November 2017

  • August 2017 Looking for the Minsky Moment
    A Guide to Retirement Planning  
    August 11, 2017
    Volume 11, Issue 6
    Nick Massey, 
    CFP(R), AIF(R)
    President
    Chief Investment Officer
    Darlene Shipe
    Investment Advisor
    Lynn J. Bilodeau
    Attorney at Law
    Investment Advisor

    Dear Nick ,
     
    Welcome to the Educated Investor, our bi-monthly newsletter with information that can help you with your retirement planning. Feel free to use this information and to pass it along to your friends and associates. If you are interested in additional information contact our office at   
    (405) 341-9929.
    Feature Article
    Looking for the Minsky Moment
     
    The stock market has been hitting new all-time highs and it's certainly a fair question to ask how far it can go.  I am reminded of an old saying, "Bull markets don't die of old age."  Well, if that's true, then what do they die of?
     
    Great News!  Federal Reserve Chair Janet Yellen says there are no bubbles forming anywhere.  She said recently, "Would I say there will never, ever be another financial crisis?  You know probably that would be going too far, but I do think we're much safer and I hope that it will not be in our lifetime and I don't believe it will be."  Well, how cool is that?  That's a bit of a stretch though.  I have a feeling that I will be able to use that quote a lot in future newsletters when it comes back to haunt her.
     
    But the relief is understandable because Fed Chairmen know what they're talking about when it comes to bubbles, recessions, and bear markets.  Well, there was that little hiccup in 1999 when then Fed Chairman Alan Greenspan said, "Nah" to the question of whether we were in a stock market bubble.  And a housing bubble in 2004?  "Nah."  And then there was that little 2007 matter with Ben Bernanke about a Sub-prime mortgage bubble?  "Nope, it's contained."  Oh well.  Maybe this time is different.
     
    I have always been a student of economic history.  Most people who have known me for a while know I consider myself more of a macro economist and one who uses demographics to understand the big picture and long term trends.  One of my favorite economists is a guy named Hyman Minsky, an American economist who died in 1996.  His research attempted to provide an understanding and explanation of the characteristics of financial crises.
     
    Isn't that a great name for an economist?  It just sounds like one.  Okay, I know it's kind of weird to have a favorite economist.  I was telling my granddaughter (who always knows how to bring me back to reality) about this recently and she said, "You know, only a total geek would have a favorite economist."  Okay, guilty as charged.  I can't help it.
     
    By the way, if you want to have a little fun - next time you're at a party or social event, standing around making small-talk about football or basketball, try saying with a straight face, "So, who's your favorite economist?"  Then watch them all move away.  Of course, if someone answers "Hyman Minsky" you should turn around and run.
     
    One of the things Minsky was known for was his studies on debt.  Not all debt is bad.  There is productive debt, such as debt that produces something or creates something of value.  Infrastructure improvement, public works, roads, bridges, etc. come to mind.  In the private sector it might be plant and equipment and things that help produce something.  Then there is unproductive debt, such as debt to generate consumer spending or temporary demand.  In the end, the money is spent and there is not much to show for it.  Finally, there is counterproductive debt, such as debt to pay other debt.  The problem we have today, both in the public and private sector, is we have too much unproductive and counterproductive debt instead of the productive kind.
     
    Anyway, Minsky was also known for his theory that stability breeds instability.  In other words, the longer things are good and going well, the more comfortable and complacent people become.  The more comfortable and the more they believe things are good, the more they are likely to spend and invest and eventually even take risk.  Sound familiar?  Things get better and better and the risks get higher until eventually it is no longer sustainable.  2007 was a good example.  The collapse of housing in just 4 states was the trigger that led to a global financial crisis.
     
    This is the classic definition of the business cycle and why things go from highs to lows and back over a period of time.  Think of it like slowly pouring sand onto a pile.  It gets higher and higher until finally one grain of sand triggers instability and the pile collapses.  In economic terms, that has become known as the Minsky moment.
     
    I tell you all this because I think we are building a number of potential Minsky moments and risks.  I don't know when this bull market will top.  No one knows that.  However, I do know that no market goes up forever.  You can't make decisions based upon the news, because the news is always good at the top, just as the news is always terrible at the bottom.  They don't ring a bell when the market tops.
     
    While the economy seems to be improving and the market is hitting new highs, there are a number of underlying warning signs.  Many are minor, but collectively they have the potential for damage.  At some point we are going to find that Minsky moment.  Probably not now, but it is something to think about.  Thanks for reading.
    S. Nick Massey, CFP®
    President
    Chief Investment Officer
     

     


A Guide to Retirement Planning  
September 6, 2017
Volume 11, Issue 7
Nick Massey, 
CFP(R), AIF(R)
President
Chief Investment Officer
Darlene Shipe
Investment Advisor
Lynn J. Bilodeau
Attorney at Law
Investment Advisor

Dear Nick ,
 
Welcome to the Educated Investor, our bi-monthly newsletter with information that can help you with your retirement planning. Feel free to use this information and to pass it along to your friends and associates. If you are interested in additional information contact our office at   
(405) 341-9929.
Feature Article
Debt Ceiling Debate - Here We Go Again
 
"I've always depended on the kindness of strangers."  So said Vivian Leigh in her role as Blanch in the Tennessee Williams play "A Streetcar Named Desire."  Over the last 10 years, I have written several columns about the US debt ceiling debates.  Here we go again.
 
In case you had not heard, the periodic silly debate over the debt ceiling is back again and will be a hot topic in September.  I say silly because the debt ceiling has become just another way for either side of Congress to impose economic terrorism with the other side, and all of us as well.  It has very little to do with getting anything done.
 
The current national debt is just shy of $20 trillion dollars.  That's a really big number.  Try writing that out on paper.  Each year that we run a budget deficit, we add the deficit to that number.  The current debt ceiling is just under $20 trillion and we are rapidly bumping up against it.  Hence the debate again on whether to raise the ceiling or not.
 
Let's step back for a moment and consider what the debt ceiling is.  The national debt total is simply the cumulative amount of spending that exceeded the amount taken in.  The ceiling is an arbitrary number agreed upon by Congress as a benchmark the treasury cannot exceed.  You might find it interesting to note that most countries do not have a debt ceiling.  However, it is our law and we have to deal with it.
 
A statutorily imposed debt ceiling has been in effect since 1917 when the US Congress passed the Second Liberty Bond Act.  Before 1917 there was no debt ceiling in force, but there were parliamentary procedural limitations on the level of possible debt that could be held by government.
 
US government indebtedness has been the norm in US financial history, as well as most Western European and North American countries, for the past 200 years.  The US has been in debt every year except for 1835.  Debts incurred during the American Revolutionary War and under the Articles of Confederation led to the first yearly report on the amount of the debt ($75,463,476.52 on January 1, 1791).
 
Every President since Herbert Hoover has added to the national debt expressed in absolute dollars.  The debt ceiling has been raised 76 times since 1962, including 18 times under Ronald Reagan, eight times under Bill Clinton, seven times under George W. Bush, and five times under Barack Obama.
 
Yes, it is absolutely imperative that we deal with our accumulating national debt.  However, the debt ceiling is not the problem. The problem is the annual budget deficits.  It is important to remember that the amount of debt we have increases only if we spend more than we take in.
 
Of course, that has been going on for a long time with annual budget deficits.  During the recent financial crisis of 2008 and for a couple years after, we had some years with over $1 trillion annual budget deficits.  This year will likely "only" be about $450 billion.  But that is like saying we are going over the cliff less rapidly.  The amount of debt is still going up.
 
To put it in individual terms, if you had $100,000 worth of obligations this year and your income was only $80,000, you are going to need to find $20,000 somewhere.  You will either need to find additional income to make up the shortfall, take it from savings, or borrow the money, or default on some of the obligations.  If your personal debt ceiling is $100,000 and you can't borrow anymore, and you can't bring in additional income, you will default on what you owe.
 
Is this the solution we are suggesting for the U.S government?  Where the debate should be concentrated is on balancing the budget.  Unless we start spending less than we take in, the debt will increase and we will continually bump up against any ceiling established.
 
Some believe that freezing the debt ceiling will force Congress' hand.  But the current debt is from money already spent or promised.  Are we really willing to tell the world that we won't honor our obligations?  The consequences of that, both intended and unintended, could be catastrophic.  Those who suggest that it doesn't matter are playing with fire and are going to get us all burned.
 
The truth is, there is nothing significant about the debt ceiling number.  What is important is finding meaningful ways to reduce annual budget deficits and at least keep the debt from getting worse.  There are serious dangers in this debt limit brinkmanship.  It's time for Congress to stop monkeying around, stop the political games, stop holding our citizens hostage over ideology, and get something done.  Thanks for reading.
S. Nick Massey, CFP®
President
Chief Investment Officer
 

 


View all..
A Guide to Retirement Planning  
August 11, 2017
Volume 11, Issue 6
Nick Massey, 
CFP(R), AIF(R)
President
Chief Investment Officer
Darlene Shipe
Investment Advisor
Lynn J. Bilodeau
Attorney at Law
Investment Advisor

Dear Nick ,
 
Welcome to the Educated Investor, our bi-monthly newsletter with information that can help you with your retirement planning. Feel free to use this information and to pass it along to your friends and associates. If you are interested in additional information contact our office at   
(405) 341-9929.
Feature Article
Looking for the Minsky Moment
 
The stock market has been hitting new all-time highs and it's certainly a fair question to ask how far it can go.  I am reminded of an old saying, "Bull markets don't die of old age."  Well, if that's true, then what do they die of?
 
Great News!  Federal Reserve Chair Janet Yellen says there are no bubbles forming anywhere.  She said recently, "Would I say there will never, ever be another financial crisis?  You know probably that would be going too far, but I do think we're much safer and I hope that it will not be in our lifetime and I don't believe it will be."  Well, how cool is that?  That's a bit of a stretch though.  I have a feeling that I will be able to use that quote a lot in future newsletters when it comes back to haunt her.
 
But the relief is understandable because Fed Chairmen know what they're talking about when it comes to bubbles, recessions, and bear markets.  Well, there was that little hiccup in 1999 when then Fed Chairman Alan Greenspan said, "Nah" to the question of whether we were in a stock market bubble.  And a housing bubble in 2004?  "Nah."  And then there was that little 2007 matter with Ben Bernanke about a Sub-prime mortgage bubble?  "Nope, it's contained."  Oh well.  Maybe this time is different.
 
I have always been a student of economic history.  Most people who have known me for a while know I consider myself more of a macro economist and one who uses demographics to understand the big picture and long term trends.  One of my favorite economists is a guy named Hyman Minsky, an American economist who died in 1996.  His research attempted to provide an understanding and explanation of the characteristics of financial crises.
 
Isn't that a great name for an economist?  It just sounds like one.  Okay, I know it's kind of weird to have a favorite economist.  I was telling my granddaughter (who always knows how to bring me back to reality) about this recently and she said, "You know, only a total geek would have a favorite economist."  Okay, guilty as charged.  I can't help it.
 
By the way, if you want to have a little fun - next time you're at a party or social event, standing around making small-talk about football or basketball, try saying with a straight face, "So, who's your favorite economist?"  Then watch them all move away.  Of course, if someone answers "Hyman Minsky" you should turn around and run.
 
One of the things Minsky was known for was his studies on debt.  Not all debt is bad.  There is productive debt, such as debt that produces something or creates something of value.  Infrastructure improvement, public works, roads, bridges, etc. come to mind.  In the private sector it might be plant and equipment and things that help produce something.  Then there is unproductive debt, such as debt to generate consumer spending or temporary demand.  In the end, the money is spent and there is not much to show for it.  Finally, there is counterproductive debt, such as debt to pay other debt.  The problem we have today, both in the public and private sector, is we have too much unproductive and counterproductive debt instead of the productive kind.
 
Anyway, Minsky was also known for his theory that stability breeds instability.  In other words, the longer things are good and going well, the more comfortable and complacent people become.  The more comfortable and the more they believe things are good, the more they are likely to spend and invest and eventually even take risk.  Sound familiar?  Things get better and better and the risks get higher until eventually it is no longer sustainable.  2007 was a good example.  The collapse of housing in just 4 states was the trigger that led to a global financial crisis.
 
This is the classic definition of the business cycle and why things go from highs to lows and back over a period of time.  Think of it like slowly pouring sand onto a pile.  It gets higher and higher until finally one grain of sand triggers instability and the pile collapses.  In economic terms, that has become known as the Minsky moment.
 
I tell you all this because I think we are building a number of potential Minsky moments and risks.  I don't know when this bull market will top.  No one knows that.  However, I do know that no market goes up forever.  You can't make decisions based upon the news, because the news is always good at the top, just as the news is always terrible at the bottom.  They don't ring a bell when the market tops.
 
While the economy seems to be improving and the market is hitting new highs, there are a number of underlying warning signs.  Many are minor, but collectively they have the potential for damage.  At some point we are going to find that Minsky moment.  Probably not now, but it is something to think about.  Thanks for reading.
S. Nick Massey, CFP®
President
Chief Investment Officer
 

 


A Guide to Retirement Planning  
September 6, 2017
Volume 11, Issue 7
Nick Massey, 
CFP(R), AIF(R)
President
Chief Investment Officer
Darlene Shipe
Investment Advisor
Lynn J. Bilodeau
Attorney at Law
Investment Advisor

Dear Nick ,
 
Welcome to the Educated Investor, our bi-monthly newsletter with information that can help you with your retirement planning. Feel free to use this information and to pass it along to your friends and associates. If you are interested in additional information contact our office at   
(405) 341-9929.
Feature Article
Debt Ceiling Debate - Here We Go Again
 
"I've always depended on the kindness of strangers."  So said Vivian Leigh in her role as Blanch in the Tennessee Williams play "A Streetcar Named Desire."  Over the last 10 years, I have written several columns about the US debt ceiling debates.  Here we go again.
 
In case you had not heard, the periodic silly debate over the debt ceiling is back again and will be a hot topic in September.  I say silly because the debt ceiling has become just another way for either side of Congress to impose economic terrorism with the other side, and all of us as well.  It has very little to do with getting anything done.
 
The current national debt is just shy of $20 trillion dollars.  That's a really big number.  Try writing that out on paper.  Each year that we run a budget deficit, we add the deficit to that number.  The current debt ceiling is just under $20 trillion and we are rapidly bumping up against it.  Hence the debate again on whether to raise the ceiling or not.
 
Let's step back for a moment and consider what the debt ceiling is.  The national debt total is simply the cumulative amount of spending that exceeded the amount taken in.  The ceiling is an arbitrary number agreed upon by Congress as a benchmark the treasury cannot exceed.  You might find it interesting to note that most countries do not have a debt ceiling.  However, it is our law and we have to deal with it.
 
A statutorily imposed debt ceiling has been in effect since 1917 when the US Congress passed the Second Liberty Bond Act.  Before 1917 there was no debt ceiling in force, but there were parliamentary procedural limitations on the level of possible debt that could be held by government.
 
US government indebtedness has been the norm in US financial history, as well as most Western European and North American countries, for the past 200 years.  The US has been in debt every year except for 1835.  Debts incurred during the American Revolutionary War and under the Articles of Confederation led to the first yearly report on the amount of the debt ($75,463,476.52 on January 1, 1791).
 
Every President since Herbert Hoover has added to the national debt expressed in absolute dollars.  The debt ceiling has been raised 76 times since 1962, including 18 times under Ronald Reagan, eight times under Bill Clinton, seven times under George W. Bush, and five times under Barack Obama.
 
Yes, it is absolutely imperative that we deal with our accumulating national debt.  However, the debt ceiling is not the problem. The problem is the annual budget deficits.  It is important to remember that the amount of debt we have increases only if we spend more than we take in.
 
Of course, that has been going on for a long time with annual budget deficits.  During the recent financial crisis of 2008 and for a couple years after, we had some years with over $1 trillion annual budget deficits.  This year will likely "only" be about $450 billion.  But that is like saying we are going over the cliff less rapidly.  The amount of debt is still going up.
 
To put it in individual terms, if you had $100,000 worth of obligations this year and your income was only $80,000, you are going to need to find $20,000 somewhere.  You will either need to find additional income to make up the shortfall, take it from savings, or borrow the money, or default on some of the obligations.  If your personal debt ceiling is $100,000 and you can't borrow anymore, and you can't bring in additional income, you will default on what you owe.
 
Is this the solution we are suggesting for the U.S government?  Where the debate should be concentrated is on balancing the budget.  Unless we start spending less than we take in, the debt will increase and we will continually bump up against any ceiling established.
 
Some believe that freezing the debt ceiling will force Congress' hand.  But the current debt is from money already spent or promised.  Are we really willing to tell the world that we won't honor our obligations?  The consequences of that, both intended and unintended, could be catastrophic.  Those who suggest that it doesn't matter are playing with fire and are going to get us all burned.
 
The truth is, there is nothing significant about the debt ceiling number.  What is important is finding meaningful ways to reduce annual budget deficits and at least keep the debt from getting worse.  There are serious dangers in this debt limit brinkmanship.  It's time for Congress to stop monkeying around, stop the political games, stop holding our citizens hostage over ideology, and get something done.  Thanks for reading.
S. Nick Massey, CFP®
President
Chief Investment Officer
 

 



May 2017

  • May 2017 Snap Away On Wall Street

    Snap Away On Wall Street

     

    I recently became aware of a product called Snapchat.  Since I’m not normally tuned into this kind of thing and am a complete novice in this area, I heard about it from my granddaughter.  She says I need to learn how to use it so I can instantly share pictures and videos with her and all my friends.  But I do that already (although not instantly but via text message), so I haven’t quite figured out why I need to do this.  Maybe someday, but that’s a subject for another day.

     

    What I also became aware of is the company that owns and developed Snapchat, Snap Inc., which became a publicly traded stock in February under ticker symbol SNAP.  Please note that I have absolutely no idea whether it is a good stock investment or not, and this is NOT a suggestion as to whether you should own it or not.  But there is an interesting back story here about the structure of the company and the publicly traded stock.

     

    After a little research, I learned some interesting things about the company.  I discovered that Snap Inc. is a camera company. The Company's flagship product, Snapchat, is a camera application that helps people to communicate through short videos and images known as a Snap. The Company offers three ways for people to make Snaps: the Snapchat application, Publishers Tools that help its partners to create Publisher Stories, and Spectacles, its sunglasses that make Snaps.  (I have no idea what I just said.)  Snaps are viewed primarily through the Snapchat application, but can also be embedded on the Web or on television in certain circumstances. According to their website, as of December 31, 2016, on average, 158 million people used Snapchat every day to Snap with family, watch Stories from friends, see events from around the world, and explore curated content from publishers.  That sounds like a lot of people and pictures to me.

     

    I may not know much about how to use Snapchat, but one thing I do know is that Wall Street has no shortage of ways to hose the gullible and uninformed.  Snap Inc. went public and sold stock to “investors” who were content, apparently, to be in possession of equity that didn’t have voting rights.  That’s right, Snap’s stock doesn’t vote.  Did you know that?  I didn’t.  In a sense, this isn’t new. This tactic has been successfully used by media companies in the past; like Twenty-First Century Fox and Viacom.

     

    But the latest goofy structure with no voting rights doesn’t come from old-geezer media CEOs, but from millennial tech CEOs.  Alphabet (known by most as Google) has split its stock into voting and non-voting share classes, and Mark Zuckerberg owns super-voting shares of Facebook.  They are basically insulated from outsiders telling them what to do.

     

    Snap just issued stock that doesn’t vote. There is one vote and it belongs to CEO Evan Spiegel.

    Evan Spiegel happens to be 26 years old, and he happens to be engaged to Victoria’s Secret model Miranda Kerr.  Knowing myself at age 26, and knowing what I might have been like had I been engaged to Miranda Kerr, you can forgive me if I am guessing that Spiegel might be a bit distracted.

     

    The key question is, “If you own stock that doesn’t vote, do you really own stock?”  Pretend you own 10 percent of a company, but you have no say in how it is run.  Do you really own part of it?  Is it equity in the company or did you just make a loan?  Interestingly enough, some of the large institutional investors are lobbying hard to keep Snap out of indexes like the S&P 500 because the stock has no voting rights.

     

    In the case of Snap, you have a company that might need a little adult supervision; but the CEO, Evan Spiegel, is accountable to no one. There are “stakeholders” and some of them like NBC Universal bought $500 million worth.  I would imagine that Spiegel would be wise to listen to them, but if he doesn’t want to, he doesn’t have to.  This sounds like a pretty sweet deal for Mr. Spiegel, but what about you?

     

    I don’t think it’s a coincidence that everyone is crazy for non-voting stock with the S&P 500 near all-time highs.  My guess is that if you tried to create non-voting stock when the S&P was at 666 (almost eight years ago), you would have been laughed out of the room.  I guess its’s a sign of the times.

     

    Okay, maybe I’m just a little jealous of a handsome, successful kid and his model girlfriend.  Actually, I wish the guy all the success in the world.  I have my doubts about the investment merits, but my real beef here is about the voting rights.  It takes a certain amount of arrogance to deny stockholders a say in the direction of the company.  That’s what happens when you go public.  You have to give up some control in exchange for being able to raise more capital and get liquidity for your investment.  Spiegel didn’t have to do that, so good for him - I guess.  As that old P.T. Barnum quote says, “There is a sucker born every minute.”  Thanks for reading.

     

    Nick Massey is President of Massey Financial Services in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.

     


April 2017

  • April 2017 Is Globalization Dead?

    Is Globalization Dead?

     

    There are a lot of very unhappy people in the streets of America right now, and it’s not just about politics.  On October 28, 2007 I wrote a column titled, “The Downside of Protectionism.”  During the Roaring 20s, the world economy benefited from that great era of globalization and free trade.  Then, as now, global trade made a lot of people uncomfortable.  And in both cases, politicians responded to public sentiment in exactly the wrong way, by attempting to stop or slow foreign competition.  There is some danger that they could do it again.

     

    On the eve of the Great Depression, Congress passed the Smoot-Hawley Tariff Act of 1930 to “protect” American business from “unfair” foreign competition.  Other countries retaliated in kind, levying tariffs of their own on American products.  As a result, the Great Depression got a whole lot greater as global trade shriveled and died.  Considering this glaring example of what not to do when it comes to trade, you would think that policy-makers would not repeat such a mistake.  They might.

     

    I wrote in 2007, “The backlash from globalization is already growing.  The bottom line is this…..the recent surge in protectionist sentiment is just one more parallel to the Roaring 20s.  The implications for the next decade, just as the decisions in the 1920s affected the 1930s, are equally negative.  We have all the ingredients in place to make the same mistakes we made then.  Let’s hope we learned our lessons and are smarter about it this time.”  Here we are, almost 10 years later, and it appears that what I wrote then was eerily predictive.  Clearly, President Donald Trump is not a fan of globalization.  Is he right?  It depends on who you ask.

     

    If we had to describe the last 50 years of economic history in one word, “globalization” would be high on the list.  Thousands of small, independent economies around the world are fused into one nearly seamless economy.  The things we use every day – food, clothing, vehicles, furniture, electronic devices, even the materials that compose our homes – now come from far and wide.  We don’t even notice.  International trade over vast distances is now so normal that we forget it wasn’t always so.

     

    Globalization entered a new phase in the 1960s.  I was born in 1947, so the explosion of the global economy has been a major part of my lifetime.  The baby boomers may be the first globalized generation.  If I reach 100, I suspect I will see children of a de-globalized generation.

     

    Just as a pendulum swings to extremes in each direction, I think we are seeing the same with globalization.  It may have peaked on one side in 2008 and is now starting the other direction.  Not that it will go that way and stay there, but it will continue on its path of finding equilibrium in a complex world.  Humanity spent the last 50 years globalizing.  I think historians will mark the 2008 financial crisis as the turning point.

     

    I don’t say this because I want a de-globalized world.  I believe the transition will happen whether any of us want it or not.  It will not happen in a linear fashion, though.  The process that brought us to this point had starts, stops and slowdowns.  Reverse globalization will have ups and downs too, but a new set of technologies will keep pushing it forward.

     

    Free trade is nice in theory.  The argument that has increasingly dominated since World War II is that free trade (trade without tariffs or regulation) is superior to protectionism in principle. Bilateral and multilateral free trade agreements have proliferated since then.  The question is whether it is preferable pragmatically.

     

    What happens in the real world?  The argument for free trade may be theoretically powerful, but it has several problems.  First, in order to trade, you must make products that others want.  If your markets aren’t protected, more advanced countries will constantly offer products at lower prices and better quality than your country can afford to produce at an early stage of development.  As a result, you are unable to develop your own industry and will be unable to purchase even low-cost goods, thus perpetuating underdevelopment and poverty.

     

    Early protectionist measures are necessary as a nation begins its industrial revolution, or else that revolution fails.  The US practiced this in the 19th century.  Germany practiced it in the 1950s. But some free trade agreements emerging today lock out economies struggling to take off, and lock in advantages to established economies.  This is the left-wing political argument.

     

    The surprising right-wing argument is that free trade doesn’t work when successful emerging economies like China take advantage of temporary low wages and their own formal or informal protectionism.  In this case, lower wages can devastate important sectors of an advanced economy while keeping out exports that could compete in other sectors of the emerging economy.  In other words, these developing countries use free trade to destroy some sectors of economies in advanced countries.

     

    It is possible for both sides to be right.  In the short run, free trade can devastate a particular economic segment.  In the long run, this might be rectified, and on the whole, the wealth of nations might grow; but it might not grow equally. Time and the distribution of benefits pose a political problem.

     

    Politics is not meant to interfere with efficient economies, as many think.  Classical economists like Ricardo or Adam Smith never used the term “economics” alone.  They always spoke of political economy.  This was not just loose terminology.  Both understood that political agreements make anything more than subsistence economies possible.

     

    They also understood that a nation is not a homogenized whole and that growth by itself, without taking into account distribution, will fail.  Taking a hypothetical example, let’s assume that free trade would create an astronomical 10 percent annual growth rate in a given country, but doing so would devastate certain major sectors of the economy.  The net worth of the nation would increase, but who would benefit from the growth?  Assume it is only certain sectors.  Looking at aggregate numbers would suggest that free trade is wonderful.  Breaking down the aggregate numbers, you would find that from a political standpoint you have created two classes: beneficiaries and victims of free trade.  The free trader might say that’s just the way it goes, and losers are losers. The losers would say that the winners live in a fantasy world if they think that they will be permitted to maintain that situation.  In other words, what happened to the idea of fairness and a level playing field?

     

    In practice, this means that the outcome of this extreme model will be confiscatory taxes, redistribution of wealth, imposition of tariffs, and the like.  The winner will say that he earned his wealth through his effort.  The loser will say the winner earned it through stacking the deck.  (Does this sound familiar?)  Those are irrelevant arguments.  More important is that both winner and loser will pursue their self-interest in the sphere that gives them the greatest advantage.  Whatever your view of it, this is happening today.

     

    Because of this, anti-globalism in on the rise.  Leaving the philosophical question out of the discussion, each side approaches the question of free trade from the standpoint of their own interests.  They both use the state to shape the economic environment as they think best—which is almost always the situation in which they make the most money.  Therefore, the argument in favor of free trade in the US has shifted.  Since World War II, the advocates of free trade have become increasingly powerful.  Since 2008, the political balance between the free traders and the protectionists has shifted, supported by a significant sector of the population who believe that they have been hurt by intensifying free trade.  They feel like there was a great party and they didn’t get invited.

     

    This sector is demanding an end to expanding free trade or a massive redefinition of its terms. The argument that it is beneficial overall has little impact on an individual basis.   In the same way a company CEO would oppose a shift in trade policy if it hurt his business, regardless of the national good, so too are individuals making the same decision.

     

    The balance between free trade and protectionism has been a major political issue in the US since its founding.  But now, free trade must demonstrate its worth, not simply assert it. We seem to be moving toward protectionism.  That will have significant effects, since the US makes up almost a quarter of the world’s economy.  What it decides has disproportional effects on the world.  The post-war trend toward free trade has likely reached its limits for this swing of the pendulum.  Some would argue that the recent rise of nationalism worldwide is an inevitable consequence.  I would have to agree with that conclusion.

     

    One argument for Donald Trump’s surprising win is partly a result of a globalization backlash.  He is, in the minds of some, the game changer.  Whether you agree with that premise or not, there is clearly a disenfranchised middle and lower class who has seen globalization and immigration (both legal and illegal) lower their wages and standard of living.  They’re angry and disillusioned, and Trump speaks their language.

     

    Globalization was supposed to make life better for everyone.  It certainly helped some people, but many got nothing out of it, and quite a few went backwards.  This is now very obvious, thanks to Trump.  Globalization benefits corporations, the wealthy, and highly educated workers, while working-class families struggle – so the argument goes.  Globalists are on the defense, hoping to put down the rebellion.  I encourage you to pay close attention as this next cycle unfolds.  It will affect all of us.  Thanks for reading.

     

    Nick Massey is President of Massey Financial Services in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


Mar 2017

  • March 2017 Understanding Interest Rates

    Understanding Interest Rates

     

    For many years you have heard me rant and rave about the Federal Reserve and their interest rate policy.  Unless you follow that sort of thing closely, you may not appreciate the finer points and what it means for you.

     

    Let’s do a little Fed 101.  The Federal Reserve Bank of the U.S. (the Fed) has two directives from Congress, which is called the dual mandate. The mandate requires the Fed to provide maximum employment and to provide price stability.  (Most central banks around the world only have one mandate – price stability.)  Price stability is another word for controlling inflation or avoiding deflation. The Fed tries to meet those objectives by tinkering with interest rate, i.e. monetary policy.

     

    The Fed’s most publicized tool for this sort of thing is what’s called the “federal funds rate,” which is the overnight lending rate charged to member banks to meet reserve requirements. A change in the fed funds rate can impact other interest rates but, the market ultimately prices in risk and its outlook of the economy.

     

    Just a couple tenths of a percentage point can very well determine if a company can borrow money from the bank cheaply enough to make a major merger, or avoid layoffs, or finance a risky product change. These rates (and the threat of higher or lower rates) are priced into the market.  When you’re dealing with billions or trillions of dollars, a few small tenths of a percentage point can make a huge ripple in the economy.  A fundamental question for us might be, “Does the Fed really set interest rates?”  Well, yes and no.

     

    The Fed has lost a lot of credibility over the last several years. They’ve vowed to be transparent but what does that really mean?  Through the actions of Fed Chair Janet Yellen and other Fed officials, it means that they reserve judgement on policy action until they’ve digested incoming economic data. The Fed has called this plan being “data dependent.” I guess that means they make a decision based on data they receive as opposed to being dependent on a secret crystal ball?

     

    Early on, following the financial crisis of 2008 when unemployment spiked to 10 percent, the Fed decided that their desired target rate would be a 6 percent unemployment rate. At the same time, they were fighting deflation – or falling prices.

     

    And since fighting deflation hadn’t been a problem since the Fed was created in 1913, it decided to experiment with what former Fed Chair Ben Bernanke called quantitative easing (QE). QE meant the government bought enough bonds to flood the market with liquidity as well as bringing the federal funds rate down to 0.0 percent.  Basically, the Fed started holding its own debt by creating and then buying bonds out of thin air.  (Wouldn’t you love to do that with your own checking account?)  The objective was to create inflation and jobs.

     

    QE was halted in 2014 but the size of the Fed’s balance sheet remains nearly as bloated now as it was when QE was stopped. The Fed has promised to “normalize” monetary policy but hasn’t described exactly what that means.  In my opinion, the success of their policies has been questionable.

     

    The unemployment rate has fallen back to where it was before the crisis, but wages for the vast majority of Americans still lag and the labor participation rate is at a three-decade low.  Inflation is increasing but without real wage growth, corporate profit growth, or increasing consumer spending.

     

    Since 2008, the Fed dropped the federal funds rate to 0.0 percent and that’s where that rate sat until December of 2015 when they raised that rate by 0.25 percent. They once again hiked last December to 0.50 percent.  The Fed only has control over the very short-term (federal funds) rate as mentioned earlier, but they expect their policy to affect rates all the way out to the 30-year Treasury rate.

     

    What the Fed can’t control is the yield curve, i.e. the spread between short-term rates and long-term rates. When the market believes there’s a lot of risk for inflation and the economy growing too fast, the long-term rates will rise faster and the curve will steepen. When the opposite is believed, the curve will flatten and the spread will narrow.  The Fed doesn’t control the yield curve; the market does.  But the Fed tries to manage the market, although in a crude fashion.

     

    So who wins in the end?  When the market believes the Fed should hike, the market will hike for them by selling off Treasury bonds and raising the yield. That in turn affects mortgage rates, corporate bond rates, municipal bond rates and even car loan rates.  The real markets adjust very quickly and sometimes violently when the unexpected happens.  Thanks for reading.

     

    Nick Massey is President of Massey Financial Services in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


Jan 2017

  • January 2017 Cassandra Has Left the Building

    2017 - Cassandra Has Left the Building

     

    My annual predictions newsletter from last January had the title, “2016 with Cassandra and Me.”  It reflected a theme based on Greek Mythology’s Cassandra, who was cursed with the ability to see the future but no one would believe her.  I couldn’t help but feel a certain bond.  After a pretty good score on my forecasts for the last nine years, I finally hit the wall and bombed pretty badly in 2016.  To paraphrase a famous Elvis saying, “Cassandra Has Left the Building.”

     

    It’s been said that those who live by the sword eventually die by the sword, so I guess I finally got my due.  It’s all in fun and I try not to take myself too seriously; but I do try to do the best I can with it.  To say that 2016 was full of surprises would be a huge understatement.  From election surprises to economic surprises, it was quite a year.  This is what I predicted for 2016 and what actually happened:

     

    #1:  “2016 will make 2015 look like a walk in the park.  After an early year sell-off, the market will be down 12 percent before a near term bottom is found.  There will be a recovery rally by the end of the year, but the S&P 500 will finish the year down 5 percent.  RESULT:  Well I sure blew that one.  We got the decline and the recovery, several times, but after a surprise win by Donald Trump in the presidential election, markets went on a tear and the S&P 500 finished the year at 2,239, up 8.7 percent from 2,059.

     

    #2:  “Rates on the 10-year Treasury bond will again be in a range between 1.7 and 2.75 percent.”  RESULT:  At least I got close on that one.  The range was from 1.323 percent low in July to a high of 2.641 percent in December, ending the year at 2.45 percent.  Since bond yields don’t tend to move too rapidly, that is an incredible move in a short period of time.  Yields spiked in anticipation of higher interest rates due to inflation and infrastructure spending in the future.

     

    #3:  “Gold may rally in the near term to as high as $1,250 but will remain under pressure in this deflationary environment and may fall below $1,000 and maybe to $900 an ounce.  RESULT:  Somewhat close.  Gold prices ranged from a low of $1,070 and a high of $1,375, and closed at $1,152, up 8 percent for the year.

     

    #4:  “Oil may finally find a bottom around $22 a barrel but won’t stay there long.  It may trade as high as $50 at some point, but will spend most of the year between $30 and $40.  RESULT:  Mostly correct.  WTI crude oil traded between a low of $26.05 and a high of $54.51 and closed the year at $53.89, up 20.8 percent.

     

    #5:  After going on an upside tear for the last two years, the dollar index might take a break this year and just trade in a narrow range between 105 and 95, after closing last year at 99.  RESULT:  Mostly correct.  The dollar index traded between a low of 91.9 and a high of 103.65 and closed at 102.40.

     

    #6:  US GDP growth will muddle along between 1 and 2 percent; not a recession but not enough to cause any real growth.  RESULT:  Close.  Third quarters estimates for GDP were 3.5 percent, after a second quarter estimate of 1.4%.  Annual GDP growth for 2016 is still estimated to be about 2.2 percent.

