In the spotlight and kicking off the second annual BaseCamp Chicago event will be a performance-focused presentation by Chicago-based investment pros Jon Hale, PhD, CFA, managing consultant at Morningstar; Chuck Carlson, CFA, CEO, Horizon Investment Services; and Mark Watson, CEO, CIO, Keel Asset Management.

Mel Miller, Chief Investment Officer and Chief Economist for Heartland Financial, USA will provide a Market and Economic Update and Forecast.

Integrating ESG and Impact Investing into Client Portfolios will be the focus of a session featuring Justin Conway, director of investment partnerships, Calvert Foundation and Paul Hilton, CFA, portfolio manager, Trillium Asset Management.

First Affirmative CEO, George Gay, will present “The Importance of Income: Fixed Income or Equity Income—Which Will Serve Your Clients’ Needs for the Future?

You can read more about the Chicago BaseCamp, as presented by the Chicago area press here and here.

A complete agenda for the day is available at the BaseCamp Chicago webpage. Register online NOW or contact Danielle Burns by phone at 877-542-8583.

But you can bet that insurance companies are adjusting their risk calculations. Extreme weather events in 2011 resulted in a record 99 declarations. The U.S. property and casualty insurance industry suffered an extraordinary $44 billion in catastrophe-related losses last year.

Insured losses in the U.S. from weather disaster have soared from an average of about $3 billion a year in the 1980s to about $20 billion a year in the last decade, even after adjusting for inflation, according to Mark Way, director of sustainability at reinsurance giant Swiss Re.

At a Capitol Hill press conference on March 1, 2012, members of the reinsurance industry—defined by the Reinsurance Association of America (RAA) as “insurance for insurance companies”—called for meaningful action by policymakers to address the reality of climate change.

At the press conference, Senator Bernie Sanders of Vermont said, “People in the business community are speaking out about the risks associated with global warming. Perhaps no industry better understands the impact of global warming than the insurance industry, whose job it is to analyze risk.”

“Demographics and coastal urbanization are catastrophic force multipliers making weather events increasingly more costly,” Pete Thomas, Chief Risk Officer at Willis Re, said.

Why Have U.S. Insurers Been So Quiet?

If there’s one industry that ought to be concerned about the threat of global warming, it’s the insurance industry. When extreme weather causes damage, they pay.

Dave Jones, California’s insurance commissioner, put it this way: “Climate change is an obvious physical threat to us all, but increasingly it also poses a serious financial threat to the insurance industry.

So, one might expect insurance companies to be calling for regulation of greenhouse gas emissions—to slow and maybe, eventually reverse global warming. And it would also be reasonable to expect insurance companies to steer some of their massive investment assets to clean energy or energy efficiency projects. But no, on both counts.

Insurance companies are all about risk, but unlike the big European reinsurance companies, insurance companies in the U.S. appear to be unwilling to risk speaking out about climate risks.

Of course, with such a heavily politicized issue, insurance companies may see no gain in talking about a topic that many consumers are confused about and, in some instances, downright hostile to.

Maybe more importantly, it should be understood that property/casualty companies write liability coverage for corporations that are being sued, or likely to be sued over climate related damages (e.g. oil and coal companies). It’s likely that they will find themselves in court arguing that climate change isn’t really causing all those damages.

But there is a group of U.S. companies—including Nike, Starbucks, and Levi Strauss—that are speaking out. They are members of BICEP, Business for Innovative Climate & Energy Policy, which is “working to pass meaningful energy and climate legislation that will enable rapid a transition to a low-carbon, 21st century economy.”

NOTE: Mention of specific companies or securities should not be considered a recommendation to either buy or sell that security.  For information regarding the suitability of any security for your investment portfolio please contact your financial advisor.

GoodGuide rates over 150,000 everyday household products based on the health, environmental, and social impacts. Using the Purchase Analyzer, consumers can directly compare products and companies based on customizable screening filters. The mobile app with barcode scanning allows you to bring this research capability into the store with you.

