Fall 2012

The election has come and gone, the campaign for 2016 has already begun, and the Republic still stands. No matter where you are on the political spectrum, it has been a long and wearying campaign, and now the mind turns to more important matters (Brine or baste your bird? Stuffing baked inside? Aunt Martha‘s marshmallow thingy, again?) Meanwhile, the third quarter that just closed brought yet more interesting results even in the face of ongoing global politicoeconomic uncertainty. In this newsletter, some interesting reading: An insight into the potential downside of betting on probability while ignoring risk [p. 1] A quick primer on the potential upheaval posed by the “Fiscal Cliff” –should Congress and the White House fail to reach a solution [p.2] Lastly on the theoretical front, John Mauldin’s take on the fallibility of assumptions in economic prognostication [p. 3] A handy cheat sheet from yours truly regarding Records Retention [p. 5] And, of course, a look at the third quarter that just closed [p. 6]

Probability Theory and Retirement Portfolios While no one would call betting on football an investment (except a bookie, and he is really investing in human frailty and probabilities and not, strictly speaking, football), all too often investors approach the markets in a fashion distressingly similar to football wagerers. You either think you are an expert on the stock market, or you hire someone whom you think is. And while we are a great deal more serious about our investments, here too we try to pick safe investments that will last us for the long run. We use models to outline the probability of success or failure, and all too often we ignore the low probabilities that would be absolutely disastrous if they came about. In most places and in most times, withdrawing 5% a year from a retirement portfolio is a reasonable approach. But not in all places and certainly not at all times. Your retirement plan should not be the investment equivalent of making NFL Fantasy Football League selections. Many investors are told that it is safe to take 5% of their savings each year to spend on retirement. And the history of the last 110 years suggests that on average this is true. But every now and then people retire at the beginning of a secular bear market. Taking out 5% at such times is about as safe as betting on football. Ed Easterling at Crestmont Research did some very basic research which shows that if you retire and decide to keep your retirement savings 100% in stocks, then if you begin to take out your savings at a 5% rate during a period when stocks are in the highest 25% of the historical average of valuation (P/E ratios), about 5% of the time you will be out of money within 23 years.

2

And this outcome has a probability that we can model. Of course, we can’t tell you what your actual experience will be, but we can demonstrate that you are involved in risky behavior! Typically, investors are comfortable taking such a risk, because at the end of a secular bull market stocks have been performing well for a very long time. Most investment models show the bull will continue – or at least the ones you get to see. (You can read Easterling’s full report at http://www.crestmontresearch.com/docs/Stock-Retirement-SWR.pdf

The Next Impending Disaster: The Fiscal Cliff The presidential race was settled on November 6, but there remains a pressing issue confronting the nation before year’s end: the so-called “fiscal cliff.” Whether you are tired of hearing about it or don’t quite know what it means besides presaging another battle between Congress and the White House – or both – the outcome affects you. The fiscal cliff issue relates to the expiration of various tax breaks plus the addition of a number of spending cuts on January 1st, 2013. The table below details the major items, with the Bush tax cuts at the top followed by the expansion of the Alternative Minimum Tax (AMT), the expiration of the payroll tax holiday, and so forth. PROVISION

EST CY 2013 IMPACT ($BN)

Bush Tax Cuts for $250k+ (includes estate tax)

$55

Bush Tax Cuts for < $250k

$155

AMT

$130

Payroll Tax Cut

$110

Unemployment Insurance

$35

Affordable Care Act (3.8% on dividends/cap gains; 0.9% on wage income for $250k+)

$25

Sequester – Defense

$55

Sequester – Non-Defense Discretionary

$38

Sequester – Mandatory (Medical + other)

$16

Tax Extenders (R&D tax credit, other)

$85

Doc fix (Medicare reimbursement)

$15

ESTIMATED FISCAL DRAG

$719 billion

% OF GDP

4.5%

All told, the spending cuts and tax hikes will total nearly $720 billion, or 4.5% of GDP. Government accounting being what it is, other estimates run as high as 5% of Gross Domestic Product (GDP). Regardless, if all this stuff goes through, many predict we will be heading toward another recession in January. The general opinion from everyone we follow is that we will see a compromise over the next couple of months that cuts this hit to a more manageable level - say between 1% and 2%.