     

    #7:  Unemployment will inch back up to 6 percent and the labor participation rate will fall slightly further to 60 percent, the worst since the 1970’s.  RESULT:  Mostly wrong.  National unemployment rate fell to 4.6 percent in November 2016, with U6 unemployment at 9.6 percent.  Labor participation rate fell to 62.7 in November 2016 and slightly up from its 10 year low.

     

    #8:  I am concerned we are about to be hit by a new financial sector crisis coming out of Asia.  Forget about the Chinese stock market.  It’s their banks you should be worried about.  RESULT:  No china surprise, yet.  The two biggest surprises for 2016 were BREXIT and the US Presidential Election.  BREXIT caused a two week drop in the market and then nobody cared anymore.  The presidential election caused about a 10 hour drop in the market and then it was straight up from there.  Nobody saw that one coming.

     

    #9:  High yield bonds (a nice word for junk bonds) took a beating in 2014 and 2015 and will do it again in 2016.  RESULT:  Wrong.  High yield bonds, after choppy trading most of the year, became a proxy for the stock market and went up with it, moving up 17 percent for the year.

     

    #10:  Commodities in general are on the downside of their long term cycle, which is a 28 to 31 year cycle.  Falling commodity prices, including oil, and slowing global demand means they are going to be under economic pressure for quite some time.  RESULT:  Commodities went mostly up due to oil prices finally bottoming and an anticipation of renewed inflation coming in 2017.  The CRB Commodities index was up 9.5% for the year.

     

    So there you have it.  2016 was my worst year of predictions since I started doing them in 2007.  I don’t plan on doing a predictions column for 2017.  Since there is so much uncertainty in everything right now, I would only be guessing.  Forecasting should be based upon some rational premise, even if wrong.  Without that, it’s just guessing and that’s not what we do.  As Clint Eastwood once said in one his movies, “A man has to know his limitations.”  However, I will continue to write and offer comment and insight into topics that I think might be of interest to you.  Until next time, thanks for reading.

     

    Nick Massey is President of Massey Financial Services in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisorMy annual predictions newsletter from last January had the title, “2016 with Cassandra and Me.”  It reflected a theme based on Greek Mythology’s Cassandra, who was cursed with the ability to see the future but no one would believe her.  I couldn’t help but feel a certain bond.  After a pretty good score on my forecasts for the last nine years, I finally hit the wall and bombed pretty badly in 2016.  To paraphrase a famous Elvis saying, “Cassandra Has Left the Building.”

     

    It’s been said that those who live by the sword eventually die by the sword, so I guess I finally got my due.  It’s all in fun and I try not to take myself too seriously; but I do try to do the best I can with it.  To say that 2016 was full of surprises would be a huge understatement.  From election surprises to economic surprises, it was quite a year.  This is what I predicted for 2016 and what actually happened:

     

    #1:  “2016 will make 2015 look like a walk in the park.  After an early year sell-off, the market will be down 12 percent before a near term bottom is found.  There will be a recovery rally by the end of the year, but the S&P 500 will finish the year down 5 percent.  RESULT:  Well I sure blew that one.  We got the decline and the recovery, several times, but after a surprise win by Donald Trump in the presidential election, markets went on a tear and the S&P 500 finished the year at 2,239, up 8.7 percent from 2,059.

     

    #2:  “Rates on the 10-year Treasury bond will again be in a range between 1.7 and 2.75 percent.”  RESULT:  At least I got close on that one.  The range was from 1.323 percent low in July to a high of 2.641 percent in December, ending the year at 2.45 percent.  Since bond yields don’t tend to move too rapidly, that is an incredible move in a short period of time.  Yields spiked in anticipation of higher interest rates due to inflation and infrastructure spending in the future.

     

    #3:  “Gold may rally in the near term to as high as $1,250 but will remain under pressure in this deflationary environment and may fall below $1,000 and maybe to $900 an ounce.  RESULT:  Somewhat close.  Gold prices ranged from a low of $1,070 and a high of $1,375, and closed at $1,152, up 8 percent for the year.

     

    #4:  “Oil may finally find a bottom around $22 a barrel but won’t stay there long.  It may trade as high as $50 at some point, but will spend most of the year between $30 and $40.  RESULT:  Mostly correct.  WTI crude oil traded between a low of $26.05 and a high of $54.51 and closed the year at $53.89, up 20.8 percent.

     

    #5:  After going on an upside tear for the last two years, the dollar index might take a break this year and just trade in a narrow range between 105 and 95, after closing last year at 99.  RESULT:  Mostly correct.  The dollar index traded between a low of 91.9 and a high of 103.65 and closed at 102.40.

     

    #6:  US GDP growth will muddle along between 1 and 2 percent; not a recession but not enough to cause any real growth.  RESULT:  Close.  Third quarters estimates for GDP were 3.5 percent, after a second quarter estimate of 1.4%.  Annual GDP growth for 2016 is still estimated to be about 2.2 percent.

     

    #7:  Unemployment will inch back up to 6 percent and the labor participation rate will fall slightly further to 60 percent, the worst since the 1970’s.  RESULT:  Mostly wrong.  National unemployment rate fell to 4.6 percent in November 2016, with U6 unemployment at 9.6 percent.  Labor participation rate fell to 62.7 in November 2016 and slightly up from its 10 year low.

     

    #8:  I am concerned we are about to be hit by a new financial sector crisis coming out of Asia.  Forget about the Chinese stock market.  It’s their banks you should be worried about.  RESULT:  No china surprise, yet.  The two biggest surprises for 2016 were BREXIT and the US Presidential Election.  BREXIT caused a two week drop in the market and then nobody cared anymore.  The presidential election caused about a 10 hour drop in the market and then it was straight up from there.  Nobody saw that one coming.

     

    #9:  High yield bonds (a nice word for junk bonds) took a beating in 2014 and 2015 and will do it again in 2016.  RESULT:  Wrong.  High yield bonds, after choppy trading most of the year, became a proxy for the stock market and went up with it, moving up 17 percent for the year.

     

    #10:  Commodities in general are on the downside of their long term cycle, which is a 28 to 31 year cycle.  Falling commodity prices, including oil, and slowing global demand means they are going to be under economic pressure for quite some time.  RESULT:  Commodities went mostly up due to oil prices finally bottoming and an anticipation of renewed inflation coming in 2017.  The CRB Commodities index was up 9.5% for the year.

     

    So there you have it.  2016 was my worst year of predictions since I started doing them in 2007.  I don’t plan on doing a predictions column for 2017.  Since there is so much uncertainty in everything right now, I would only be guessing.  Forecasting should be based upon some rational premise, even if wrong.  Without that, it’s just guessing and that’s not what we do.  As Clint Eastwood once said in one his movies, “A man has to know his limitations.”  However, I will continue to write and offer comment and insight into topics that I think might be of interest to you.  Until next time, thanks for reading.

     

    Nick Massey is President of Massey Financial Services in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisorMy annual predictions newsletter from last January had the title, “2016 with Cassandra and Me.”  It reflected a theme based on Greek Mythology’s Cassandra, who was cursed with the ability to see the future but no one would believe her.  I couldn’t help but feel a certain bond.  After a pretty good score on my forecasts for the last nine years, I finally hit the wall and bombed pretty badly in 2016.  To paraphrase a famous Elvis saying, “Cassandra Has Left the Building.”

     

    It’s been said that those who live by the sword eventually die by the sword, so I guess I finally got my due.  It’s all in fun and I try not to take myself too seriously; but I do try to do the best I can with it.  To say that 2016 was full of surprises would be a huge understatement.  From election surprises to economic surprises, it was quite a year.  This is what I predicted for 2016 and what actually happened:

     

    #1:  “2016 will make 2015 look like a walk in the park.  After an early year sell-off, the market will be down 12 percent before a near term bottom is found.  There will be a recovery rally by the end of the year, but the S&P 500 will finish the year down 5 percent.  RESULT:  Well I sure blew that one.  We got the decline and the recovery, several times, but after a surprise win by Donald Trump in the presidential election, markets went on a tear and the S&P 500 finished the year at 2,239, up 8.7 percent from 2,059.

     

    #2:  “Rates on the 10-year Treasury bond will again be in a range between 1.7 and 2.75 percent.”  RESULT:  At least I got close on that one.  The range was from 1.323 percent low in July to a high of 2.641 percent in December, ending the year at 2.45 percent.  Since bond yields don’t tend to move too rapidly, that is an incredible move in a short period of time.  Yields spiked in anticipation of higher interest rates due to inflation and infrastructure spending in the future.

     

    #3:  “Gold may rally in the near term to as high as $1,250 but will remain under pressure in this deflationary environment and may fall below $1,000 and maybe to $900 an ounce.  RESULT:  Somewhat close.  Gold prices ranged from a low of $1,070 and a high of $1,375, and closed at $1,152, up 8 percent for the year.

     

    #4:  “Oil may finally find a bottom around $22 a barrel but won’t stay there long.  It may trade as high as $50 at some point, but will spend most of the year between $30 and $40.  RESULT:  Mostly correct.  WTI crude oil traded between a low of $26.05 and a high of $54.51 and closed the year at $53.89, up 20.8 percent.

     

    #5:  After going on an upside tear for the last two years, the dollar index might take a break this year and just trade in a narrow range between 105 and 95, after closing last year at 99.  RESULT:  Mostly correct.  The dollar index traded between a low of 91.9 and a high of 103.65 and closed at 102.40.

     

    #6:  US GDP growth will muddle along between 1 and 2 percent; not a recession but not enough to cause any real growth.  RESULT:  Close.  Third quarters estimates for GDP were 3.5 percent, after a second quarter estimate of 1.4%.  Annual GDP growth for 2016 is still estimated to be about 2.2 percent.

     

    #7:  Unemployment will inch back up to 6 percent and the labor participation rate will fall slightly further to 60 percent, the worst since the 1970’s.  RESULT:  Mostly wrong.  National unemployment rate fell to 4.6 percent in November 2016, with U6 unemployment at 9.6 percent.  Labor participation rate fell to 62.7 in November 2016 and slightly up from its 10 year low.

     

    #8:  I am concerned we are about to be hit by a new financial sector crisis coming out of Asia.  Forget about the Chinese stock market.  It’s their banks you should be worried about.  RESULT:  No china surprise, yet.  The two biggest surprises for 2016 were BREXIT and the US Presidential Election.  BREXIT caused a two week drop in the market and then nobody cared anymore.  The presidential election caused about a 10 hour drop in the market and then it was straight up from there.  Nobody saw that one coming.

     

    #9:  High yield bonds (a nice word for junk bonds) took a beating in 2014 and 2015 and will do it again in 2016.  RESULT:  Wrong.  High yield bonds, after choppy trading most of the year, became a proxy for the stock market and went up with it, moving up 17 percent for the year.

     

    #10:  Commodities in general are on the downside of their long term cycle, which is a 28 to 31 year cycle.  Falling commodity prices, including oil, and slowing global demand means they are going to be under economic pressure for quite some time.  RESULT:  Commodities went mostly up due to oil prices finally bottoming and an anticipation of renewed inflation coming in 2017.  The CRB Commodities index was up 9.5% for the year.

     

    So there you have it.  2016 was my worst year of predictions since I started doing them in 2007.  I don’t plan on doing a predictions column for 2017.  Since there is so much uncertainty in everything right now, I would only be guessing.  Forecasting should be based upon some rational premise, even if wrong.  Without that, it’s just guessing and that’s not what we do.  As Clint Eastwood once said in one his movies, “A man has to know his limitations.”  However, I will continue to write and offer comment and insight into topics that I think might be of interest to you.  Until next time, thanks for reading.

     

    Nick Massey is President of Massey Financial Services in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.

     


October 2016

  • October 2016 Something is Happening Here

    Something is Happening Here

     

    “There’s something happening here.  What it is ain’t exactly clear.”  The opening line to Buffalo Springfield’s 1966 hit offers a good opening for a discussion about today’s economy and the impact on individuals.  Maybe economist and New York Times columnist Paul Krugman should step out of his ivory tower and listen to the song.

     

    Krugman seems to be confused.  According to his column this summer, he doesn’t understand why Americans are so gloomy that they might vote for Donald Trump in November.  He wrote, “Things in American seem A-Okay.  If you want to feel good about the state of America, you could do a lot worse than what I did this morning: take a run in Riverside Park. There are people of all ages, and, yes, all races exercising, strolling hand in hand, playing with their dogs, kicking soccer balls and throwing Frisbees. There are a few homeless people, but the overall atmosphere is friendly.”

     

    Seriously Paul?  Most Americans have never heard of gorgeous Riverside Park, but places like that are wonderful for people who can afford to live there.  Such places have boomed thanks to changes in the economy, but also from deliberate government policies designed to make them prosper.  Wall Street, unlike Main Street, got bailed out during the financial crash.  Most Americans may not be able to tell you what TARP stands for, or what quantitative easing is, but they have a good understanding of who benefited the most from them - the people able to take morning jogs in Riverside Park.

     

    Most Americans believe in capitalism, but know that a lot of its top beneficiaries are not fully exposed to marketplace discipline. Most Americans are painfully aware that life is good for people like Paul Krugman, and they know that he doesn’t care what’s happening to them.  Charles Murray, author of “Coming Apart” created his “bubble quiz” to illustrate the degree to which much of the upper-middle class has grown detached from the experience of workaday Americans.  When PBS invited its readers to take the quiz, the zip code where this detachment was most pronounced was 10023, the Upper West Side in New York City.  What a coincidence!  Isn’t that where Krugman likes to live and run?

     

    The fact that people can go from almost any background to living in one of America’s most prosperous and unique neighborhoods is a testament to this country’s greatness.  But not everybody has had the same opportunity.  Many haven’t been able to improve their lives at all.  Millions of Americans are hurting.  And similar problems are showing up in other advanced countries.  McKinsey Consulting found that real incomes (incomes adjusted for inflation) have stagnated or declined in 65 to 70 percent of households in the developed world.  That’s 540 million people.

     

    Unlike Krugman, journalist and author Richard Longworth actually went to talk with some of them. “They perceive that these people—globalization’s winners—have never spent 30 seconds worrying about globalization’s losers,” he writes in “Caught in the Middle”, his 2007 book on globalization.

     

    The recovery from the great recession has not been so kind to the middle and lower class.  Wages have been flat to negative when adjusted for inflation.  Many who were unemployed are now employed, but fall in the category of “underemployed” relative to where they used to be.  In the coming months and years, you will hear a lot more about income inequality and hollowing out of the middle class in this country.  That is part of the downside of the great globalization we have seen for the last several decades and now much of it is coming to light.

     

    Instead of jogging in Riverside Park, Krugman should spend some time talking to people in Flint, Michigan, the South Side of Chicago, California’s Central Valley, rural Oklahoma, or any of the many decaying industrial cities and towns throughout the Midwest and Northeast.  That might clear up some of his confusion.

     

    As we approach the November presidential election, this is clearly one of the reasons why so many people are angry.  Hillary Clinton and Donald Trump offer two completely different answers to the problem and we will soon see who prevails.  But make no mistake about it, the voters are mad as hell and want things changed.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.

     


Sept 2016

  • September 2016 Waiting for Godot in November

    Waiting for Godot in November

     

    Waiting for Godot is a play by Samuel Beckett, in which two characters, Vladimir and Estragon, wait endlessly and in vain for the arrival of someone named Godot.  Godot's absence, as well as numerous other aspects of the play, have led to many interpretations since the play's 1953 première.  Considered by some to be one of the great classics in literature, others have not been so kind.  Whatever your opinion, the play consists of enough symbolism and complex hidden meaning, that you can easily have it mean almost anything you want.

     

    "Nothing happens, nobody comes, nobody goes, and it’s awful!"  That phrase, said by one of the main characters, somehow sums up the whole plot of this short tragicomedy in two acts.  Strange?  You bet!  So much so that a well-known Irish critic of the time said, "nothing happens, twice".

     

    The play starts with two men, Vladimir and Estragon, sitting on a lonely road.  They are both waiting for Godot.  They don't know why they are waiting for him, or who he is, but they think that his arrival will change things for the better.  The problem is that he doesn't come, although a kid does and says Godot will eventually arrive.  Pozzo and his servant Lucky, two other characters that pass by while our protagonists are waiting for Godot, add another bizarre touch to an already surreal story, in which nothing seems to happen and discussions between the characters don't make much sense.

     

    However, maybe that is exactly the point that Samuel Beckett (1906-1989) wanted to make.  He was one of the most accomplished writers in the "Theatre of the Absurd", that wanted to highlight the lack of purpose and meaning in the universe.  Supposedly, when Beckett was pressed for answers about the meaning, he said, "If I knew who Godot was, I would have said so in the play."  So, we don't know.  The result is a highly unusual play that poses many questions, but doesn't answer them.

     

    Does of any of this sound vaguely familiar today?  As we enter the final stages of the 2016 Presidential Race, and as we watch the crazy gyrations of the economy and stock market, I couldn’t help but think back to when I read “Waiting for Godot” many years ago.  When I finished reading, I had the same empty feeling I have today.  What does it all mean?  Am I missing something or is everyone else as confused as me?  We’re all sitting here waiting for today’s Godot to come and change things for the better.  But is the Godot of today Hillary or The Donald?  Does it even matter?  I certainly don’t know.  You’ll have to decide that one for yourself.

     

    As we wait for November, if this period of time doesn’t go down in history as one of the most bizarre ever, it will certainly rank near the top on that list.  In the meantime, I guess I’ll join Vladimir and Estragon of the roadside bench and see what, or who, comes along.  One thing for sure – I think most of us will just be glad when it’s over.  Then we can go back to worrying about more important things – like who will win the Big 12 Championship or what did the Kardashians do last week?  Thanks for reading.

     

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


August 2017

  • August 2016 Do You Want a Piece of ARAMCO?

    Do You Want a Piece of ARAMCO?

     

    We all know that Saudi Arabia has a lot of oil.  So much so, that they have been able to influence the oil market and prices for decades.  They also have a problem.  The country’s wealth is completely dependent on oil revenue, which state officials use to bribe, i.e. motivate, the population into cooperating.  As long as the money flows, everyone is happy and they don’t care a lot about what the rulers do.

     

    However, with the price of oil moving up and down in the $40 to $50 range, after falling from over $100 in recent years, the Saudis have been dipping into their national reserves by huge amounts to make good on their social promises.  They need oil prices over $60 to balance their budget, but that might not be in the cards anytime soon.

     

    Saudi officials decided they needed to change course and they came up with a plan.  To break the country’s dependence on oil, it will invest in other technologies and industries, retrain its working population, and set the country on a course for the 21st century.  To finance this transition, the government will sell shares in its national oil company to the public.

     

    Most likely, it will list shares on their national stock exchange and on another major hub like New York or London.  No one knows yet when, or if, this will actually happen, but the conventional thought is that when shares of the oil company, Aramco, hit the market, it could cause a feeding frenzy.

     

    Aramco could be valued between $2 trillion and $3 trillion.  That’s a lot of money.  The Saudis are talking about selling perhaps 5 percent of the company, which would raise between $100 billion and $150 billion.  For their investment, shareholders would get no control, no visibility, no assurance that company officials would work on their behalf, and a history full of self-interested dealings that are meant to benefit Saudis and no one else.  Thanks, but I think I’ll pass.

     

    In case you’re not current on the history of Middle Eastern oil exploration, Aramco stands for Arabian American Oil Company.  It’s a long story, but a few milestones are noteworthy.  In 1933, Saudi Arabia sold a concession to Standard Oil allowing the company to explore for oil.  It took five years, but eventually they found it, and started paying the Saudis a set fee per unit of oil produced.  During the 1940s, other oil companies joined the group, and several major oil fields were found.

     

    Saudi Arabia decided it wasn’t getting paid enough after western energy companies started cutting deals with other countries in the area, like Iran.  So, in 1950, Saudi officials persuaded Aramco to split the profits 50/50 between the western firms and the Saudi government.  “Persuaded” meant they threatened to nationalize the company’s assets.  To borrow a phrase from the Godfather, “they made them an offer they couldn’t refuse.”

     

    Production continued during the 1950s and 1960s.  OPEC (Organization of the Petroleum Exporting Countries) was formed in 1968 as several oil-producing countries came together after geopolitical tensions bled into their oil operations.  By 1973, the Saudi government was again dissatisfied with its profit-sharing arrangement and now they wanted ownership.

     

    The Saudi government again “persuaded” the companies of Aramco to sell 25 percent to the Saudi government.  Their share of ownership was increased to 60 percent after the 1973 Israeli Middle East War, and then was pushed to 100 percent by the mid-1970s.  The Saudi government didn’t just take the company, they paid for the shares.  In 1973 terms that came to about $2.7 billion, which would equate to roughly $15 billion today.

     

    Of course, at the time, the proven oil reserves in Saudi Arabia were just 93 billion.  Today they have 260 billion, so Aramco should be worth a lot more.  But how much more?  If the company controls three times the amount of reserves, shouldn’t today’s value be three times what they paid, or $45 billion?  Something doesn’t add up.

     

    If the company is worth $2.5 trillion today as Saudi Arabia claims, then it should have been worth a third of that in 1973, adjusted lower for inflation, given the difference in proven oil reserves.  That would put the fair value back then at $155 billion.  And yet the Saudis paid just $2.7 billion by threatening nationalization, i.e. just taking over the company outright.  That’s a heck of a negotiation strategy!

     

    Fast forward to the present, when the country hopes to end its reliance on oil in its national economy.  Granted, this will be exceptionally difficult, given that the Saudis produce little other than oil and sand.  But that’s their goal.  And to do it, they want to raise money from private investors, who will end up owning part of the very oil company that the government is trying to de-emphasize.

     

    If the Saudis aren’t successful, and oil remains by far the largest contributor to the economy, what happens to shareholders if oil prices are stuck at low levels?  Do they get anything?  Dividends? Anything?  I can’t see the Saudis joyfully shipping money out of the country when they are bleeding cash.

     

    If the Saudis are able to end their reliance on oil, then what?  Will they keep investing in new technology and exploration to keep Aramco growing?  Or will private investors find themselves holding onto an asset in long-term decline?  Given their history, as well as their goals, this looks like an investment that no one could love.

     

    When it hits the market, perhaps in 2017 or 2018, I think share prices will move with the price of oil for a little while. But when shareholders find themselves unable to get straight answers from Aramco officials, and then see the kingdom siphon off assets for other projects, chances are these shares will be relegated to an unloved corner of the market.  Study this one carefully before you wade in.  Thanks for reading.


July 2016

  • July 2016 Which Poker Table Are You At?

    Which Poker Table Are You At?

     

    As we look at the stock market moving back and forth in a narrow range, and digest what is largely mixed economic news, it’s fair to ask whether the cup is half-full, or is the cup half-empty?  On one hand, the market has not been able to make a new 

    high during the past twelve months.  On the other hand, it could be argued that the market has had an entire year to go down, and yet it is still within about 3 percent of its all-time bull market high.  Which is right?  To bring up a rather famous quote from Harry Truman, “Somebody find me a one-handed economist.”  To resolve what may seem like a quandary, it’s best to refer to the basic Law of Supply and Demand.

     

    History shows that the desire to sell typically contracts during healthy market advances as everyone gets on board.  But, that has not been the case throughout the last year.  During the latter stages of old bull markets and the evolving stages of new bear markets, the DJIA and the S&P 500 Index can be highly deceptive in determining the inner workings of a broad list of stocks.  While these two popular guides are still near to their highs, segment-by-segment and stock-by-stock analysis tells a very different story.  Over half of all small-cap stocks, over 30 percent of mid-cap stocks, over 15 percent of large-cap stocks, and over 40 percent of all domestic common stocks listed on the NYSE are already in established bear market patterns and down 20 percent or more from their highs.  In 2015, while the S&P 500 was basically flat for the year, if you took out 4 stocks (Facebook, Amazon, Netflix, and Google), the index was down over 6 percent.  Looking at an index alone is very deceptive.

     

    Adding to this confusion is the amount of monkey business going on with corporate earnings.  We recently finished “earnings season” for the 1st quarter, and we get a little break before it starts all over again in July.  The financial magicians, also known as chief financial officers that run some of America’s largest corporations, use all the tricks in the book to make things look better than they are.

     

    Over the years, there has been a change from the use of Generally Accepted Accounting Principles (GAAP) earnings, to pro forma earnings.  Pro forma earnings are when you adjust for unusual, non-recurring, one-time expenses.  Examples would be taking out one-time costs of layoffs; or one-time costs of an asset write-down; or one-time costs associated with a takeover; or one-time costs of currency losses.

     

    In corporate America, the creative use of pro forma accounting rules can make them appear more prosperous than they really are.  The use of “extraordinary items” and “non-cash charges” has turned some corporate earnings reports into a pack of lies.

     

    Almost 40 years ago, when I first got in the investment business, most companies followed GAAP rules.  Now most companies report earnings based on pro forma rules.  Worse yet, the trend is growing.  In 2010, 70 percent of the companies in the S&P 500 were reporting earnings based on pro forma results.  That percentage has increased to more than 90 percent today.  The simple reason is that Pro Forma calculations make it easier for companies to manipulate their earnings and make profits appear higher than they really are.  As a result, there is a huge difference between how corporations are advertising performance and how they actually did.  If corporate America were forced to use GAAP rules, S&P 500 earnings would have been 12.7 percent less than reported.  The last time the gap between “real” and “manipulated” profits were that wide was back during the 2009 Financial Crisis.  Hmmmm.  Just a coincidence maybe?

     

    Let’s put those profits in perspective. The P/E ratio of the S&P 500 using pro forma accounting is 16.5 times forward earnings estimates.  However, the P/E ratio increases to 21.5 time earnings using GAAP rules.  If you were a CEO or CFO wanting your stock to look cheap or fairly valued instead of expensive, which number would you rather use?  Despite what you hear on CNBC and Bloomberg, stocks are not reasonably priced today.

     

    That’s bad enough, but even with the use of pro forma accounting, the profits of the companies in the S&P 500 have declined for the last three quarters in a row.  The last time this happened was Q1, Q2, and Q3 of 2009.  Oops, there’s that annoying 2009 coincidence again.  What should really worry you is that stocks are much more expensive than they seem and very vulnerable to a pull-back.

     

    All of this smoke and mirrors wouldn’t work without a certain amount of cooperation from corporate accountants, Wall Street analysts looking the other way, and innocent investors who don’t know any better.  A friend of mine was fond of saying that, “if you’re sitting at the poker table and you haven’t figured out who the sucker is in the first 30 minutes, it’s you.”  Could that be you in this case?

     

    Risk is very high right now.  You might think about taking a few chips off the table during these uncertain times.  A little risk management now and then never hurts.  Thanks for reading.

     

    Chief Investment Officer
    2601 Kelley Pointe Parkway, Suite 202 | Edmond, OK 73013 | Phone (405) 341­9929 | Fax (405) 
    341­9979
    www.householdergroup­ok.com
    Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through 
    Householder Group Estate and Retirement Specialists, LLC, a registered investment advisor.  
    Householder Group Financial Advisors and Householder Group Estate & Retirement Specialists are 
    separate entities from LPL Financial.
    Certified Financial Planner Board of Standards, Inc. owns the certification marks CFP®, CERTIFIED 
    FINANCIAL PLANNER™ and federally registered CFP (with flame design) in the U.S., which it awards to
    individuals who successfully complete CFP Board's initial and ongoing certification requirements.

    S. Nick Massey, CFP®, AIF®

    President, Chief Investment Officer

    2601 Kelley Pointe Parkway, Suite 202 | Edmond, OK 73013 | Phone (405) 341­9929 | Fax (405) 

    341­9979

    www.householdergroup­ok.com

     

    Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through 

    Householder Group Estate and Retirement Specialists, LLC, a registered investment advisor.  

    Householder Group Financial Advisors and Householder Group Estate & Retirement Specialists are 

    separate entities from LPL Financial.

     

    Certified Financial Planner Board of Standards, Inc. owns the certification marks CFP®, CERTIFIED 

    FINANCIAL PLANNER™ and federally registered CFP (with flame design) in the U.S., which it awards to

    individuals who successfully complete CFP Board's initial and ongoing certification requirements.

    The opinions voiced in this material are for general information only and are not intended to provide specific advice and recommendations for any individual.  All Performance referenced is historical and is no guarantee of future results.  All indices are unmanaged and may not be invested into directly. 

     


Which Poker Table Are You At?

 

As we look at the stock market moving back and forth in a narrow range, and d....

  • June 2016 Life Expectancy is Crucial to Retirement Planning

    Life Expectancy is Crucial to Retirement Planning

     

    A funny things happens to most people somewhere around age 60.  We wake up one day and realize that there are more days behind us than ahead of us.  Of course, we always knew that, but the point becomes much clearer as we finally admit it.

     

    In creating a financial plan for yourself, one of the most important variables is the one you can’t predict or do anything about - life expectancy.  How long you will live will determine your quality of life in your later years and whether or not you have to worry about money.  Will you find out that you saved too little, or perhaps deprived yourself of a better life by saving too much?

     

    Baby boomers are finally starting to get real about this.  Until recently, boomers have been far too cavalier about retirement, sometimes claiming Social Security at 62, figuring they’d live to be about 80; or retiring (without doing the math) on the hope that everything will all work out.  Hope is not a retirement strategy.  Now it’s starting to hit them that they might live longer than they ever expected and there’s a real possibility that their money could run out.

     

    The Insured Retirement Institute (IRI) has been conducting an annual survey on boomer retirement expectations for the past five years.  Over that time, confidence has eroded sharply.  The latest survey, Boomer Expectations for Retirement 2016, found that only 24 percent of boomers are confident they will have enough savings to last throughout retirement, versus 36 percent in 2012.  In those five years, the future has come into sharper focus.

     

    Where boomers once visualized their retirement like the photos in the mutual fund ads, they are now starting to see what their own retirement might actually look like.  When boomers do finally wake up and consider how they will support themselves in their old age, Social Security suddenly becomes more important and perhaps even a lifeline. Today, nearly 60 percent of boomers see Social Security as a major source of income, compared to 40 percent a few years ago.

     

    In fact, changes to Social Security ranked as the top concern among boomers looking ahead to their late 80s, higher even than health care expenses, inflation, and having enough money for basic expenses.  The realization that Social Security will be a major (perhaps sole) source of income, and the fear that benefits could be reduced just when they need them the most, scares boomers to death.  Well, not to death actually, because an early death would solve their financial problems.  It’s the possibility of living an extra-long life that really scares them.

     

    This gets back to the life expectancy issue.  People have relied on the average life expectancy of the population as a whole when figuring their own life expectancy.  This, of course, is terribly flawed.  Fifty percent of all people will live longer than the average.  (Actually it’s the mean, not the average, but close enough for our discussion.)  Only life insurance companies, and Social Security policy makers, need to be concerned with the average life expectancy of a population.

     

    My point is that these life expectancy studies that calculate the average age of death for a given population are fairly worthless on an individual basis, except for giving us a broad understanding of some of the factors that can contribute to mortality.

     

    Even some of those so-called personalized life-expectancy tests show wide disparities.  For example, I did the “Abaris life expectancy calculator” (you can Google it for free) and it said I had a 75 percent chance of living past age 86 and would probably make it to age 94.  Another website, “Living to 100”, has me hanging around to age 91.  Interesting stuff, but what am I supposed to do with that information?  It does drive home the point that life expectancy can make a big difference when doing financial planning.  If people assume an average life expectancy, they’ll be in deep trouble when their money runs out with 10, 20 or 30 years of life left.

     

    By the way, the IRI study asked boomers what they would do if they were to run out of money.  Seven in 10 boomers said they would downsize to the point where they would be able to subsist solely on Social Security, while a little more than half said they would return to work, if able.  Far fewer said they would seek assistance, either from children, other family, church, or social services.  Downsizing and returning to work are admirable choices that reflect a sense of personal responsibility, but may be difficult in practice.  For example, returning to work will require both the ability and opportunity to do so.  How many people could realistically return to work at 80 or more?

     

    Baby boomers are beginning to face their futures with more honesty than before, or at least they’re worried about running out of money rather than failing to see that it could happen.  And they recognize the two most important sources of income: Social Security and earnings from work.  Where they’re missing the boat and not seeing the whole truth is thinking they can wait until their savings run out before maximizing their income sources.  The time to work is before you start living off your savings.  And if you think you might have to subsist on Social Security alone, the time to maximize that income is before you start collecting - by delaying the start of Social Security to age 70 if you can.

     

    The IRI study concludes by saying: “Unfortunately, many boomers who haven’t planned and haven’t saved will face tough choices in the years ahead.  Staying healthy and able to work may be the best prescription that can be written for boomers who are past their prime earning years and unable to save, while for the youngest, the time is now to tighten budgets, save as much as possible and tap into the resources that can help them navigate a course to a successful retirement.”  Check with your financial advisor, or call me, if you would like help in determining what you need to do.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


Life Expectancy is Crucial to Retirement Planning

 

A funny things happens to most people some....

  • May 2016 Overconfidence Can Be Dangerous

    Overconfidence Can Be Dangerous

     

    "She should have died hereafter; there would have been a time for such a word.

    Tomorrow, and tomorrow, and tomorrow, creeps in this petty pace from day to day, to the last syllable of recorded time; and all our yesterdays have lighted fools the way to dusty death.  Out, out, brief candle!  Life’s but a walking shadow, a poor player that struts and frets his hour upon the stage and then is heard no more.  It is a tale told by an idiot, full of sound and fury signifying nothing"

    – Macbeth, Act V, Scene 5

     

    If you’re like me, perhaps you studied Macbeth in some literature class.  I was in high school when we all had to memorize this famous message of despair.  Perhaps you did also.  For some reason, it stuck with me and I can still recite it from memory to this day.  I am reminded of it often as I watch the daily grind of the market as it churns violently within a narrow range of lower highs and higher lows.  Someday it will break out, and probably quite dramatically.  Which direction it goes is up for debate.

     

    I’m having a little trouble with confidence in forecasting the direction.  But that is a good thing.  Overconfidence can kill you in this business, and lack of it is a sure-fire way to mediocracy.  Some people have no trouble with confidence.  You baseball fans might recall when Rickey Henderson broke Lou Brock’s all-time stolen base record.  Rickey held second base in the air and proclaimed, “I am the greatest of all time” while Lou Brock was standing next to him.  Rickey never suffered from a lack of confidence.  Oh, to have the confidence of Rickey.

     

    I think baseball is one endeavor where you can never have too much confidence.  The same is probably true with other sports and most things in life.  In investing and trading, that’s not the case. You need to have a healthy dose of skepticism in your own abilities.  A little fear doesn’t hurt either.  I recall from my auto racing days that I had a t-shirt which read, “Some Fear.  If you haven’t scared yourself half to death occasionally, you’re not going fast enough.”  I think investing is that way too.

     

    Hardly a day goes by that we don’t hear about Donald Trump lately.  Trump obviously does not suffer from a lack of confidence.  Nate Silver didn’t, either.  The well-known statistician predicted early and often that Trump wouldn’t last long in the Republican presidential race. He wasn’t alone.  A lot of people said Trump would flame out over time.  What distinguished Nate Silver from everyone else was the confidence with which he was saying it.  He was all but guaranteeing it.  He operates in a world filled with mathematical models that had never before failed him.  Then they failed him.

     

    When you do what I do for a living and manage large amounts of money for people, you try not to say things like, “This absolutely, positively cannot happen.”  That’s because anything can happen.  (Besides, the regulators wouldn’t let me say it anyway.)  It’s just a matter of measuring the probability, no matter how remote. There is no such thing as a sure thing.

     

    People outside of finance often don’t understand that. They go through life with a level of certainty that people like me just don’t have.  Investing and trading makes you really humble.  You’re wrong occasionally and you have to admit when you’re wrong, or you will get carried out in a body bag (figuratively speaking).  Typically, people get into trouble with overconfidence when they find themselves in a trade they feel strongly about and it progressively goes against them, day after day after day.  So they double and triple down and keep adding to the position.  This is not a mistake professionals make. This is an amateur mistake.  Pure ego says “I know better than the market.”  No, you don’t.

