an earnings recession. On the one hand, interest rates are so low that the stock market is one of the few sensible investment options that one can find for income and inflation protection. On the other hand, with the economy near stall speed, a double dip recession and global slowdown could rapidly develop into a bear market.

“This ship, the Euro Titanic, has now hit the iceberg” — British Parliamentarian Nigel Farage exclaimed this past June. Fortunately, the music has played on–Mario Draghi, President of the European Central Bank, and Ben Bernanke, Chairman of the U.S. Federal Reserve, have offered practically unlimited liquidity to drive economic growth.

The markets have responded positively with the S&P 500 rallying 13.5% since early June.* Perhaps this stark analogy is just a nightmare from which we will awaken. The US economy will strengthen, European austerity will lead to economic stability, and the unprecedented financial accommodation of central banks around the globe will solve our collective fiscal imbalances.

Perhaps, the enormous fiscal liabilities of countries like Greece, Spain, Portugal and the United States, will begin to wind down and we will grow ourselves out of this precarious financial position. Under these circumstances, we recommend buying securities with growing dividends or distributions. Securities that pay dividends tend to be safer than those which do not. Further, those securities which can grow their dividends or distributions can create inflation hedged income streams.  This income profile sharply
contrasts  bonds and money markets which do not keep up with interest rates or inflation risks. If interest rates begin to rise, the potential losses to bond investors could be quite severe. Money markets offer little return or inflation protection and Federal Reserve
commentary suggests that this may not change until 2015.

At Income Growth Advisors, LLC, we continue to recommend Master Limited Partnerships (MLPs) and dividend growth stocks with the expectation of generating income streams that will outpace inflation. This inflation focused approach should be of particular interest to financial advisors and those planning for their retirements. We question government reports of inflation in the 2-3% range and alternately believe that the average American family is experiencing inflation from food, gasoline, and healthcare at far higher rates. One firm reports that their proprietary rate of inflation in the fifty largest US metropolitan centers was 9.9% last year.# When planning ones retirement over a typical 30 year time frame, the difference between what the Bureau of Labor and Statistics reports as compared to a 9.9% level of inflation could have a devastating impact on ones long term retirement savings and income.

Because stocks and MLPs are risky assets, we want to specifically identify those securities whose business models are both long term and durable. Our thinking is not really different than the advice that Warren Buffet has been offering for decades. Buy good stable durable franchises that will grow bigger and stronger in the future. Likewise, Buffet and Income Growth Advisors, LLC question the value of bonds, since their yields are not high enough to keep up with cost of inflation. Buffet, too, has been a long time
investor in pipelines, our favorite MLP sector.

MLPs offer a combination of attractive tax advantaged yields, distribution growth, inflation protection through PPI (Producer Price Index) escalators, and durable business models. The need for petroleum distillates is highly certain as these products fuel most forms of transportation. Likewise, natural gas demand is certain and growing. It is needed to heat our homes, fuel power stations, and serve a growing global export market. Both petroleum and natural gas are enjoying a renaissance through the development of unconventional reserves through fracking and horizontal drilling of massive new shale gas properties which promise to drive US energy independence in the coming decade. This boom will increase exploration, gathering, processing and transportation capital expenditures and add an estimated $300 billion in capitalization to the MLP sector in the decades ahead.

Since 2000, MLPs have significantly outperformed the S&P 500 on a total return basis. Since
December 31, 1999 through September 30, 2012, the Alerian Total Return Index rose from 191.75 to 1267.74,*an annualized 17.4% total return. Over the same period the S&P 500’s total return was 1.7% annualized.

Our MLP asset class performance has outperformed this benchmark since 2001. Our results are still being prepared for Global Investment Performance Standards and an audit, and may be subject to possible revision as we prepare for certification. Our dedicated single strategy MLP account performance since 12/31/2007 has outpaced the Alerian Total Return performance by 5.25% before management fees 19.31% vs. 14.06%.*

For retirement plans, we recommend owning dividend growth stocks selected through our Quantitative Dividend Growth strategy. Our model selects stocks whose dividends are growing and above 3%. Additionally, our model requires growing earnings and positive price momentum or they are dropped from our holdings during our quarterly rebalancing. While our strategy is unfunded, our simulated returns have not had a down year since December 31, 1999, and have had an annualized 13.47% return through September 30, 2012 before fees versus 1.66% for the S&P 500.*

Our Quantitative Dividend Growth strategy utilizes two macro market hedging signals which led the model to exit the market during the two major market declines of the last twelve years. One signal is based on S&P 500 earnings turning down, as they did in the declines of 2000-3 and 2008-9. This particular indicator appears close to turning negative as we approach “the fiscal cliff and the Presidential election.”

We believe the combination of these two strategies should provide clients with growing income streams which outpace inflation, provide wealth preservation, and generate income needed for one’s retirement. It is precisely because of these tenacious systemic problems caused by governmental fiscal irresponsibility, its consequential currency debasement, and other pernicious financial risks which overshadow the present secular bear market that we deliberately chose the banal firm name of Income Growth Advisors, LLC.

So, if watching the evening news of riots in Europe where protesters throw Molotov cocktails is disquieting, remember that our strategies are specifically designed for these challenging times and the uncharted territory we may enter.

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The information expressed on our website is based upon the interpretation of available data. The data being presented was obtained or derived from sources believed to be accurate, but Tyson Halsey and Income Growth Advisors, LLC

(IGA) cannot and does not guarantee the accuracy of these sources which may be incomplete and/or condensed. The data and information presented is provided for informational purposes only, and is not offered as a basis for trading in securities nor is it offered for that purpose.

Nothing contained herein should be construed as a recommendation to buy or sell any securities.

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