2

3

What will this fiscal hill (as opposed to fiscal cliff) do the economy? Bank Credit Analyst, a prominent provider of economic data to many of the world’s largest financial institutions, developed a useful matrix associating the fiscal drag in 2013 with their expectation for GDP and earnings growth. A 5% drag would translate into growth contracting by 2.5% next year and earnings falling 17.5%, as you can see below. A drag of 1% to 2% should mean the economy stays out of recession. Chart 6: FISCAL CLIFF SCENARIOS

FISCAL DRAG 2013 (% GDP)

REAL GDP GROWTH (%)

0

3.5

1

2.3

2

1.1

3

-0.1

5

-2.5

S&P 500 PROFIT GROWTH (%) 12.5 6.5 0.5 -5.5 -17.5 BCA

The trouble is that none of us know just how the political debate will play out over the comingmonths. Also, the problem is more complex than just postponing any change. Simply moving the cliff leaves the underlying problem intact: if current policies stay in place, the deficit will still be over 5% of GDP a decade from now (down from 7% today), and the debt held by the public will climb from 73% of GDP to 90%.

The Economics of Assumptions? We all want to have numbers that are “real.” But economics is different from accounting. Economics makes assumptions in almost all of the models it uses, and those assumptions come with biases. How many discussions do we get into that proceed along the lines of: “Look at this statistic. It clearly goes up [or down] with GDP [or employment or…]. Therefore, if we could just fix ‘X,’ we would solve the world’s problems.”

For instance, any competent economist can clearly demonstrate to you that raising taxes on the rich will have no effect on their spending, by using just one or two correlations in certain time frames. Throw in a few good stories, and the obvious conclusion is that we should raise taxes on the rich again and again. Just ask French President Francois Hollande – it’s their fairshare.

3

4

Another one can just as easily show you that raising taxes on the rich will result in serious economic calamity. “Just see what it did in this situation. And see what cutting taxes did there.” The counterargument then runs that your interpretation misses some other factor, so your conclusion is wrong. And so on and on. This relates to a quote from Anne Rice, whose character was talking about another form of knowledge—but the observation applies doubly to economics: “Very few beings really seek knowledge in this world. Mortal or immortal, few really ask. On the contrary, they try to wring from the unknown the answers they have already shaped in their own minds – justifications, confirmations, forms of consolation without which they can't go on. To really ask is to open the door to the whirlwind. The answer may annihilate the question and the questioner.”

Human beings seek certainty. We actually get an endorphin rush when we get an explanation for something we do not understand. Whether it’s religion, politics, philosophy, a crossword puzzle, or economics, we want to be able to come to a definite conclusion that we think is correct. There is psychological rest in certainty, along with the physiological rewards). Models, even flawed ones, give us the illusion of certainty. We need to be careful of what illusions we cling to. Models can be useful, but they are not exact. They give us a sense of direction. Using them is more like navigating by the North Star than using a GPS system. The more variables that enter into the actual situation, the less likely we are to be able to come up with that one “easy-button” policy prescription. We elect politicians and then expect that somehow the world will improve in accordance with their promises. What we really need to do is try to see what general direction they are leading us in and base our votes and our personal decisions on whether we like that direction. But to trust an economist, or even worse a politician, with a model? That can be dangerous. Let’s close with a quote from central banker Richard Fisher, president of the Dallas Federal Reserve: “It will come as no surprise to those who know me that I did not argue in favor of additional monetary accommodation during our meetings last week. I have repeatedly made it clear, in internal FOMC deliberations and in public speeches, that I believe that with each program we undertake to venture further in that direction, we are sailing deeper into uncharted waters. We are blessed at the Fed with sophisticated econometric models and superb analysts. We can easily conjure up plausible theories as to what we will do when it comes to our next tack or eventually reversing course. The truth, however, is that nobody on the committee, nor on our staffs at the Board of Governors and the 12 Banks, really knows what is holding back the economy. Nobody really knows what will work to get the economy back on course. And nobody – in fact, no central bank anywhere on the planet – has the experience of successfully navigating a return home from the place in which we now find ourselves. No central bank – not, at least, the Federal Reserve – has ever been on this cruise before.”