     

    The downfall of most investors, eventually, is overconfidence.  A quote from the movie Fight Club says, “On a long enough timeline, the survival rate for everyone drops to zero.”  It applies here also.  Eventually, given enough time, everyone will suffer from overconfidence and blow him or herself up.  I’ve been there.  I don’t know a single investment manager who hasn’t been there at one time or another.  You will find that the investors and investment managers who last into their seventies and eighties are very boring, cautious people.  Some might say I’m living proof.

     

    The problem (for all of us) is that people in positions of power almost never have any experience with finance, or math, or probability, and suffer from a great deal of overconfidence.  They make an error and refuse to admit they are wrong, so they compound the error.  You see this played out over and over again in American politics.  Sound familiar?

     

    Speaking of politics, when I look at potential leaders, I like to look at how introspective people are, their awareness of themselves, their strengths and shortcomings.  I try to imagine XYZ presidential candidate in a position where they have to admit that they’re wrong.  Can they do it?  Maybe they should have been traders first.

     

    It’s one thing to do it as a trader, when lots of money is at stake.  But what if you are president—and lives are at stake?  Otherwise, they are in the position where they have committed an error and continue to compound the error, doubling down, with possibly terrible consequences.  Just sayin’.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment adviso


Overconfidence Can Be Dangerous

 

"She should have died hereafter; there would have been a....

April 2016

  • April 2016 OMG! Acronyms Gone Wild!

    OMG!  Acronyms Gone Wild!

     

    So there I was, minding my own business, reading all manner of economic research.  Yes, I know.  I need to get a life.  But your fearless analyst knows no boundaries when it comes to researching useful, and sometimes not so useful, information for my readers.  And then I stumbled across the following.

     

    It seems that in mid-2014, a group that called themselves MuckRock posted a report online which they had received after a FOIA (Freedom of Information Act) request to the DOJ (Department of Justice).  The 83 page report was written by an analyst at the FBI IRSU (Federal Bureau of Investigation Intelligence Research Support Unit).  Within those 83 pages were just under 3,000 separate terms which the FBI had spent who knows how many hours compiling (and, no doubt, a significant amount of tax dollars) in a glossary of internet slang and text acronyms.

     

    The work was certainly comprehensive, and was also a ridiculous waste of time and taxpayer money.  You probably think I’m exaggerating, but oh contraire. In the introduction, the author(s) refer to the guide as a primer on shorthand used across the internet, including “instant messages, Facebook and MySpace.”

     

    Now, I hate to break it to the FBI IRSU, but MySpace is most definitely ALY (“A Little Yesterday”).  At least that is what people far more “in the know” about these things tell me.  More importantly, taxpayers could have gotten the same thing for far less money by hiring a room full of teenagers with smartphones.

     

    Anyway, the contents of the document make for unintentionally entertaining reading.  For example, FBI analysts felt the need to share the meaning of the following acronyms with their agents:

     

    • BFFLTDDUP (“best friends for life until death do us part”)

    • BTDTGTTSAWIO (“been there, done that, got the T-shirt and wore it out”)

    • DNFTT (“do not feed the troll”)

    • E2EG (“ear-to-ear grin”)

     

    As exercises in code-breaking in the age of terror, one could argue it’s essential to understand cryptic messages flying around in cyberspace.  But that doesn’t lessen the faint whiff of ridiculousness when one reads in an official government-sanctioned document things such as:

     

    • IITYWIMWYBMAD (“if I tell you what it means will you buy me a drink?”)

    • NIFOC (“naked in front of computer”)

    • PMYMHMMFSWGAD (“pardon me, you must have mistaken me for someone who gives a damn”), or the potentially extremely useful one right now:

    • SHCOON (“shoot hot coffee out of nose”)

     

    Apparently GOS (“Girlfriend Over Shoulder”) is actually an important code for some reason, as is PDBAZ (“Please Don’t Be A Zombie”).  As I think back on military slang from my Army days, “Whiskey Tango Foxtrot” comes to mind.

     

    With all due respect to the FBI, perhaps nowhere will you find a group of people more in love with acronyms than within the financial services world.  In the last 8 years alone, we’ve had a crisis blamed largely on such things as MBS (“Mortgage Backed Securities”), HELOCs (“Home Equity Line of Credit”), and CDOs (“Collateralized Debt Obligation”); a rescue predicated upon QE (“Quantitative Easing”), ZIRP (“Zero Interest Rate Policy”) and TARP (“Troubled Asset Relief Program”); and have created an altogether new (and largely unfamiliar) environment where HFTs (“High Frequency Traders”) run wild and BTFD (“Buy The Failed Dip”) is recognized as an ‘investment strategy.  In 2008 I thought we should have created the “Congressional Reassignment of Assets Program”, but the government failed to see the humor in that one.  You figure it out.

     

    We’ve had fifteen years of BRIC’s (“Brazil, Russia, India, China”), the popularity of which spawned such things as the CIVET’s (“Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa”), MINT’s (“Mexico, Indonesia, Nigeria and Turkey”), and of course the infamous PIIG’s (“Portugal, Italy, Ireland, Greece and Spain”).

     

    It’s reached the point where it feels like people come up with an amusing acronym and then group together a selection of random countries which have no bona fide links to each other, safe in the knowledge that nobody will bother to try and understand WHY these particular countries are connected.  As long as it’s cute and easy to remember, who cares?

     

    How about TOSSERS?  (“Tuvalu, Oman, Senegal, Saint Maarten, Eritrea, Rwanda and Sweden”).  This is a group of countries which are collectively responsible for the creation of 87.6 percent of the world’s fake acronyms.  Okay.  I made that one up; but I could be right.

     

    Anyway, in 2015, as the recent bull market in US equities had grown a little long in the tooth, a group of companies emerged from the mist as true market leaders.  And whaddya know, they formed one of those nifty little acronyms.  Yes, Facebook, Amazon, Netflix and Google joined forces to become FANG.  FANG has (or have, I never know which one to use) taken over the world.  Don’t believe me?  In 2015, those four stocks rose 60.69 percent as the S&P fell an insignificant 0.73 percent.  Once you strip FANG out of the broader index, you find that the S&P496 was down almost 5 percent last year.  I’m thinking SNAFU and FUBAR.  (Another couple of jewels from my military days.  If only we could have sent text messages in those days.)

     

    If you remove any residual feel-good optimism from the last five years, you’d be staring at a market which is distinctly overvalued, suffering from severe lack of any real breadth and, technically, looks ripe for the sort of correction that definitely scares the horses (or the bulls).  What’s more, the economic data (which have been clearly deteriorating) have not exactly cooperated.

     

    So what does all this have to do with anything?  Probably not much, but it’s an interesting story I thought I would share with you and add some perspective to this crazy market we are experiencing.  Besides, I haven’t been on a good rant in quite a while and I was overdue.  There, I feel much better now.  GTTYA and BBFN (“Good Trading To You All, and Bye Bye For Now”).  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.

     

    The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.


OMG!  Acronyms Gone Wild!

 

So there I was, minding my own business, reading all manner o....

  • April 2016 Is Gold Back?

    Is Gold Back?

     

    Has the long slide in gold finally stopped and reversed, or is this just a short term rally in a continued downtrend.  In my opinion, it is the latter.

     

    After looking dull for years, gold is finally sparkling again.  Could the “gold bugs” finally be right?  With the stock market moving all over the place, and Fed Chair Janet Yellen hinting at the possibility of negative interest rates, it is no wonder that gold is up about 17 percent for the year.  People are nervous and understandably so.  But before you run out and fill up the trunk of your car with precious metals (and maybe some canned goods and ammo), let’s look at gold with a cold, analytical eye.

     

    For some people, believing in gold isn’t just a matter of passionately believing in the investment merits of gold.  For them it’s an identity, and an extreme one at that.  It reminds me of a radical political movement or even a religious cult.

     

    For some, the attachment goes deeper and they have a fundamental belief that gold is the “one true store of value” or the “one true currency,” and that all imposters are heretical.  (By the way, don’t be that guy at the party who goes on endlessly about the merits of gold and how everything else is going to crash and burn.  It kills the mood and people will walk away from you.  Either that or you will put people to sleep faster than an anesthesiologist.  Just a little friendly advice.)

     

    Let’s strip away all the ideology and try to look at gold on its own merits. I would agree that gold does have its uses, but that it is still the wrong hedge to own in this market.  Let’s look at the arguments in favor of gold:

     

    #1. Gold is an inflation hedge.  Yes, perhaps.  Over the years, gold has indeed proven to be a decent inflation hedge.  The big problem here is that an inflation hedge is only valuable when you actually have inflation.  For now, we don’t, or we have very little.  In fact, with crude oil prices still looking weak, consumer price inflation isn’t even 1 percent.

     

    Many people believe that because of all the loose monetary policy of the past several years, rampant inflation is right around the corner.  That seems logical, right?  But you could have made the same arguments about Japan at any point over the past 20 years, and you would have been wrong.

     

    The fact is that all the monetary easing in the world will have little impact on inflation at a time of aging demographics and weak demand from cautious borrowers, which is where we are today. And in Japan, they’re still fighting outright deflation, even after 20 years of monetary easing that is far more than even we have done.  Gold can indeed be an inflation hedge.  But if you buy it now, you’re effectively buying expensive insurance for a risk you don’t need to insure yet.

     

    #2. Gold is a crisis hedge.  I’m somewhat sympathetic to this view.  There is some merit to the idea of having a true hedge in the event that the world economy really does crater as some might suggest.  I really don’t believe that could happen, but what do I know?  So yes, having a little gold bullion buried in the backyard, along with some shotgun shells, is okay if that makes you feel better.  But as far as safeguarding an investment portfolio, I’m less convinced of gold’s value as a crisis hedge.

     

    Have you noticed that when the world gets really crazy, investors tend to flock to the U.S. dollar and to U.S. government bonds rather than to gold?  In fact, the price of gold actually fell during the 2008 meltdown, and I would expect more of the same in the event of another global crisis.  It would seem that the world believes if the dollar and US Treasuries crash, anything else would be far worse.

     

    One of my favorite quotes from Art Cashin, who is Senior Floor Trader at the New York Stock Exchange, when asked what he thought of gold, said, “I think you should own just enough gold to bribe the border guard on the way out.”  Priceless!

     

    #3. Gold is a store of value.  This one I just don’t buy.  Besides being a bright and shiny object, I really don’t know what gold has going for it.  It has little in the way of commodity value, outside of its modest use in jewelry, electronics and dentistry.  It doesn’t pay any interest or dividends, and it pretty much only trades on sentiment.  That’s it.  Assigning a real value to gold is just about impossible.

     

    Yes, gold can be a store of value – sometimes.  But there are long stretches of time when it isn’t, like the 20 years between the 1980s and 1990s when gold lost value almost every year.  It’s important to remember that gold is still down significantly from its 2011 high of $1,921 an ounce and hasn’t broken out of that downward spiral.

     

    In my opinion, if you are determined to own hard assets, choose something that generates income.  It could be a rental house, a commercial building or even a piece of farmland.  You shouldn’t expect any of these to appreciate in price in the deflationary economy we’re facing, but you’ll at least collect rental income along the way, and your judgment won’t be impaired by the politics and ideology that tend to swirl around gold.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


Is Gold Back?

 

Has the long slide in gold finally stopped and reversed, or is this just a sho....

Harley has a Demographic Problem

 

Over the years, I have written many times about the Harley Davidson company because it makes a great case study in demographics.  I think they’re a great company and they make great motorcycles.  In fact, I have owned several over the years and still own one.  But they have a demographics problem.

 

Demographically speaking, the largest segment of the population buying the big cruiser-type motorcycles, like Harley and other similar models, are white males between the ages of 45 and 55 years old.  Since the average age of the baby-boomer generation is slightly older than that, and there are around 10,000 of us turning 65 every day, you don’t need to be an economist to see a problem.

 

I was talking to a 20-something young man recently about motorcycles.  (Any guy under 40 is a young man to me.)  He was telling me about the motorcycle he had just purchased.  I asked a few questions: What style is it?  How big is the motor?  How much did it cost?  What I didn’t ask was an obvious question: What brand is it?  I had a pretty good idea of what his answer would be – a Honda, Kawasaki or Suzuki most likely.  I also knew what it probably wouldn’t be – a Harley.  That’s a problem for our iconic American motorcycle company.

He seemed like a successful young man and an independent thinker.  He reminded me some of myself at that age.  He is exactly the kind of person Harley would love to capture, perhaps molding him into a life-long Harley rider, and part of their new wave of customers.  And yet the idea of buying one of their bikes doesn’t cross the mind of most people his age.

As far as he was concerned, Harleys are for old guys.  (I have to confess that I thought the same way when I was that age.  I’ve been riding since I was 16 but never even considered a Harley until I was in my 50’s.)  More specifically, they’re built for people valuing comfort over speed and who want a passing association with outlaws and rebels.  They’re still the bikes of James Dean, Marlon Brando and Peter Fonda.  That’s an image Harley has worked tirelessly to change, but it is slow going, and their earnings show it.

 

(Please note that I am NOT suggesting you should or should not buy Harley Davidson stock.  I’m just telling a story about the effect demographics can have on a company.)

Since the mid-2000s, Harley has recognized their demographic hurdle, for which I give them a lot of credit.  The pool of aging, professional men willing and able to spend $25,000 on a motorcycle to foster a rebel spirit was dwindling.  How many 20 and 30 something’s can drop that kind of change on a motorcycle?  The company needed to attract new types of clients or face falling sales.

The economic downturn of 2008 hurt Harley along with every other company that relied on customer financing, but their pain went deeper.  While sales and their stock price have since rebounded, they still haven’t cracked the code of appealing to younger and more varied clients.

On their website, Harley has a tab labeled “Demographics.” It takes you to a page where the company discusses its new focus on young buyers, women, African-Americans and Hispanics. Harley describes the company’s new “Street” bike series, which cost about a third of their typical cycle, and points to its sales leadership across most categories.  Company officials clearly understand their dilemma and are working to bridge the gap with potential growth segments of the population.

The company shipped 36 percent of its bikes overseas, so there’s no doubt a strong dollar hurt sales.  But here at home, things just aren’t going their way.  Overall, their U.S. market share fell from 56 percent in 2013 to 52 percent last year.


Some of the problem with changing their image stems from their dealer network.  I recently visited a new store in Scottsdale, AZ.  It is the biggest and nicest motorcycle store I have ever seen.  I heard that for the grand opening they featured a performance by the Doobie Brothers.  While I like them, I’ll bet the young man I was talking to couldn’t name a single song of theirs.  Demographics.

Although such marketing tactics seem at odds with the company’s expanding focus, dealers are still in the game to make money.  Twenty-somethings might be the riders of the future, but today they focus on the low-cost – and low-profit – street models, whereas older riders pony up for the $25,000-plus models.

As for changing the company’s image, they’re doing all the right things and pursuing the right strategies, and yet it’s not working.  So far, the company is a victim of its past success.  It is so closely associated with the existing theme, which the company spent decades building, there’s little room for anything else.

To prove the point, imagine a person riding a Harley.  Do you see a young person, perhaps a woman, or a person of color?  Or do you see a grizzled old guy who rides on the weekends and wears a tie at work?  Someone like me.  I hope they succeed in changing that image.  In the meantime, I’m just waiting for better weather so this old geezer can get out for a nice weekend ride.  Thanks for reading.

 

Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


Harley has a Demographic Pr....

  • March 2016 Inflation or Delation-Which is it?

    Inflation or Deflation – Which is It?

     

    I have written many times that one of the challenges for the economy and most major central banks, including our Federal Reserve, is that they are fighting deflation, not inflation.  In fact, they would actually like to create about 2 percent inflation, but are having little success at it.  However, if you ask most people, they feel like there is plenty of inflation going on.  So what gives?

     

    Typically, there are two types of people in the inflation camp.  You have the people who follow the Consumer Price Index (CPI), which has come to represent inflation itself.  But this index has been so heavily manipulated over the years that it is biased at best.  Then you have everyone else living in the real world, who have seen the cost of goods mostly rise.  For them, the idea of deflation just seems like a bad joke.  Have you looked at prices in the grocery store lately?  (Actually, I wouldn’t know since you’ll rarely ever see me there, but I have it on good authority from reliable sources.)

    In general, commodity prices have gone down for the last few years.  You would think that would help improve the standard of living for the average person.  It hasn’t.  Yes, gasoline prices have dropped dramatically, and that certainly helps the family budget.  But, unless you drive a lot, it’s not that big of an impact.  It’s not like people have a lot of extra cash lying around just because gas prices have fallen about 50 percent.


    The CPI is the most widely followed inflation tracker, and one that matters a great deal to the Fed.  The government uses this index to determine cost of living adjustments on social security and a wide variety of other things.  Do you think they might have an incentive to keep it low?  Just sayin’.

    The CPI over the last 12 months was up 1.4 percent, and up 2.0 percent for the same period for core inflation, which excludes food and energy, thus hitting the Fed’s target for inflation.  Since food and energy is often a volatile number, those items are excluded in measuring core inflation.

     

    Where does this number come from?  The Bureau of Labor Statistics (BLS) compiles the prices on a basket of goods to calculate price inflation, and a quick glance tells me that a few of my favorite things have gone up substantially in price over the last few years.  Boneless chicken breast – up 13 percent.  Coffee – up 12 percent.  Bacon – up 18 percent.  Steak – up 32 percent.  And wine – up 66 percent!  (Ouch. That one hurts!)

    On top of food prices, college tuition is going up.  If you have someone in college, or about to go, you are feeling the pain.  We’ve also seen housing prices move up.  And don’t get me started on health care costs!  With all of this considered, you can’t help but wonder why inflation on the CPI is only up by 2 percent?  It’s because the calculation has been manipulated over the years in a couple of major ways.

    CPI is a measure of changes in product costs over a period of time. The product “basket” can change when a product becomes too expensive and is substituted by a cheaper alternative. Like when you switch to hot dogs or chicken because steaks become too expensive.  Can you really consider hot dogs or chicken a substitute for steak?  The BLS does.

    Another way CPI is manipulated is through “hedonic” adjustments – a fancy word for pricing in quality improvements over price increases.  If you bought a 40” TV two years ago for $500, and today you buy the same size TV for $700, hedonically you might be paying less because of additional features (Picture-in-picture, HD, etc.).  These additional features, or improvements, add value and are deducted from the price. Magically, inflation is removed.

    Finally, there’s the simple fact that the CPI weighs some products in the basket heavier than others.  For instance, food is weighted at about 14 percent of the index, while energy is weighted at about 7.5 percent.  Never mind the fact it might be more or less for most people.  If the kids are grown and you are retired, you probably don’t buy as much food or drive as much.  Conversely, healthcare costs can be a significant factor if you are a senior citizen.

    More interesting, however, is the cost of housing.  The CPI doesn’t measure how much you pay on your mortgage or determine a figure from the overall value of your home.  Instead, it calculates how much your housing cost would go up if you rented your house to yourself!  What genius thought of that?  Not only that, but this meaningless figure makes up about 25 percent of the calculation of the index.  However, there is no calculation – none – for an increase in sales prices for homes.  Brilliant!

    It’s not that the Fed wants a lot of inflation.  But they do want some.  As a consumer, our dollars buy less when prices go up.  As a bond investor, when inflation rises, the value of your bonds go down.

    But no inflation, or worse yet – deflation, tends to put the brakes on consumer spending.  If you think prices are going up tomorrow, you might be more inclined to buy today.  But if you think prices are going down, you’ll most likely wait.  And when people aren’t buying, the economy slows down and jobs are lost since companies aren’t making money.

    So it’s clear why the Fed is obsessed with 2 percent inflation when it comes to interest rate policy.  Any more, and the economy might overheat.  Any less, and people might decide they should wait until tomorrow to spend.

     

    So, do we have deflation or inflation?  The answer is yes.  The Fed is fighting their form of deflation, and the rest of us are determining our own personal version of the CPI.  The next time you hear news about the inflation rate, you can very smugly nod your head and say, “Yeah, right?”  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


Inflation or D....

  • Feb. 2016 All Dressed Up

    All Dressed Up

     

    Protruding from the sand along England's northeast shore near Hartlepool is a vertical wooden mast.  The mast dates back to the Napoleonic Wars, when Napoleon’s armies were marching through Europe, sweeping all before them in the aftermath of the French Revolution.  It was all part of France's aggressive attempt to take what it deemed as its rightful place at the head of the European table.

     

    Of course, with Napoleon's disastrous invasion of Russia in 1812, the French Army suffered one of the worst military defeats in history.  At the time of our Hartlepool story, Britain, the mightiest naval power the world had ever seen, was locked in combat with France.

     

    Hartlepool, a small port community, was founded in the 7th century.  Around the time of the Napoleonic Wars, Hartlepool had a population of about 900 people — all of whom seemed to be obsessed with the possibility of being attacked by France.  Gun emplacements were established and defenses constructed in order to repel any French aggression.  The Hartlepudlians stood ready to fight the first Frenchman who dared set foot upon their beloved sand.

     

    One night during a terrible storm, a French fishing boat that had been pressed into the service of the Emperor, capsized and sank off the coast near Hartlepool.  There was only one survivor — a monkey who found himself washed ashore, exhausted, battered and bruised from his ordeal.  He was still clinging to the mast, now buried in the sand, which remains there to this day.

     

    One can only imagine how glad he must have been to end up on Hartlepool's beach.  Unfortunately for him, he happened to be wearing a French naval uniform, which would, sadly, be the direct cause of his tragic demise a few hours after his miraculous escape from a watery grave.

     

    Historians guess that the monkey was dressed in a sailor's uniform for the amusement of the ship's crew, but the Hartlepudlians were most definitely not amused.  Keep in mind; these were not exactly worldly people, even by early 19th century standards.  Upon finding him in a uniform with which they were unfamiliar, they immediately arrested him as a French spy and proceeded to force the confused monkey to stand trial right there on the beach.  You can’t make this stuff up folks.

     

    The monkey was questioned to discover why he had come to Hartlepool; but with the monkey unable (or perhaps unwilling) to answer their questions, and with the locals uncertain as to what a Frenchman looked like, they reached the inevitable conclusion that the monkey was a French sailor and therefore a spy.  The monkey was sentenced to death and hanged from the mast on the beach.

     

    Minstrels later immortalized the tale in "The Monkey Song," a popular ditty of the time.  I’ll spare you the words, but it makes a great drinking song in your favorite pub.  Needless to say, it made a laughing stock of the good folks of Hartlepool.  To this day, the citizens of Hartlepool are known, much to their chagrin, in England (and around the world) as "monkey hangers."

     

    Now at this point you are no doubt thinking to yourself, "Massey has finally lost it.  Where is he going this time and what does this have to do with the economy and stock market?"  Not much actually, but it’s a great story and I couldn’t resist using it to entice you in.  Okay, since you have indulged me and my tales of monkeys swinging from yardarms, I'll tell you.

     

    The people on that storm-tossed beach were confronted with something they didn't recognize, and though logic suggested they ought to investigate further before they took any action, the animal spirits of a group of excitable people ensured that they forgot about clear-headed analysis and did something that their descendants still regret over two centuries later.

     

    Today, investors all over the world are confronted by markets that have been dressed up for the amusement of the crew in charge of the ship (think central bankers), and nobody seems to recognize what they are looking at.  Sure, they look like markets, but at the same time there is an unfamiliarity that is extremely unnerving to at least a few in the gathering crowd.

     

    The majority of the mob, however, has decided that they look enough like markets to charge in blindly in the expectation that all will be as it should.  Things are not as they should be.  Far from it.  Everywhere one looks are signs that the markets are just monkeys dressed up in fancy costumes.  There, how about that for a metaphor you’ve never heard before?  As we proceed through the rest of this year, I’ll work hard to help you identify who is real and who is in costume.  This will be one very wild year.  Stay tuned.

     

    It has been said that, “We learn from failure, not from success.”  It has also been said that, “Smart people learn from their mistakes.  But the real sharp ones learn from the mistakes of others.”  Which one will you be?  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


All Dressed Up

 

Protruding from the sand along England's northeast shore near Hartlepool is a....

February 2016

  • Feb. 2016 2016 with Cassandra and Me

    2016 with Cassandra and Me

     

    My beautiful and talented wife, also affectionately known as the BTW, says I’m sometimes too negative.  I try not to be, but perhaps I am.  And one should never argue with someone with superior knowledge.  I can’t help it though, because I see so many things wrong with the big picture that I feel it’s my job to at least warn people.  There’s more than a whiff of 2008 in the air and people are getting nervous.  While I don’t think it will be that bad, there are plenty of reasons to be nervous.

     

    If you ever read a little Greek mythology in school, you might be familiar with the story of Cassandra.  In Greek mythology, Cassandra was the beautiful daughter of King Priam of Troy.  A common version of her story is that Apollo granted her the power to see the future in exchange for her love.  She agreed but then later backed out of the deal.  Angered by the deceit, Apollo let her keep the power of prophecy but also gave her the curse of the world never believing her.  She remained beautiful but was considered insane.

     

    I can relate, at least with the insane part.  Such is the curse that comes with making predictions.  Sometimes it takes far longer than you had anticipated to be right.  So as I tee-up my predictions for 2016, it’s with a certain amount of trepidation. With so much volatility and uncertainty in the world, this might be my most difficult one yet.  But duty calls and your fearless forecaster will take another shot at it.  Here is what I see for 2016:

     

    #1:  2016 will make 2015 look like a walk in the park.  As I write this, the overall market is down about 8 percent for the year in just the first two weeks – the worst 2 week start to the year EVER.  Is this the worst of it, or just the beginning of the long overdue bear market?  I think we will see some rebound from here, but the market will remain under pressure as sellers who wish they had sold before, sell into rallies.  That will likely remain the case for several months and the market will be down 12 percent before a near term bottom is found.  There will be a recovery rally by the end of the year, but the S&P 500 will finish the year down 5 percent.  That would put it at 1,955 at year-end after a low of 1,812.

     

    While I think a huge bear market is coming (defined as down 20 percent or more), I think it is coming next year, not this one.  Typically, you need a recession to get a bear market and there is not one on the horizon – yet.  The economic consequences of low oil prices will have negative effects on the stock markets of the world.  Many sovereign wealth funds holding multiple trillions of dollars are having to liquidate a portion of their assets in order to maintain their governments. These vehicles were created as the ultimate rainy day fund, and it is raining hard right now.

     

    #2:  “Rates on the 10-year Treasury bond will again be in a range between 1.7 and 2.75 percent.  Even though the Fed has suggested they will be raising the Fed Funds rate, longer term rates on treasury bonds will remain the safe haven play and rates go nowhere.  The Fed will have a difficult time raising rates any further in this environment and may actually be forced to lower rates back to zero before the year is out.

     

    #3:  Gold may rally in the near term possibly to as high as $1,250 but will remain under pressure in this deflationary environment and may fall below $1,000 and maybe to $900 an ounce.

     

    #4:  “Oil may finally find a bottom around $25 a barrel but won’t stay there long.  It may trade as high as $50 at some point, but will spend most of the year between $30 and $40.  There is still too much new supply coming on and there are no indications of a global increase in demand in the near term.  In the meantime, there are some nasty margin calls coming to all parts of the energy markets.  (Sorry!  I hope I’m wrong on this one.  Please don’t shoot the messenger.)

     

    #5:  After going on an upside tear for the last two years, the dollar index might take a break this year and just trade in a narrow range between 100 and 90, after closing last year at 99.  This will give some commodities and emerging market countries a small break, but not much.  At least it won’t be getting worse - for now.

     

    #6:  US GDP growth will muddle along between 1 and 2 percent, not a recession but not enough to cause any real growth.  US company earnings will stall at current levels as profit margins shrink.  That is why the stock market will remain under pressure as stock price/earnings multiples contract.

     

    #7:  Unemployment will inch back up to 6 percent and the labor participation rate will fall slightly further to 60 percent, the worst since the 1970’s.

     

    #8:  I am concerned we are about to be hit by a new financial sector crisis coming out of Asia.  Forget about the Chinese stock market.  It’s their banks you should be worried about.  Chinese banks are not healthy at all.  If something happens there, the result will be a huge credit freeze coming out of Asia that will look a lot like 1997.

     

    #9:  High yield bonds (a nice word for junk bonds) took a beating in 2014 and 2015 and will do it again in 2016.  At least 20 percent of those bonds are related to the oil industry and fracking.  Smaller companies in those categories will be forced to default with oil prices at this level.  Stay away.  If this isn’t a storm warning, I don’t know what is.

     

    #10:  Commodities in general are on the downside of their long term cycle, which is a 28 to 31 year cycle.  Falling commodity prices, including oil, and slowing global demand means they are going to be under economic pressure for quite some time.

     

    So there you have it.  I’m sorry I don’t have a happier message for you.  We’ll take a look again next January and see how I did.  In the meantime, be very cautious in 2016.  Sometimes I feel a certain kinship to Cassandra.  Hopefully I’ll fare better than she did.  Stay tuned and thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


2016 with Cassandra and Me

 

My beautiful and talented wife, also affectionately known as the ....

  • January 2016 Still Lucky

    Still Lucky

     

    My annual predictions newsletter from last January had the title, “Do You Feel Lucky?  Well do ya’ Punk?”  Actually I did, and as it turned out, I was.  After a pretty good score on my forecasts for 2014, I was ready to give it another shot in 2015.  (You can read the entire article on my website at www.nickmassey.com.)

     

    Regarding economic forecasting, economist John Kenneth Galbraith once said, “There are only two kinds of forecasters – those who don’t know and those who don’t know they don’t know.”  Depending on the year, some may suggest that I’m in the second camp.

     

    While it is a humorous comment, there is certainly an element of truth in it as I take my annual look back at what happened last year and what I think might happen in the next.  You might call it my annual victory lap or slow crawl to the locker room, depending on how I did.  It’s all in fun and I try not to take myself too seriously; but I do try to do the best I can with it.

     

    This is what I predicted for 2015 and what actually happened:

     

    #1:  “2015 will be a very volatile year as the markets search for direction and react to every piece of news.  I think the market will see a 10 percent correction sometime this year.  But it will rebound to be up 10 percent by fall before dropping again and finishing the year unchanged around 2,060.”  Results:  Pretty close.  Two out of three is not bad.  I didn’t quite get the upside number, but was right-on with the other two.  The S&P 500 was down 9.4 percent at one point, was up about 4 percent at one point, and finished unchanged at 2,059.

     

    #2:  “Rates on the 10-year Treasury bond will range between the current historic low of 1.7 percent, to 2.5 percent as everyone anticipates the inevitable Fed raising of short term rates.”  Results:  Correct.  Rates ranged between 1.67 and 2.49 percent and finished the year at 2.27, which was up 7.26 percent.

     

    #3:  “Gold is not dead, but is still on life support.  Gold may rally for a short while but will find a bottom at $1,000 before any meaningful rise in the future.”  Results:  Pretty close.  Gold traded between $1,045 and $1,306, but finished down 10.8 percent for the year at $1,060.

     

    #4:  “Oil will trade between $40 and $75 a barrel, but will trade more toward $60 for much of the year.  $40 may be the bottom after the market finishes blowing out all the traders and speculators on the wrong side of the trade.”  Results:  Not quite there, but somewhat close.  $75 was wishful thinking and I didn’t think we would break $40 on the downside so soon.  Oil traded between $35.35 and $65.61 and closed at $37.06, down 31 percent for the year.

     

    #5:  “After hitting a six year high of 92 on the dollar index, the US dollar will continue to rise in value against most other currencies.”  Results:  Correct.  The dollar traded between 89.86 and 100.51 and closed at 98.69, up 7 percent for the year.

     

    #6:  “US GDP growth will likely average 2.75 to 3.25 percent for the year.”  Results:  Correct.  While final figures may not come out for several more weeks, it looks like GDP will average about 2.8 percent for the year.  The economy continues to muddle along – not great but not bad either.

     

    #7:  “While the unemployment rate dropped to 5.6 percent, the labor participation rate has only gone up to 62.8 percent.  Nothing much has changed.”  Results:  Mostly correct. Unemployment improved a little further to 5.0 percent, but the labor participation rate dropped further to 62.5 percent, the lowest since the late 1970’s.

     

    #8:  “High yield bonds (a nice word for junk bonds) took a beating in 2014 and will do it again in 2015.  Stay away.”  Results:  Correct.  The high yield index fell 4.6 percent for the year.

     

    #9:  “Emerging markets suffer with a rising dollar, making it even more expensive to pay back debt owed in dollars.  Many emerging market countries, and some developed countries, are commodity exporters.  Falling commodity prices, including oil, and slowing global demand means they are going to be under economic pressure for quite some time.”  Results:  Correct.  The MSCI emerging markets index fell 18 percent for the year.

     

    #10:  Commodities in general are on the downside of their long term cycle, which is a 28 to 31 year cycle.  Results:  Correct.  The CRB Commodity index fell 25 percent last year.

     

    So how did I do?  I guess I would give myself an A minus on this one.  What do you think?  In two weeks I’ll stick my neck out once again with my predictions for 2016.  Maybe I should just heed the words of Mark Twain when he said, “It ain't what you don't know that gets you into trouble.  It's what you know for certain that just ain't true."  Maybe I should, but I just can’t help myself.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.

     

     

     


Still Lucky

 

My annual predictions newsletter from last January had the title, “Do You ....

  • Dec. 17, 2015 A Letter from Ben

    A Letter from Ben

     

    If you have been reading my columns over the last several years, you know I have not been a fan of the Federal Reserve and their monetary policies.  I have been particularly critical of former Fed Chairman Ben Bernanke.  That got me to thinking and wondering what Mr. Bernanke would say to me if we were to talk or if he sent me a letter.  Of course, I’m pretty sure Ben doesn’t even know I’m alive and wouldn’t particularly care what I think.  I thought it might be kind of fun to imagine what he would say if he did write to me.  So with some serious tongue-in-check dialogue, here’s what my buddy might write in a letter from Ben.  I had this imaginary letter urgently delivered to me in the middle of my remarks at a recent event and it got a lot of great laughs as I read it out loud.

     

    FEDERAL RESERVE OF THE UNITED STATES

     

    Dear Mr. Macy:  (Ben never could get my name right)

     

    Since you have been writing about me and criticizing me for years, I thought it was time I finally wrote back.  In case you had not noticed, I retired a couple of years ago and now I’m living the good life.  You won’t have me to kick around anymore, you smart-alect little jerk.

     

    Perhaps you noticed that I took you off my holiday greeting card list years ago.  The clincher for me was when you suggested that recognizing me for my efforts at the Fed was like giving a medal to an arsonist for putting out the fire that he started.  That one hurt.

     

    Do you know how hard it is to be Fed Chairman and sit through all those boring meetings and pretend like you have a clue?  Who do you think you are anyway?  Just because I only went to Harvard and MIT, and you went to USF, you think you’re hot stuff.  By the way, what is a “Don” anyway?  (“The Dons” is the school nickname for the University of San Francisco.)

     

    Now that I’m retired, I can go on the speaking tour and make millions talking about stuff that nobody understands anyway.  Since the banking regulations are a lot tougher because of me, I hope I’ll be able to qualify for a mortgage on my new house.  Maybe I’ll decide to become a financial advisor and write newsletters like you.  Do you think there might be a place for me in your office at Householder Group?

     

    Anyway, I wish you and your clients all the best in the coming years.  When I get my new Harley, maybe we can go riding sometime.  I look really awesome in leather.  Please go easy on Janet Yellon, the new Fed Chairman.  She’s a little sensitive and doesn’t want anyone to know that she doesn’t have a clue either.

     

    All the best,

     

    Ben

     

     

    Well, wasn’t that nice?  Maybe there is hope for him yet.  It looks like I may have to find someone else to pick on.  Of course, in case you somehow missed the joke, this is just an imaginary letter to poke fun at the former Fed Chairman one last time. For you regulators out there – I’m just kidding!!!!!!