Green America, a nonprofit membership organization that promotes ethical consumerism, offers Responsible Shopper, a searchable database with corporate responsibility information on hundreds of companies. They also publish the National Green Pages, the only nationwide directory of responsible businesses in the United States.

Consumers can also seek out Benefit Corporations (B Corps). Because current corporate law generally requires that companies place shareowner interests above all others, it can be difficult for companies to take employee, community, and environmental interests into consideration when making decisions.

B Corps have a unique legal structure that expands corporate accountability so that companies are allowed to make decisions that are good for society, not just their shareowners. First Affirmative is now a certified B Corp, joining over 500 other privately held companies who have changed their corporate structure for the common good.

Hidden costs lurk in many places—clothing, food, consumer electronics and, of course, energy. In the short run, consumers feel good about “screaming deals” and companies thrive because they can sell their wares below actual cost and still make a tidy profit. However, collectively, we are running up a huge “bill” in the form of environmental damage, health costs, an exhausted supply of natural capital, and increasing income disparity.  In the long run, someone has to pay.

Who Pays, and How?

Economists call these hidden costs “negative externalities”—defined simply as any cost not included in a price. Taxes, regulation, and litigation are mechanisms that can be used to take hidden costs into account (e.g. taxing cigarettes, implementing pollution restrictions, or filing a lawsuit seeking damages from an oil spill). However, a far more efficient, market-based way to deal with externalities is to “internalize” them—so that the price of a product or service reflects all costs. Of course, this is easier said than done.

Hidden costs are accrued over time, and the source and size is not always apparent. Early in our industrial development, it was all too easy to overlook these costs—resources were abundant, the benefits seemed to far outweigh the damage, and there was always a new frontier to exploit. But we are now running up against the limits of our planetary resources.

According to a report by KPMG, Expect the Unexpected: Building Business Value in a Changing World, 10 interacting “megaforces” are causing a rapid escalation of the environmental costs incurred by our economy. Environmental costs across 11 industries rose by 50% between 2002 and 2010-from an estimated $566 billion to $854 billion. These costs do not show up on financial statements. If companies were required to “internalize” just these identified impacts, average earnings could be cut by a staggering 40 percent.

As resources become scarce, pressure on companies to recognize their share of these costs will likely increase. This new accounting could cause a fundamental shift in how companies must operate in order to remain relevant. “The link between sustainability and financial results is becoming increasingly clear,” said John Vehimeyer, CEO of KPMG LLP. “Companies that recognize the external influences on their organizations and leverage them as opportunities are realizing a competitive advantage.”

Measuring What’s Hidden

Companies are finding ways to measure and manage the environmental and social impact of their products, and a few are sharing information with consumers. Patagonia has developed The Footprint Chronicles and Nike launched the Considered Design program. Both evaluate environmental and social impact information for the entire lifecycle of each product.

In the wake of these efforts, the apparel industry formed the Sustainable Apparel Coalition, which brings together apparel and footwear brands, retailers, manufacturers, industry experts and the EPA. The coalition is developing a standardized, industry-wide tool for measuring the environmental and social performance of apparel products and the supply chains that produce them. The outdoor industry has also come together to create a similar tool with their Eco Index, now in beta testing. Through these efforts, industries can develop metrics and share best practices to both identify hidden costs and to drive those costs down.

In the B Corporation Annual Report, B Lab has recognized First Affirmative Financial Network as:

• Among the 15 top U.S. corporations in terms of positive worker impact.
• One of three U.S. financial services companies to rank the highest on positive worker impact.
• One of only three Colorado corporations to rank in the top of positive worker impact.

“B Corporations are leading a global movement to redefine success in business,” said Jay Coen Gilbert, co-founder of B Lab, the nonprofit organization that certifies B Corporations and governs the independent third party standard used to generate the comparable assessment of corporate impact. “These companies are the best in the world at being the best for the world,” Coen Gilbert added.