4

5

We indeed have not been on this cruise before as a nation and as a world. We know what happens when one country or another runs up against the limits of borrowing power. But when the bulk of the developed world does? Another cruises, indeed.

Drowning in Paper? Guidelines for Records Retention As the year comes to a close and you prepare (or think about preparing) for filing your 2012 tax return next spring, here are some guidelines about which papers you need to keep from the past tax season, and for how long. One Year •

While it’s important to keep year-end mutual fund and IRA contribution statements forever, you don’t have to save monthly and quarterly statements once the year-end statement has arrived.

Three Years • • • •

Credit Card Statements Medical Bills (in case of insurance disputes) Utility Records Expired Insurance Policies

Six Years • • • • • • • •

Supporting Documents For Tax Returns Supporting Documents for Stock and Bond Sales Accident Reports and Claims Medical Bills (if tax-related) Sales Receipts Wage Garnishments Other Tax-Related Bills

Forever • • • • • •

Legal Records Important Correspondence Income Tax Returns Income Tax Payment Checks Investment Trade Confirmations Retirement and Pension Records

Variable Life Spans • • • • • •

• • •

Car Records (keep until the car is sold) Credit Card Receipts (keep until verified on your statement) Insurance Policies (keep for the life of the policy) Mortgages / Deeds / Leases (keep for 6 years beyond the agreement) Pay Stubs (keep until reconciled with your W-2) Property Records / Improvement Receipts (keep until property sold) [ED: not 6 years after the sale? See above] Sales Receipts (keep for life of the warranty; keep a copy with the warranty) Warranties and Instructions (keep for life of the product) Depreciation Schedules and other Capital Asset Records (keep for 3 years after the tax life of the asset).

5

6

Third Quarter of 2012: Climbing the Wall of Worry It seems like every quarter we find ourselves saying the same thing: what a difference a quarter makes! In the first two months of 2012, the U.S. stock market was recording excitingly positive returns. Then came a difficult second quarter where the indices fell across the board, nearly wiping out the first quarter gains. Now, in the last three months, while many investors were still anxious about Europe, deficits, paralysis in Washington and unemployment, the markets have delivered an unexpected gift: a steady, gradual rise in stock prices that seemed, week by week, contrary to the mood expressed in the financial press. Here at the end of the third quarter, entering the home stretch for the year, returns on many of the broad stock indices are, surprisingly, well into double-digit territory. Market historians will look back on the past three months as a bullish quarter, and probably conclude that investors in the first three quarters of 2012 must have been ebullient bordering on giddy. Overall, the Wilshire 5000—the broadest measure of U.S. stocks and bonds—was up 6.15% for the third quarter, and is returning a robust 15.85% so far this year. The other stock market sectors moved in a very similar pattern. The widely quoted S&P 500 index of large company stocks gained 5.76% for the quarter, and now stands at a 14.56% gain so far this year. The Wilshire U.S. Mid-Cap index index rose 5.59% in the three months ending September 30, up 11.86% for the year. Small company stocks have posted returns nearly identical to the large multinationals. The Wilshire U.S. Small-Cap gained 5.16% in the third quarter, up 15.19% in the first nine months of 2012. The technology-heavy Nasdaq Composite Index was up 6.17% in the third quarter, and up 19.62% year to date. Twelve years after the "tech wreck" disaster in this sector, tech stocks appear to be market leaders again. The next time you read gloomy headlines about the economy, remember that every single industry sector in the S&P 500 is posting gains so far this year, led by telecommunication stocks (up 21.04%), information technology (up 20.64%), consumer discretionary goods manufacturers (up 19.99%), and financial stocks (19.88% gains so far this year). Global stocks have not been as robust as American shares, but they, too, are in positive territory. The broad-based EAFE index of developed economies rose 6.14% for the third quarter, and is now in firmly positive territory, with a gain of 6.95% so far this year. For the first time this year, European stocks are showing gains for their investors, up 8.13% in dollar terms for the recent quarter and up 8.00% for the year. The EAFE Emerging Markets index of lesser-developed economies rose 6.97% in the third quarter, and is now up 9.41% for the year. Commodities have also moved into positive territory, with the S&P GSCI index rising 11.54% for the quarter, and up 3.47% this year. Energy and petroleum prices are up very modestly (0.55% and 0.93% for the year respectively); the biggest mover is agriculture (up 18.44% so far this year), with grain prices rising 31.05% due to the Midwestern drought. On the bond side, those of us who could not imagine how U.S. Treasuries could possibly offer lower yields are watching it happen. The 12-month T-Bonds are now yielding just 0.15%, as investors seem to be happy to essentially lend the government money with a promise that they will get it back again 12 months later. Locking up your money for three years gets you 0.31% a year. Ten-year issues yield 1.63%, and 30-year Treasuries bring a 2.82% annual coupon yield. Muni bonds are also down from where they were last quarter, with aggregate yields of 0.203% (1-year), 0.624% (5-year) and 1.742% (10-year). The aggregate of all AAA corporate bonds is yielding 0.76% for bonds with a five-year maturity.