     

    This will be my last column for this year, so I’ll be back in January with my annual predictions scorecard and we’ll see how I did in 2015.  In the meantime, here’s wishing everyone a Merry Christmas and a Happy New Year.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


A Letter from Ben

 

If you have been reading my columns over the last several years, you know ....

  • Dec. 9, 2015 Lessons from Leonardo Fibonacci

    Lessons from Leonardo Fibonacci

     

    When I was a young stockbroker and commodities trader in the late 1970s, I became aware of a mathematical formula called Fibonacci ratios.  What a great Italian name!  It just rolls off the tongue like it should be a great Italian dish or a fine wine instead of mathematics.

     

    Actually, it is a theory or formula developed by Leonardo Fibonacci in the 12th century and he unleashed a body of knowledge that would change the world and how people looked at it.  Leonardo was a world class geek by the standards of his day, with a passion for mathematics.  He also learned to read books in Arabic and translated them back into Latin.

     

    In a story written a few years ago by my friend and hedge fund trader John Thomas, I learned some interesting things about Fibonacci.  He particularly liked studying ancient math books where he learned that the Arabs had developed a numbering system vastly superior to the Roman numerals, which were then in use in Europe.  More importantly, they mastered the concept of zero and the placement of digits in addition and subtraction.  The Arabs themselves borrowed these concepts from Indian mathematicians as far back as the 6th century.

     

    Think about how significant this was to the world of math.  Try multiplying CCVII by XXXIV. (The answer is VMMXXXVIII, or 7,038).  Try designing a house, a bridge, a computer software program, or just balancing your check book with such a cumbersome numbering system.  Imagine our national debt of $18 trillion in Roman numerals.

     

    Fibonacci also discovered a series of numbers which seemed to have magical predictive powers.  The formula is extremely simple.  Start with zero, add the next number, and you have the next number in the series.  Continue the progression and you get 0,1,1,2,3,5,8,13,21,34,55.... and so on.  Not surprisingly, the sequence became known as the "Fibonacci Sequence" or “Fibonacci Ratios.”

     

    The great thing about this series is that if you divide any number in it by the next one, you get a product that has become known as the "Golden Ratio".  This number is 1:1.618, or 0.618 to one.  Fibonacci's original application for this number was that it could be used to predict the growth rate of a population of breeding rabbits.  I guess that was a valuable skill back then.  I wonder if we could use it today to predict the growth rate of a population of central bankers.  Sorry.  I couldn’t help myself.

     

    Fibonacci ratios are mathematical relationships, expressed as ratios, derived from the Fibonacci sequence.  The key Fibonacci ratios are 0 percent, 23.6 percent, 38.2 percent, and 100 percent.  The key Fibonacci ratio of 0.618 is derived by dividing any number in the sequence by the number that immediately follows it.  For example: 8/13 is approximately 0.6154, and 55/89 is approximately 0.6180.  Got that?  We’ll have a quiz in the morning.

     

    Over the centuries, other great mathematicians experimented with the numbers and discovered a number of interesting applications or coincidences.  It turns out the Great Pyramid in Egypt was built to the specification of a Fibonacci ratio, as well as the rate of change of the curvature in a sea shell or a human ear.  It also is the ratio of the length of your arms to your legs. Upon closer inspection, the Fibonacci sequence turned out to be absolutely everywhere.  Coincidence or by design?  You be the judge.

     

    Fibonacci introduced his findings in a book entitled "Liber Abaci" ("Free Abacus" in English), which he published in 1202. In it he proposed the 0-9 numbering system, place values, lattice multiplication, fractions, bookkeeping, commercial weights and measures, and the calculation of interest. It included everything we would recognize as modern mathematics.

     

    In the early 1980’s I used the Fibonacci ratios to come up with trading patterns that I used to day-trade commodity futures contracts for myself and clients.  When I saw a certain pattern, I would use the ratios to find the ideal potential trade entry point, the ideal target to sell, and the ideal point to bail out if things went wrong.  I thought I had discovered the magic formula of all time.

     

    The good news was that it worked almost exactly 61 percent of the time, just like Fibonacci would have predicted.  The bad news was that the percentage was the average over a one year period or longer.  The short term results were all over the place.  When it was hot, it was incredible.  When it went on a losing streak, the draw down was so bad it took an incredible leap of faith to hang in there.  Sadly, most people don’t have the stomach for that kind of trading, including me.  Needless to say, my Fibonacci trading days are long in the past.

     

    Today, Fibonacci ratios are used by many technical traders as they try to find support and resistance levels for stock and option prices.  High-frequency traders have developed computer models to take advantage of this.  Knowing where the Fibonacci traders would likely place their buy and sell orders, they place stop-loss orders just under that price to go short and then enter large, rapid-fire sell orders above it to try and drive the price down and trigger the stops.  This is not a game for the faint of heart.  It’s also why a lot of technical trading theories of the past are not working so well anymore.

     

    So what does all this mean for most of us today?  Probably not much.  But it’s a great story and perhaps you learned a little about some of the methods Wall Street traders use.  Now you know the rest of the story.  As for me, I’ll just have a glass of that Fibonacci wine please.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


Lessons from Leonardo Fibonacci

 

When I was a young stockbroker and commodities trader in the....

  • Nov. 18, 2015 Whistling Past the Graveyard

    Whistling Past the Graveyard

     

    Did you ever get the feeling that something was just not right?  You don’t quite know why, but something doesn’t feel right.  But most of us just ignore it and move on – a little like whistling past the graveyard.

     

    We all know the story of the proverbial frog in slow-boiling water.  If you were to drop a frog into a pot of already-boiling water, it would quickly jump out, immediately sensing the danger and, naturally, taking actions to escape it.  But if you drop a frog in a pot of cool water, then very gradually bring the water to a boil, the frog will cook to death, unable to sense the ever-increasing danger.

    Unfortunately, many investors become “boiled frogs” because they simply focus on the stock market in aggregate, meaning they focus on the S&P 500 index, or the DJIA (Dow Jones Industrial Average), rather than individual components of the index.  They also use arbitrary lines in the sand - like the “20 percent down” definition of a bear market – to determine when to bail on a bull market.

    If you ask 100 experienced investors to recall their most difficult years in the stock market, they will undoubtedly name bear market years such as 2000 to 2003, or 2007 to 2009.  They will probably also say those years were so difficult because they didn’t realize they were in a bear market until it was too late.  Of course, we can look at charts of market history and easily identify when markets topped and when they bottomed.  Bear markets are much more difficult to identify in real time because most investors rely on the DJIA or the S&P 500 Index to be an accurate proxy for the broad list of stocks.  As long as the S&P 500 is in a positive trend, they think all is well.

     

    While that may be true during the early stages of a new bull market, the patterns of the large company price indexes are highly deceptive during old bull markets.  If you think about it, you have to know that the S&P 500 Index is always at its high the day before each bull market ends, thus misleading investors.  Research shows that the internal weakness leading to major bear market declines typically begins among the small-cap stocks, an area that few investors ever watch.  Eventually the weakness spreads to the mid-caps, while the large-caps are the last to weaken. Thus, when the DJIA reached a new bull market high on January 14, 2000 (remember the dot-com bust?), which also subsequently proved to be the top day of that bull market, only 3.5 percent of NYSE traded stocks were at new highs, while 55.33 percent of stocks were already down 20 percent or more from their bull market highs.  In other words, over 55 percent of stocks were already qualifying as bear market losses.  A similar situation existed at the top of the last bull market in October 2007.  Investors relying only on the guidance of the DJIA or S&P 500 were blindsided.

     

    Market breadth is another concept that tries to determine just how healthy a stock market is.  Rather than focusing on a stock market index, it looks more closely at the individual stocks that make up the index.  It quantifies just how many of those stocks are making gains (acting bullish) versus how many are suffering losses (acting bearish).

     

    There are, of course, a number of different ways to make these calculations.  But the concept is always the same.  So too are the interpretations.  Essentially, if a stock market index is rising… and a majority of individual stocks are also rising, then the market is considered healthy, and bullish.  But if a majority of individual stocks are falling, even if the stock market index is rising, then trouble is likely ahead.  Let’s take a look at what market breadth is saying about today’s stock market.

     

    It is the internal condition of the market – not the big-cap price indexes – that provides the warnings of a developing bear market.  Currently, most investors are probably not aware that as of late October 2015, 56 percent of small-caps, 32 percent of mid-caps and 24 percent of large-caps have already lost 20 percent or more of their value.  That is far more intense than the losses found in a typical short term correction.

     

    The basic question now facing investors is whether or not the market advance in recent weeks marks the start of a strong rally that might push most stocks to new bull market highs.  To answer that critical question, we turn to the law of supply and demand, which infers that strong rallies require two elements: evidence of dynamic buying enthusiasm (rising demand) accompanied by a significant withdrawal of sellers (shrinking supply).  So far, we have seen little evidence of that.  What we are seeing is a concentration of investor demand for large-cap stocks while small-caps and mid-caps have lagged.  This is following the classic pattern of gradual deterioration seen at major market tops.  You need to be aware that without full knowledge of what is going on internally and externally, you are operating at serious disadvantage to the traders and professionals.  It’s a little like bringing a knife to a gun fight.

     

    What should you do?  It depends on your comfort level.  At this point, we are still fully invested.  I think it is probable the current rally will continue to year-end and likely into spring 2016, fueled by a relatively few large-cap or mega-cap stocks.  This would cause the DJIA or the S&P 500 Index to rise to a new high, encouraging many investors to buy aggressively at perhaps exactly the wrong time – similar to the final bull market peaks in January 2000 and October 2007.  Accordingly, investors should watch for worsening signs of the selectivity already occurring in the mid-cap and small-cap stocks.  For now, enjoy the ride but buckle up.  To borrow one of my favorite phrase from my friends in the bomb squad, “If you see me running, try to keep up.”  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.

     


Whistling Past the Graveyard

 

Did you ever get the feeling that something was just not right?....

  • Nov. 4, 2015 Debt Ceiling Silliness is Back Again

    Debt Ceiling Silliness is Back Again

     

    The late country comedian, Jerry Clower, told some funny stories in his day.  My favorite was his coon huntin’ story.  Long story short, Jerry and his buddy went on a night coon hunt with a neighbor, Mr. Barron, and his hired hand, John Eubanks.  John was known far and wide for his ability to climb trees.  John believed in giving the coons a sporting chance.  When a pack of hounds treed a coon, John didn’t believe in shooting it out of the tree.  Instead, he’d climb the tree and poke the coon with a sharp stick and knock him down among the dogs.  The coon at least had the option of whooping all the dogs and getting away.  The outcome was entirely up to the coon.

     

    On this dark night, things were going according to plan until John, high up in a huge tree, poked the treed coon with his sharp stick.  But the coon turned out to be a lynx, what they called a souped-up wild cat around those parts.  Instead of falling, the lynx stood his ground, so to speak, and started making minced meat out of poor old John.

     

    John yelled down to Mr. Barron, who had a pistol, “Shoot this thang, shoot this thang—it’s killing me.”  Mr. Barron yelled back, “I can’t shoot it, I might hit you.”  “Shoot this thang.”  Mr. Barron replied, “Can’t, might hit you.”  Finally, in desperation, John yelled down, “Well, just shoot up in here amongst us.  One of us got to have some relief.”

     

    I thought of this tall tale recently while reading about the debates over the debt ceiling.  It appears that they may be fixing to “shoot up here amongst us” again.  As we watch the political circus going on in Congress, perhaps Mark Twain was right when he said that “politicians and diapers must be changed often, and for the same reason.”  This would all be quite humorous if it were not so serious.

     

    In case you had not heard, the periodic silly debate over the debt ceiling is back again.  I say silly because the debt ceiling has become just another way for either side of Congress to impose economic terrorism with the other side, and all of us as well.  It has very little to do with getting anything done.  The House of Representatives recently passed a budget agreement that increases spending by $80 billion above sequestration caps and lifts the debt ceiling through March 2017.  Now it goes on to the Senate.

     

    I have been saying for a long time that nothing really matters to anybody until it matters to everybody.  Most people never believed that our leaders would actually start shutting down the government to prove a point or hold the public hostage for political ideology.  At least that is the hope.

     

    Let’s step back for a moment and consider what the debt ceiling is.  The national debt total is simply the cumulative amount of spending that exceeded the amount taken in.  The ceiling is an arbitrary number agreed upon by Congress as a benchmark the treasury cannot exceed.  You might find it interesting to note that most countries don’t have a debt ceiling.  Be that as it may, it is our law and we have to deal with it.

     

    A statutorily imposed debt ceiling has been in effect since 1917 when the US Congress passed the Second Liberty Bond Act.  Before 1917 there was no debt ceiling in force, but there were parliamentary procedural limitations on the level of possible debt that could be held by government.

     

    US government indebtedness has been the norm in United States financial history, as well as most Western European and North American countries, for the past 200 years.  The US has been in debt every year except for 1835.  Debts incurred during the American Revolutionary War and under the Articles of Confederation led to the first yearly report on the amount of the debt ($75,463,476.52 on January 1, 1791).

     

    Every President since Herbert Hoover has added to the national debt expressed in absolute dollars.  The debt ceiling has been raised 75 times since 1962, including 18 times under Ronald Reagan, eight times under Bill Clinton, seven times under George W. Bush, and four times under Barack Obama.

     

    Yes, it is absolutely important that we deal with our accumulating national debt.  However, the debt ceiling is not the problem. The problem is the annual budget deficits.  It is important to remember that the amount of debt we have increases only if we spend more than we take in.  Of course, that has been going on for a long time with annual budget deficits.  In the past few years we have had several over $1 trillion annual budget deficits, and this year will likely “only” be about $425 billion.  But that is like saying we are going over the cliff less rapidly.  The amount of debt is still going up.

     

    Where the debate should be concentrated is on balancing the budget.  Unless we start spending less than we take in, the debt will increase and we will continually bump up against any ceiling established.  Some believe that freezing the debt ceiling will force Congress’ hand.  But the current debt is from money already spent or promised.  Are we really willing to tell the world that we won’t honor our obligations?  The consequences of that, both intended and unintended, could be catastrophic.  Those who suggest that it doesn’t matter are playing with fire and are going to get us all burned.

     

    The truth is, there is nothing significant about the debt ceiling number.  What is important is finding meaningful ways to reduce annual budget deficits and at least keep the debt from getting worse.  There are serious dangers in this debt limit brinkmanship.  It’s time for Congress to stop monkeying around, stop the political games, stop holding our citizens hostage over ideology, and get something done.  Otherwise, they are again just “shooting up here amongst us” all.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


Debt Ceiling Silliness is Back Again

 

The late country comedian, Jerry Clower, told some funn....

Oct. 2015

  • October 2015 The Markets According to Callie and Sophie

    The Markets According to Callie and Sophie

     

    We have two babies at home, who we affectionately call “The Girls.”  Actually, these are the 4-legged type girls and we spoil them rotten.  If there is such a thing as reincarnation, I’d want to come back as one of our dogs.  We can’t refer to them as dogs though, because they would be highly offended.

     

    One is a 90 pound German Shepard, named Callie, who is strong, beautiful, and looks and sounds absolutely ferocious.  (Rin Tin Tin would be proud, if you’re old enough to remember who that is.  If not, Google it.)  Unfortunately, unlike ole Rinty, she is a gentle soul and worries about everything.  The other is a 1 ½ year old Lab/Border Collie mix named Sophie.  Sophie came to us full of energy with absolutely no fear or worries about anything.  But after about a year of watching Callie being nervous, Sophie figured there must be something to worry about and she now has a lot of the same anxiety.  They are quite the pair.

     

    We are seeing something similar in the global financial markets.  After anticipating a Federal Reserve rate hike for most of this year, the Fed held off once again in September.  At first the market response was positive, and then it was as if the entire world looked around and thought, “If the Fed didn’t have the nerve to raise rates this time, what do they know that we don’t know?  Things must be worse than we thought.”  The market immediately sold off and has been nervous ever since.  Callie and Sophie couldn’t have staged it better.

     

    So here we are about a month later and where are we?  Since Yogi Berra passed away recently, it’s appropriate to use one of his many famous quotes here,  “We’re lost, but we’re making good time.”  Nobody is quite sure where we’re going, but we all seem to think we’re just about there. 

     

    As I have said many times over the last several years, I think we’re in a secular (long term) bear market that started in 2000 and probably has a few more years to go.  We’ve had a couple of cyclical bull markets in between, the current one having started in March 2009.  If that is correct, then I think it might be fair to say we are in for a cyclical bear market soon.  I don’t know if that is now, next quarter, or next year, but I am quite sure we will see one within the next two years.  The question is, “What do we do about it?”

     

    No market goes up forever without some kind of set-back along the way, and this bull market is getting pretty old.  Only two have lasted longer.  But when the bear market comes, will it be quick and violent, long and drawn out, or somewhere in between?  There is always a recession out in front of us someday.  How do we predict when?  Adding to the problem is that because of global central bank intervention, nobody is quite sure what the indicators are anymore because nothing is “normal.”

     

    For that reason, we need to be on “recession watch.”  At this point there are no indicators suggesting that one is imminent.  At the same time, global GDP is clearly slowing down and many are now predicting a significant slowing of US GDP in the coming quarters.  Slowing is certainly different than declining and the classic definition of a recession is two or more quarters of negative growth.  I don’t see that happening yet, but if it does, that would lead to an out and out bear market that could easily be down 40 percent.  Downward revisions in the recent unemployment numbers, and a slowing economy in China and other parts of the world recently, didn’t help.

     

    Lately, I’ve started hearing comments from many leading analysts about an “earnings recession.”  Ultimately, stocks are priced on some multiple of earnings, and many analysts have been steadily cutting 3rd quarter earnings projections.  Since we’re just starting earnings season reporting, we’ll find out soon how things are looking.

     

    Thomson Reuter’s data shows that analysts expect a 3.9 percent decline in S&P 500 earnings this year and expectations are falling for future quarters as well.  That has led to talk of an earnings recession, defined as two or more consecutive quarters of falling corporate profits.  If that happens, not only do stocks fall, but the multiple that investors are willing to pay for those earnings (PE ratios) falls also and adds to the problem.

     

    Earnings forecasts are notoriously trend-following and typically miss the turns.  If earnings are beginning to fall – and it appears they are – it is highly likely that earnings estimates will be too high.  At current market valuations, that would be a big negative surprise and there is nothing that the stock market hates worse than a surprise.

     

    In the big picture, income (corporate or individual) can’t grow unless the economy grows.  Will economic growth come into harmony with income growth?  We know they have to meet eventually.  At present, it appears GDP will stay in slow-growth mode.  That means it probably won’t be able to pull earnings up with it.

     

    So what should you do about it at this time?  Probably nothing right now.  But I think I might take a cue from Callie and Sophie and stay just a little bit nervous.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


The Markets According to Callie and Sophie

 

We have two babies at home, who we affectionately....

Sept. 30, 2015

  • Sept. 30, 2015 Whipchained Again

    Whipchained Again

     

    Market traders sometimes use the term “whipsawed” when describing what happens when you find yourself repeatedly losing money by being on the wrong side of a trade.  When I was a rookie stockbroker in 1977 in the San Francisco area, one of my fellow traders was a Chinese man who went by the Americanized name Paul.  Paul was a great guy and very smart.  But he sometimes hit a streak of bad luck with a series of losing trades.  Paul also had a little trouble with American slang.  One day he was looking particularly dejected and told me, “Bad day. Bad day.  I just got whipchained.”  I said, “Do you mean whipsawed?’  He said, “Yeah, that.”  Nobody could keep a straight face.

     

    Whether you call it whipsawed or whipchained, lately a lot of investors have gotten up close and personal with the term.  It’s been a rough August and September, with the market finally correcting 10 percent, then whipping back and forth from there.  Up or down several hundred points on a daily basis has been the norm.  If you tried to trade it, chances are you were on the wrong side of the trade.

     

    Everyone was sitting on pins and needles waiting the for the Fed announcement of whether they would raise rates or not.  When they decided not to, the market went crazy in both directions.  At first the reaction was to the upside because that meant the party was still on and the booze was free.  Then it appeared as though traders decided that if things weren’t good enough to raise rates, then it meant that things were worse than they thought and the market sold off hard.  It’s been that way ever since.  Talk about getting whipchained!

     

    Let’s have a little chat about corrections.  After all, in my opinion, this is just a correction and periodic corrections are quite normal.  They’re not a lot of fun, but they are normal.  Wall Street defines a correction as falling at least 10 percent.  They define a bear market as falling 20 percent.  We did get the 10 percent drop in late August but rebounded from there.  Frankly, I wouldn’t be surprised if we retest that August low again in the coming four to six weeks.  But that is a long way from a bear market.

     

    Sometimes the market is just not a lot of fun.  I’ve lived through a lot of blowups, going back to 1977.  That includes 1985, 1997, 1998, 2001, 2002 to 2003, 2007 to 2009, 2011 and today.  They all kind of feel the same after a while.  Nobody wins from corrections except for the traders, which today mostly means computers.

     

    Long-term investors inevitably get sucked into the media “market turmoil” spin cycle and then puke their well-researched, treasured positions at the worst possible time.  I’m not trying to minimize the significance of a correction, because some corrections turn into real bear markets.  And if you are in a bear market, you should get out.  If it is only a correction, you probably want to add to your holdings – at the right time.  In my opinion, this is a correction.

     

    So what were the two big bear markets in the last 20 years?  The dot-com bust and the global financial crisis.  Two generational bear markets in a 10-year span.  Hopefully something we’ll never see again.  In one case, we had the biggest stock market bubble ever and in the other, the biggest housing/debt crisis ever.  Both good reasons for a bear market.

     

    So what are we selling off for lately?  Something wrong with China?  Not to minimize what is going on in China, because it is now the world’s second-largest economy.  But, after a decade of ridiculous overinvestment, it is possible that they’re on the edge of a very serious recession, whether they admit it or not.  But the good news is that the yuan is strong and can weaken a lot, and their interest rates are high and can come down a lot.  China has a lot of policy tools it can use (unlike the United States).  I don’t think they’re ready for a meltdown – yet.

     

    Let’s think about some “minor” corrections over the last 20 years:  1997: Asian Financial Crisis.  1998: Russia/Long-Term Capital Management (LTCM).  2001: 9/11.  2011: Greece.  All of these were big volatility events.

     

    In retrospect, these “crises” look kind of silly.  The Thai baht broke—big deal.  Russia’s debt default was only a problem because it was a surprise.  And the amount of money LTCM was down—about $7 billion—is peanuts by today’s standards.  After 9/11, stocks were down 20 percent in a week.  The ultimate buying opportunity.  And in hindsight, we can see that the market greatly underestimated the European Central Bank’s commitment to the euro.

     

    So what are we going to say when we look back at this correction in 10-20 years?  What will we name it?  Will we call it the China crisis?  I mean, if it’s a big volatility event, it needs a name.  Let’s pretend it’s the future and we’re looking back at the present.  My guess is that we will think this was all pretty stupid.

     

    I used to get all revved up about this stuff.  That’s when I made my living timing tops and bottoms and short term cycles.  I don’t do that anymore.  I do my research and run my models.  Then I ride my motorcycle or bicycle, go have a nice dinner and relax with a great glass of wine.  In full disclosure, I started reducing equity exposure in my models a few weeks ago and started hedging this week.  That was to reduce the volatility and protect the downside for the next weeks and before what I think will be a year-end rally.  If you’re worried and don’t know how to do that, call me.  Perhaps I can help.

     

    In the short run, we’re dealing with a volatile news driven market.  Whenever this event leaves the headlines, it will soon be replaced with headlines about something else.  The fun never ends.  Be careful, do your homework, and don’t let emotions rule the way you invest.  If not, you might get whipsawed, whipchained, or just plain whipped.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


Whipchained Again

 

Market traders sometimes use the term “whipsawed” when describ....

September 2015

  • Sept, 9, 2015 - China-Not What, But Why?

    China – Not What, But Why?

     

    Lately, the news is all about China and it is causing havoc with the stock market.  Unless you’ve been living in a cave the last few weeks, you know that China has been devaluating their currency and making a number of other moves to bolster their economy and prop up their stock market.  Stock markets around the world reacted badly.  To paraphrase a quote from Captain Renault in Casablanca, “I’m shocked…shocked…. that there is economic manipulation going on in China!”  Are you kidding me?  Of course there is!  Every country in the world is trying to position themselves for what is in their own best interests.  We are too.

     

    I won’t go too much into what the Chinese are doing.  That is pretty well documented in just about every news piece on the market you may have read lately.  It’s important to understand not so much “what” they are doing, but “why” they are doing it.  In the world of developed countries, and especially those with democracies, economic slowdowns or recessions are painful and sometimes cause political changes.  In China, that situation can cause a revolution, political upheaval and death to those thought responsible.  It is to be avoided at all costs.  You can be sure Chinese leaders will do whatever is necessary, ANYTHING, to keep that from happening.  Everything else is secondary.

     

    Is growth in China falling off a cliff?  I don’t think so.  If it were, we would have seen this sort of policy shift months ago, and a lot more drastic stuff today.  But is growth in China uncertain, within a political environment where the governing regime is not only accustomed to certainty but requires a high threshold level of growth for its survival?  Yes, I believe it is; and that is more than enough to mobilize the traditional pro-growth tools of monetary policy – easy credit and a weaker currency – into high gear.  That’s what you just saw.

     

    Unlike the Western countries, in the Chinese context, easy money is not just central bank balance sheet expansion or even lowering short term interest rates.  It’s turning a blind eye to credit expansion in the shadows.  It’s guaranteeing liquidity to banks so that they don’t worry about interbank lending.  It’s bailing out wealth management products.  How long will they do this?  Until the uncertainty goes away.

     

    A little Chinese history is in order here.  Deng Xiaoping (1904 – 1997) and his ally and mentor Zhou Enlai (1898 – 1976), were the primary architects of modern China and what you might call their version of communist capitalism.  They seized control of the Chinese army and communist party after Mao Tse-tung’s death in 1976.  They introduced a more pragmatic version of communism with a market-driven ideology of modernization and economic growth.  It turns out that even devoted communist ideologists longed for a better life.  Deng was willing to do anything to set the future course of the modern Chinese State.  He wasn’t interested in political purity, but in economic results.  As he once famously said, “It doesn’t matter whether the cat is black or white, as long as it catches mice.”

     

    Deng’s political genius was his ability to sell his vision of economic modernization and growth as an end goal to other political and military leaders.  Permanent revolution is tiring and doesn’t pay that well.  Deng offered a vision of stability and wealth, and thus began the journey to the Chinese economic power we see today.

     

    Today, however, the Chinese State faces two main threats, each stemming from or accelerated by the Great Recession and Western policy responses to that crisis.  First, QE and other “emergency” Western monetary policies of the past five years threaten the political unification of Deng Xiaoping from the outside China.  Second, massive wealth inequality and concentration in China, which is driven largely by those same monetary policies, threaten it from inside China.  We’re talking revolution when the “people” aren’t happy, and that can create a really bad day.

     

    Chinese political stability depends on robust and real domestic economic growth.  Not the “appearance” of economic growth that can be constructed within capital markets.  Not the liquidity-driven asset price inflation of Western monetary policy.  Chinese political stability depends on the actual production of actual things by actual people working in actual factories.  The prospects for that real economic growth are made significantly worse the longer the West persists in favoring financial asset inflation and a low-growth status quo.

     

    When western economic policies finally caused them enough problems, they decided not to play ball anymore.  Do they care that the rest of the world is unhappy about it?  Seriously?  Again, they are going to do what they think is best for them.  The rest of the world will then have to decide how they are going to deal with it.

     

    The internal threat of income inequality to Chinese political stability is even more destabilizing.  Have there always been rich people and rich families in China?  Of course.  But the scope and meaning of “rich” is so different today than it was in 1984, or 1994, or even 2004, as to be a laughable comparison.  It’s not just that concentrated private wealth in the modern manner has created an entire class of hyper-privileged Chinese families with the ability to bypass State control.  It’s not just that these hyper-privileged families wield political power independently of any State apparatus.  Most importantly, many of the former politically powerful and privileged people of China didn’t get to participate in the wealth party.  You can be quite certain they are not happy.  They also still have a lot of influence and many would like to change things back to the old way.  Current leaders need to walk a fine line to keep everyone happy so that doesn’t happen.

     

    I don’t know what China is going to do going forward, and perhaps they don’t either at this point.  One thing you can be sure of is that they will do what they think is in their best interests and not care too much about what anybody else thinks.  The question for us will be when, or if, China loses control of the situation and they become the trigger for the next global economic downturn.  In that sense, China matters a lot.  Stay tuned.  Thanks for reading.

     

     

     

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer

     


China – Not What, But Why?

 

Lately, the news is all about China and it is causing havoc....

  • August 26, 2015 - A Different Look at Immigration

    A Different Look at Immigration

     

    “Everything ends badly. Otherwise it wouldn’t end.” – Brian Flanagan (Tom Cruise), “Cocktail” (1988)

     

    We’ve had a lot of mixed economic news lately.  Greece is quiet (for now) and China is in the headlines as they go to extreme measures to prop up their stock market and economy.  (I’ll write more about that soon.)  Demographic trends are terrible in Germany and Japan, but they don’t look so hot here either.  Yet we still hear news of a strengthening U.S. economy.

     

    Some say that immigration is on the rise.  Huh?  I’m not sure what they’re looking at, but immigration is not increasing, and certainly not over pre-2008 trends.

     

    U.S. immigration is getting worse (i.e. lower amounts) over time, and that does not serve us well.  Of course, that depends on whether you think less immigration is a good thing or a bad thing.  Immigration, whether legal or illegal, is a hot topic in the current presidential campaign, largely due to Donald Trump.  However, few people are fully aware of just how much immigration has driven population and economic growth in the U.S throughout history.

     

    From the late 1800’s into World War I, there was a massive wave of immigration that fed our population.  It peaked at 1.25 million per year between 1907 and 1914.  Then, in 1991 we hit another peak of 2.25 million when we offered the amnesty program.  Keep in mind that was against a population of 250 million versus 99 million in 1914.  That’s a difference of 1.6 percent per year in 1914 and 0.5 percent in the early 1990s.

     

    That’s a huge drop!  The main point here is our country will never see the wave of immigration we saw a hundred a years ago, or even in the last few decades!  Demographic experts have been forecasting for years that we’d see a major decline in both immigration and birth rates – the two things an economy needs most.  Despite unprecedented stimulus from our government and the Federal Reserve, both of these declines are occurring.

     

    Immigration – both legal and illegal – has dropped from a peak of 2.25 million 24 years ago to just over one million in 2014.  Births have dropped from a peak near 4.35 million in 2007 to 3.9 million last year.  And like so many economists, the Census Bureau is extrapolating the short term to think births will continue upward in a straight line.  It forecasts that we’ll have 420 million people by 2060.  But a more realistic assumption about birth and immigration suggests about 360 million.  That’s a lot of people for sure, but that’s 60 million fewer people that won’t need homes, offices, groceries, gadgets, etc.

     

    Immigration – for the most part – has been pretty good the past several years.  That’s largely thanks to Mexico, and to a lesser degree Latin America.  Now, before you get all riled up and start waving your tea party badge at me and sending hate mail, stay with me for a moment.  I’m talking economics here, not politics.  I’m also talking about legal immigration.

     

    Since 2000, immigration from Mexico has fallen dramatically while immigration from Asia has gone up slightly.  Over the long term, Mexican immigration doesn’t look so big now.  It has fallen from around 400,000 a year in 2000 to around 100,000 in 2014.  Let’s take an even closer look.  Between 1995 and 2000, 2.95 million Mexicans crossed the border (legally).  Then, from 2005 to 2010, it balanced out to zero as a reaction to the great recession.  Just as many Mexicans came in as left!  Have you heard anybody talk about that in the campaign rhetoric?

     

    Meanwhile, immigration from Asia has been rising, but not by much.  Between 2000 and now, immigration from India has climbed to 120,000 a year from 80,000.  From China it’s up to 140,000 from 80,000.  That nowhere near offsets the drop in immigration from Mexico.

     

    Perhaps you may be in the camp that thinks this is a good thing.  But it’s not.  Our birth rates are not high enough and immigration is important to our sustained economic growth over the long term.  Instead of having to wait for them to become adults, most immigrants come into the country in their 20’s and 30’s and can immediately become productive.  Illegal immigration is another subject and I’ll leave that to you and the politicians to decide what should or should not be done about it.

     

    Fortunately, there is some good news in all this. We’ll likely get more immigration from China in the next few years as they take drastic measures to control their unstable economy.  Many people, especially the wealthy, will be trying to get themselves and their money out of the country.  That adds productivity and spending to our economy.

     

    But overall, immigration is falling.  And if it looks bad now, just wait until we have the next economic downturn.  We should take a lesson from Australia.  The Land Down Under has one of the best immigration policies in the world.  The country encourages immigration.  However, they’re very selective in the skills they targets.  They don’t let it happen by accident.  As a result, Australia has a larger echo boom generation than its baby boom and that’s why they have the best demographic trends in the world as far as wealthy countries go.

     

    But over here, we will probably see our millennials (or echo boomers) reject higher immigration rates as we sort through our issues with income inequality.  In slow economic times, immigration is not politically popular.  After all, we saw the same thing during previous boom and bust time.  Like all things, it goes in cycles.

     

    Ultimately, cutting down on immigration will be a huge mistake for us.  This country relies on immigration – always has.  And it has clearly worked to our advantage both in innovation and population growth.  So before you heed the “wisdom” of so many news types and political junkies bashing immigration, take a step back and look at the bigger picture.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor


A Different Look at Immigration

 

“Everything ends badly. Otherwise it wouldn’t en....

  • August 12, 2015 - After Greece: The Problem with the Euro

    After Greece: The Problem with the Euro

     

    So Greece accepted the terms offered by the European Union (i.e. Germany) recently and now everything is cool.  Yeah, right!  If you believe that, I’ve got a bridge I want to show you.  Ironically, after lots of tough talk, Greece finally agreed to a deal that was worse than the one they turned down previously.  Maybe they should take negotiating lessons from Donald Trump.

     

    The thing that is interesting, which is quite telling, is that nobody is talking about it anymore.  Well, I’m sure they’re talking about it in Greece; but the rest of the world moved on to other hot topics.

     

    In the big picture of Europe, the far more important question has to do with the European Union in general and whether it will survive as a concept.  The European Union consists of 28 countries.  It allows for the free transfer of goods, people, and capital across national borders. The euro zone takes it a bit further, with 19 of those 28 countries sharing a single currency called the Euro, allowing for easier trading.

    But the point of creating these organizations wasn’t just to facilitate trade.  The member states wanted something more.  They wanted an end to the hostilities on the continent that had ripped apart their nations for centuries.  Whether it was England, France, Germany, Prussia, Italy, or some other country, Europe has a long history of being at war.

    As technology and weaponry advanced over the years, wars became more devastating.  This culminated in the massive destruction in World War I, followed by more in World War II.  By forging closer economic ties among the nations, the architects of the EU hoped to derail any growing animosity that might arise among nations.  After all, bombing your customer is not good for business.  So far, this has worked pretty well, but not everything has gone according to plan. Greece is a prime example of things gone wrong.

    To join the euro zone, nations must commit to fiscal responsibility and promise never to leave.  In exchange, these members let a single institution, the European Central Bank (ECB), oversee their central banking functions.  Essentially, member nations hand over the sovereignty of their currency to a board of administrators, over which they have no control, but they still have to balance their own budgets, keep tax revenue flowing, and manage their expenses.

    Therein lies the problem: euro zone members kept their fiscal responsibilities but gave up their monetary powers.  In doing so, they surrendered two of the main monetary tools used in tough economic times – interest rates and control over the money supply.