Unlike traditional corporations, B Corps consider the full impact of all internal decisions on their employees, suppliers, community, consumers, and the environment—and are legally allowed to do so. This is the way First Affirmative has conducted business every single day over the past 24 years.

The recognition that First Affirmative is receiving today is a confirmation of the value of operating in a more responsible manner, and it reflects an important characteristic of the companies we look to own in client portfolios.

B Lab is a nonprofit organization dedicated to using the power of business to solve social and environmental problems. B Lab certifies B Corporations which must: 1) meet rigorous standards of social and environmental performance; 2) legally expand their corporate responsibilities to include consideration of stakeholder interests; and 3) build collective voice through the power of the unifying B Corp brand.

The B Impact Assessment is the most rigorous, comprehensive, and comparable independent assessment of overall corporate impact. The assessment shows the relative value businesses create for society by comparing nearly 200 individual metrics on corporate impact on workers, consumers, suppliers, community, and the environment.

Does Gender Influence Corporate Responsibility?

A recent study, Gender and Corporate Social Responsibility, from Catalyst and Harvard Business School found that companies with more women serving on their boards and more women among the ranks of corporate officers contribute significantly more than companies with fewer or no women in senior roles.  Average donations of companies with three or more women directors were 28 times higher than those of companies with no women directors.  Companies with 25% or more women corporate officers as of 2007 made annual contributions that were 13 times higher than by those with no women corporate officers.

A cynic might say that higher charitable giving has a negative impact on the bottom line; after all, the money given away represents a cost to the company.  But could it be that women are better able to recognize the value of targeted philanthropy?  Corporate philanthropy is a cornerstone of corporate social responsibility—women may help companies tap into the benefits of integrating responsible philanthropy into their business models.

By the Numbers

A report by Catalyst, The Bottom Line, Corporate Performance and Women’s Representation on Boards indicates that Fortune 500 companies with the highest representation of women board members attained significantly higher financial performance, on average, than those with the lowest.

The study also revealed stronger-than-average performance at companies with at least three women directors on three key indicators.  Companies with the highest percentage of women on boards exceeded average return on equity by at least 53%, return on sales by at least 42%, and return on invested capital by at least 66%.

A Missed Opportunity

Women are woefully underrepresented in corporate boardrooms worldwide.  The 2011 Corporate Boards Report from Governance Metrics Inc. (GMI) found that of the 4,200 companies covered worldwide by GMI, the aggregate percentage of board seats held by women was only 9.8%.  In the United States, the aggregate percentage of female directors is just over 12%.  Even the most progressive of companies seldom have three or more women board members.  But as evidence continues to mount in support of the observation that gender diversity in boardrooms and executive suites can produce better outcomes for companies, shareowners, and communities, companies seeking to outperform their competitors need to re-evaluate how they choose board members and why.

For a full report on the benefits of increasing the number of women on corporate boards and the ongoing efforts by shareowners to improve gender diversity, read The First Affirmative publication, Deeper Thinking: A Woman’s Place in the Boardroom.

According to the Interfaith Center on Corporate Responsibility (ICCR), “Traffickers in the sex trade are gearing up for their most profitable weekend of the year.” Members of ICCR have been working with hotels and law-enforcement venues in the cities that host mammoth sporting events, including the 2010 World Cup in South Africa and last year’s Super Bowl in Dallas,to raise awareness of the risks of child sex trafficking that takes place during these events. ICCR targets hotels where much of the illegal activity takes place, providing assistance for training their staff to recognize trafficking when it occurs and how to report it to authorities.

Human trafficking reaches far beyond sporting events; it is prevalent throughout the entire global economy. According to the U.S. State Department’s 2010 Trafficking in Persons Report, an estimated 12.3 million people are victims of forced labor and human trafficking, and 1.2 million children are trafficked every year, primarily for sexual exploitation and child labor. Global annual profits made from trafficking—the modern world version of slavery—are estimated to be $31.6 billion.

