Saturday, August 31, 2013

To Be . . . Pollyanna . . . Or Not To Be

I used to be a member of the World Future Society.  One of the things I learned was that peering past tomorrow is not only difficult but was meant to be difficult.  The greatest obstacle is our many unknown biases or prejudices, which keep us from being purely analytical.  The most common bias is that of recency, i.e., whatever has been trending lately will continue to trend that way in the future.

Two new books reflect that bias.  They are Niall Ferguson's The Great Degeneration and David Stockman's The Great Deformation.  You can tell by their titles that they are grim prophecies.  They are also both from the Austrian school of economics, often described as the Tough Love school as they insist on balanced budgets every year and minimal national debt.  I believe in the Austrian economic philosophy as a starting point, until they become as strident as the Tea Party.

Certainly, history is littered with failed civilizations, and the "great American experiment" may yet fail.  That's why it is essential to balance our reading with the latest study by the Boston Consulting Group.  They recall how the U.S. became uncompetitive due to high labor costs.  While those high labor costs created the great American middle class over the last century, the "hollowing-out" of that middle class over the last business cycle has made our labor costs competitive once again.  Adjusted for productivity, our labor costs are now 18% cheaper than in Japan and 34% cheaper than in Germany.  Instead of out-sourcing jobs, the U.S. is now re-sourcing jobs or bringing them back to America, because it makes business sense.

In addition to our improved labor costs, the U.S. is now a very low-cost provider of energy, thanks largely to the explosion in natural gas reserves.  Natural gas has dropped in price by 50% in the U.S.  Natural gas costs 2.6 times as much in Europe and 3.8 times as much in Japan.  In other words, two of the primary cost drivers of business, i.e., the cost of labor and the cost of energy, have come down dramatically in the United States.  Position those new advantages alongside our traditional advantages in technology, labor mobility and democratic institutions, it is not surprising that our exports of manufactured goods are rising rapidly.

Lastly, the growth in entitlements has been slowed, albeit not nearly enough.  And, revenues have been increased, albeit not nearly enough.  Still, there has been a change in degree or direction.

The recency bias in the books of Ferguson and Stockman blinded the authors to the benefits from hurting the middle class, from unbridled energy exploration, and from dumping fewer IOUs on our grandchildren.  America is changing, and I think it is changing for the better, albeit slowly.

The 1913 class Pollyanna by Eleanor Parker told the story of a young girl named Pollyanna, who always maintained an optimistic viewpoint.  It entered our lexicon that being a Pollyanna meant ignorance of bad news.  Maybe, the Boston Consulting Group is being Pollyanna-ish.  I think not.  By the way, that book had a happy ending.  So will the "great American experiment!"

Thursday, August 29, 2013

The Fixed in Fixed Income

When people think of fixed income, they usually think of bonds.  They also think of bonds as "safe" investments.  Bonds are NOT safe investments!  The market value or worth of those bonds is NOT fixed. Only the interest payments from the bonds are fixed.  The value of the bond is fixed only on the date of maturity.

Here's the math:  If you buy a bond for $1,000 paying 3%, you receive interest payments of $30 per year.  If prevailing interest rates then rise to 4%, what happens?  You still receive the same interest payments of $30 per year.  But, why would anybody else pay you $1,000 for a bond that pays only $30 per year when they could buy another bond for a $1,000 that pays them $40 per year.  However, they will pay you roughly $750 ($30/4%) for that bond that will mature at $1,000 on the maturity date but pays only $30 per year until then.  So, you've had a 25% loss in market value of the bond.  As I said, the market value of bonds is not fixed.

Now, because interest rates have been so low for so many years, investors needing income have increasingly bought bond alternatives, such as high-dividend stocks or REITs or MLPs.  While perfectly good investments, neither their income nor market value is fixed.  Here's my point:  the market values of bond alternatives will also decrease as interest rates rise, although probably not as much as bond values will decrease.

Rates have moved up sharply in the last six weeks, which means the market values of most fixed-income assets have dropped.  I expect that to continue, but I don't expect the income from those bond alternatives to decrease.  I do expect investors will enjoy the continued income -- while complaining about the decrease in market values.

Wednesday, August 28, 2013

Seasonal Fall

Did I mention that September is historically one of the two worst months for Wall Street?