6

7

Is there an explanation for this three-month bull market during what can only be described as trying economic times? People who have long experience with the investment markets are fond of saying that rallies "climb a wall of worry;" that is, the markets go up most steadily when it requires courage to buy into them. These past three months seem to be one of the best examples of this adage that you are likely to see. Today, it requires a certain degree of courage to believe in the long-term future of the economy and the long-term return on investments. Some economists think that the stock rally was a gift from the central banks. For months, it was rumored that the U.S. Federal Reserve Board would engineer another stimulus package, which had already been dubbed "QE3"--and indeed Fed Chairman Ben Bernanke announced that the Fed would inject $40 billion a month into the market for securitized home mortgages. This addition to the money supply possibly will drive down mortgage rates and (again possibly) stimulate the housing and homebuilding sectors of the economy into hiring again. Meanwhile, the European Central Bank has finally announced that it would do what economists were calling for three years ago: purchase Euro zone government bonds to reduce the borrowing costs of countries that are restructuring their finances--notably Spain and Italy. After two press conferences on different sides of the Atlantic, some of our worst-case economic scenarios (a 2008-like collapse of the Euro zone banking system; a U.S. recession) seem to have become less likely to occur. The U.S. economy is certainly not in danger of breaking any speed records as it continues to climb out of the Great Recession; in the last week of September, the government announced that from April through June, GDP grew at just a 1.3% annual rate. Economists remain wary of the "fiscal cliff” that will take place, absent Congressional intervention, at the stroke of midnight, December 31. Add in the discouraging 8.1% unemployment rate, and there is plenty of reason not to be bullish on stocks for the last three months of the year. But of course that was also true before stocks went up over the past three months. Optimists can point to 96,000 new jobs added in August, and the fact that long-term, the unemployment rate has been trending downward from around 10% at this time three years ago. A Bloomberg News survey recently forecast that the U.S. economy will grow at an annual rate of 2.1% over the next three months, and forecasts from the Federal Reserve Board anticipate 2.5% to 3% GDP growth in 2013. At the upper end of that estimate, we are talking about a return to economic normalcy, and a chance to chip away at the jobless rate. Who's right? Who knows? All we know for sure is that the global economy is in a slow-growth recovery, with little indication that growth will accelerate dramatically or that the Fiscal Cliff guarantees the U.S. will slide back into recession. What is very apparent to this adviser is that buy/hold methodology has not worked for almost 13 years with the S&P 500 index delivering a return from 1-3-2000 to 11-12-2012 of -5.66%. Could it all turn around tomorrow? It is a possibility, yet history also teaches us that this could continue for another 12 years. As winter arrives, I am reminded that the portfolios of recent referrals that I have reviewed are designed for sunny weather; they are driving around on sunny weather tires. I don’t know if you have looked outside lately, but the weather is certainly not sunny, au contraire, it is very stormy. Life&Wealth Advisors’ clients are driving around on rainy day tires. So when the sun finally does come out again, you will have survived the storms and can take advantage of the good weather again.