    When an economy slows down, the government can try to get it moving with lower interest rates.  That, in theory, results in more borrowing and spending.  The second option is to print money to drive down the value of its currency, which lowers the cost of exports.

    Without control over monetary policy, both of these options are off the table.  That leaves a much less attractive one – reducing the nation’s costs through deflation by lowering prices and lowering wages.  This approach goes by another name - austerity.

     

    One familiar analogy would be that of a family.  If a family gets in financial trouble, they have to find a way to increase income, reduce expenses (austerity) to a sustainable level, or temporarily take on additional debt in hopes that the problem will be fixed before it overwhelms them.  Option 1 is best, but hard to do sometimes; option 2 is not much fun; and option 3 has limits before everything blows up.

    Greece is in the throes of this today, and it’s not pretty.  The country grew in the 2000s based on poor risk control (lending too much) and a building boom fueled by speculators.  After the financial bubble burst, many borrowers defaulted, leaving Greek banks with bad debt.  Economic activity dropped dramatically.  Today, Greek GDP is 25 percent lower than it was before the financial crisis.

    Without the ability to change its monetary policy, Greece was left with the unenviable task of deflating its economy to a sustainable level.  This meant lowering prices, cutting wages and benefits, and a host of other unpleasant things.  Of course, the average Greek citizen doesn’t understand any of this.  He/she just knows that life got a lot worse and they’re angry.

    Leaders of the euro zone recognize the issue, and have offered a long-term solution – give the ECB control over fiscal as well as monetary policy.  Member nations would submit their annual budgets for approval, and the ECB would then monitor them for success or failure.  At some threshold, euro zone leaders would dictate fiscal policy to national governments.  Such decisions would include things like pension payments and employment law.  Good luck with that!

    Keep in mind that these nations were at war with each other less than 100 years ago, and most of them don’t speak the same language or have the same backgrounds.  How is that supposed to work?  Every nation I’ve ever visited or read about has great pride in their country.   When things get tough, it’s hard to see how any nation would choose to give up more of who they are to a governing body in a distant country.

    The euro zone appears to be an experiment that went too far.  Sharing a currency is a great idea if everything goes well, but that never happens.  The current situation with Greece is far from the only problem that will arise.  When the Greek euro tragedy finally comes to an end, another tale of woe in the euro zone will rise to the top and take its place.  I think the euro zone will always be hobbled by such issues.

    But there is one good thing to all of this - Europe has not had a military conflict since the inception of the euro zone.  That’s a big bright spot at an otherwise bleak time.  From that point of view, choosing to fight over who prints money, or who sets interest rates, is better than waving goodbye as your sons and daughters head off to war.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.

     


After Greece: The Problem with the Euro

 

So Greece accepted the terms offered by the European....

  • July 8, 2015 - Fun with Statistics

    Fun with Statistics

     

    Mark Twain is often credited with the famous line, “There are three kinds of lies: lies, damned lies, and statistics."  It is a phrase describing the persuasive power of numbers, particularly the use of statistics to bolster weak arguments.

     

    When I was growing up I used to have fun playing around with statistics and how they were used.  Yeah, I know.  I’m a little weird.  When I told my daughters about this, they looked at me and said, “Dad, you were a geek.”  I protested and provided all kinds of facts and figures and macho tales to prove otherwise, to which they said, “You were still a geek.”

     

    You can learn a lot from dead people.  No, I don’t talk to them.  But I do learn a lot from statistics about them.  As an example, an often quoted statistic says that life expectancy in the U.S. has increased by thirty years since 1900.  We hear that people lived, on average, to the age of 48, while today they’re living to the ripe old age of 78.

     

    Think about that for a moment.  That implies that back in 1900 there were no “old” people.  That doesn’t make sense, so I did a little research.  Sure enough, the average age of death for a man in 1900 was 48 and today it is just over 78.  A 30 year difference.  However, if you look at the rate of death by age, the numbers look quite different.

     

    Yes, the average age of death in 1900 was 48, BUT over 15 percent of the deaths occurred before the age of five.  This enormous number of deaths before the age of five had the effect of dramatically lowering the average age of death in those days.  For many of those who made it past five years old, they survived well into their 70s and 80s.

     

    Interestingly, we commonly attribute the extension of life to advances in health science that allow us to live into old age.  While some of that is true, the far bigger reason was because advances in health science stopped many of us from dying as children.

     

    This is another example of misleading averages. When you dig just a little deeper it’s obvious that the average age of death in 1900 is a pretty useless number.  The same thing happens in the world of investing.  Since 1926, the average return on large cap stocks has been around 9 percent.  That seems pretty good.  I’d like a 9 percent return each year.  Wouldn’t you?

     

    But of course the return is not 9 percent every year; it’s just the average.  In fact, the returns are quite spread out.  Technically speaking, the returns have a wide dispersion from the mean (the average of all the numbers).  So if the average return is 9 percent, but there’s a wide dispersion from this number, then how do we know what to expect each year?  Good question.  I’m glad you asked.

     

    Have you ever gone online and used one of those free financial planning programs to calculate what your investments might do in the future?  Be careful.  Most, if not all, financial software uses normal distributions and standard deviations to calculate expected returns for investments.  Without getting too complicated, the software assumes that the returns are normally distributed (like a bell curve), with a set standard deviation (or how far each year strays from the expectation of the average).  The average return of large cap stocks may be 9 percent, but the standard deviation is 19 percent.  Now that’s a different animal.

     

    If you want to be 99 percent sure that your estimate of next year’s return is correct, you must be willing to accept a range of returns.  In this case, that range is three standard deviations (three times nineteen) above and below the average of 9 percent.  To be 99 percent sure – not 100 percent, mind you – that you have a good estimate of next year’s return on large cap stocks, you must be willing to accept a range of returns from 9 percent minus 57 percent (three standard deviations below) to 9 percent plus 57 percent (three standard deviations above). In other words, you could see a range of negative 48 percent to positive 66 percent, or a 114 percent spread around the expectation of 9 percent!

     

    How do you feel now?  What kind of financial planning is that?!  Who in their right mind would invest in something with the thought that it’s “okay” to have anywhere from a loss of almost 50 percent to a gain of more than 60 percent each year?  That’s crazy!  And yet that’s the exact way most financial software operates.

     

    If you suddenly feel less sure about buying and holding equities, and have less faith in the statement that “over the long term, equities go up,” join the club!  This suggests a rather dim future for traditional asset allocation strategies.

     

    There are better ways.  Instead of simply plodding along, buying and holding with the hope that it all works out in the end, be proactive!  Take an active role in estimating the risk and reward potential of markets, industries, and individual securities.  Look across the economic landscape at the different forces that are driving markets at the moment and ask yourself: “Does all this make sense?”  If the answer is “No,” then unless you know what you’re doing, you could be set to experience the low end of the expectation range for equities!  Not having fun with statistics?  Perhaps I can help you.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


Fun with Statistics

 

Mark Twain is often credited with the famous line, “There are thre....

July 2015

  • July 17, 2015 - Looking for Signs of a Market Top

    Looking for Signs of a Market Top

    “Don’t fear the bear!”  That’s typical advice from companies who promote “long term” investing as the only route to success in the stock market.  Yet, since 1899, bear market declines in the Dow have averaged 37 percent - a substantial dent in the value of a portfolio.  The loss looks even worse considering that it will take an almost 60 percent rise in the next bull market just to get back even.

    What if, instead of just riding it out through gut-wrenching declines, we could identify major bull market tops and avoid the worst of bear markets?  Wishful thinking, right?  Given the age of this current bull market, we are always looking for ways to help investors at least recognize the warning signs of a major market top.  Most important though, is the recognition that the end of a bull market is a drawn-out process over months or even years.  In fact, the process of deterioration begins long before the final highs in the major price indexes.  As the old saying goes, “They don’t ring a bell at the top.”

    Historically, Advance-Decline lines have been amoung the most useful indicators in warning of an approaching major market top.  As a bull market ages, investors typically find fewer and fewer stocks at valuations justifying new buying.  Eventually, this increasingly selec tive buying is reflected by a lag between the Advance-Decline lines and their corresonding price indexes, with the initial divergence typically beginning about four to six months prior to the final high in the S&P 500. Currently, the Advance-Decline lines are providing no indication of an imminent market top.

    While there are still few signs of an imminent major market top, there are ample indications of an aging bull market, which is now one of the longest-lasting ever.  Only two bull markets have lasted longer.  The slow process of forming a major top can lull investors into a sense of complacency.  All the while, though, the slowly deteriorating market conditions can wreak havoc on an investor’s portfolio.

    As noted above, Advance-Decline lines are very useful in warning of an imminent market top.  These indicators, though, are much less useful in reflecting the process of deteriorating strength that characterizes an aging bull market.  For example, at the time of the May 21st, 2015 high in the S&P 500, only 27.1 percent of the stocks in the S&P 500 were at, or within 2 percent of, their 52-week highs.  And, 12.5 percent of the stocks in the Index were already down 20 percent or more.  In in other words, these stocks were already in their own individual bear markets at the same time the media was celebrating a new bull market high.

    You need to know that just because a major index like the S&P 500 or the Dow is making a new high, it could well be that only a handful of stocks in the index are actually doing well while many others could be showing great signs of weakness.  Bottom line – you need to look at the whole picture, not just the index.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


Looking for Signs of a Market Top

“Don’t fear the bear!”  That’s t....

  • July 2015 - Thoughts on the Forgotten Depression

    Thoughts on the Forgotten Depression

     

    Those of us among the Baby Boom generation recall the Ed Sullivan show, which ran on Sunday evenings from 1948 to 1971.  In the early years of television, it was THE variety show that you just couldn’t miss.  He brought Elvis to our living rooms and later the Beatles.  One act I recall was a guy who would balance china plates on top of long thin sticks.  There would be perhaps 10 or so, and he would start a plate spinning on top of one stick, move to the next and start it, and so on down the line.  By the time he got to the last one, the first one had slowed and was about to fall off.  The suspense was in watching to see if he could get them all spinning without any falling off and breaking on the ground.

     

    As I think of that image, I can’t help but think of our Federal Reserve and Central Banks around the world trying to balance and manipulate economies as they jump from one crisis to another.  I wonder how long they can keep all the plates spinning in the air.  I have been ranting about the futility of all this for years.

     

    My father was born on a small farm in Mississippi in 1904, the second of 12 children.  He never stayed on the farm when he grew up, but instead lived in Chicago during the 20’s and 30’s.  By the time I came along in 1947, he was living in Sioux City where I grew up.  He was quite the storyteller and some of the stories of driving a taxi in Chicago during the gangster era were quite fascinating and colorful, to say the least.

     

    I asked him once why he never considered staying on the farm and making that his profession. His reply was that by the time he finished high school, which would have been around 1921, agriculture prices had collapsed, the economy was in the tank, and they were actually paying people to destroy livestock and plow under crops.  There was just no future in farming for him.

     

    I never fully understood that story until recently when I read a fascinating book by James Grant titled “The Forgotten Depression: 1921; The Crash That Cured Itself.”  I highly recommend it if you are a student of economic history.  After reading it, I finally understood what my father had been talking about.

     

    As President Warren G. Harding took office in March 1921, Americans were in a bad mood, disillusioned by World War I and fearful of alleged radicals.  Communism in Europe, and especially Russia, was becoming a growing concern among Americans who feared it would spread to the U.S.  But the main source of anguish and anger was the unstable economy, which in the span of just three years had gone from an inflationary boom to a deflationary bust.

     

    The wartime boom and easy credit had created full employment.  From 1918 to 1919, General Motors went from 49,118 to 85,980 employees.  But the boom also caused rapid inflation, which averaged 16 percent annually from 1917 to 1919.  Can you imagine 16 percent inflation?  Prices rose faster than wages, which triggered massive strikes by coal miners, steelworkers, longshoremen, garment workers and others.  In 1919, 20 percent of all workers were on strike, the percentage ever.  Meanwhile, high prices helped farmers, whose products were in great demand by a war-ravaged Europe.  Their 1919 harvest tripled in value since before the war.

     

    Then came the bust.  As Europe recovered and credit tightened, industrial America ground to a halt. In 1918, GM’s sales were averaging 52,000 cars a month.  By January 1921, they were 6,150.  As companies sold off bloated inventories, production volume, prices and wages declined; and layoffs increased.  A 1921 survey showed an unemployment rate of 15.3 percent.  Farmers who borrowed to buy more land — assuming prices would remain high — couldn’t repay their debts.  In the second half of 1920, the average price for 10 leading crops dropped 57 percent.  Now I understand what my father was talking about.  Nobody wanted to stay in farming; they were all trying to get out.

     

    So what did newly elected President Harding and the government do about all this?  Nothing!  They stayed out of the way and let things run their course.

     

    What does this have to do with today?  It may help explain our slow and tepid recovery from the 2007-2009 Great Recession.  This disappointing recovery contrasts sharply with the 1920’s experience, when the economy rebounded strongly into what we now call the Roaring 20’s.  The 1920 to 1921 bust was awful, but it was short and over quickly.  Once the recovery started, depleted inventories had to be replenished and production was restarted.  Lower prices for building materials encouraged a housing boom.

     

    So why was there such a rapid recovery then and why wasn’t it repeated a decade later in the Great Depression?  James Grant thinks he has answers.  The lesson, Grant argues, is that if left alone, the economy generates powerful recuperative forces.  He writes:

     

    “The hero of my narrative is the price mechanism. . . . In a market economy, prices coordinate human effort.  They channel investment, saving and work. ... The depression of 1920-1921 was marked by plunging prices, the malignity we call deflation.  But prices and wages fell only so far.  They stopped falling when they became low enough to entice consumers into shopping, investors into committing capital and employers into hiring.  Through falling prices and wages, the American economy righted itself.”

     

    Grant is a respected financial commentator and an outspoken champion of free markets.  He believes that if left to themselves, markets will eventually self-correct.  The proposition at the core of his book is that modern economic policies (i.e. quantitative easing and other stimulus), may actually impede or slow recovery.  In other words, get out of the way, let the downturn happen and get it over with.  It is clearly painful, but the process runs its course faster and paves the way for recovery faster.  I agree.  There is certainly some food for thought here.  You’ll have to decide for yourself what you think.

     

    In the meantime, I will continue to rant and rave and warn about the actions of central banks around the world, which I believe will someday come back to haunt us all.  Maybe I’ll be like a modern-day Paul Revere, riding through town on my Harley screaming “the central bankers are coming!”  Okay, maybe not.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


Thoughts on the Forgotten Depression

 

Those of us among the Baby Boom generation recall the E....

June 2015

  • June 2015: Risk With Vern And Me

    Risk with Vern and Me

     

    He was dealt four great cards.  The jackpot depended on the next card.  But before it was dealt, a shot was fired out in Nuttal & Mann's Saloon in 1876, and Wild Bill Hickok hit the floor… dead from a gunshot to the back of the head.  His four cards – aces and eights – were forever immortalized as the Dead Man’s Hand.  It became the symbol of gambles gone wrong, where hidden risks outweigh the rewards.

    Risk is a funny thing.  Everybody loves it when it works out, but it can be quite painful when it doesn’t.  I learned a lot about risk from a cat named Vern.  Vern was a cat I had years ago; or I should say he had me.  He wasn’t anything special; just an ordinary gray barn cat.  But he was special to me, and he made me smile and laugh.

     

    Vern was a house cat meant to live his life protected indoors.  However, Vern didn’t seem to know this, and he never missed an opportunity to be out hunting for whatever it was that he liked to hunt.  Unfortunately, in the real world, the hunter can sometimes become the hunted.

     

    As long as Vern hunted during the day, the risks were fairly small.  He almost always managed to come home around dinner time, carrying his trophy from the hunt, much to the dismay of my horrified daughters.  But night time was a different matter.  The big hunters came out at night, the risks got higher, and the odds changed against him.  As hard as I tried to prevent it, Vern often managed to find the right moment to bolt out the door and he was out for the night.  He always came home; although more than a few times he looked like he got the worst end of a fight.

     

    I never understood why he would never abandon the thrill of the hunt in exchange for the comfort of watching TV and eating snacks with me in the easy chair, but that’s just the way he was.  The good news is that Vern was lucky and lived a long and happy life.

     

     This is not a story about Vern.  This is a story about risk.  More specifically, it’s about asymmetrical risk; when the risk in one direction is far greater than the other.  This is the risk/reward equation people talk about but rarely consider. 

    Asymmetrical risk has nothing to do with the odds of a given risk, but everything to do with the consequences of a given risk.  In Vern’s case, the odds that a coyote would kill him were relatively low and the odds were more in his favor.  For example, let’s say the odds were 50-to-1 in his favor.  But the consequences of that risk were incredibly asymmetrical.  In our hypothetical 50-to-1 risk, Vern returns home alive 50 times out of 51.  But one time in 50, the coyotes kill him.  By those numbers, that's a good risk.  In reality, that's a horrible risk.  No investor would take a bet like that...at least not knowingly.

    As investors, we can’t afford to turn a blind eye to risks, especially not to asymmetrical risks. We can’t afford to take risks which are likely to work, but are likely to wipe us out if they don't work.  Understanding your potential reward is worthwhile.  Understanding your potential risk is everything.

    So here we are with markets near all-time highs.  What’s not to love?  What could possibly go wrong?  Well, the bears say plenty.  Are we on the verge of a melt up (new highs) or a melt down?  The bulls say stocks are reasonably valued right now so there’s little chance of a crash happening anytime soon.  Really?!

     

    First, even on normal valuations measured by price-to-earnings (P/E) ratios, stocks are as highly valued as they were before the last crash in late 2007.  In fact, 2015 looks a lot like 2007 did.  Back then, GDP and job growth was just okay.  Stocks had seen a bull market for about five years, and nine out of ten such markets don’t last longer than that.  This one has been running about six and a half years.

    The so-called experts say there were no real negative signs in the economy.  But think about that for a moment.  There are never bad signs in the economy near a top.  How could there be?  That’s when the economy looks its best.

     

    How did Japan look in late 1989 before a two-decade downturn into early 2009?How did the U.S. economy look in late 1929 just before the greatest stock market crash in its history?  How did the U.S. economy look in early 2000 before the tech wreck?  And how did the economy look in late 2007 before the last great recession?

     

    You can’t look at the economy for meaningful signs of an economic slowdown or a stock market crash.  You have to look at demographics that foreshadow major changes years and decades in advance.  You have to look at the smart money, the insiders who see changes before the public and the media do.  And you have to look at the technical factors showing supply and demand characteristics.  As the old stock market saying goes, “They don’t ring a bell at the top.”

     

    I’m not suggesting the market is about to crash.  I have no idea when that is coming.  In fact, I think the market will likely trend up through 2015 and possibly into 2016 because there are no technical signs of a top yet.  However, I do know that no market goes up forever, and this bull market is getting long in the tooth.  Risks are building.  Be careful.  My pal Vern beat the odds, but you may not be so lucky.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.

     

     

     


Risk with Vern and Me

 

He was dealt four great cards.  The jackpot depended on the next ....

  • June 2, 2015: What Would The Wolfman Say?

    What Would The Wolfman Say?

    Some of you might remember a colorful DJ from the 60s and 70s who went by the name Wolfman Jack.  He spoke in a raspy voice and became known for some pretty outrageous comments back in the day.  I could hear him late at night on AM radio when he broadcast out of Mexico with a super powerful signal that would skip across the country.  My mother wasn't a fan; I used to hide the transistor radio under the covers and listen.  He would often close his show with a few rules, the last of which was always "Don't ever mess with the Wolfman."

     

    One of his favorite satirical commercials went like this: "You say ya kids ain't got no clothes; ya ain't got no food in the frigerator - then buy yourself a color TV baby!"  The Wolfman would get a big laugh today if he were alive to see how the joke has come true with individuals and government living beyond their means.

     

    Along the same theme comes a great poem from former Dallas Federal Reserve President Bob McTeer.  "My house is under water, for sure.  My car is upside down, you bet.  But I'm getting me a consolidation loan and finally getting out of debt."

     

    We have become so accustomed to debt that we think it's normal.  Even the stock market has gotten to the point where just the suggestion of a reduction in debt and monetary stimulus sends the market plummeting.  Today there is daily speculation as to when the Fed will finally start raising rates, while the market jumps up or down in anticipation.

     

    One analogy of the economy is it being like a drug addict.  The addict never wants to face the pain of withdrawal and constantly needs more drugs to avoid it.  Our economy has become stimulus addicted and just the suggestion of coming off sends investors for the exits.  There is just too much money floating around and that inflates asset prices.  It also hurts consumers and tax payers.  Sooner or later, the insanity has to stop because this is unsustainable.  Unfortunately, it doesn't look like that is going to be anytime soon.

     

    Most of the recent stock market news has been about short term expectations.  Will we see a correction or a crash?  Big one or little one?  Who knows?  Let's step back for a moment and look at the big picture instead.  In my mind, there is no question anymore about the market being in a secular (long term)bear market since the market peaked in 2000.

     

    To refresh your memories, a secular bull market is a long-term bull market of ten to twenty years duration.  Within that long-term uptrend there are cyclical (shorter term) bear markets lasting six months to a year or two; but when they end the long-term uptrend continues to even higher new highs.  1982 to 2000 was the last secular bull market.

     

    A secular bearmarket is a long-term sideways pattern of ten to twenty years, in which there are periodic cyclical bull markets that carry the market back to previous peaks.  It goes up and down in a big wide sideways channel.  Just when it looks like things are about to break out, it rolls over and heads down again.  We are just a little over the top of that channel now.

     

    Secular bullmarkets are wonderful for 'buy and hold' investing, since the market soon recovers from the periodic cyclical bear markets and rockets up to higher highs.

    On the other hand, secular bearmarkets are great for traders and market-timers, providing repeated opportunities to make profits from the uptrend in the cyclical bull markets, and then from the downside in short-sales and inverse trading vehicles in the subsequent and frequent cyclical bear markets.

     

    Obviously, it is critical to recognize which investing environment we're working in and adjust strategies accordingly.  The last 120 years were clearly divided into three completed secular bull markets and three completed secular bear markets.  I believe we are currently in a fourth secular bear, which began at the peak in 2000.  We bottomed in late 2002, hit a new high in late 2007, hit a low in early 2009 and hit a new high recently.  Bottom line - it's all still pretty much in that wide channel.

     

    The real question we need to answer is whether this secular bear is close to ending or has further to run.  The previous three secular bear markets lasted an average of 18 years. The current one is in its 15th year.  If this one hits the average, we have another 3 years or so of running up and down in a big sideways channel.  The good news is I don't see any technical signs of a major top yet.  Stay tuned.

     

    Before he died in 1995, Wolfman Jack had another great quote where he said, "I started out as an opportunistic renegade.  By now, I've lasted long enough to become sort of an American Original Respectable Renegade."  Maybe there's hope for me yet.  Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


What Would The Wolfman Say?

Some of you might remember a colorful DJ from the 60s and 70s who went by the name Wolfman Jac....

  • April 18, 2015: Danger, Will Robinson! Danger!

    Danger, Will Robinson! Danger!

     

    Those of you over 60, and some of you over 50, might remember a TV show titled “Lost in Space.”  It ran from 1965 to 1968 and had to be one of the corniest shows ever produced.  But I couldn’t help but watch it.  I was especially fond of the robot that sounded the alarm at any sign of danger by saying in its robotic voice, “Danger, Will Robinson!  Danger!”

     

    As you have read in many of my past newsletters, I have some concerns about how long the current bull market has been going and when we will finally see some kind of correction, or even a long term top.  After all, no bull market in history has gone up indefinitely.

     

    Knowing that, how will we know when it’s time to head for the exits?  Should we rely on the news?  That’s problematic because the news always looks good at the top.  By the time the news gets bad, the show is over or at least largely on its way.  Should we wait for earning reports to get worse or for negative reports on the economy?  Same problem.  While underlying fundamentals ultimately drive the markets, prices usually fall long before negative fundamentals show themselves.  What can help us, at least somewhat, are technical indicators and supply/demand characteristics of the stock market.

     

    To quote the legendary investor Warren Buffet: “The first rule of investing is don't lose money; the second rule is don't forget Rule No. 1.”  This statement reinforces the fact that preservation of wealth remains the number one priority for most investors.  For most market participants, the most significant risks occur during bear markets.  It is easy to look at history and identify when a bull market occurred, and when a bear market occurred.  However, it is very difficult to look forward in real time and identify when a bull market transitions into a bear market.  It is not surprising that a large number of studies and work focus on how to generate the highest returns, but what tools does an investor have to guard against significant losses in a bear market?

     

    It is important to remember that the stock market is driven by the interaction between buyers and sellers.  At major bull market tops, buying enthusiasm begins to fade and the desire to sell begins to expand.  This relationship goes back to the fundamental law of supply and demand that states an environment of increasing demand and limited supply leads to higher prices, and higher prices eventually lead to an exhaustion of demand.  The fundamental law of supply and demand applies to all aspects of economics, and especially to the stock market.

     

    Understanding the forces of supply and demand in the market is a critical component in evaluating the underlying process of bull markets and the gradual signs of erosion that appear in advance of bear markets.  As the major market price indexes continue to move to new highs, most investors are unaware of the actions of buyers and sellers as prices become extended and subtle signs of weakness begin to appear.  Many times, while a major market index is making new highs, it could be driven by just a few stocks in the index while many are actually well off their highs.

     

    In the stock market, one of the tools that help display signs of broad market strength is the number of individual stocks that are at or near their 52-week highs each time the major price indexes record new highs.  Signs of increasing selectivity near market tops often warn of a weak market that can result in a sharp decline in prices.  The number of stocks that are at new highs often begins to decline in the later stage of a bull market as demand for a broad list of stocks begins to fade.  Also, the number of stocks that have declined by 20 percent or more from their highs often increases during the later stage of a bull market.

     

    A 2010 report by Lowry Research titled “The Nature of Bull Market Tops” provided an in depth historical perspective about how market tops gradually form as investor demand begins to fade and subtle signs of erosion begin to appear.  This report provides an extensive study covering each of the major bull market tops dating back to 1929.  In each case, the final bull market high, as registered by the DJIA, was used to investigate the underlying condition of the broad market.  Four classifications were used to assess the strength of the bull markets: the percent of NYSE-listed stocks at new bull market highs, the percent of stocks within 2 percent of their bull market highs, the percent of stocks off by 20 percent or more from their bull market highs, and the percent of stocks off by 30 percent or more from their bull market highs.

     

    While company fundamentals may influence certain investors to buy or sell an individual stock, it is difficult to identify, out of thousands of possibilities, what predominant factors are influencing millions of investors to fuel an entire bull market. But, the law of supply and demand infers that the reasons “why” investors buy or sell are unimportant.  It is the dominance of buyers over sellers, or sellers over buyers, which is vital to determining the trends of the stock market.

     

    The 2007 market top provided a classic example of a market displaying strong price performance in the major market indexes, but subtle signs of eroding investor demand beneath the surface.  Several months before the October 2007 market highs in the DJIA, a gradual decrease in the number of stocks at or near their highs began to occur.  As the DJIA rose to a new bull market high, the number of stocks within 2 percent of theirs began to decline rapidly and the number of stocks off 20 percent or more from the 52 week high increased rapidly.  This was a huge red flag that something wasn’t right.  Of course we all know what happened after that.  Buying pressure fell and selling pressure increased and stayed that way until after the bottom in March 2009.

     

    So where are we now?  The good news is there are no signs currently, based upon this analysis, that the market is displaying signs of an imminent long term top.  Because of that, we remain comfortable, although cautious, being fully invested.  When that changes you may well hear me do my best robot imitation and begin yelling “Danger, Will Robinson!  Danger!”  Stayed tuned.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


Danger, Will Robinson! Danger!

 

Those of you over 60, and some of you over 50, might remember....

  • March 25, 2015: Hoes Buy and Hold Still Work?

    Does Buy and Hold Still Work?

     

    Since the market recovered to its 2007 peak two years ago and has made new highs since, Wall Street is finally able to resurrect its saying “The market always comes back”. Investors are again becoming convinced that buy and hold is the way to go. But if the market went down, how long could you wait for it to come back? It’s one thing if you are 30, 40 or even 50 years old; but it’s quite another if you are 60, 70 or older.

     

    With the market hitting new highs in early March of this year, and with many conditions in the economy back to their levels of 2000 and 2007, this might be a good time for a few reminders of how long it often takes the market to “come back.” For example, last December was the 25th anniversary of the Japanese market’s last peak – in 1989. What does that have to do with US investors? A lot.

     

    In 1989, Japan’s stock market was the most popular in the world, made so in no small part by the involvement of U.S. investors. In the mid-1980s, as stock markets around the world soared before the 1987 US market crash, the Japanese stock market was one of the biggest winners. Then, in the ’87 crash the U.S. market lost 36 percent of its value in 3 months, while the Japanese market declined only 18 percent and immediately began to soar again. Investors around the world were so impressed by its strength and resilience they poured even more money into it, driving it ever higher and laughing off warnings of bubble conditions.

     

    A year later in 1990, when global markets suffered their next, and mercifully brief bear market (the U.S. market fell 21 percent in just 3 months), the Japanese market plunged 65 percent from its 1989 peak to its 1992 low. In spite of numerous rallies, it fell even lower over the years and was down 82 percent by 2009. 82 percent!!!! Now, 25 years later, it has still not recovered even halfway back to its 1989 peak.

     

    Just buy and hold is what Wall Street recommends. Don’t worry. The market always comes back.

     

    Japan is far from an isolated example. It was 26 years after the 1929 U.S. market crash before the market returned to its 1929 level (in 1955). Just ten years later, in 1965, the Dow reached another peak, at 1,000, before plunging into a bear market. It was 17 years later, in 1982, before the market made it back to that peak and began to move higher.

     

    Only 17 years after that devastation, investors who bought and held in 1999 and 2000 had a similar experience. The S&P 500 lost 50 percent of its value in the 2000-2002 bear market, recovered in the 2003-2007 bull market, only to lose it all again in the 2007-2009 bear market. It was not until two years ago that the market returned to its 2000 and 2007 peaks and moved higher. That was another 13-year waiting period. Oh, my head hurts!

     

    Think about that. In the 86 years since 1929, buy and hold investors would have been waiting a total of 56 of those years for the market to “come back.” Many middle-age to older investors in each period did not live long enough to see the recovery. This is something to think about for those who have been convinced the market does indeed always come back. Clearly it does. But do you have enough time?

     

    Wall Street has another sales slogan that works for them because it also sounds so easy, requiring no vigilance or action by passive investors; “It’s not market-timing that works, but time in the market.” (They’re not referring to how many years it takes for buy and hold investors to recover from bear market losses). Since Wall Street has a vested interested in having you stay fully invested, it’s not surprising they would feel this way.

     

    The truth, as most experienced investors realize, is that it’s not only how much you make in bull markets, but even more so how much you don’t give back in the inevitable bear markets. Everyone experiences a bad year now and then. What is important is to make sure it’s not real bad and you don’t dig yourself into a deep hole that takes forever to climb out of. Now is not a bad time to keep that in mind.

     

    At this point I remain bullish on the market and fully invested. But there will come a time, probably not too far from now, when that will change. It’s important not to lose sight of where we are in the longer-term cycle. Only two of the last 25 bull markets lasted longer than this one - those of the 1920’s and 1990’s. We also know how those exceptional bull markets ended.

     

    So enjoy the continuing bull market. I don’t know when it will end, but I do know it will. And when it does, whether this year or next year or later, it will, as always, end badly for the majority of investors. Be careful and don’t be one of them. Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK. Nick can be reached at www.nickmassey.com. Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.

     


Does Buy and Hold Still Work?

 

Since the market recovered to its 2007 peak two years ago and has made new highs since, Wall S....

  • Feb. 21, 2015: Staring at the Dragon Scroll

    Staring at the Dragon Scroll


    I recently heard about the animated film “Kung Fu Panda”, in which a villainous snow leopard named Tai Lung desperately wants to obtain the secret Dragon Scroll that is said to hold the secret to limitless power. The scroll is protected by a group of Kung Fu masters who are joined by a hapless panda bear named Po.  Since I no longer have children in the house, I get this valuable information on good authority from young children I know (and Google).

    At the end of the movie, Po has mastered Kung Fu and successfully fends off Tai Lung.  Before getting trounced and sat upon by a fat panda. Tai Lung gets a peak at the contents of the Dragon Scroll and finds nothing but a reflective surface.  Po, who has already looked at the scroll, points out that the secret of limitless power is what lies inside of us.

    What does this have to do with economics?  The theory of Keynesian economics is based on the same premise.  For six long years it has stolen money from savers, pushed investors to take on ever more risk, and worked desperately to tilt the economy in favor of borrowers.

    In the early 1930s, the world was in the grips of the Great Depression.  Until that time, most governments had taken a hands-off approach to the economy, allowing the overall business cycle of growth-boom-bust-recovery to play out on its own schedule.

    But the depths of the depression caused leaders to rethink this policy.  They went searching for tools that would allow them to tame the business cycle by erasing, or at least greatly reducing, the effects of its downside.  They found their answer in the British economist John Maynard Keynes.

    The typical business cycle involves rising demand, which calls for businesses to produce more goods and services.  As businesses increase their output, they hire more people and/or increase wages, as well as buy more inputs from other businesses (raw materials, components, etc.).  This gives workers and other companies even more capital with which to buy stuff, leading to even higher demand.

    Unfortunately, all of this money sloshing around encourages consumers and businesses to take on excessive risk.  Counting on ever-rising incomes, consumers take on debt to buy more things.  Businesses, counting on more orders, use credit to expand their operations.  Bankers are part of the cycle as they seek to lend out as much as they can.

    At first, the rising use of credit serves as a supercharger to the business cycle, which simply reinforces the aggressive behavior of consumers and business owners.  But as demand for credit increases, money becomes more expensive in the form of higher interest rates.

     

    Eventually the marginal borrowers, both consumers and businesses, fail under the weight of their debt payments.  Their income and orders don’t grow sufficiently to cover their mounting debt payments.  The demand for goods and services slows down a bit.  As lenders incur losses, they tighten their lending standards and lend less in order to rebuild their reserves.  The decrease in available credit slows demand even further, leading to more losses, which aggravates the losses at banks.  Non-payment on debts leads to shrinking credit, which leads to falling demand, causing businesses to fire workers and order less, which causes even more bad debts.

    The old way of dealing with this was to allow the liquidation of over-borrowing and over-spending.  Assets would be sold to pay debts.  The excessive risk-taking on the part of consumers, businesses, and banks would be “cured” through the pain of retrenchment.

    During the 1930s, the magnitude of the economic downturn caused people to demand action from their politicians.  Surely there must be something they could do to alleviate the suffering of everyday people.  No one should endure any pain or suffer the consequences of bad decisions.  Enter John Maynard Keynes.

    To Keynes, this is where governments can be helpful.  Instead of allowing the sell-off to continue until an economy reached some base level, the government could borrow money and spend it on… well, on anything — as long as it employed people and ordered goods and services from business.  In this way, the government would supplant the private sector in demanding goods and services and eventually jump-start the virtuous cycle.  That’s a nice theory.

    The problem is the business cycle is based on the psychology of consumers and business owners.  On the way up, they take on more risk through purchasing and the use of debt, while on the way down; they trim their buying and shed debt as best they can.  Nothing in the Keynes model addresses this psychological state.  In fact, the model itself states that governments should continue with the deficit spending meant to bolster aggregate demand until the “animal spirits” of consumers and entrepreneurs have returned.

    Another word for it might be “confidence.”  Keynes called it “naïve optimism.” Attempts by politicians and others to talk up confidence by making optimistic noises about economic prospects have rarely done much good.

    This is the basic building block of the economic theory behind the printing of more than four trillion dollars, and the reason that it doesn’t do much to rebuild our economy.  At the end of the day, we’re told to look into the Dragon Scroll and realize that the power to reinvigorate the economy lies within us.  If only we would throw caution to the wind and once again take on debt with abandon, buy stuff we don’t need, and live like there’s no tomorrow… then all would be right with the world.