In addition to history working against us this year, there is now greatly increased violence in the Middle East, and bombardment of Syria is certain.  Right after that, we have a budget battle and a dangerous debt ceiling battle in the U.S.  And, who can forget the Greek debt deal unravels in October . . . and probably Cyprus as well?

Oh, did I mention October is historically the other worst month of the year?

Sit back, work on your golf game, and remember that there is often a "Santa Claus Rally" in late December and that January is historically the best month of the year!

Monday, August 26, 2013

God Bless The Average Bear

Most people suspect that a financial advisor should be smarter than the average bear.  Everybody believes a financial advisor certainly should not be dumber than the average bear.  But, I ask you -- would an average bear be dumb enough to have done this 8-mile obstacle course in Wintergreen on Sunday, August 25th?

. . . unless he won first place in his elderly age group?

Saturday, August 24, 2013

Worry . . . Worry . . . Worry . . . Why?

Insurance giant Nationwide Financial just completed a survey of adults with $100 thousand or more in investible assets.  Not surprisingly, 58% of the respondents were afraid of death.  However, 83% are afraid of another financial crisis.  In other words, more people are afraid of another financial crisis than they are of dying.

There are so many ways to digest this nugget.  The philosopher queen of the libertarian party, Ayn Rand, would be pleased that people are just worrying about themselves, instead of world peace or the end of suffering.

Extentialists would be annoyed that 58% of us still over-rate the importance of death, which they regard as "the ultimate absurdity."  If you're going to think about it at all, think about controlling the risk factors to your health and how to find a good financial planner to help with your estate planning.  Worrying about death is just plain silly!

Financial planners marvel that survivors of the Great Recession are too afraid of risk and will do one of two things.  They will either refuse to take risk appropriately, or they will over-react to the next bear market, which is always inevitable.  We give clients a risk questionnaire to identify their risk tolerance but know they can become extremely risk-adverse without even a moment's notice.

Although painful to admit, it would be better for the non-existential financial planner if clients worried more about death and less about another financial crisis.  After all, you will survive many business cycles, but you only die once.

But, the existential financial planner wants you to accept risk as normal, especially during bear markets . . . and just enjoy your life now!

Worrying doesn't help.  It is just another risk factor to your healthy life.

Wednesday, August 21, 2013

A Potpourri of Advice

Obviously, I study the thoughts of many.  In no particular order, here are a few from today alone:

1.  Best Long-Term Thinking:  Roger Altman is Chairman of Evercore Partners and wrote in the current issue of "Time:"  The U.S continues to enjoy built-in advantages that other nations lack:  a growing population and the prospect of further immigration, big and flexible housing and stock markets, the most dynamic energy sector in the world, a huge and resilient consumer market and unparalleled technology leadership.

2.  Best Saying-Everything-in-a-Title:  RiverFront Investment Group is an investment manager, whose current newsletter is entitled Normal Pullback After Extreme Optimism.  That sums up the current investing environment.  While the market was unreasonably optimistic earlier this year and the stock market got ahead of itself, this current pullback is perfectly normal.  (they also do not expect tapering to begin next month.)

3.  Best Forecast-of-the-Day:  This week, Goldman Sachs (AKA the Vampire Squid) predicted the S&P will end this year at 1,750 -- it is about 1,650 now.  They also predict it will end 2014 at 1,900.  They also "expect the Fed to taper QE at the Sept meeting."

With respect to the market's short-term obsession with the question of when tapering by the Fed will begin, I think RiverFront is correct, i.e., tapering will NOT begin in September, and think that both the Vampire Squid and my beloved Dr. Jeremy Siegel of Wharton are incorrect.  We'll see . . .

That's enough reading for today.  It is time to get to work, but the clear take-away is that the stock market is much more obsessed with the short-term actions of the Fed than the long-term potential of America.

Monday, August 19, 2013

The Dog That Didn't Bark

The federal government could be shut down within six weeks!  While the stock market is obviously pricing in the increasing uncertainty, where are the politicians?  The Continuing Resolution that is currently funding the government expires September 30th.  Shouldn't somebody be hitting the panic button by now?

It could be a false sense of security because the deficit has fallen so much this year already, from 7.2% of GDP last year to only 4.2% this year.  Republicans can pat themselves on their back for sequestration that reduced spending by 2.9%.  Democrats can pat themselves on their back for the higher payroll tax, plus their good luck that Fannie & Freddie repaid more of their bailout debt than expected.