Because much of the human trafficking is hidden within the global supply chain, Rep. Carolyn Maloney, D-N.Y introduced H.R. 2759, the Business Transparency on Trafficking and Slavery Act. If passed, the law will require companies with gross revenues in excess of $100 million to disclose existing policies and management systems designed to address trafficking, slavery, and other forms of human rights abuses within their supply chains. H.R. 2759 would apply to publicly traded or private entities and have far-reaching global impact. This bill expands upon the first of its kind California Transparency in Supply Chain Act, which enforces similar provisions on all retailers and manufacturers doing business in the state of California.

Socially conscious investors strongly support this bill to combat human trafficking. A coalition of institutional investors, research organizations, and investment firms, representing $42 billion dollars of investments under management, sent a letter to the leadership of the House, where support appears to be weak. The letter requests “the Republican leadership to ensure that the Financial Services Committee places H.R. 2759 at the top of its agenda and moves it to the House floor in an expeditious manner.” First Affirmative Financial Network is one of the 80 signatories.

Through April 2011, stocks performed well despite spiking oil prices after revolutionary unrest in the Arab world, and a global supply-chain disruption caused by the Japan earthquake and tsunami.

In late April major U.S. stock indexes reached their highest level since 2007, while small company stock indexes reached all-time highs.  Prices then retreated as investors’ focus turned to Europe’s debt crisis and congressional bickering over the U.S. debt ceiling.

Debt Crisis

Stocks churned throughout the summer, jumping for a week or two, and then falling back, as European policy makers scrambled at summit after summit to ward off the debt crisis.  Almost like clockwork, concerns about Greece defaulting, and even the possibility of breaking up the euro-zone, alternated with expectations that a crisis would be averted.

In early August, following a showdown in Washington over the U.S. debt ceiling, the rating agency Standard & Poor’s (S&P) downgraded the U.S. government’s credit rating.  The stock market reacted swiftly and violently.  The Dow Industrials gave up and then regained 400 points or more for four consecutive days.  Even after that wild week, volatility remained high for months, with the VIX* reaching sustained levels not seen since the fourth quarter of 2008.

Stocks Go Nowhere in 2011

For all the ‘sturm und drang’ that characterized the financial markets in 2011, the S&P’s 500 finished the year virtually unchanged.  But even this disappointing result is better than what well-diversified investors achieved.  Small and mid-cap stocks both lost ground in 2011.  International stocks got clobbered, especially emerging markets.

In spite of the slow economic recovery, American companies generated record profits last year, but the stock market’s positive fundamentals were no match for the unceasing parade of negative headlines from Europe (debt crisis), Asia (Japan earthquake, tsunami and nuclear crisis), the Mideast (the “Arab Awakening”), and the U.S. (legislative gridlock).

Amid the uncertainty, investors rushed to safety wherever they could find it.  Among the various categories of stocks, big, steady, dividend paying stocks did relatively well.  The Dow Jones Industrials Average beat the Russell 2000 Index (small-cap stocks) by its biggest margin in 13 years.

High Volatility, High Correlations

Volatility and correlations among stocks increased.  Last year there were 69 days in which 90% of the S&P 500 stocks moved in the same direction—more than the combined total from two other very volatile years, 2008 and 2009.

Will 2012 provide a return to normalcy, where stock prices are supposed to reflect fundamental valuations?  We can only hope.  True, stocks are attractively priced, with expectations for continuing corporate profit growth intact and price-to-earnings ratios at relatively low levels.  On the other hand, the political stalemate in the U.S. has not been remedied, and is not likely to improve in this, an election year.  Europe’s debt crisis is still unresolved as well.  With so much geopolitical uncertainty out there, it would be unwise to expect normal markets any time soon.