    At this point you might wonder how such an approach could work.  Wouldn’t people know that as soon as the government withdrew from the markets they would simply be back where they were before, albeit having traveled through a government redistribution program that taxes everyone in order to funnel income to a few?  Maybe.  But if you’re asking these questions, then clearly you’ve not stared into the Dragon Scroll of economics long enough, since you have not regained that economic confidence known as animal spirits.  Excuse me as I go back to staring at the scroll.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


Staring at the Dragon Scroll


I recently heard about the animated film “Kung Fu Panda”, i....

  • Jan. 24, 2015: "Do You Feel Lucky? Well Do Ya' Punk?"

    “Do You Feel Lucky?  Well do ya’ Punk?”

     

    Well, yes.  Actually, I do.  After a pretty good score on my forecast in 2014, I’m ready to go again.  This is less about Dirty Harry and more about whether it is better to be lucky or good when it comes to forecasting.  If I try, maybe I can be both.

     

    Sometime in the 1980’s, comedian Billy Crystal had a routine he did about old guys and how they would go on about how hard life was in the “old” days.  “We had no air”, he’d say in an old man’s voice.  “No food.  We ate wool coats and we were happy.”  I can recall lots of similar stories from my father talking about walking miles to school in rural Mississippi while barefoot and how we were all spoiled and soft today.  Then he would project out into the future and say how things were going to be even softer.

     

    I sometimes find myself doing the same thing.  I can still remember my rookie years as a stockbroker.  We had to carve order tickets on rocks and then walk them five miles down the road to the telegraph operator.  It was hard work but we were happy.  I guess I have become my father.

     

    So what does this have to do with anything?  No much, but I liked the story.  Maybe it has something to do with forecasting.  I’ll bet that sometime in years to come, all we’ll have to do is just sit back and wait for the future to show itself electronically.  Hmmm.  The world has gotten too soft.  In the meantime, as I project into the future, here is what I see for 2015:

     

    #1:  2015 will be a very volatile year as the markets search for direction and react to every piece of news.  I again think the market will see a 10 percent correction sometime this year, and it may be happening in January.  But it will rebound to be up 10 percent by fall before dropping again and finishing the year up just 5 percent.  If you are a good trader, it will be a fun year.  For the rest of us, not so much.  A 10 percent drop could go to 1850 on the S&P and about 16,000 on the Dow.  A 10 percent rise would be 2,260 on the S&P 500 and 19,600 on the Dow. 

     

    We have been taught that a bear market cannot occur without the  aggressive Fed tightening that inverts the yield curve and causes a recession.  We should question whether that rule still applies after six years of ZIRP (Zero Interest Rate Policy).  Other strategists are unanimously predicting 5 to 17 percent market gains in 2015.  Not one is calling for a decline.  That reason alone tells you something else will happen.  It will be a year that favors good stock pickers versus those just riding the index.  Investors should hedge their gains.

     

    #2:  Interest rates on bonds will grind upward, but not substantially.  That means no bond market crash, just modestly lower prices.  Rates on the 10-year Treasury bond will range between the current historic low of 1.7 percent, to 2.5 percent as everyone anticipates the inevitable Fed raising of short term rates.  This is not the time to be in long term bonds.  The only way rates shoot up rapidly is if there is a raging bull market in stocks and the “flight to quality” trade in bonds is reversed.  That’s not likely to happen at this stage.

     

    #3:  Gold is still on life support but the pulse is getting stronger.  Gold may rally for a short while but will find a bottom at $1,000 before any meaningful rise in the future.

     

    #4:  Oil will trade between $40 and $75 a barrel, but will trade more toward $60 for much of the year on slowing global demand and increased supply.  $45 may be near a bottom after the market finishes blowing out all the traders and speculators on the wrong side of the trade.

     

    #5:  Even after hitting a six year high of 92 on the dollar index, the US dollar will continue to rise in value against most other currencies.  The Yen will lose another 10 to 20 percent against the dollar and the Euro will fall another 10 percent on its way to parity with the dollar.  Your European vacation is getting cheaper.

     

    #6:  US GDP growth is likely to slow in the first quarter as consumer spending slows and the reality of disappointing retail sales hits home.  Lower oil prices represent a savings to consumers and some businesses, but a contraction to businesses involved in or related to the oil industry.  The full impact on the US economy will depend on how long oil prices stay low.  While the US economy is showing signs of recovery, the rest of the world is slowing.  US GDP growth will likely average 2.75 to 3.25 percent for the year.

     

    #7:  While the unemployment rate dropped to 5.6 percent, the labor participation rate has only gone up to 62.8 percent.  Many who have found jobs replaced them with ones paying much less.  Expect to hear a lot more about the uneven job recovery this year.  Nothing much has changed.

     

    #8:  High yield bonds (a nice word for junk bonds) took a beating in 2014 and will do it again in 2015.  About 20 percent of high yield debt issued in the last several years is in the oil sector, particularly those involved in fracking.  Low oil prices will put many of them in a bind.  Yield differentials between junk and quality are widening, which means the price of junk drops.  A higher yield won’t be enough to offset the fall in price.  Stay away.

     

    #9:  Emerging markets suffer with a rising dollar, making it even more expensive to pay back debt owed in dollars.  Many emerging market countries, and some developed countries, are commodity exporters.  Falling commodity prices, including oil, and slowing global demand means they are going to be under economic pressure for quite some time.

     

    #10:  Commodities in general are on the downside of their long term cycle, which is a 28 to 31 year cycle.  Gold topped in September 2011, industrial commodities (copper, aluminum and iron) topped in early 2012, agricultural commodities (corn, soybean, wheat) in summer of 2012, and oil in summer of 2014.  This is likely the last leg of the commodity bear market that has already taken prices down to 2009 lows.  Gold will recover first and oil last, but it is too early to start buying yet.

     

    So there you have it.  We’ll take a look again next January and see how I did.  In the meantime, be cautious in 2015.  Remember, you can’t always get what you want…..but if you try, sometimes you get what you need.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


“Do You Feel Lucky?  Well do ya’ Punk?”

 

Well, yes.  Actually, I ....

  • Jan. 10, 2015: 2014 Surprises and Surprises

    2014 – Surprises and Surprises

     

    Today marks my 38 year anniversary in the investment business.  On this day in 1977 it was my first day at Dean Witter in Cupertino, California, and to say that I was scared and overwhelmed would be an understatement.  Sometimes I still am.  A lot has changed over those years, including the economy, the markets and just life in general.  I can’t say that I’ve seen it all, but I’ve certainly seen a lot.  It’s been a fascinating ride.

     

    Bull markets normally last an average of 4.5 years.  By that time, stocks are usually over-valued, the market is over-extended, the Fed is making plans to cool off the enthusiasm, and the bull market/ bear market cycle begins to sequence into the next bear market. 

    Super bull markets, those that go beyond the norm, have been once in a lifetime anomalies, driven by unusual, life-changing technological transformations.  In the last 100 years there have only been two.

     

    The 1920’s super bull market, fueled by the introduction of electricity into homes and factories, transforming lives, lasted a record nine years (before ending with the 1929 crash). Seventy years later, the 1990’s super bull market, fueled by the introduction of computers and automation, established a new record, lasting 9.3 years (before ending with that bubble bursting in 2000).  The current bull market has now lasted 5.9 years.  Hmmmm.  Just an observation.

     

    Last year I said, “If the volatility and uncertainly of 2013 bothered you, 2014 will drive you crazy.”  That turned out to be quite true.  Here are my 2014 predictions and the results.

     

    #1:  “I think the market will see a 10 percent correction sometime this year, probably before summer, but recover to finish the year up 8 percent.  That would put the Dow around 18,000 and the S&P 500 around 2,000 sometime during the year.”  Result:  Correct.  The Dow closed up 7.5 percent at 17,823 and the S&P 500 closed up 11.4 percent at 2,058.  We saw a couple of short term corrections but never got to 10 percent.

     

    #2:  “Interest rates on bonds will rise, but not substantially.  That means no bond market crash – yet.  Rates on the 10-year Treasury bond will range between 2.8 and 3.8 percent.”  Result:  Wrong.  Rates surprised everyone when they went the other way, with the 10-year trading between 2.99 and 2.06 percent, and closing the year at 2.17 percent.  The entire world went looking for safety and drove prices up and yields down.  At least I can take some comfort in the fact that nobody I know got it right either.

     

    #3:  “Gold is not dead, but certainly on life support.  Gold will likely have a short term rebound to $1,400 before falling to $1,000.”  Result:  Mostly Correct.  Gold traded as high as $1,389 and as low as $1,132, closing at $1,184.

     

    #4:  “Oil will trade between $80 and $100 a barrel but will trade more toward $80 for much of the year on slowing global demand, increased supply, and easing tensions with Iran.”  Result:  Correct and then even more.  When oil broke through the $80 support level, the bottom fell out.  Oil traded as high as $101 and as low as $52, closing at $53.27.

     

    #5:  “Despite fear of a collapsing US dollar, the dollar will actually rise in value against most other currencies as other countries try to devalue their currencies to make their exports cheaper.”  Result:  Correct.  The US dollar index traded over 91, a five year high.

     

    #6:  “US GDP growth is likely to slow in the first quarter as consumer spending slows and the reality of disappointing retails sales hits home.  The Federal Reserve and new Fed Chairman Janet Yellen will panic and crank up the printing presses again to slow the current tapering process of reducing bond purchases.”  Result:  Wrong.  Consumer spending remained steady, GDP for 2014 will be around 3 percent, and the Fed ended their bond purchases (QE) in October.  They have vowed to keep short terms rates near zero for the “foreseeable future.”

     

    #7:  “US demographics will continue to be a drag on economic growth and consumer spending as the baby-boomers on average are now past peak spending years and are beginning to spend less, save more and reduce debt.  This trend will be in place for at least the next decade.”  Result:  Correct.  This is a long term trend that is just beginning.

     

    #8:  “Forget about employment.  At this stage of the economic cycle, we should be generating a robust 400,000 jobs a month, not a paltry 200,000.  Still, that's better than 100,000 a month, or none.  Yes, we may grind down to 6 percent unemployment, but that will be just because more people gave up looking, not because they got a job.  The employment participation rate, the lowest since the 70’s at 62.5 percent, will not change in any significant amount in 2014.”  Result:  Correct.  While the unemployment rate dropped to 5.8 percent, the participation rate has only gone up to 62.8 percent.  For the reasons cited above, nothing much has changed.

     

    So there you have it.  Forecasting is tough, but 6 out of 8 isn’t bad in this environment.  While I try not to take all of this too seriously, it’s always fun to try.  This is one more reason why, no matter what we think will or will not happen, we stick with our investment discipline and don’t try to make market bets.  You shouldn’t either.  I’d give myself a B plus for 2014.  What do you think?

     

    In two weeks I’ll stick my neck out once again with my predictions for 2015.  I can give you a preview though.  What will the market do?  In the words of J.P. Morgan, "it will fluctuate."  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


2014 – Surprises and Surprises

 

Today marks my 38 year anniversary in the investment bu....

  • Dec. 6, 2014: Dollar up, Gold and Oil Down

    The Dollar Up, Gold and Oil Down


    For a long time now, the “gold bugs” have perpetuated a myth about how the U.S. dollar is falling and that it’ll ultimately crash.  They have been wrong and continue to be wrong.  In fact, the exact opposite has happened, with various unanticipated consequences.  The story has changed but they’re still singing the same old song.

     

    In my January 25, 2014 predictions column, I wrote the following about the dollar, gold and oil:

     

    #3:  “Gold is not dead, but certainly on life support.  Gold will likely have a short term rebound to $1,400 before falling to $1,000.  Sorry gold bugs.”  Today it is around $1,200 and falling, after a recent low this year of $1,132.

     

    #4:  Barring a big blow-up in the Middle East, oil will trade between $80 and $100 a barrel but will trade more toward $80 for much of the year on slowing global demand, increased supply, and easing tensions with Iran.”  Oil hit $65 recently.

     

    #5:  Despite fear of a collapsing US dollar, the dollar will actually rise in value against most other currencies as other countries try to devalue their currencies to make their exports cheaper.  This is the 21st century version of trade wars.”  The dollar index is at a 5 year high.


    Let’s take a look at the real story.  The U.S. dollar did fall dramatically from 1985 to early 2008, a staggering 58 percent.  That’s a major devaluation for a reserve currency that’s usually valued higher than normal due to the fact that dollars are bought at a higher pace since they’re used for global transactions.


    What most people don’t realize is that the U.S. led the debt bubble from 1983 to 2008 and there were several factors that caused the sharp dollar devaluation.  Total debt in the U.S. grew 2.54 times GDP for a span of 25 years and the country experienced near constant trade deficits since 1970.  In an effort to compensate, the largest economy in the world circulated more dollars overseas in foreign exchange reserves.

    We flooded our economy and the world with dollars and that caused the 58 percent devaluation despite the fact that the U.S. was experiencing the greatest boom in world history.  What’s happening now is the beginning of the greatest deleveraging of the debt and financial asset bubble in modern history.

    Over the next several years, more dollars will be destroyed through debt deleveraging and trade surpluses than any other currency, and that will rebalance the devaluation of 1985 to 2007.  I believe the dollar will continue to go up.  Not forever, but at least over the remainder of this decade.

    So, has the dollar been crashing?  No, it’s been trending up since the last great recession started in early 2008.  And it continues to trend up despite the fact that the Fed printed more and more dollars until October of 2014.

    Why?  Since 2012, the European Central Bank (ECB) printed more dollars than we did due to an even greater crisis that has persisted longer for them, and they have started printing again to buy sovereign bonds.  In early 2013, Japan went crazy printing at two to three times its past rate, out doing the U.S by a wide margin.  And on October 31st they announced an even greater increase of 15 percent to 20 percent.  To use an old poker saying, they “went all in.”  It’s win or bust this time.

    In other words, the reason the dollar has gone up more recently has to do with greater money printing from other governments while we finally tapered for the first time over the last year.  It’s not crashing or even falling.  It spiked up 27 percent during the worst of the last financial crisis of late 2008 when gold crashed 33 percent and silver 50 percent.  The dollar was the safe haven, not gold or silver.

    Even during the strongest period of the recent recovery, which was primarily due to money printing, gold has fallen 40 percent from its peak in 2011 and silver 67 percent.  Why?  Despite all of this money printing, inflation has been flat or falling in most developed countries and back near deflation levels in Europe.  Even Japan’s off-the-charts money printing cannot get inflation back up to a measly 2 percent.

    I’m not suggesting that things are great, but as the expression goes, we are the best house in a bad neighborhood.  As much as I hate it, I think the Fed will do it again if the economy slows down in the next few years.  But if we begin printing again, the weaker countries will do it as well and even more so.

    If the dollar index, currently around 89, breaks strongly above 89, I think it will be a sign that commodity prices are trending even lower, that the global economy is slowing even more while deflation continues.  U.S. exports will also slow.  But a higher dollar will also bring greater value to the 50 percent of earnings of S&P 500 companies that will be worth more in higher valued dollars.

    However, there are other consequences of a strong dollar.  Since oil is generally priced in dollars, a rising dollar means lower oil prices in dollar terms.  In addition to some of the fundamentals causing oil prices to drop recently, the rising dollar is part of it.

    So, will the dollar crash as some have said?  I think not. To paraphrase a famous line from Mark Twain, rumors of the dollar’s death have been greatly exaggerated.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


The Dollar Up, Gold and Oil Down


For a long time now, the “gold bugs” have perpetuated a....

Nov. 2014

  • Nov. 15, 2014: Anatomy of a Market Correction

    Anatomy of a Market Correction

     

    Back in July 2007, I got the opportunity to appear on CNBC at the New York Stock Exchange the day the Dow hit 14,000.  That was a big milestone for me since in 2006 I had predicted that the Dow would hit 14,000 in 2007.  At the time, that was a pretty outlandish claim.  Obviously, it turned out that I was right.  The market kept going before finally topping out around 14,150 in November, 2007.

     

    Of course, we all know what happened after that.  Early 2008 started out with the market heading south as the news kept getting worse.  I wasn’t too worried at the time because I wasn’t expecting a correction of any significance until 2010, when I thought, for demographic reasons, we would start the next leg down of a secular bear market.  By May of 2008 I woke up and realized it was a major credit crisis and I started to hit the sell button and make adjustments.  We took losses that year, but at least not as bad as it could have been.

     

    I often think about that year and what I could have done differently.  It haunts me to this day.  I had a plan for how I was going to handle the next correction and maybe even make money for our clients while it went down.  Of course, as usual, the market operates on its own timetable and wasn’t cooperating with mine.  What I had failed to consider was; if the world actually was blowing up, would I have been able to execute my trade?

     

    So there is this whole idea of emotions we have to consider when we’re talking about the market.  For example, you might have a plan to buy stocks when the index gets below a certain level, but when the market gets to that point, you:  A) may not have the capital; and B) might be panicking with everyone else.  It’s nice to have a plan, but paraphrasing Mike Tyson, everyone has a plan until they get punched in the face.

     

    I remember reading Russell Napier’s 2009 book about bear markets, called Anatomy of the Bear.  He talked about all the big bear markets in the US, including the granddaddy of them all, the stock market crash of 1929 and the Great Depression.  One of the things that I learned from this book was that if you can time the bottom exactly right, you can make a lot of money in a very short time.  For example, if you had bought the lows in 1932, you could have doubled your money in a matter of months.

     

    I wanted to do that.  I remember 1985 to 1987 when the market was going steadily up.  I was looking for a correction.  I prayed for a bear market so I would get my chance to buy at the lows.

    Little did I know that I would get my chance on October 19, 1987 when the Dow dropped 22.6 percent (508 points) in just one day.  Like almost everyone else, I blew my opportunity.  When the market is down that much in one day, or down over 50 percent from 2007 to 2009, who has the courage to buy stocks?  Hindsight being 20/20, you can say, “Did you think it was going to zero?”  Actually, yes.  In October 1987 and in March of 2009, people thought it was going to zero.  But for those people who: A) had capital; and B) weren’t terrified, it was a once-in-a-lifetime opportunity.

     

    So let’s talk about those two situations.  A). Does everybody have capital?  Remember, the hard part of this is not picking bottoms.  Many people can do this quite capably.  Panic liquidation is easy to spot.  But few people have the ability to take advantage of it, because they’re fully invested.  If things head south rapidly and you’re fully invested, you have just kissed a fair amount of your capital goodbye.  As for B), you tend not to be terrified if you have capital.  Cash can be quite comforting in those situations.

     

    Many people, including me, thought the sudden drop in the market in October of this year was the beginning of the long overdue correction.  The price action was terrible.  Would it get worse? I thought so.  Of course we all know now that it dropped about 8 percent and bounced once again to new highs.

     

    We’re seeing excesses that we haven’t seen in many years.  It’s been over 1,000 days since we’ve had a correction of any magnitude. With the market down about 5 to 8 percent, nobody is particularly worried, because every other time the market was down that much, it ended up going higher.

     

    Back to emotions.  What is it going to “feel” like if the market goes down further?  How about 10 to 15 percent, or even 20?  How will people behave if the S&P 500 gets to, say, 1,700?  That’s “only” 16 percent.  I can tell you what it will be like if the S&P gets to 1,700.  It’s going to be like it was in October 1987 or March 2009 when everyone got the “deer in the headlights” look.  Will you remain calm and objective when the floor traders on the stock exchange are buried under an avalanche of panicked sell orders from institutional money managers?  At 1,700 trading floors will be very noisy.

     

    It’s been so long since we’ve had a real correction, I’m guessing that most people have forgotten what a correction feels like.  When you go that long in between corrections, people are sitting on a mountain of capital gains.  And unless the capital gains really start to disappear, there is little pressure to sell.  But if you’re the owner of a group of stocks, and you’ve watched them evaporate to the tune of 15 to 20 percent or so, that tends to focus the mind a little bit.

     

    I tell you all this not to alarm you, but to get you to think a little bit about what you own and how you will act.  As with any steep correction, there will be fantastic opportunities.  But they will only be available to those who have capital.  Remember, bear markets don’t just destroy the bulls’ capital, they destroy the bears’ capital, too.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.

     


Anatomy of a Market Correction

 

Back in July 2007, I got the opportunity to appear on CNBC at....

Oct. 2014

  • Oct. 25, 2014: Change Is In The Air

    Change is in the Air

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    “Then you better start swimmin' or you'll sink like a stone.  For the times they are a-changin'.”  Those words, written by Bob Dylan in 1964, might describe where we could be now with the stock market.

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    Did you feel it last week?  No, not the earthquake.  I mean the sudden shift in feeling about the economy and the markets.  It started about a month ago.  Subtle at first, like the early hint of fall in the air before winter arrives.  Then suddenly last week the unstoppable bull market got mauled by the bear.  If you watched too closely you could have gotten seasick with all the violent up and down movements.

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    Suddenly there’s a new feeling in the air about the economy and markets.  Unbridled confidence has been replaced with doubt and worry.  Was this the long overdue correction I have been talking about?  Some of you thought I was crazy, but now you’re not sure.  Was that it, or is there more downside to come?  Those are tough questions with difficult answers.  I suspect we will find those answers in the coming weeks.

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    Late last year I wrote a story about economist Hyman Minsky.  Minsky was known for his theory which basically said that stability breeds instability.  The longer things are good, the more complacent people become, the more risk they take, the more unstable things become.  Finally, the “Minsky Moment” arrives and triggers a collapse, much like the final grain of sand on a sand pile causes it to suddenly collapse.  Perhaps we just saw a preview of one of those Minsky Moments.

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    Is the long overdue correction happening now?  I think this is probably round one of several rounds to come.  Will the market continue down from here?  Probably not right now.  That would be too easy.  The markets always do something other than what people expect.  We are rebounding this week and I suspect we will see several more weeks of volatile action as people digest recent events.  But make no mistake about it, the easy-money ride is over and this is where it gets really tough.  Buckle your seatbelts boys and girls because this is where the ride really gets wild.

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    Many analysts, except me, have been telling you that when you look back in history, stocks are not overvalued.  Really?  It’s truly puzzling to me how they arrive at that conclusion.  Even though Price-Earnings ratios (P/E ratios) aren’t quite as high as they were when the market peaked in early 2000, it doesn’t mean that stocks aren’t overvalued.  (P/E Ratio is the price of a stock or index divided by the earnings per share.)

    A better way to look at P/E ratios is the methodology created by Yale professor Robert Shiller.  Rather than looking at P/E ratios based on current earnings or estimated future earnings (which may or may not happen), Shiller takes the average of the last 10 years of inflation-adjusted earnings.  This has become known as the Cyclically Adjusted Price/Earnings (CAPE) ratio.  This method takes some of the volatility out of the number and creates a longer term reference point.  Traditional P/E ratios often get understated near market tops due to strong surges in earnings.  As I have stated many times, things always look good at a market top and they don’t ring a bell to tell you it is time.

    The CAPE P/E ratio for the S&P 500 was near 27 in 2007 and higher than all previous major tops, with the exception for the ones in 1929 and 2000.  Today the CAPE ratio is 29.  Based on that analysis, stocks are clearly overvalued today.  That doesn’t necessarily mean that stocks could fall now, but it certainly tells us they are not bargains.

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    Economies go through seasons just like our weather and in my opinion we are in, or about to go into, a deflationary (winter) season.  But corporate earnings are good now – right?  Profit margins are up, so life is good.  How can the market drop when earnings are good?  It’s the rapidly growing risk premium, not the drop in earnings that investors bring on when they suddenly flip from confident to fearful.  P/E ratios dropped to 8.2 in late 1974 and then dipped further in late 1982 to 6.6.  I would expect to see P/E ratios decline as risks grow in the next downturn.

    rn


    Now that investors have nowhere else to go with their money and are convinced that the Fed will not let the market fall, all we need is for something to go wrong and flip them from their sense of false security into extreme fear like in late 2008.  If we had a contraction in P/E ratios similar to the contraction in 1974, it would result in a 58 percent decline in stocks as well as a sharp decline in earnings.  While I certainly don’t think things are that dire, you can see that stock prices can fall simply due to P/E contraction.

    rn

     

    rn

    I think markets are likely to remain in this volatile range through this month and early November.  We could see another rally after that as we come into November and December.  However, we may have already seen the peak for this year.  We’ll see.

    rn

     

    rn

    Since I started this story with Bob Dylan, I think I’ll end with another one of his famous lines.  “You don’t need a weatherman to know which way the wind blows.”  Watch out.  That breeze might soon turn into a strong gale.  Thanks for reading.

    rn

     

    rn

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.

    rn

     


Change is in the Air

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  • Oct. 18, 2014: What Happened To The Middle Class?

    What Happened to the Middle Class?

    As tempting as it is to talk about the stock market this week, I’m saving that for next time when we have more information.  Instead, I think I’ll do some ranting and raving about a subject that affects most of us.  Let’s talk about a recent report of income and wealth in America.  It tells the story of how much the middle class has suffered since 2007.

    Recently, the Federal Reserve released the 2013 Survey of Consumer Finances (SCF).  This tri-annual survey is a valuable source of information that provides a snapshot into the financial life of the median American in inflation-adjusted 2013 dollars. Notice that I said “median” and not “average”… that’s important.  I know.  This is a lot of statistical talk, but please bear with me.

    The average number can be skewed by a few people at the top or bottom of any measurement.  The median gives us the point at which half the people are above and half the people are below, which is a much better indicator of what’s going on.  Because the SCF has been conducted for decades, we can see how people have progressed, or regressed, over time.

    For most people, if you are feeling less wealthy than you’re used to, it’s not your imagination.  The changes over the last six years are consistently horrible, particularly for those in the middle income brackets.  The SCF provides information on things like income and net worth for people based on several factors.  These include:  Age of Head of Household, Percentile of Income, Family Structure, Education of Head of Household, Race of Head of Household, Current Work Status of Respondent, Region, Urbanicity, Housing Status, and Percentile of Net Worth.

     

    Since 2007, median net worth has dropped almost any way you measure it. The only group that escaped a decline was the Current Work Status category called “other,” whose median net worth in 2007 was $6,000, and in 2013 was $9,000.  I suspect most of you are not in that group.  Yes, I know… the fat cats on Wall Street and corporate executives are raking in ridiculous sums of money, so there must be small pockets of people that have seen their fortunes rise over the past six years.  But these groups are so small that they exist at the edges of society.

    For the median person, the one in the exact middle in all of these categories except the one mentioned above, it’s nothing but losses.  Looking at just one classification — net worth by percentile of income — the drop in median net worth from 2007 to 2013 is quite dramatic.

     

    When we move over to the change in median income itself, the results are still miserable, though not as dramatic.  Almost every group in every category suffered a decline in income over the past six years.  The exceptions were households led by those over 65 years old, households of retirees, and those with net worth in the 90 percent to 100 percent range – the REALLY wealthy people.   Again, breaking it out by percentile of income, there were losses in every group.

     

    While the median at the bottom and the top of the food chain experienced little change in inflation-adjusted earnings over the past six years, those in the middle income and just below were hit hard.

    Now, think of these two statistics together.  For those who earn between the 40th and 59.9th percentile of earnings, meaning those right in the middle of wages in the U.S., income has fallen by 12 percent while their net worth has plummeted by 38 percent.  And that’s over six years!  This isn’t a one-year aberration, or some fluke in the data. This is six years.

    So where is the economic recovery everyone keeps talking about?  Where is the improving economy that is supposed to carry the U.S. through the second half of the decade?  How are people supposed to not only grow their standard of living, but also put money away for their future?

    Keep in mind that the inflation numbers used to adjust the data are the official Consumer Price Index (CPI) figures.  If we used more realistic numbers over those same six years, showing higher spending on medical expenses, education and food, the reports would be even worse.  No wonder people are angry.

    Whenever you read about the recovery gaining speed, or about consumers gearing up for higher spending, think about these numbers.  Think about the millions of Americans who can’t even tread water financially, and have watched their situation deteriorate for more than five years.  These are not high school dropouts, or even just high school graduates (only 35% of Americans have a college degree, so by definition 50% of earners must include many college grads).

    Think about them when someone at the Fed, in Congress, in the Administration or at the New York Times crows about how they “saved” us.  I’m not buying it.  We still have a long way to go on our path toward economic recovery.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


What Happened to the Middle Class?

As tempting as it is to talk about the stock market this week, I&r....

  • Oct. 3, 2014: Children Are Expensive Worldwide

    Children Are Expensive Worldwide

     

    As you probably know after all these years, I have a strong interest in demographics and its effect on investments, the economy and our personal lives.  One area having a profound effect on our personal wealth is having children.  While I’m sure you love your children as much as I love mine, you have to admit that they are expensive little critters.

     

    In the United States, the Department of Agriculture estimates that it costs an average of $245,000 to raise a child born this year.  No way you say?  Do the math.  Just to get to age 18 is about $13,600 a year.  From your own experience, do you really think it is less than that?  Keep in mind this doesn’t include college. That’s extra.

    While the number might be mind-boggling, the idea that children are expensive isn’t new, at least not in the Western world.  We’ve long since succumbed to the reality that our kids are giant suction machines, intent on removing every last nickel we have in our pockets. But most of the time we are willing participants.

    We sign them up for soccer, SAT tutoring, music lessons and drama classes, and send them off to adventure or science camps every summer.  We make sure that they stay involved with travel sports when their regular sport season is over.  Add to this the latest set of gadgets and gizmos, and you have a great recipe for overspending on junior.

    When a two-income family takes the step into parenthood, they get a huge reality check.  They find out that one of the biggest costs associated with kids is daycare.  The going rate is roughly $200/week, or $10,400 per year.

    Americans look at these figures and shake their heads, knowing that many young people simply can’t afford to have more children if they want to keep them at a high standard of living.  It appears that a fair number of Asian countries have come to the same conclusion.

    According to the CIA “Factbook”, the estimate of the fertility rate of women in the U.S. this year is 2.01, which means women of child-bearing age are anticipated to have 2.01 children, on average. This is slightly below the rate of 2.10 that is needed to replace our population (one for each parent, plus a little for mortality and those who don’t have kids).

    This might sound low, but we’re ahead of just about every other developed nation on the planet, and light years ahead of some major Asian nations.  The same source shows the five countries with the lowest fertility rates are South Korea (1.25), Hong Kong (1.17), Taiwan (1.11), Macau (0.93), and Singapore (0.80).  This is very interesting because the list doesn’t include the poster child of declining populations, Japan (1.42), or the best-known forced family planning country, China (1.55).

    The bottom five countries have all experienced incredible growth over the last 50 years and the standard of living in each nation has risen dramatically.  Along with it, the pressures of raising children to exacting standards so that they can attend the best schools and have all that life has to offer has increased as well.  So parents self-regulate, choosing to have fewer children so they can focus their spending on one child, or maybe two.

    From a demographic standpoint, this works for a little while. The standard of living increases because there are more productive workers and fewer mouths to feed.  But eventually the tables turn.  There are more retirees than new workers, reflecting the falling number of children entering the workforce.  At this point, governments are like deer in the headlights, not sure which way to go.

    How do you fill in the gaps of missing populations?  No one knows.  This is exactly the situation faced by each of the five bottom countries, which have been offering tax and various other incentives to entice families to have more children.  Russia has even been paying women to have children.  It’s not working.

    This is also what led China to ease its one-child policy last fall, hoping to create a wave of births this year.  So far, the program has fallen flat.  Of the 11 million families eligible to file for permission to have a second child, less than 3 percent have done so.  This probably has something to do with the fact that raising a child is estimated to cost over 40 percent of the average income in China.

    The normal structure of a society is to have a larger number of children in successive generations or at least have roughly the same number of kids in the next generation.  This way, there will be enough workers and consumers not only to help the country grow, but also to care for the aging members of the population.

    Over the last 25 years the world has watched Japan and witnessed what occurs when there are fewer children.  The economy stagnates.  Consumers hold tightly to their assets.  Property prices fall.  Aging citizens begin to determine the direction of the country and there are few opportunities for the young.

    In a nation like Japan, which had achieved a high level of wealth before it began to age, many of the ill effects are being mitigated by government spending.  What happens when a country the size of China, which has grown dramatically in the last 20 years but is still not rich, starts to grey?  Who’ll care for the elderly?  Who’ll buy the internal assets of the country to keep their domestic economy not just afloat, but growing?

    Having children is certainly expensive, but not having them can be the death of a nation.  These trends take years to develop and can’t be undone quickly.  When choosing areas for your investment dollars, consider how a country might grow — or contract — demographically.  This could enable you to avoid the next Japan.  Thanks for reading.

     

    Nick Massey is a financial advisor and President of Householder Group Financial Advisors in Edmond, OK.  Nick can be reached at www.nickmassey.com.  Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment advisor.


Children Are Expensive Worldwide

 

As you probably know after all these years, I have a strong....

Sept. 2014

  • Sept. 9, 2014: Bonds or Stocks

     

    Bonds or Stocks?

     

    As I sat and contemplated what to write about this week, and find something my readers would find interesting and/or amusing, I remembered an old quote from former President Lyndon Johnson.  Always known for a colorful phrase or two, he once said: "Did you ever think that giving a speech on Economics is a lot like pissing down your leg?  It seems hot to you, but it never does to anyone else".  I've often had the same feeling - about economics that is.

     

    So in honor of LBJ and with the same level of enthusiasm, let's talk about bonds this week.  That ought to get you excited.  What's up with bonds this year anyway?  Weren't they supposed to plummet when the bond bubble burst and interest rates went up and bond prices down?  Instead, the exact opposite happened.

     

    Bonds prices continue to defy the experts and forecasters, including me, continuing to make new highs even as talk increases that the Fed will have to begin raising interest rates sooner than previously expected.  The 10 year Treasury bond started this year around 3.0 percent and most thought they would go to around 3.5 percent.  Instead they went the other way and are currently trading around 2.4 percent.

     

    Since bond interest rates and stock prices are often considered predictors of the future, interest rates often go down in anticipation of stock prices going down also.  Instead they have mostly moved in opposite directions from one another.  Are bonds perhaps saying the stock market has it wrong and the economy is not as strong as the Fed thinks, or that something is going to happen that will cause a safe haven flight to bonds?

     

    Bonds or Stocks: Who's Right?  Treasury bonds spiked to new one-year highs and yields to one-year lows recently, trading as low as a 2.30 percent yield.  The bond market seems to be telling us that serious deflation is continuing for the indefinite future and we should buy more bonds.

     

    Then again, corporate profits are at all-time highs, just closing one of the strongest reporting periods in history.  In addition, the forecast for the rest of the year looks pretty good also.  Many would argue that with dividend yields for many stocks in excess of interest rates paid by government bonds, the bull market is alive and well.  So if the stock market is telling us to buy more stocks, maybe the bond market has it wrong.

     

    Stocks! Bonds! Stocks! Bonds! Which group of talking heads is right? The stock bulls or the bond bulls?  Oh, my head hurts!  What is your humble analyst to do?

     

    Could it be that for one of the few times in history both are right?  At least that is what the markets are telling us for 2014.  You buy everything, both stocks and bonds, which is what we have always done in our models anyway.  Yes, you still need them both in your portfolio.

     

    There is a possible explanation for all this - the end result of a cash glut caused by unprecedented quantitative easing by central banks all over the world.  (Not that I approve of this tactic, as you well know, but that is a story for another day.)  There is so much money chasing everything these days, it is truly unbelievable for people like me who have been around this industry for almost 40 years.  Prices can only go up right?  Yeah right!  If you believe that then I'm afraid you will be in for a rude awakening someday.  I just don't know when.