But, that is very short-term thinking.  The present value of our future spending on entitlements has not been restrained . . . or even discussed.  Sequestration and small tax increases are impotent in the face of the entitlement burden.  Is anybody discussing this?

I know, I know . . . it is the dog days of summer, when everybody is on the beach, but this is important.  A government shutdown will absolutely decrease GDP.  The longer it is shutdown, the bigger the damage to GDP.

I'm suspicious "the fix is in," meaning there is some understanding a shutdown will be avoided by postponing any resolution or decision now.  When that becomes apparent, there will be a brief market rally.  If there was a "grand bargain," there would be a strong bull run, very strong indeed!  But, that won't happen.

The dogs need to get off the beach, get back to Washington, and start barking at each other, please!

Friday, August 16, 2013

Waiting To Hear The Cannons Fire

I don't know if it is true but have always heard that the expression "sell on the rumors of war and buy when you hear the cannons," originated after one of the Napoleonic Wars, when several investors made a huge fortune buying stock at the low point.

The point of this old adage is that the stock market anticipates news.  If the news is expected to hurt the market, the market is already down before the news is actually announced.

That's exactly what the stock market has been doing the last few weeks -- slowly leaking value as it waits for the onslaught of bad news this Fall.  Next month holds the German elections and the latest chapter in the Greek debt tragedy.  October holds another debt ceiling debacle in Congress.  Despite our generally improving economy, pointed reminders of our vulnerability to another financial crisis are in the near future.

Overlaying this slow leaking of value, Egypt blows up, increasing the leakage.  The "Arab Spring" suddenly becomes the "Arab Fall."  The stock market becomes headline-dependent again.  Gold rises, along with interest rates.   This geopolitical overlay has turned the slow leak into an annoying hiss.

As long as uncertainty rises, the stock market will leak, and I expect that will continue another two months or so.  So, take another summer vacation, walk your kid to school this year, and plan your Holiday Season, when the stock market should be putting a present under the tree for you . . .

Sunday, August 11, 2013

"Psst, Mister . . . Want A Hot Stock Tip"

Most Registered Investment Advisors (RIAs) have a low regard for stockbrokers.  RIAs understand Nobel-Prize-Winning Modern Portfolio Theory, which demonstrates higher returns can come from portfolios with lower risk, which is the "Holy Grail" of investing,.  This happens when you invest a portfolio in different asset classes appropriately.  By comparison, a stockbroker has a "hot stock" for you.

Importantly, RIAs have a fiduciary responsibility to do the right thing for their clients.  That doesn't mean they cannot make mistakes, but they must do whatever is in the clients best interest, not their best interest.   Stockbrokers only have a duty to do whatever is "suitable" or "good enough" for their client.  It is a small nuance in words but a big difference in trust.  For example, some mutual funds are notorious for sending stockbrokers and spouses to exotic resorts for putting clients into those mutual funds.  How's that for a conflict-of-interest?  Can you trust the mutual fund he sold you?  What about the better mutual funds that don't send their salesmen to Hawaii?

Investors are wising up and leaving stockbrokers.  Responding to this loss, brokerage houses have allowed some stockbrokers to become RIAs  . .  sort of . . . call them "RIA-Lite."   Traditional RIAs are now called "Fee-only RIAs".  They have no hidden fees.  All fees are fully disclosed.  Stockbrokers have multiple hidden revenue sources.  Besides earning commissions on each trade, they add to the price of bonds they sell to customers, called a "mark-up."  In addition, they get kickbacks every year from hidden "12b-1" fees paid by the higher-cost mutual funds they sell to customers.   And, you'd be shocked by the commissions they are paid for selling you annuities.  The shame of it all is that you don't even get to deduct those fees on your taxes . . . because you don't even know about them.

So, I marvel anybody would ever do business with a stockbroker instead of a Fee-only RIA.  Wait a minute!  There is somebody outside my window, and I hear him saying "Hey buddy, wanna a hot stock?" Yeah, I think I'll do business with someone who doesn't use Modern Portfolio Theory, does not hold a CERTIFIED FINANCIAL PLANNER certificate, charges me hidden fees, and takes his wife to Hawaii each year.  What a deal!  I think I can trust him . . .