Why Fundamentals Matter

The headlines about European and American debt crises mattered more than fundamentals last year. If the market just ignores fundamentals, why should investors pay any attention to them?

In The Intelligent Investor, Benjamin Graham wrote, “In the short run, the market is a voting machine, but in the long run it is a weighing machine.”  This sentence is an apt description of how the financial markets operate.

The voting machine combines behavioral finance, high frequency trading, money flows, demographics, trading on rumors and news, etc.  When critics refer to the financial markets as a casino, they are referring to the voting machine.

But the market is also a weighing machine.  This is the essential reason why financial markets exist—to determine the value of financial instruments.

The voting machine element of the market causes securities to become mispriced in the short term.  The weighing machine aspect of the market causes securities to become accurately priced over the long-term.

Fundamentals Are Improving

In a recession, top-line growth (increasing revenues) becomes difficult, and so companies typically manage what they have more control over, which means they are very focused on managing costs.  This explains why companies have been slow to hire new workers, and inventories are being kept low.

A positive surprise on the economy causes consumers and businesses to spend, which translates into increased corporate revenues.  With extraneous costs having been squeezed out, every additional dollar of revenue flows right through to the bottom line to enhance earnings.  We have seen recent strengthening in U.S. economic indicators—never mind the bad news in Europe and in D.C. Furthermore, a strengthening trend can set a virtuous cycle in motion.

The S&P 500 Index ended calendar year 2011 at about 1,258. For the year, the Index generated about $97 of profits per share, a record.  Thus, its price/earnings ratio was about 13 (1258 divided by 97).  If 2012 earnings for the S&P 500 companies reach $107 per share (a reasonable estimate), and if the market’s price-to-earnings ratio doesn’t budge, the Index will rise more than 10%.

Is this a prediction?  No; we are simply pointing out that fundamentally, stocks are attractive.  What we cannot say is whether investors will notice.  In 2011 they didn’t, because the market behaved more like a voting machine.

Sentiment: A Contrarian Indicator

Normally, sentiment is a contrarian indicator.  When there is excessive optimism, the market becomes extended, frothy, and vulnerable to a pullback, or worse.  Conversely, excessive pessimism often causes stocks to become bargain-priced.

Market followers will recognize that they are not immune to the effects of emotion, and the urge to buy or sell at inopportune times.  How concerned were you in the depths of the 2008 financial crisis?  In retrospect, that was a good time to invest.  Did you get caught up in the dot-com bubble of 1999-2000?  If so, you probably got burned.  Except for Apple and just a handful of other companies, technology stocks that survived are nowhere near their 2000 highs, twelve years later.

Current sentiment readings indicate that today there is still a fair amount of pessimism priced into stocks.  In 2011 investors piled into Treasurys, despite the historically low yields available there, and the momentum has not yet shifted back toward stocks.

What Surprises Lie Ahead?

Perhaps the biggest surprise of 2011 was the gravity of the situation in Europe.  Now that we are more aware of the challenges there, it is hard to see how Europe can continue to produce negative surprises.  Certainly other surprises are in store; but will any of them disrupt the markets as much as the European debt crisis did in 2011?

Conversely, there is the promise of at least some clarity.  One way or another, on November 7, 2012, the results of the U.S. Presidential election will be in.  The stock market hates uncertainty, and in an election year, some amount of certainty is pre-ordained.  As far as the stock market is concerned, it may not even matter very much what the election outcomes are—just knowing that there will be a certain outcome may be beneficial.

Summary

If the hyper-attention to headlines that characterized investor behavior last year gives way to fundamentals, and assuming the US economic recovery continues, there is good reason to expect stocks to do well in 2012.  Competing investments are not very attractive: bond and savings deposit yields are low, and offer no growth potential.  Meanwhile, corporate balance sheets are very strong. Sentiment is pessimistic, a favorable indicator.  And although election years are not always good for stocks (e.g. 2008), when political gridlock is one of the major problems, the promise of clarity may provide a boost.