7

8

Note: The views stated in this letter are not necessarily the opinion of Life&Wealth Advisors, Inc, and should not be construed, directly or indirectly, as an offer to buy or sell any securities mentioned herein. Investors should be aware that there are risks inherent in all investments, such as fluctuations in investment principal. With any investment vehicle, past performance is not a guarantee of future results. Material discussed herewith is meant for general illustration and/or informational purposes only, please note that individual situations can vary. Therefore, the information should be relied upon when coordinated with individual professional advice. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Indexes cannot be invested in directly, are unmanaged and do not incur management fees, costs or expenses. No investment strategy, such as asset allocation, can guarantee a profit or protect against loss in periods of declining values. International investing involves special risks not present with U.S. investments due to factors such as increased volatility, currency fluctuation, and differences in auditing and other financial standards. These risks can be accentuated in emerging markets.

8

9

The Smallish Print Compliance Our 2011 Uniform Application for Investment Adviser Registration, known as the ADV II, is available upon your request. This document, which we are required to file annually, provides detailed information about our practice. We will be happy to supply you with an e-mail or paper copy; just let us know.

Privacy Notice Pursuant to Regulation S-P adopted by the Securities and Exchange Commissions, it is the policy of Life&Wealth Advisors, Inc. (“Advisor”) to keep confidential nonpublic personal information (“information”) pertaining to each current and former Client (i.e., information and records pertaining to personal background, investment objectives, financial situation, investment holdings, account numbers, account balances, etc.) unless Advisor is: (1) previously authorized by the Client to disclose information to individuals and/or entities not affiliated with Advisor, including, but not limited to the Client other professional Advisors and/or service providers (i.e., attorney, accountant, insurance agent, Chauner Securities, Inc., investment advisor, account custodian, etc.); (2) required to do so by judicial or regulatory process; or (3) otherwise permitted to do so in accordance with the parameters of Regulation S-P. The disclosure of information contained in any document completed by the Client for processing and/or transmittal by Advisor in order to facilitate the commencement/ continuation/termination of a business relationship between the Client and a nonaffiliated third party service provider (i.e., Chauner Securities, Inc., investment advisor, account custodian, insurance company, etc.), including information contained in any document completed and/or executed by the Client for Advisor (i.e., Advisory agreement, Client information form, etc.), shall be deemed as having been automatically authorized by the Client with respect to the corresponding nonaffiliated third party service provider. Each individual and/or entity affiliated with Advisor is aware of Advisor’s Privacy Policy, and had acknowledged his/her/its requirement to comply with it. In accordance with Advisor’s Privacy Policy, each such affiliated individual and/or entity shall have access to information to the extent reasonably necessary for Advisor to perform its services for the Client, and to comply with applicable regulatory procedures and requirements. Should you have any questions regarding the above, please contact Gary P. Gardner, President of Life&Wealth Advisors, Inc., at 925-937-7800.

9

10

References: Fiscal Cliff

Source: Gemmer Asset Management

The Economics of Assumptions

The article was from “Thoughts from the Frontline,” a free weekly economic e-letter by John Mauldin http://www.JohnMauldin.com/

Probability Theory and Retirement Portfolios:

Ed Easterling, Crestmont Research http://www.crestmontresearch.com/docs/Stock-RetirementSWR.pdf

Third Quarter Market Report:

Wilshire index data: http://www.wilshire.com/Indexes/calculator/ Russell index data: http://www.russell.com/indexes/data/daily_total_returns_us.asp S&P index data: http://www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf--p-us-l-Nasdaq index data: http://quicktake.morningstar.com/Index/IndexCharts.aspx?Symbol=COMP International indices: http://www.mscibarra.com/products/indices/international_equity_indices/performance.html Commodities index data: http://www.standardandpoors.com/indices/sp-gsci/en/us/?indexId=spgscirg--usd----sp-----Treasury market rates: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/ Aggregate corporate bond rates: http://finance.yahoo.com/bonds/composite_bond_rates Employment rate: http://www.washingtonpost.com/business/economy/us-adds-96000-jobs-in-augustunemployment-rate-drops-to-81-percent/2012/09/07/30374bfa-f8e9-11e1-83980327ab83ab91_story.html Economic data: http://www.usatoday.com/story/money/markets/2012/09/28/stocks-end-third-quarter/1600451/

10