Friday, August 9, 2013

Too-Big-To-Think . . Out-Of-The-Box

My view of Wells Fargo is that, unlike Goldman Sachs, they have a large number of good and decent people trapped in a hopelessly hidebound giant, that is more focused on yesterday's ideas than tomorrow's.  Still, because they are so giant and publish to so many readers, I do follow their thinking.  In no particular order, here is the latest:

1.  GDP will continue to grow slowly but steadily, ending next year at 2.4%.
2.  Job growth will remain about 200 thousand a month.
3.  The unemployment rate will drop slowly to 7.0% by the end of 2014.

Even though they predict inflation to remain muted, they do expect the capacity utilization rate to hit 80% in the third quarter of next year.  To classical economists, that is the traditional "trigger" for inflation.

Lastly, they expect the interest rate on 10-year Treasuries to rise from 2.6% now to 3.4% during the fourth quarter of next year.  But, they expect the rise to be slow and steady.

I've become more interested in "behavioral finance" recently.  Why is it that different people will view the same economic data and come to different conclusions?  It is due to their biases, of course.  One of those biases is the "recency bias," which means a person naturally assumes that whatever is happening today will continue to happen tomorrow.  I suspect Wells Fargo may be guilty of that bias, probably as a result of too much compromise among too many economists.  They are certainly too-big-to-fail and may also be too-big-to-think-out-of-the-box.

Thursday, August 8, 2013

Laborare Est Orare

Recently, I blogged about the Calvinistic roots of the Presbyterian Church and explained why that church is often considered "pro-business."  To my surprise, I received some criticism for that generalization and also learned that "pro-business" is not necessarily a compliment.

Full Disclosure Time:  The family church of the Flinchums was the venerable, old Indian Valley Presbyterian Church, so deep in the backwoods of rural Virginia that a GPS would get a headache looking for it.  In that church was a wonderful hundred-year-old stained-glass window from England, placed there in honor of my grandmother, Hallie.  Written in pieces of stained-glass was the Latin phrase Laborare Est Orare, which means "To Work Is To Love."  That is so consistent with Calvinism, and I make no apology for my pro-business Presbyterian roots.

The tragedy is that the old family church was recently euthanized and no longer exists.  It seems the national Presbyterian organization authorized the ordination of gay ministers.  In a panic that some gay preacher might have a burning desire to lead a hostile congregation deep in the backwoods of rural Virginia, the congregation aborted itself by seceding from the national organization.  So, the old Flinchum church no longer exists.

It was a victim of its own anti-gay rhetoric.  To the congregation, they were pro-Bible, not anti-gay.  I guess that's a good reason to euthanize a church . . . ?

Calvin was right to be pro-business, but there is no indication he was homophobic.  There are so many divisive issues, demanding our time and our emotions, that I simply cannot care about all of them.  I care about being pro-business (and even served as president of the local Chamber of Commerce.)  But, I don't have the time or emotion to care about gays.  I wish them well and don't understand why people think I should care more.  I don't have time . . . because I work . . . like any good existential Calvinist . . .    

Wednesday, August 7, 2013

In Search Of . . . Women

Women make up over half of the population.  They are almost two-thirds of the total labor force.  But, only one-third of financial advisors are female . . . why?

I went to Indianapolis recently to hear a lecture by Kathleen Burns Kingsbury, author of How to Give Financial Advice to Women.  It was primarily geared to help male advisors deal with female clients.  She had five "practical strategies."  First, when meeting with a female client, sit directly across from her and give her lots of eye contact.  Second, make sure she gets to tell her story, because "women connect and build relationships by sharing the details of their lives."  Third, don't do a data-dump on her.  "Use analogies and stories she can relate to."  Fourth, meet with her individually, because husbands and wives have quite a different view on the role of money.  [I require my clients to complete a risk questionnaire independent of each other, and they rarely agree.]  Fifth, when discussing investment performance, discuss it in terms of her life goals, not just his.

Personally, I felt totally comfortable with these suggestions.  In fact, I generally prefer working with women, as it eliminates the ever-present competition between men.  But, this still doesn't explain why so few women enter financial planning.

Kingsbury talks about women being "natural nurturers."  Indeed, I have always thought of financial planning as financial social work -- helping people make some of the most important decisions they'll ever make.  Unfortunately, young financial planners are forced to be salesmen instead of nurturers for many years, until they build up their "book of business."

One of the two leading candidates to replace Ben Bernanke at the Fed is Larry Summers, who lost his job as President of Harvard University, because he made some condescending statements about the ability of women to do math.  While I cannot speak to that, I do think financial planning is perceived as more math-intensive than it really is.  While it is somewhat math-dependent, it is not difficult nor high-level math.  Mere nimbleness with arithmetic is usually sufficient.