In 2011 investors fled from risk.  At some point, the fundamental case for stocks will once again attract investors. Maybe this year…

* Often referred to as the fear index or the fear gauge, the VIX represents one measure of the market’s expectation of stock market volatility over the succeeding 30 day period.

Kevin O’Keefe, Managing Member and Chief Investment Officer of First Affirmative Financial Network, LLC, is responsible for due diligence and monitoring of mutual funds and separate account managers.

 B Corps offer an alternative to “business-as-usual.”  A new class of corporation, B Corps are legally required to pursue the creation of a material positive impact on society and the environment, while meeting higher standards of accountability and transparency.  Current law requires corporations to prioritize the financial interests of shareholder over the interests of workers, communities, and the environment.

 B Corps are structured to maximize profits for society, not just for their shareowners.  With the growing public demand to move away from corporate greed and corruption, B Corps offer a much needed solution to better serving the “99%.”

 In December 2011, New York became the seventh state to legally recognize B Corps; joining California, Hawaii, Virginia, Maryland, Vermont, and New Jersey.  Similar legislation is pending in North Carolina, Pennsylvania, Michigan, and Washington DC, and will be introduced in Colorado in early 2012.

As of the date I am writing (December 9, 2011) the S&P stands at 1255.19.  Since July 1, 1999, we have experienced Y2K, 9-11, the Bear Market of 2001-2002 (one of the three worst in the past 100 years), the Financial Crisis of 2008-2009 (also one of the three worst Bear Markets in a century), and we are now living through the potential meltdown of the European Union.

In twelve and a half years, stock prices, like a roller coaster, have finished where they began; but the ride has been terrifying for many people.  This performance (or lack thereof) is being referred to as the “Lost Decade,” an especially chilling appellation for Baby Boomers nearing retirement age.

Possible Good News #1:

The Dividend Yield on the S&P 500 is higher than the Ten-Year U.S. Treasury Bond.

Stocks of large U.S. companies are extremely inexpensive relative to government bonds.  I would, personally, much rather own a portfolio of equity income focused blue chip stocks that are paying dividends of around 3.5%—and that also have the likelihood of both increasing dividends over time AND increasing in value—than owning 10 year Treasurys that will pay me 2% for ten years and then merely give me my money back.

Possible Good News #2:

Stocks are much more reasonably priced compared to earnings.  At the beginning of what is now being called the “Lost Decade,” stocks were more highly priced relative to 10-Year Trailing Earnings than ever before.  Investors paid a very high historical price, and failed to receive any reward.  (A possible corollary to gold today?)

 With stock prices versus trailing earnings at a much more reasonable ratio today, it is quite possible that the performance of equity markets over the next ten years will be much closer to “normal.”

Possible Good News #3 and #4

#3:  For each of the rolling 60-year periods ending from 1986 to 2010, the compound average growth rate of the stock market (as reflected in the S&P 500) has been over 9%.  This analysis includes the last eleven periods that include the “Lost Decade!”

#4:  Periodic investments into the markets[iii], such as in 401(k) retirement accounts, can still succeed.  This chart shows the history of an actual client who invested in 1996, and who has made monthly contributions to her IRA ever since.  Despite the “Lost Decade” her account is worth 51% more than the value of her contributions over time. 

Obviously, no one can accurately predict what will happen in the weeks or months to come.  But looking at longer-term trends and ratios can give an idea of what “normal” behavior is for markets and what is not.

[ii] Past performance is not a guarantee of future results.

[iii] Dollar Cost Averaging is a method of investing which can reduce the impact of short-term price fluctuations on your investment portfolio. It involves the investment of a fixed dollar sum at regular intervals over time, the result of which is an average price, based on the number of shares or units obtained at each of the prices prevailing on the dates of purchase.  Dollar Cost Averaging will not guarantee a positive return in a declining market.