     

    Take a look at the U.S. government's accounts, and you get a partial explanation. Over the past four years, the budget deficit has gone from near $1.6 trillion to "only" $600 billion.  (Remember when we would have thought $600 billion was a big number?)  It could be as low as $300 billion in the next couple of years.  This has been a result of tax increases, higher earnings and reduced government spending in some areas.  We're still a long way from a balanced budget, but at least the direction is better.  This has caused the Treasury to massively cut back on new bond issuance because they didn't need to replace some bonds as they matured.  In fact, some recent government bond auctions have faced an outright shortage of bonds, prompting bid prices to spike.

     

    The incredible thing is that this has been happening in the face of the Federal Reserve's winding down of quantitative easing.  By October, it will have reduced $80 billion a month in bond buying to zero.  This is why virtually everyone in the world got the bond market wrong this year.

     

    However, I still have a chance to be right.  Eventually either the stock market or bond market is wrong.  Between now and the end of the year I'm betting it's the bond market.  I expect bonds to give up all of their gains going into year-end, ending unchanged on the year with 10 year Treasuries showing a 3.0 percent yield.  In the meantime, it looks like a "hold both stocks and bonds" scenario to me.

     

    Having started this story with an LBJ quote, we should go full circle and end with another gem from the former US president, which ties in with my idea that you have to be in the game at this point and not on the sidelines with either stocks or bonds.  As LBJ said of FBI chief J Edgar Hoover: "It's probably better to have him inside the tent pissing out, than outside the tent pissing in".  Thanks for reading.

     

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


 

  • August 2014: Youth Unemployment a Problem for the Economy

    Like many of you, I am a member of the well-known baby boom generation – the 74 million born between 1946 and 1963. Most of us recall that when we finally got out of school, whatever your schooling was, we couldn’t wait to get out of the house and on our own. Of course, the world was different then and things have become much more complicated.

    As parents, many of us looked forward to being “empty-nesters” and getting the kids out of the house. Now, in many cases, keeping them out has become a challenge as well. Some has used the term “boomerang generation” to describe those who leave but keep coming back to live at home.

    The Pew Research Center estimates that in 2012, 57 million Americans lived in multi-generational households, which is defined as two or more adult generations under the same roof. This is more than twice the number of people in such arrangements in 1980. While some of this could be aging parents of boomers moving into the family home, that is a very small percentage.

    This is all about the kids who have finished their education but have yet to move out (whether by choice or circumstance), or have moved back with their parents, new families in tow, because of unemployment or financial troubles.

    There are a million jokes and humorous stories about kids that won't leave; even a movie (Failure to Launch, 2006). But for those with kids in this situation, this is not a laughing matter, nor is it a laughing matter for the economy.

    What if they never leave? This question goes well beyond fears of seeing more cars in the driveway and dishes in the sink. It's at the heart of our nation's ability to grow. Just under 25 percent of the people 25 to 34 years old are living with their parents. That number was 18 percent in 2007 and 11 percent in 1980.

    The really interesting part is that the number of adult kids living with their parents has continued to increase in the years since the financial crisis, instead of immediately soaring in the recession and then falling back. This means that we are storing more economic horsepower in the basement or the extra bedroom. When a group this large delays doing the normal economic progression of adulthood, there is the question of when, if ever, they catch up.

    The big reasons for the change are obvious. The recession put a lot of people out of work and stopped many people from finding employment. The effect on young adults has been even worse. The lack of job opportunity alone was enough to drive many people back to their parents' doorsteps. But this was not the only force at work.

    When they couldn’t find jobs, many went back to school or stayed in school longer to increase their job prospects. But for some, the jobs didn’t materialize but the student debt did. Student loan debt was ramping up during the 2000s, so many graduates — whether employed or not — were carrying an extra burden. In the meantime, home lending requirements were severely tightened. Many young workers who might have previously bought a home were cut out of the market (for better or worse).

    It's been six years since the financial crisis, and the latest research shows that we still have exceptionally high rates of multi-generational homes. Many of the problems that existed at the start of the financial crisis are still with us today, although maybe not to the same extent. Employment is still difficult, but people are finding work. However, their level of compensation is still, on average, down by more than 7 percent from pre-crisis levels.

    Student loan debt has done nothing but increase. At the same time, lending standards remain very strict, even though there are several programs meant to encourage first-time home buyers.

    Perhaps both generations are realizing that, from an economic perspective, the arrangement can make sense as the younger group is able to save more of what they earn so that when they do strike out on their own, they do so in a stronger position. But this comes at a cost. Young people are taking longer to get on the one-way train of consumer spending that tends to start with marriage, parenthood, and that all-important first home.

    The real estate website Trulia, recently reported that millennials are indeed taking longer to get on this path, which explains the drop in home purchases by this group. If this trend continues, the economic recovery of the U.S. will take longer and be at a lower level than expected.

    It's possible that wages will pick up dramatically in the next 12 months, leading to a rush of confidence among young people and lenders. This will trigger a mass exodus from multi-generational homes and a huge bump in U.S. economic activity. It's possible, but I don't see signs of it happening yet.

    With continued slack demand, the downward pressure on wages should remain in place, keeping a record number of adult kids entrenched in their parents' homes, eating their food and blocking the driveway. This will lead to disappointment for those anticipating and investing for a strong rebound in housing and the economy in general. We need to find ways to reverse this trend. Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


Like many of you, I am a member of the well-known baby boom generation – the 74 million born between 1946 and 1963. Most of us recall that wh....

July 2014

  • July 2014: Cassandra and Me

    My beautiful and talented wife, also affectionately known as the BTW, says I’m sometimes too negative. I try not to be, but perhaps I am. And one should never argue with someone with superior knowledge. I can’t help it though because I see so many things wrong with the big picture that I feel it’s my job to at least warn people.

    If you ever read a little Greek mythology in school, you might be familiar with the story of Cassandra. In Greek mythology, Cassandra was the beautiful daughter of King Priam of Troy. A common version of her story is that Apollo granted her the power to see the future in exchange for her love. She agreed but then later backed out of the deal. Angered by the deceit, Apollo let her keep the power of prophecy but also gave her the curse of the world never believing her. She remained beautiful but was considered insane.

    Sometimes I can relate, at least with the insane part. Such is the curse that comes with making predictions. Sometimes it takes far longer than you had anticipated to be right. I have been predicting a market correction of 10 percent or more for over two years now. So far it has been the complete opposite as the market continues to defy logic and most prognosticators. At least I have a lot of company. So let’s take a closer look at this never ending bull market and put things in perspective.

    Here is what keeps me worried. There are three observations that can be made about the current resilience of the stock market. 1. The market has gone over 33 months, since 2011, without at least a 10 percent correction, and that was a 19 percent correction. 2. It has gone over 1,000 days without a 20 percent correction. That’s the longest stretch since it went 1,127 days from July, 1984 to August 1987 - 30 years ago. 3. The average bull market over the last 100 years lasted 53 months. The current bull market is now a very rare 65 months old. The last time it came close to that long was the 2003-2007 bull market, which lasted 60 months to its November 2007 top. Clearly, the current bull market is flirting with the odds in trying to last even longer.

    So what does it mean? Perhaps nothing, perhaps a lot. Three data points are not statistically meaningful.

    Much of the analysis we see and hear lately is concerned with whether the stock market is in a bubble or not. Some headlines suggest we are in a market bubble that is about to burst at any time. Others suggest we are not in a bubble and the party will run for at least another couple of years. So which is it? Beats me. But we have to consider the following.

    The reasoning seems to go that if we can determine whether the market is in a bubble, we can know when we need to get out because it’s due for a serious collapse. But if we can determine it is not in a bubble, we can be assured the bull market has several more years to go? Huh? Sounds like nonsense to me.

    There have been 25 bear markets over the last 113 years, or one on average of every 4.5 years. The average decline was 36.5 percent. The ten worst averaged a decline of 49.9 percent. How many of those serious bear markets were the result of the market being in a valuation bubble that burst? Well, there was 1929. And 70 years later there was 2000.

    Bear markets begin, as did the 2007-2009 bear, not due to a valuation bubble bursting, but in anticipation of a potential recession or financial crisis (domestic or global), rising inflation, rising interest rates, global events, or just because the bull runs out of energy.

    So all the bubble talk is probably too much. However, 15 percent corrections are quite common and bear markets take place on average every 4.5 years. We’re way overdue. Remember though, a correction is just that – a correction. It’s not a crash.

    So what would a 10 percent correction look like? Let’s put some real numbers on it. A 10 percent decline would take the Dow down to about 15,400, its level at this year’s January low, also its level in May of last year. A 20 percent decline would take it down to about 13,700 and wipe out all of this year’s gain, and almost all of last year’s. But then, no one expects those previous kinds of normal market volatility to happen anymore. So why even think about it. Right?

    People are way too complacent right now. Even Fed Chair Janet Yellen said investor complacency was one of her worries. I have no idea when the next real correction will start, but I think it’s fair to say it’s not a question of if, but when. In the meantime, your “ray of sunshine” analyst will be calling up the spirit of Cassandra for guidance. Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


My beautiful and talented wife, also affectionately known as the BTW, says I’m sometimes too negative. I try not to be, but perhaps I am. And....

  • July 2014: FATCA Won't Cause the Dollar to Collapse

    The infamous bank robber Willie Sutton was once asked why he robbed banks. His response was simple, "Because that's where the money is!" Taking a page from Willie’s play book, Senator Max Baucus, Representative Charlie Rangel, and Senator Harry Reid are about to embark on a worldwide search for money.

    In 2010, Congress passed House Resolution (H.R.) 2847, the Hiring Incentives to Restore Employment Act, or HIRE. This legislation included a number of tax breaks meant to encourage businesses to put people on the payroll. This law also called for greater scrutiny of foreign accounts that U.S. citizens hold in an effort to improve tax compliance, thereby bringing in more tax revenue and helping to offset the tax breaks of the HIRE Act. This portion of the law is called the Foreign Account Tax Compliance Act, or FATCA.

    The tax breaks went into effect quickly. Were more people hired than otherwise would have been? Who knows? The greater scrutiny of foreign accounts took more time to implement, and just recently went into effect on July 1st of 2014. The reason for the long lead time was the complexity of the process.

    The U.S. has essentially mandated that every foreign financial firm report back to the IRS on accounts that U.S. citizens hold. The scope of this can’t be overstated. The idea that a government would demand foreign companies proactively report on account holders is a huge change. Typically, governments require reporting from their citizens, not the institutions their citizens work with. That's because a government has some sway over its citizens. It can impose fines and even send them to jail. But the US Government also has some leverage over foreign financial firms that other governments don’t have.

    Since the U.S. dollar is the world’s reserve currency, acting as the basis of so much trade, our government can penalize foreign firms who don't comply with the new tax law. In essence, if the IRS determines a foreign bank hasn't complied, it can withhold a portion of any proceeds due the foreign bank if they are processed through the U.S.

    To avoid this, the foreign bank — or pension fund, or trust company, or whatever — must complete IRS documents about their accountholders, regardless of whether or not their American clients want their information released. As a result, FATCA is causing shockwaves around the world. Some of them were expected, as people holding foreign accounts and evading taxes realize they have fewer places to hide, which was the point of the law.

    Some shock waves are a surprise. Many U.S. nationals that are legally living and working abroad are being told by the banks where they live to “shove off.” It appears that many foreign financial institutions would rather close all of their U.S. national client accounts than deal with the headache of complying with the law and the possible ramifications of withholding if they accidentally run afoul of the law. This is leaving law-abiding Americans, who are simply going about their lives, in a state of chaos.

    So while FATCA is probably snaring some of the tax cheats, as it was intended to do, it is also upending the lives of many people who are simply innocent bystanders. However, what FATCA is NOT doing, and won’t do, is cause the collapse of the U.S. dollar by driving foreign financial firms completely away from their dollar dealings. We know this is true because it hasn't happened yet, and prior to July 1st we would have already seen most of the shakeout from this law.

    You may have heard reports that FATCA was going to cause the collapse of the dollar and lead to global financial chaos as the world abandoned the dollar. This is complete nonsense and usually promoted by someone trying to sell you gold or some other so-called remedy to the demise of the US. Remember that FATCA was part of HIRE, so it was passed in 2010. For the past four years, foreign financial firms have been working with the IRS to determine if they want to muddle through compliance or simply kick out all of their American accountholders.

    In other words, the fallout from the law is happening, or has happened, ahead of implementation and no foreign companies or even entire countries have turned their backs on the dollar because of FATCA. While it could cause some problems or inconvenience for US citizens abroad if their foreign bank decided they didn’t need the hassle and kicked them out, that has nothing to do with foreign commerce where the majority of international trade still takes place using the dollar. For better or worse, the dollar is still the dominant trade currency. My view remains that the dollar will not fall and, in fact, will be going up in this current environment.

    What does bother me though is this has the distinct smell of a new agency, such as the Energy Department, which will employ thousands and become mired in a governmental process for decades to come. This is a typical program governmental bureaucrats love to start.

    The revenue believed to be raised will be approximately 800 million dollars per year for the US Treasury. That sounds like a lot until you consider the cost of people, technology, travel expenses, investigative follow-up, etc. etc. etc., all government documented of course, which has been estimated to be billions of dollars. Less money coming in versus more money going out - another governmental winner right out of the chute. It’s just not worth it.

    Willie Sutton had a better way. He didn't think the money was there, he knew it was there. The common sense thing to do is not create another bureaucratic agency costing billions of dollars, accomplishing nothing and creating more international intrigue on the suspicion the money is there. Let the game of hide and seek FATCA-style begin! Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


The infamous bank robber Willie Sutton was once asked why he robbed banks. His response was simple, "Because that's where the money is!" Taking a p....

June 2014

  • June 2014: When Too Much Cash is a Bad Thing

    I’ve often said there’s no such thing as too good looking, too much horsepower or too much cash. It turns out that may not be entirely true, at least for the cash part. European countries have a problem. Their banks are busting at the seams with cash. In the aftermath of the 2008 financial crisis, there still aren’t many borrowers – at least not qualified borrowers – looking to take on more debt. This has left banks with wads of idle euros lying around, which they're putting on deposit at the European Central Bank (ECB).

    At first this suited everyone just fine. The ECB even paid the banks interest on their deposits of excess reserves, which kept the money close at hand instead of potentially fueling runaway inflation as all of those euros got lent out. But now things aren’t so rosy.

    For the last year and a half, the euro zone's inflation rate has fallen and is now approaching zero. You might call that the twilight zone for central bankers. You see, inflation doesn’t really scare central bankers. They believe they know how to fight it and a little inflation actually helps them overcome policy errors. It’s deflation that scares them to death and keeps them up at night.

    So what’s wrong with having extra cash? For one thing, banks make money by lending, not sitting on cash. What do you do when consumers and businesses refuse to spend at the rate you want them to? You can make loans cheaper through lower interest rates, but after that there aren’t many options.

    Looking at huge amounts of euros on the books, the ECB decided they needed to act. So they recently cut interest rates to negative 0.1 percent. That’s right. A negative number. Now the central bank actually charges member banks to hold their cash. The ECB did this hoping it would motivate banks to remove their excess deposits and use the funds to provide loans to businesses and consumers. The thought was that more lending would lead to more cash flowing through the economies of European countries, which would mean more euros chasing goods, and therefore rising inflation.

    There’s only one problem: Charging banks to hold their excess cash does nothing to motivate consumers and businesses to borrow more money. When it comes to credit, Europe is not facing a supply problem. There's plenty of cash and credit available for qualified borrowers. Instead, it's facing a demand problem. People and businesses aren't motivated to borrow at a higher level.

    To get borrowers to do more, the ECB would have to improve the confidence among Europeans that their businesses will receive more orders, their workers will receive higher pay, and their citizens (particularly the youth) will actually gain employment. Without these critical factors, making more funds available for lending is like putting more fuel in the tank of a car with no engine.

    So what is a bank in the euro zone to do? If making more loans is a non-starter, then European banks will have to decide what to do with their extra cash. They can keep the funds at the ECB and pay the penalty, but banks aren’t making a lot of profit these days so ponying up for a penalty seems unlikely. The most probable outcome is that banks will use the funds to buy securities, particularly bonds issued by euro zone countries. These bonds would require the smallest reserve requirement against loss so that banks could invest the most money.

    It wouldn't make sense to buy German bonds, which pay almost no interest. Instead, the banks will probably buy short maturity bonds of peripheral countries, particularly those that have struggled in recent years, because that’s where the yield is. This will likely cause the interest rate paid on Greek, Irish, Portuguese, Spanish, and Italian bonds to drop as banks pile into bonds issued by these countries. What is not likely to happen is that the euro zone countries get any respite from their steady march toward outright deflation.

    This trend is occurring because many countries are still dealing with the debt hangover from the financial crisis, their populations are aging and want to save more not spend more. In addition, large numbers of European youths have no income so they can't spend at all. At the end of the day, negative interest rates on excess reserves held at the ECB does nothing to change any of this. So I guess there can be too much cash, but I’m still pretty sure you can’t have too much horsepower. Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


I’ve often said there’s no such thing as too good looking, too much horsepower or too much cash. It turns out that may not be entirely ....

May 2014

  • May 2014: Revisionary History?

    As you may have heard, the financial world is all abuzz about former New York Fed President and Treasury Secretary Tim Geithner’s book titled “Stress Test.” To be fair, it’s actually quite a fascinating and well-written book about what went on behind the scenes during the financial crisis of late 2008.

    Poor little Timmy. To hear him tell it, we were close to blood in the streets, empty ATMs and people hiding money in mattresses. These are the dire things from which Geithner saved us, at least according to him.

    All hail hero Tim Geithner! Or not. To me this is a little like giving an arsonist a medal for putting out the fire that he started. Of course, he’s not entirely responsible and he had lots of help from people like former Fed Chairmen Alan Greenspan and Ben Bernanke, and former Treasury Secretary Hank Paulson. But, Mr. Geithner wants to rewrite history.

    You might recall that Greenspan laid the groundwork that made the subprime fiasco possible. And in 2007 Ben Bernanke assured us all the subprime crisis was contained. My favorite was in 2007 when bazooka Hank Paulson asked Congress for permission to purchase about $700 billion in “troubled assets”, but only if necessary. His reasoning, as he described it to Congress, was that if you have a bazooka in your pocket and everyone knows it, you won’t have to use it. Next thing we knew it looked like the shootout at OK Corral.

    While the bailouts and handouts Geithner pushed through the economy are now five to six years in the past, many of us still remember them, and we don’t regard them fondly. (If you’ve read any of my past columns, you know that I’m not a fan.)

    But now Geithner is on a mission to sell books and resurrect his image. I guess being thought of as one of the main guys who forked over billions of taxpayer dollars to bankers and corporate mavericks doesn’t feel so good.

    So he’s taken to the airwaves and pages to set the record straight... or should I say, adjust the record to his view. There is his view and then there is reality. In The Wall Street Journal on May 13, 2014, Geithner pointed out the possibility of utter collapse that hung over the financial system in late 2008, and how that eventuality was avoided only because of the extraordinary measures he, Paulson and Bernanke took. Without their heroic efforts, we were well on the way to repeat some of the worst parts of the Great Depression: shantytowns, soup lines, and a severe retrenchment in the banking system brought on by bank runs.

    However, this ignores just a few things. We did away with soup lines and shantytowns by instituting unemployment insurance, which put the checks in the mail. States handle this system, but it was supplemented by federal laws that extended benefits from 27 weeks up to 99 weeks in the hardest-hit areas.

    As for bank runs, that’s what deposit insurance is for, and it works. While there is a conversation to be had about the efficacy of deposit insurance and whether it motivates banks to be as risky as the laws allow, it's evident that depositors weren't running for the doors, even as banks went under. Depositors knew their money would be available at the end of the day.

    Bailing out poorly managed banks did nothing to address either of these situations, no matter what Mr. Geithner claims. His main point in the article is that, in times of crisis, regulators have to do what is wildly unpopular to save the system so the innocent victims can be rescued.

    I disagree. The reason the bailouts were so unpopular, and remain so today, is because the efforts didn’t rescue the little guy. Wiping out the stock and bondholders of Citigroup, Bank of America, and Bear Stearns would have been painful for some, but certainly not a catastrophe for all. So instead, we not only left the bad companies standing, we left the bad actors in charge and handed them billions of dollars. Now the world knows that if anything happens to shock the financial system in the future, the U.S. government will come running with a bucket of taxpayer cash to put out the fire.

    Moral hazard - where one profits when things are good but doesn't suffer when things are bad - is alive and well, witnessed by the fact that the worst offenders have some of the lowest borrowing costs when taking on new debt, and their stock prices are dramatically higher.

    It's been said that the financial crisis was a depression headed for Wall Street, not Main Street. That’s not entirely true. While Wall Street would have (and should have) suffered more if the financial institutions had been allowed to implode, there was still a deflating housing and property bubble that swept across the nation.

    What's so frustrating about the way the crisis was handled is they singled out for saving the exact people and firms that had created much of the crisis! We would be much better off today if the main thrust of the downturn had been allowed to take its course, protect depositors in banking institutions, and letting the rest of the chips fall where they may.

    The drop would have been deeper, but the rebound would have been on more solid footing, with lending institutions and investment banks clear on what the word “risk” actually means and who takes it. Let’s hope next time it will be the people taking the risk who get the rewards and the losses, not the taxpayers. Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


As you may have heard, the financial world is all abuzz about former New York Fed President and Treasury Secretary Tim Geithner’s book titled....

  • May 2014: Find Your Own Investment Benchmark

    When talking about investing, sooner or later the conversation turns to performance. Of course everyone wants to know how their investments have done. But the follow-up question should be “compared to what?” If your portfolio earned 5 percent and you’re a conservative investor taking little risk and trying to beat the risk free rate of return (basically 0.5 percent now), then you did pretty well. On the other hand, if you were investing aggressively to beat the S&P 500 that returned 30 percent and you made 5 percent, well that’s not so hot.

    When it comes to investing, much of our deeply-engrained “human nature” works against us… tripping us up when we can least afford a fall, and pitting ourselves against our own success. Benchmarking, comparing to an investment benchmark or index, is one of those natural, yet self-sabotaging, tendencies.

    We’re all inclined to do it, yet it doesn’t help us reach our most important, personal goals. There is a better way. So let’s talk about benchmarking. Even Warren Buffett isn’t immune. Although the “Oracle of Omaha” has proven himself a master investor over a multi-decade period, his Berkshire Hathaway’s relative “lackluster” performance over the past few years has prompted many to wonder if he has lost his Midas touch.

    Yet, Buffett’s returns are only lackluster if you compare them to stock market indices, like the S&P 500 or the Dow Jones, today. Shares of Berkshire Hathaway have returned an average of more than 14 percent annually over the past four years. Those are returns that any reasonable investor should gladly accept. (Of course this is just for illustration and to make a point. I am not suggesting you should or should not invest in Berkshire Hathaway.)

    Still, critics of Buffett’s long-term, value-investing approach will show you a chart plotting Berkshire’s returns relative to the Nasdaq 100 Index since March 2009. Based on the comparison to the Nasdaq 100, they’ll conclude that Buffett is falling behind and not deserving of your hard-earned investment dollars. I think that’s a false conclusion and an example of how benchmarking can lead investors to poor, money-losing decisions. The pitfalls of benchmarking are many, but the two most important to know are these.

    First is the apples to oranges comparison. Many times, the comparison of two stocks — or a stock to a market index — doesn’t make sense. Warren Buffett doesn’t invest much in growth-style technology stocks, so why would a comparison to the Nasdaq 100 Index make sense? It doesn’t. Yet the comparison is still made.

    But there’s a bigger problem with benchmarking. It has no relation to your personal financial goals. Here’s a question for you. If “Stock A” averages 12 percent annual gains, but can drop 40 percent in bear markets; and if the Dow averages 8 percent annual gains, but only drops 25 percent in bear markets; which investment will allow you to retire comfortably?

    Obviously, that’s a trick question that can only provide nonsense answers. And that is the trouble with benchmarking. Although it is human nature to compare things — to compare ourselves to our peers and our investments to market averages — the process doesn’t help us reach our own, personal financial goals.

    Don’t just take my word alone for it. Consider a key conclusion reached by Dalbar’s 20th Annual Quantitative Analysis of Investor Behavior report. In their own words:

    “Investors should not judge their investment success by market index comparisons but instead, they should evaluate their progress towards achieving personal financial goals.”

    Dalbar’s study goes on to delve deeply into statistical proof that shows investors have historically underperformed the stock market. It reminds us of the humbling fact that “the average investor cannot be above average.” And it shows how the long-term return of the Dow is nearly double the return achieved by the average investor.

    For many investors, the process of benchmarking inevitably leads to performance chasing, whereby they invest in stocks, or funds, that have outperformed the market in recent history, while ignoring stocks and funds that have underperformed. And then, thanks to Murphy’s Law, those historical trends reverse, leaving investors with losses on the new underperformers, and missed opportunities on the new out performers. Don’t fall victim to this temptation! Instead, judge your investment portfolio’s performance relative to your own personal financial goals and risk tolerance. In the end, that’s what really matters.

    Of course, simply ignoring the natural urge to benchmark your performance will only help you avoid one of the many psychological pitfalls you face as an investor. You also need a proactive, well-defined investment game plan. You need to set realistic goals, like how much money you’ll need to save and by what age, to retire comfortably. And you need an emotion-free process that’s capable of getting you from Point A to Point B. If you don’t know how to do that, I encourage you to find a financial advisor who can help you. Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


When talking about investing, sooner or later the conversation turns to performance. Of course everyone wants to know how their investments have do....

April 2014

  • April 2014: Is It Time to Sell in May?

    Well, here we go again with that time of year. Time for that old Wall Street Saying, “Sell in May and go away.” This is the seasonality theory that suggests the market makes most of its gains from November through May and the months of May through October are generally flat or down. But is it true? While certainly not a foolproof formula, research suggests there is some merit to it and it works more often than not.

    If you were to follow this theory in practice, it would mean selling all positions in late April to early May and then stay in cash until late October to early November. During that time period you wouldn’t make any money (especially with today’s near zero interest rates), but you would not lose any money if the market went down during that time period. Of course, if the market went up you would not lose money either, but you would miss out on the potential gains because you were sitting in cash. This does not take into consideration the tax consequences of selling either.

    Among many confirming studies, an academic study published in the American Economic Review in 2002 concluded that, “Surprisingly we found this inherited wisdom of Sell in May to be true in 36 of 37 developed and emerging markets. Evidence shows that in the United Kingdom the seasonal effect has been noticeable since 1694 (no misprint).”

    A study in 2011 of the S&P 500 from 1993 to 2010 by Zacks Investment Research, was based on a slight variation of the basic Sell In May strategy. It changed the entry date to the sixth trading day before the end of October rather than November 1, but retains the rule to exit on May 1. Its conclusion was that, “For the S&P 500 a buy & hold investor turns $1 on February 4, 1993, into $1.96 on December 31, 2010, whereas Sell in May and move into cash, counting interest on cash (the Fed Funds monthly rate), and dividends for the buy and hold, had a final wealth of $3.73, some 90.7 percent higher. Applied to the Russell 2000 Index, the final wealth was $2.04 for buy and hold, and $4.94 for Sell in May, 141.7 percent higher.”

    Of course the market does not begin a rally each year exactly on Nov. 1, or roll over into a correction exactly on May 1 each year. So what has happened to the theory lately? Many like to point out that it didn’t work for the last two years. That is true, at least to the extent that there was not a significant correction in the summer months in either year, as the Fed pumped in additional stimulus to prevent a correction from taking place. The so-called ‘Bernanke Put’ had a positive effect.

    But even against that massive Fed influence, in those years the effect of seasonality could be seen. Though there was no correction in 2013, the market made most of its impressive gain for the year in the favorable seasons, and was basically sideways in the unfavorable season. That was also true in 2012. The big question for 2014 regarding seasonality is whether it will be three straight years that it does not outperform the market?

    Or will it resemble 2011, when massive QE stimulus did not succeed in preventing a 19 percent market decline in the unfavorable season, and the only thing that prevented it from becoming even worse was the Bernanke Fed rushing in to more than double the QE from $40 billion a month to $85 billion? It seems like a fair question, since the Fed is now tapering back stimulus, and this month will have it back down to $45 billion, its level of 2011 before it was doubled, and will have it down to $35 billion in May, $25 billion in June.

    So what will it be this year? Should you sell in May? Beats me. You’ll have to decide that for yourself. But there are enough red flags in addition to the seasonality issue that a certain degree of caution is warranted. So far, after a lot of volatility, the market is basically flat for 2014 and has continued to avoid the 10 percent correction that history says is overdue. Over the last 60 years, there has been a correction of 10 percent or more on average of every 18 months. It has now been 30 months since the last one (the S&P 500’s 19 percent decline in the summer of 2011). In addition, the second year of the 4 year Presidential cycle is often negative and the average decline has been 21 percent.

    I’m not suggesting that you should sell, and I still think by the time all is said and done, 2014 will see the market up 8 to 10 percent sometime during the year. If you are an active trader, this is a dream market if you’re good at it. If you’re not a trader, then it’s probably best to just stay put. However, perhaps now is not the best time to be adding significant market exposure; or maybe you should even reduce exposure a little or hedge some of your positions. Just saying. Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


Well, here we go again with that time of year. Time for that old Wall Street Saying, “Sell in May and go away.” This is the seasonality....

February 2014

  • February 2014: All Dressed Up

    Protruding from the sand along England's northeast shore near Hartlepool is a vertical wooden mast. The mast dates back to the Napoleonic Wars, when Napoleon’s armies were marching through Europe, sweeping all before them in the aftermath of the French Revolution. It was all part of France's aggressive attempt to take what it deemed as its rightful place at the head of the European table.

    Of course, with Napoleon's disastrous invasion of Russia in 1812, the French Army suffered one of the worst military defeats in history. At the time of our Hartlepool story, Britain, the mightiest naval power the world had ever seen, was locked in combat with France.

    Hartlepool, a small port community, was founded in the 7th century. Around the time of the Napoleonic Wars, Hartlepool had a population of about 900 people — all of whom seemed to be obsessed with the possibility of being attacked by France. Gun emplacements were established and defenses constructed in order to repel any French aggression. The Hartlepudlians stood ready to fight the first Frenchman who dared set foot upon their beloved sand.

    One night during a terrible storm, a French fishing boat that had been pressed into the service of the Emperor, capsized and sank off the coast near Hartlepool. There was only one survivor — a monkey who found himself washed ashore, exhausted, battered and bruised from his ordeal. He was still clinging to the mast, now buried in the sand, which remains there to this day.

    One can only imagine how glad he must have been to end up on Hartlepool's beach. Unfortunately for him, he happened to be wearing a French naval uniform, which would, sadly, be the direct cause of his tragic demise a few hours after his miraculous escape from a watery grave.

    Historians guess that the monkey was dressed in a sailor's uniform for the amusement of the ship's crew, but the Hartlepudlians were most definitely not amused. Keep in mind; these were not exactly worldly people, even by early 19th century standards. Upon finding him in a uniform with which they were unfamiliar, they immediately arrested him as a French spy and proceeded to force the confused monkey to stand trial right there on the beach. You can’t make this stuff up folks.

    The monkey was questioned to discover why he had come to Hartlepool; but with the monkey unable (or perhaps unwilling) to answer their questions, and with the locals uncertain as to what a Frenchman looked like, they reached the inevitable conclusion that the monkey was a French sailor and therefore a spy. The monkey was sentenced to death and hanged from the mast on the beach.

    Minstrels later immortalized the tale in "The Monkey Song," a popular ditty of the time. I’ll spare you the words, but it makes a great drinking song in your favorite pub. Needless to say, it made a laughing stock of the good folks of Hartlepool. To this day, the citizens of Hartlepool are known, much to their chagrin, in England (and around the world) as "monkey hangers."

    Now at this point you are no doubt thinking to yourself, "Massey has finally lost it. Where is he going this time and what does this have to do with the economy and stock market?" Not much actually, but it’s a great story and I couldn’t resist using it to entice you in. Okay, since you have indulged me and my tales of monkeys swinging from yardarms, I'll tell you.

    The people on that storm-tossed beach were confronted with something they didn't recognize, and though logic suggested they ought to investigate further before they took any action, the animal spirits of a group of excitable people ensured that they forgot about clear-headed analysis and did something that their descendants still regret over two centuries later.

    Today, investors all over the world are confronted by markets that have been dressed up for the amusement of the crew in charge of the ship (think central bankers), and nobody seems to recognize what they are looking at. Sure, they look like markets, but at the same time there is an unfamiliarity that is extremely unnerving to at least a few in the gathering crowd.

    The majority of the mob, however, has decided that they look enough like markets to charge in blindly in the expectation that all will be as it should. Things are not as they should be. Far from it. Everywhere one looks are signs that the markets are just monkeys dressed up in fancy costumes. There, how about that for a metaphor you’ve never heard before? As we proceed through the rest of this year, I’ll work hard to help you identify who is real and who is in costume. Stay tuned.

    It has been said that, “We learn from failure, not from success.” It has also been said that, “Smart people learn from their mistakes. But the real sharp ones learn from the mistakes of others.” Which one will you be? Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


Protruding from the sand along England's northeast shore near Hartlepool is a vertical wooden mast. The mast dates back to the Napoleonic Wars, whe....

  • February 2014: Emerging Market Turmoil and Taper Tantrums

    I hate to say “I told you so” – but I told you so. Actually I don’t hate it because I was right. The title of my September 21, 2013 Edmond Sun column was “Beware of Emerging Market Currencies.” And here we are in 2014 with emerging market currencies and stocks going in the tank.

    In that column I wrote, “As we move into the fall of 2013 and turn the calendar to 2014, I expect this trend to continue. Economic activity in the U.S. is steady, although at a very low level. There are no signs of a robust explosion to the upside. Likewise, Europe is not spiraling down, but it’s not on a soaring trajectory either. This leaves the BRIC (Brazil, Russia, India, and China) economies and their compatriots to deal with growth internally, and now to deal with their own mini-credit bubbles and locally inflated asset prices.”

    There is some consensus opinion lately that the cause of the U.S. stock market decline so far this year has been the problem the Fed’s tapering is creating in emerging markets. But emerging markets have been struggling for three years and they certainly had no effect on the bull market in the U.S.

    As the Fed lowered interest rates to basically zero over the last several years, the hot money went looking around the world for better returns. Money poured into emerging market countries looking for higher rates. This also drove their currencies higher and created challenges as to what to do with all the money. As is often the case, not all of it was deployed wisely.

    We are now seeing what happens when it goes the other way. In the last few months, with the decision that the Fed would begin tapering the amount of QE (bond buying), the hot money has been leaving emerging countries like rats leaving a sinking ship. Currencies and stocks in India, Brazil, Indonesia and many others fell like a rock. Of course, the Fed says that is not their problem, but if it spirals out of control it will become our problem.

    The U.S. Federal Reserve's decision to taper monetary expansion by another $10 billion recently has major ramifications for world markets. In comparison to the total amount being spent on a monthly basis, the taper may seem gradual, but it has created an enormous hole in market demand. To put it in context, $10 billion of debt purchases is more than the average monthly portfolio investments into Turkey, India, Brazil, Indonesia, Thailand, Chile and Ukraine combined. The $20 billion that has already been removed from the market is roughly equivalent to the monthly flows of all those countries plus Mexico and Canada.

    The same buyers who poured into these emerging market currencies are now quickly rushing OUT. This leaves developing countries with few options and all of them are bad. They could raise interest rates (attracting more carry trade buyers), but that would slow or choke their economic growth. They could buy their own currencies in bulk to prop up prices, but they’d deplete their currency reserves. Or they could do nothing (allowing the free market to figure it out), which would likely put emerging market currencies into a free fall and create very high inflation. This is truly one of those “between a rock-and-a-hard-place” scenarios.

    On January 28th, Turkey raised its overnight lending rate from 7.75 to 12.5 percent. Yes, that is in just one day! Will it work? We’ll see. While the hike is a bolder-than-expected move designed to jolt investor interest, they are basically using a sword to fight off a barrage of artillery as a wrenching political crisis continues to erode investor confidence.