The bottom line is that I don't know why women are under-represented in financial planning.  But, I also remember the banking industry back in the 1970s, when it was largely male-dominated.  That is no longer the case, as women have excelled and pushed the "glass ceiling" higher and higher.  I suspect it will be the same in financial planning.  At least, I hope so . . .

Tuesday, August 6, 2013

"Expect The Bull Market In Equities To Continue"

My favorite professor at Wharton was undoubtedly Dr. Jeremy Siegel.  Although he has the demeanor of the stereotypical absent-minded professor, he has a laser-sharp mind, capable of piercing tall mountains of data.  However, he has never seen a glass as half-empty . . . only half-full.  His landmark book, Stocks For The Long Run, is required reading.

In addition to the headline above, he reminds us that 73% of companies have beat their earnings expectation this quarter, and 56% have beat their revenue expectations, which is great.  So, corporate America is strong!

He points out that the labor market improved last month better than we realize.  The non-farm payroll report or "Jobs Report" showed only 163 thousand jobs were created.  This estimate is based on reports filed by businesses.  However, the Household Jobs Report, which is based on random phone calls to homes, shows a much stronger 227 thousand jobs were created.  Plus, the unemployment rate did tick down to 7.5%.  So, America's labor market is certainly improving.

But, does this mean the Fed will begin reducing Quantitative Easing in September?  Dr. Siegel gives that a 75% probability.  At first blush, that would be a clear signal the stock market will fall.  But, maybe not!

Some people see the current sideways drift in the stock market to be the prelude to a bear market.  Some see it as typical of the "dog-days" of August, when trading volume is very low.  More people see it as a "consolidation" of market gains, which is necessary to begin the next leg of the bull market.  However, it could be that the market is already factoring-in the news that QE will begin slowing down next month.  In that case, there will be minimal reaction to the news.  While Dr. Siegel didn't opine on this point, I really doubt that he would disagree.  After all, the glass is half-full, isn't it? 

Monday, August 5, 2013

Going Out-Of-Style ?

One of the longest-running debates among investment strategists is whether "growth" stocks or "value" stocks are best.  This is called "style" investing.  Which style is best?  While there are long detailed definitions of the different styles, a shorthand distinction is that value stocks usually pay dividends while growth stocks usually do not.  Importantly, there is a common misconception that growth stocks will grow faster than value stocks. That may sound grammatically correct, but it is usually not correct.  Take a long at this chart:

Chart foriShares Russell 1000 Growth Index (IWF)

The blue line shows growth stocks while the green line shows value or dividend-paying stocks.

As you can see, value stocks have out-performed growth stocks since 2000 but not always.  Note that the distance between the lines changes over time.  Sometimes, growth stocks grow faster than value stocks, as they are right now.

This causes much consternation among income investors, who normally buy value stocks.  They are accustomed to outperforming those investors chasing growth, and they lose bragging rights at cocktail parties.

A common mistake income investors make during these times is to abandon income and chase growth.  (After all, you can spend capital gains just as easily as dividends or interest.)  But, what happens when value becomes the dominant style again, as it normally does?  Oh, yeah . . . I forgot -- they'll recognize value is outperforming again and immediately shift back.  Of course, they will . . .

Some mistakes never go out of style.

Friday, August 2, 2013

A "Technical" Ceiling ?

When enough people believe something will happen, that is often enough reason to make it happen.  That is called a "self-fulfilling prophecy."

I am not a fan of technical analysis (using graphs and charts to find meaning) in the stock market.  Comparing technical analysis to fundamental analysis is like comparing voodoo economics with classical economics.  But, I know a great many investment strategists use technical analysis, which forces me to pay attention to any prophecy in their graphs and charts.  Take a look at this one:

Chart of the Day

On an inflation-adjusted basis, the Dow has bounced off the ceiling twice.  Technicians would suggest that the bull market would be over if it bounced off the ceiling a third time.  Yesterday was the third attempt, and it appears it did NOT bounce.  It easily shot thru the ceiling, suggesting we are now in a new bull run.

Today's Jobs Report was disappointing, but Dow futures are only down slightly.  If the Dow closes flat or only slightly down today, the technicians will be partying this weekend.  I suppose I should be happy if they are???