    Many emerging country economies are very export dependent, particularly commodities. With commodities in the early stages of a multi-year decline, and capital searching for more attractive or safer opportunities in the US and other developed countries, emerging markets face a daunting challenge. Yes, they certainly will be the places where long term growth opportunities abound, but in the near to intermediate term, they’re in a bind.

    After the sharp decline, especially in the first month of 2014, emerging market stocks may well be due for a short term bounce. In my opinion, that could be short lived and there is still plenty of downside left. Some analysts are talking about what a bargain they are now. I think it’s best to stand aside for now.

    You could call this being hit by a BRIC. Beware. The one positive consequence for us, as I’ve been saying for a while now, is a very bullish outlook for the dollar. Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


I hate to say “I told you so” – but I told you so. Actually I don’t hate it because I was right. The title of my September ....

January 2014

  • January 2014: 2014 – Play It Again Sam

    "Crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought." Economist Rudi Dornbusch.

    Call me old-fashioned but I’m just not buying the “everything is better” story. 2014 will be full of surprises and even more challenging than 2013. This bull market is getting pretty old and nothing goes straight up forever. Over the last 110 years, except for the unusual decades of the 1920’s and 1990’s, a bear market has come along an average of every 4.4 years. The last one began December 2007 - six years ago. You know this thing is headed south at some point. You just don’t know when.

    Having said that, it now looks like the next slowdown for the economy and markets will likely take place in late 2014 or 2015. As much as I hate the Fed’s quantitative easing, it has probably bought another positive year for the stock market and risk assets, but at a terrible cost in the future. In many ways, faith in the Federal Reserve today is roughly equivalent to faith in the words “dot com” in 1999. Be careful.

    For now, it's all about earnings. S&P recently posted an update to their 2014 EPS (earnings per share) forecast. The forecast for 2014 as-reported earnings was $106 in late December. Now it's about $120 – up 13 percent from the previous forecast just a few weeks ago and up 20 percent versus the 2013 estimate of $99.42.

    If the forecasters are right, then the P/E (price/earnings) ratio at the end of 2014 will be in the neighborhood of 15, less than the long-term average and down considerably from today. This can only be described as a bullish number.

    This kind of news would normally point to prosperity across the real economy and call for a celebration – but take heed: prices do not always reflect reality, and analysts' expectations consistently tend to overstate actual earnings at tops. They also tend to be too bearish at market bottoms. Basically, analysts tend to forecast for the near future more of what has happened in the recent past. At turning points they really miss the boat.

    So what’s in store for the markets and the economy in 2014? Nobody knows for sure, but this is my annual stab at it. While I am quite concerned about the next major market downturn, I don’t think 2014 is it. But if the volatility and uncertainly of 2013 bothered you, 2014 will drive you crazy. Here are my predictions:

    #1: I think the market will see a 10 percent correction sometime this year, probably before summer, but recover to finish the year up 8 percent. That would put the Dow around 18,000 and the S&P 500 around 2,000 sometime during the year. Even a correction to 1,700 on the S&P, the current 200-day moving average, would only be an 8 percent correction.

    #2: Interest rates on bonds will rise, but not substantially. That means no bond market crash – yet. Rates on the 10-year Treasury bond will range between 2.8 and 3.8 percent.

    #3: Gold is not dead, but certainly on life support. Gold will likely have a short term rebound to $1,400 before falling to $1,000. Sorry gold bugs.

    #4: Barring a big blow-up in the Middle East, oil will trade between $80 and $100 a barrel but will trade more toward $80 for much of the year on slowing global demand, increased supply, and easing tensions with Iran. When, not if, the real estate bubble in China bursts, oil could fall even further.

    #5: Despite fear of a collapsing US dollar, the dollar will actually rise in value against most other currencies as other countries try to devalue their currencies to make their exports cheaper. This is the 21st century version of trade wars.

    #6: US GDP growth is likely to slow in the first quarter as consumer spending slows and the reality of disappointing retails sales hits home. The Federal Reserve and new Fed Chairman Janet Yellen will panic and crank up the printing presses again to slow the current tapering process of reducing bond purchases.

    #7: US demographics will continue to be a drag on economic growth and consumer spending as the baby-boomers on average are now past peak spending years and are beginning to spend less, save more and reduce debt. This trend will be in place for at least the next decade.

    #8: Forget about employment. The news will always be bad. At this stage of the economic cycle, we should be generating a robust 400,000 jobs a month, not a paltry 200,000. Still, that's better than 100,000 a month, or none. Yes, we may grind down to 6 percent unemployment, but that will be just because more people gave up looking, not because they got a job. The employment participation rate, the lowest since the 70’s at 62.5 percent, will not change in any significant amount in 2014.

    I still think there is a major crash coming, but it is not likely this year. The most likely catalyst for the next crash will be global triggers in major fault-lines like southern Europe and China. China is the next major domino to fall, but trouble in southern Europe and a fall-off in U.S. real estate could add to the problems.

    So what should you do with your investments this year? My advice is to tread very carefully and get defensive later in the year if the Dow gets near 18,000. Take advantage of the move up this year and be prepared to protect yourself when the time comes… and I think that is coming sooner rather than later. Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


"Crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought." Economist Rudi Dornbusch.

....
  • January 2014: 2013 – The Year that Quantitative Easing Bought

    In “The General Theory of Employment, Interest and Money” John Maynard Keynes referred to what he called the “euthanasia of the rentier." (A rentier is a person or entity that receives income derived from economic rents, i.e. income from patents, copyrights, real estate, interest or profits.) Keynes argued that interest rates should be lowered to the point where it secures full employment (through an increase in investments). At the same time he recognized that such a policy would probably destroy the livelihoods of those who lived off their investment income, hence the expression. Published in 1936, little did he know that his book referred to the implications of a policy which, three quarters of a century later, would be on everybody's lips. Welcome to QE, Quantitative Easing, the Frankenstein monster created by our Federal Reserve and many central banks around the world.

    It’s that time of year again when I review my predictions for last year and stick my neck out again for 2014. Napoleon Bonaparte once said, “Never interrupt your enemy when he is making a mistake.” In looking at my result for 2013, someone should have interrupted me. It was a tough year, at least for my predictions.

    The problem – the thing I have despised so much – was QE. I have written several times over the last couple of years why I thought the Federal Reserves’ QE program was a mistake. It’s not that it doesn’t work, the Fed’s ongoing money printing and purchase of up to $85 billion a month worth of Treasury bonds and mortgage backed securities. Oh it works alright. For now. The problem, in my opinion, is that it didn’t solve anything, created other problems, and only postponed dealing with many others.

    I never believed that the Fed and every major central bank in the world would take QE this far and this long. So much for that thought.

    In the meantime, all that money had to go somewhere and it was quite clear that the stock market was a primary destination. With interest rates near zero, investors had no choice but to accept safety and no return on investments, or step out of their comfort zone into riskier assets. As it turned out, the stock market was a nice place to be. All major indices hit record highs by the end of the year. The Dow closed at 16,576 – up 26.5 percent. The S&P 500 hit 1,848 – up 29 percent. If you were heavily invested in equities, you were probably quite happy. If you invested in money market, CD’s or bonds, probably not so much.

    So with that as background, how did I do last year? In a word – lousy. The danger in making public forecasts is you occasionally get a little egg on your face. Last year I got the whole omelet. Here’s what I said and what happened:

    1. Stocks will finish higher in 2013, but there will be hard work along the way as a classic “sell in May and go away” pattern happens for the 5th year in a row….. up 10 percent for the year. Result: At least I was right on the direction, but we never got the correction and finished up 29 percent.

    2. The next leg of the European sovereign debt crisis comes back in the summer triggering the summer downturn. A nasty, public slugfest in congress over the debt ceiling will further give stock owners ulcers. Result: While the problems in Europe are still brewing, nothing much has happened for now and Europe pretty much stayed out of the headlines. The stock market mostly ignored the debacle in Congress and didn’t seem to care.

    3. The Fed will use any substantial weakness in the market to launch another quantitative easing program. Result: We didn’t get the market drop but the Fed continued QE anyway.

    4. The Treasury bond market has finally peaked but is not ready to pop the bubble yet. Yields will just move to a higher trading range. The range for the ten year Treasury bond yield was 1.40 percent - 1.90 percent in 2012. We probably move in a new range of 1.90 percent to 2.50 percent. Result: Partially correct. The 10 year moved up to a 2.40 to 2.95 range.

    5. The U.S. government runs another $1 trillion deficit for the 6th year in a row. Result: A $680 billion deficit, the lowest since 2008, mostly due to higher tax receipts and lower government spending – the one positive effect of sequestration.

    6. Gold is not dead; it is just resting. Result: Gold is not dead but appears to be in a coma, closing the year at $1,204 – down 28 percent for the year.

    7. For the economy, the second lost decade continues. I am sticking with a 2 percent GDP growth forecast for 2013. Result: GDP figures picked up in the 2nd and 3rd quarters to 3.6 percent, but it still looks like less than 3 percent when the fourth quarter figures come in.

    8. Forget about employment. I believe that the US has entered a period of long-term structural unemployment. Yes, we may grind down to 7 percent, but no lower than that. Result: Latest unemployment figure was 7.0 percent.

    So there you have it. It was a tough year for forecasting and the only negative year I’ve had since starting the annual predictions six years ago. I’ll try to do better this year. This is one more reason why, no matter what we think will or will not happen, we stick with our investment discipline and don’t try to make market bets. You shouldn’t either.

    In two weeks I’ll stick my neck out once again with my predictions for 2014. Maybe I should just heed the words of Mark Twain when he said, “It ain't what you don't know that gets you into trouble. It's what you know for certain that just ain't true." Maybe I should, but I just can’t help myself. Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President, Chief Investment Officer


In “The General Theory of Employment, Interest and Money” John Maynard Keynes referred to what he called the “euthanasia of the r....

December 2013

  • December 2013: Should Have Seen It Coming

    In looking at economic history, it's always fun to look back and play “Monday-morning quarterback.” Even more so if you weren’t involved.

    In 1929, credit and trading on margin (borrowed money to buy stocks) were truly a way of life. U.S. businesses were manufacturing for the entire world, the Roaring Twenties were decidedly roaring, and shoeshine boys were handing out stock tips just like a modern-day Jim Cramer. Banks played fast and loose with depositors' money, and it seemed there was no way the good times would ever come to an end. Ah, but they did. What happened next? Crash-Depression-War.

    "Should have seen it coming," the pundits said. "It was obvious to all who were really paying attention," historians chimed in. "Only the fools stayed in the game," others added.

    When Barron's printed their "rate of cash burn" issue in the late 1990s, dot-com stockholders simply shrugged and said, "They'll just float a new stock issue." 20-year-old "techies" would stand on a street corner, preach about a so-called educated business plan, and become instant millionaires as Wall Street welcomed them with open arms. Every company that had the term "dot-com" attached to it was assured of making their stockholders much wealthier than ever imagined. In fact, it wasn't unusual for people to quit their jobs and simply trade stocks on the beach. What happened next? Crash-Recession-War.

    "Should have seen it coming," the pundits said. "It was obvious to all who were really paying attention," historians chimed in. "Only the fools stayed in the game," others added.

    Essentially starting in 2002, Alan Greenspan's artificially low interest rates eventually turned home ownership into a game of "flip and pretend." Banks sliced and diced mortgages and utilized leverage to never-before-seen heights. The world embraced Keynesianism, and saw wealth expand with every uptick of the market coupled with every devalued currency. The ultimate collapse of Lehman Brothers and Bear Stearns was completely unimaginable – until it did. What happened next? Crash-Depression-War.

    "Should have seen it coming," the pundits said. "It was obvious to all who were really paying attention," historians chimed in. "Only the fools stayed in the game," others added.

    Today, Investors Intelligence reports that the category of "committed bulls" is at its highest point in 26 years, matching the extremes of 1987. Such extremes were also seen in 1929, 1999, and 2008. Indeed, these days we're experiencing smokescreen earnings reports, significant wealth disparity, and widespread corporate and governmental corruption, all matching levels not witnessed in almost a century. Yet, much like gawkers at an accident site, Wall Street instructs everyone to, "Keep on moving folks, there's nothing to see here."

    Oh, but it’s different this time. "Should have seen...obvious to all...only the fools." What will happen next? Crash? Depression? War? New highs? Beats me. I guess we’ll find out soon. Thanks for reading.

    S. Nick Massey, CFP®, AIG®

    President

    Chief Investment Officer


In looking at economic history, it's always fun to look back and play “Monday-morning quarterback.” Even more so if you weren’t i....

  • December 2013: Looking for the Minsky Moment

    As we approach the end of the year, I want to step back and look at the big picture. By that I mean the economy and the markets. The stock market has been hitting new all-time highs and it’s certainly a fair question to ask how far it can go.

    Great News! New Federal Reserve chair designate Janet Yellen says there are no bubbles forming anywhere. Not in real estate, not in the stock market, not anywhere. Well that’s a relief. The markets took it that way, despite the opinions of some, including David Stockman, former budget director under Ronald Reagan, who argues that “we have bubbles everywhere”, in stocks, junk bonds, and a housing market “riddled with a new wave of speculators.”

    But the relief is understandable because Fed Chairmen know what they’re talking about when it comes to bubbles, recessions, and bear markets. Well, there was this little hiccup in 1999 when then Fed Chairman Alan Greenspan said, “Nah” to the question of whether we were in a stock market bubble. And a housing bubble in 2004? Nah. And then there was that little matter with Ben Bernanke about a Sub-prime mortgage bubble? Nope. “It’s contained.” Oh well. Maybe this time is different.

    I have always been a student of economic history. Most people who have known me for a while know I consider myself more of a macro economist and one who uses demographics to understand the big picture and long term trends. In doing so, I have generally been right about those trends. While demographics and macro trends are valuable, they don’t tell us much about the short term. That is a completely different challenge.

    One of my favorite economists is a guy named Hyman Minsky, an American economist who died in 1996. His research attempted to provide an understanding and explanation of the characteristics of financial crises. Isn’t that a great name for an economist? It just sounds like one. Okay, I know it’s kind of weird to have a favorite economist. I was telling Jennifer Cook (who always knows how to bring me back to reality) about this recently and she said, “You know; only a total geek would have a favorite economist.” Okay, guilty as charged. I can’t help it.

    By the way, if you want to have a little fun - next time you’re at a party or social event, standing around talking about football or basketball, try saying with a straight face, “So, who’s your favorite economist?” Then watch them all move away. Of course, if someone answers “Hyman Minsky” you should turn around and run.

    One of the things Minsky was known for was his studies on debt. Not all debt is bad. There is productive debt, such as debt that produces something or creates something of value. Infrastructure improvement, public works, roads, bridges, etc. come to mind. In the private sector it might be plant and equipment and things that help produce something. Then there is unproductive debt, such as debt to generate consumer spending or temporary demand. In the end, the money is spent and there is not much to show for it. Finally, there is counterproductive debt, such as debt to pay other debt. The problem we have today, both in the public and private sector, is we have too much unproductive and counterproductive debt instead of the productive kind.

    Anyway, Minsky was also known for his theory that stability breeds instability. In other words, the longer things are good and going well, the more comfortable and complacent people become. The more comfortable and the more they believe things are good, the more they are likely to spend and invest and eventually even take risk. Things get better and better and the risks get higher until eventually it is no longer sustainable. 2007 was a good example. The collapse of housing in just 4 states was the trigger that led to a global financial crisis.

    This is the classic definition of the business cycle and why things go from highs to lows and back over a period of time. Think of it like slowly pouring sand onto a pile. It gets higher and higher until finally one grain of sand triggers instability and the pile collapses. In economic terms, that has become known as the Minsky moment.

    I tell you all this because I think we are building a number of potential Minsky moments and risks. If you read my recent newsletter I talked about risk and market tops. I don’t know when the market will top. No one knows that. However, I do know that no market goes up forever. You can’t make decisions based upon the news, because the news is always good at the top, just as the news is always terrible at the bottom. They don’t ring a bell when the market tops.

    While the economy seems to be improving and the market is hitting new highs, there are a number of underlying issues deteriorating. Many are minor, but collectively they have the potential for damage. At some point, probably sometime in 2014, we are going to find that Minsky moment. Which one will it be? Something to think about. Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


As we approach the end of the year, I want to step back and look at the big picture. By that I mean the economy and the markets. The stock market h....

November 2013

  • November 2013: Risk and Reward in Uncertain Times

    He was dealt four great cards. The jackpot depended on the next card. But before it was dealt, a shot rang out in Nuttal & Mann's Saloon in 1876, and Wild Bill Hickok hit the floor… dead from a gunshot to the back of the head. His four cards – aces and eights – were forever immortalized as the Dead Man’s Hand. It became the symbol of gambles gone wrong, where hidden risks outweigh the rewards.

    Risk is a funny thing. Everybody loves it when it works out, but it can be quite painful when it doesn’t. I learned a lot about risk from a cat named Vern. Vern was a cat I had years ago; or I should say that Vern had me. He wasn’t anything special; just an ordinary gray barn cat. But he was special to me and made me smile and laugh a lot.

    Vern was a house cat meant to live his life protected indoors. The problem was Vern didn’t seem to know that and never missed an opportunity to be out hunting for whatever it was that he liked to hunt. Unfortunately, in the real world the hunter can sometimes become the hunted.

    As long as Vern hunted during the day, the risks were fairly small. He almost always managed to come home about dinner time carrying his trophy from the hunt, much to the dismay of my horrified daughters. But night time was a different matter. The big hunters came out at night and the risks got a lot higher and the odds changed against him. As hard as I tried to prevent it, Vern often managed to find the right moment to bolt out the door and he was off for the night. He always came home; although more than a few times he looked like he got the worst end of a fight.

    I never understood why he would never abandon the thrill of the hunt in exchange for the comfort of watching TV and eating snacks with me in the easy chair, but that’s just the way he was. The good news is that Vern was lucky and lived a long and happy life.

    This is not a story about Vern. This is a story about risk. More specifically, it’s about asymmetrical risk; when the risk in one direction is far greater than the other. This is the risk/reward equation people talk about but rarely consider.

    Asymmetrical risk has nothing to do with the odds of a given risk, but everything to do with the consequences of a given risk. In Vern’s case, the odds that a coyote would kill him were relatively low and the odds were hugely in his favor. For example, let’s say the odds were 50-to-1 in his favor. But the consequences of that risk were incredibly asymmetrical. In our hypothetical 50-to-1 risk, Vern returns home alive 50 times out of 51. But one time in 50, the coyotes kill him. By the numbers, that's a good risk. In reality, that's a horrible risk. No investor would take a bet like that...at least not knowingly.

    As investors, we can’t afford to turn a blind eye to risks, especially not to asymmetrical risks. We can’t afford to take risks which are likely to work, but are likely to wipe us out if they don't work. Understanding your potential reward is worthwhile. Understanding your potential risk is everything.

    So here we are with markets at all-time highs. What’s not to love? What could possibly go wrong? Well, the bears say plenty. Are we on the verge of a melt up (new highs) or a melt down? The bulls say stocks are reasonably valued right now so there’s little chance of a crash in 2014 to 2015. Really?!

    First, even on normal valuations measured by price-to-earnings (P/E) ratios, stocks are as highly valued as they were before the last crash in late 2007. In fact, 2013 looks almost exactly like 2007 did. Back then, GDP and job growth were good, but not great. Stocks had seen a bull market for about five years, and nine out of ten such markets don’t last longer than that.

    The so-called experts say there were no real negative signs in the economy. But think about that for a moment. There are never bad signs in the economy near a top. How could there be? That’s when the economy looks its best.

    How did Japan look in late 1989 before a two-decade downturn into early 2009? How did the U.S. economy look in late 1929 just before the greatest stock market crash in its history? How did the U.S. economy look in early 2000 before the tech wreck? And how did the economy look in late 2007 before the last great recession?

    You can’t look at the economy for meaningful signs of an economic slowdown or a stock market crash. You have to look at demographics that foreshadow major changes years and decades in advance. You have to look at the smart money, the insiders who see changes before the public and the media do. And you have to look at valuations on stocks and real estate that suggest a bubble or long-term peak is about to burst. As the old stock exchange saying goes, “They don’t ring a bell at the top.”

    I’m not suggesting the market is about to crash. I have no idea when that is coming. In fact, I think the market likely trends up well into spring of 2014. However, I do know that no market goes up forever and this bull market is getting long in the tooth. Risks are building. Be careful. My pal Vern beat the odds. You may not be so lucky. Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


He was dealt four great cards. The jackpot depended on the next card. But before it was dealt, a shot rang out in Nuttal & Mann's Saloon in 187....

October 2013

  • October 2013: What Numbers Do You Really Need?

    As I write many of my columns, I usually try to include a little humor or a catchy story to start out. But there’s none of that in this one. Just cold, hard reality. If you are one of the 78 million Baby Boomers rolling into retirement over the next 20 years, you might want to sit down and do a little math. Retirement is a lot more complicated than it used to be. Bonds have reached the end of a 30-year bull market. Globalization means that events in faraway places have a direct impact on the stock and bond markets here. In addition, Social Security, the single most important source of income for a majority of Americans, may be facing changes in the years ahead.

    So, before you quit your job and venture into the next stage of your life, stop for a minute to consider a set of numbers that could make the difference between retiring comfortably and well, not so much.

    1. What is a reasonable estimate of your cost of living? This should be obvious, but most Americans dramatically underestimate their living expenses. Be honest and thorough. What do you pay for housing, including property taxes and insurance? What about utilities? And what about medical expenses or insurance premiums not covered by Medicare? What do you spend in a given month on restaurant dining and entertainment, or on the grandkids?

    Whatever total figure you come up with, tack on an additional 25 percent. No matter how thorough you are, I promise you will forget something. The total you come up with here is the single most important figure. It’s the dollar amount you’ll need to generate from your portfolio investments and/or pension and from Social Security.

    2. How much can you expect to receive from Social Security? According to the Social Security Administration, 53 percent of married couples and 74 percent of unmarried beneficiaries depend on Social Security for at least half of their income. A shocking 46 percent of unmarried beneficiaries rely on Social Security for 90 percent or more of their income. Social Security matters.

    3. How much do your other investments need to earn to meet your retirement expenses?

    Take your expense estimates from above and subtract the after-tax Social Security payout from question two. Also subtract any other fixed income streams you expect, such as from a traditional pension or a trust. The amount left over is what you’ll need to generate from your investment portfolio. This number is critical because it will determine what kind of returns you need to generate and what kind of risk you can take.

    Let’s look at an example. Let’s say you need $100,000 per year to maintain your lifestyle in retirement and that Social Security will pay both of you a total of $50,000. After taxes, that $50,000 becomes around $36,000, meaning you’ll need your portfolio to throw off $64,000 in after-tax income. On a $1.5 million portfolio, that amounts to a return of 4.3 percent after tax, or a little less than 6 percent before tax, assuming a 28 percent tax rate.

    Oh, you don’t have a $1.5 million portfolio? Hmmm, that could be a problem if these are your numbers. You may need to downsize your retirement goals or postpone retirement for a few more years to build a bigger nest egg. Personally, I wouldn’t want to bank on generating a 6 percent return given that the 10-year Treasury yields less than half that now. I wouldn’t be comfortable assuming much more than about 4 percent, which in our example here means that we need a larger portfolio or a smaller retirement.

    4. What do you expect the inflation rate to be? Inflation is the single most dangerous figure for would-be retirees because it is the one they never see coming. Inflation creates a nightmare scenario where your expenses rise while your income remains fixed.

    This means that your investment portfolio will need to generate enough to make up the difference. If you assume an inflation rate of 3 percent, your $100,000 per year in living expenses will be $103,000 after the first year. This means that your portfolio will need to generate $67,000 instead of $64,000, not counting how much your social security may (or may not) go up. On the same $1.5 million portfolio, this means a required after-tax return of 4.5 percent rather than 4.3 percent and a pre-tax return of 6.25 percent.

    That may not sound like much, but remember that inflation is like interest. It compounds over time. By year two, you’re looking at expenses of $106,000 and a required pre-tax return of 6.5 percent on that same $1.5 million portfolio. To compensate for this, you need portfolio growth and, more importantly, adequate exposure to income-producing asset classes that have built-in inflation protection.

    I used very conservative numbers in this article and I encourage you to do the same. It’s better to be too conservative and end up with a bigger cushion than expected in retirement than to find yourself strapped for cash.

    If this all sounds ominous and serious, it is. Retirement is far too important to leave to chance. If you haven’t done what you need to do, it’s never too late. Start now. If you don’t know what to do, get with a good financial advisor to help you. Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


As I write many of my columns, I usually try to include a little humor or a catchy story to start out. But there’s none of that in this one. ....

  • October 2013: Monkeying Around with the Debt Ceiling

    As we watch the political circus going on in Congress, perhaps Mark Twain was right when he said that “politicians and diapers must be changed often, and for the same reason.” This would all be quite humorous if it were not so serious.

    Speaking of monkeys, what’s more fun than a barrel of monkeys? Nothing. At least those were the words of the Milton Bradley Company and their game called “Barrel of Monkeys.” Perhaps you played it when you were a kid. The rules were pretty simple, written on the bottom of a plastic barrel. “Dump monkeys onto table. Pick up one monkey by an arm. Hook other arm through a second monkey's arm. Continue making a chain. Your turn is over when a monkey is dropped.”

    What could be better than assembling a long chain of tangled monkeys, each reliant on those on either side of it, with just the one person holding onto a single monkey's arm at the top end of the chain, responsible for all those monkeys dangling from his fingers?

    Of course, with great power comes great responsibility; and that lone hand at the top of the chain of monkeys has to be careful. Any slight mistake and the monkeys will tumble, and that is the end of your turn. You don't get to go again because you screwed it up and the monkeys came crashing down.

    So what does this have to do with Congress and the debt ceiling? Everything. They are the ones holding on to all of us monkeys as they have us all dangling arm in arm hoping they can somehow find a steady hand. Of course they have been playing this game for years and it looked like they might be picking up monkeys for a long time to come. The chain of monkeys hanging from their hand has become so long that they have no real idea where it ends. Until now.

    I have been saying for a long time that these days nothing matters to anybody until it matters to everybody. Most people never believed that our leaders would actually start shutting down the government to prove a point or hold the public hostage for political ideology.

    The proof of this is seen in the fact that as soon as it looked like they might actually do it – shut down the government and default on our debt obligations - markets began to crumble. All of a sudden, boom! That’s all it took. The monkeys began to shiver, shake and screech. Of course, everyone also thinks this is a repeat of 2011 where markets dropped during the debt ceiling debates and then exploded to the upside once an agreement was reached. Let’s hope so.

    Let’s step back for a moment and consider what the debt ceiling is. The debt total is simply the cumulative amount of spending that exceeded the amount taken in. The ceiling is an arbitrary number agreed upon by Congress as a benchmark the treasury cannot exceed. You might find it interesting to note that most countries don’t have a debt ceiling. Be that as it may, it is our law and we have to deal with it.

    A statutorily imposed debt ceiling has been in effect since 1917 when the US Congress passed the Second Liberty Bond Act. Before 1917 there was no debt ceiling in force, but there were parliamentary procedural limitations on the level of possible debt that could be held by government.

    US government indebtedness has been the norm in United States financial history, as well as most Western European and North American countries, for the past 200 years. The US has been in debt every year except for 1835. Debts incurred during the American Revolutionary War and under the Articles of Confederation led to the first yearly report on the amount of the debt ($75,463,476.52 on January 1, 1791).

    Every President since Herbert Hoover has added to the national debt expressed in absolute dollars. The debt ceiling has been raised 74 times since March 1962, including 18 times under Ronald Reagan, eight times under Bill Clinton, seven times under George W. Bush, and three times under Barack Obama.

    The debt ceiling is not the problem. The problem is the annual budget deficits. It is important to remember that the amount of debt we have increases only if we spend more than we take in. Of course, that has been going on for a long time with annual budget deficits. We have had over $1 trillion in budget deficits each year for the last 5 years and this year will likely “only” be about $500 billion. But that is like saying we are going over the cliff less rapidly. The amount of debt is still going up.

    Where the debate should be concentrated is on balancing the budget. Unless we start spending less than we take in, the debt will increase and we will continually bump up against any ceiling established. Some believe that freezing the debt ceiling will force Congress’ hand. But the current debt is from money already spent or promised. Are we really willing to tell the world that we won’t honor our obligations? The consequences of that, both intended and unintended, can be catastrophic. Those who suggest that it doesn’t matter are playing with fire and are going to get us all burned.

    The truth is there is nothing significant about the debt ceiling number. What is important is finding meaningful ways to reduce annual budget deficits and at least keep the debt from getting worse. There are serious dangers in this debt limit brinkmanship. It’s time for Congress to stop monkeying around, stop the political games, stop holding our citizens hostage over ideology, and get something done. Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


As we watch the political circus going on in Congress, perhaps Mark Twain was right when he said that “politicians and diapers must be change....

September 2013

  • September 2013: Beware of Emerging Market Currencies

    You know the old one-liner jokes that start with “You know you’re in trouble when…”  Now we can add one from the world of finance: You know you’re in trouble when the Greek stock market beats your stock market.

     

    From the end of 2012 through the middle of August, all four BRIC countries (Brazil, Russia, India and China) could claim this dubious distinction.  In U.S. dollar terms, Brazil’s stock market was down 29.9 percent, Russia’s market was down 14 percent, India’s market had fallen 21.4 percent, and China’s market had dropped 7.1 percent. 

     

    During that same period, the Greek stock market posted a 1 percent return.  The point here is all about the BRICs, the recent darlings of the investment world, and how they have fallen.

     

    In large part, global consumption drove the incredible growth in these four countries – along with many others around the globe – over the past fifteen years.  The thirst for energy and gadgets exploded during the late 1990s and early 2000s, giving raw material providers and cheap labor countries an incredible boost to their economies and their markets.

     

    Yes, the 2008 financial crisis briefly hit these emerging countries, but then the central banks of the world took over.  As they flooded the world with cheap capital, providers of raw materials and cheap labor got their second wind.  It seemed for a couple of years, from 2009 through 2011, these countries would be able to take a pass on the fallout from the greatest financial upheaval since the 1930s.  Until now.

     

    The feeling was that a rise of economic activity in these young, developing nations could offset a drop in activity in the aging countries of the world.  This view held for a while, but then reality hit.  It turns out that, while these youthful economies do have legitimate domestic consumption and growth, most of their outsized gains are reliant on selling to those stodgy, old, Western economies (as well as Japan) that are now limping along.

     

    Without the U.S., the European Community and Japan buying more and more, the BRICs had to devise their own plan for creating growth, which typically involved extending a lot of credit on easy terms.  We all know how this story ends – with lots of bad loans and questionable assets on bank books.

     

    The last six months have been something of a wakeup call, with many previously high-flying countries that rely on exporting to either the EU or the U.S., or their suppliers pushed back on their heels.  In U.S. dollar terms, South Korea is down over 10 percent, Mexico has dropped more than 6 percent, and even Canada, which is not a young country but is definitely a raw materials supplier, has fallen by 3.6 percent in dollar terms.

     

    As we move into the fall of 2013 and turn the calendar to 2014, I expect this trend to continue.  Economic activity in the U.S. is steady, although at a very low level.  There are no signs of a robust explosion to the upside.  Likewise, Europe is not spiraling down, but it’s not on a soaring trajectory either.  This leaves the BRIC economies and their compatriots to deal with growth internally, and now to deal with their own mini-credit bubbles and locally inflated asset prices.

     

    In addition to taking a backseat to Greece when it comes to market returns, it is possible that one of these countries or a group of them could trigger the next global financial crisis.  We are about to see one of the unintended consequences of quantitative easing and what happens when it unwinds.

     

    As the Fed lowered interest rates to basically zero, the hot money went looking around the world for better returns.  Money poured into emerging market countries looking for higher rates.  This also drove their currencies higher and created challenges as to what to do with all the money.  As if often the case, not all of it was deployed wisely.

     

    We are now seeing a preview of what happens when it goes the other way.  In the last few months, with just the hint that the Fed “might” begin tapering the amount of QE (bond buying), the hot money has been leaving emerging countries like rats leaving the ship.  Currencies in India, Brazil, Indonesia and many others fell like a rock.  Of course, the Fed says that is not their problem, but if it spirals out of control it will become our problem.

     

    The same buyers who poured into these emerging market currencies are now quickly rushing OUT.  This leaves developing countries with few options and all of them are bad.  They could raise interest rates (attracting more carry trade buyers), but that would slow or choke their economic growth.  They could buy their own currencies in bulk to prop up prices, but they’d deplete their currency reserves.  Or they could do nothing (allowing the free market to figure it out), which would likely put emerging market currencies into a free fall and create very high inflation.  This is truly one of those “between a rock-and-a-hard-place” scenarios.

     

    You see a positive feedback loop on the way in: Buyers bid up prices, higher prices entice more buyers, who further bid up prices.  This quickly turns into a negative feedback loop on the way out: Something changes and spooks buyers, they sell, pushing down prices, which spooks other investors, who then sell in panic… pushing prices down even further.

     

    The global economy is teetering in a very precarious position.  All it will take is one major crisis to trigger a chain of events that spirals out of control.  The collapse of emerging market currencies, much like what happened in 1997, could be it.  You could call this being hit by a BRIC.  Beware.  The one positive consequence for us, as I’ve been saying for a while now, is a very bullish outlook for the dollar.  Thanks for reading.

     

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


You know the old one-liner jokes that start with “You know you’re in trouble when…”  Now we can add one from the worl....

August 2013

  • August 2013: Siren Songs from Hedge Funds

    The “Odyssey” is one of two major ancient Creek epic poems attributed to Homer. The poem mainly centers on the Greek hero Odysseus and his 10 year journey home after the fall of Troy. Along the way he had to encounter the Sirens, who were dangerous but beautiful creatures, portrayed as “femme fatales”, who lured nearby sailors with their enchanting music and voices to shipwreck on the rocky coast of their island. Odysseus had his crew tie him to the mast so he wouldn’t be able to steer towards the Sirens and crash on the rocks.

    The Securities and Exchange Commission (SEC) may have just created a new modern Siren of sorts. They are relaxing the rules on how hedge funds can advertise and market themselves. I think it’s a mistake because it means you’re about to be bombarded with advertisements from these entities. The ads will be slick. They’ll be enticing. They will be touting returns that most people can only dream of in an area where only the rich get to play. Odysseus and the Sirens come to mind.

    Okay, so maybe you don’t need to be tied down or handcuffed to your desk, but I definitely suggest you turn the page, change the channel or do anything else to stay away from these funds! They can be destructive to your wealth and the average person has no business in such investments.

    In 1999 there was a hedge fund that rode the internet craze to incredible heights. The fund was up 332 percent in that one year alone and up another 53 percent in the first couple of months of 2000. Then the wheels came off. By the middle of April 2000, the fund was down 89 percent in just four months. Think about what would have happened if you were an investor in that fund.

    For example, let’s say you put in $100,000 on January 1, 1999. By the end of the year your account showed $432,000, at which point you owed the manager his fee, 2 percent of the account value for management plus 20 percent of the profits. That equates to $75,000. Still, you have $357,000 left, which is a 257 percent gain. What’s not to love?

    But by early April the fund has fallen 89 percent for the year, bringing your account down to $39,270. But wait, it gets worse. You see, this is a hedge fund, so it’s a partnership. As a partner, you are distributed paper profits every year, even if you don’t take them out of your account.

    Because this was a short-term trading fund, let’s assume you were allocated all the profits in your account at the end of 1999 – i.e. $257,000. Your tax bill at the 35% rate would be about $90,000. Unfortunately, your account is now only worth $39,270. So your hedge fund investment went from $100,000 to $39,270, to a negative $50,730. Ouch!

    Before I start getting hate mail, let me say there is nothing inherently wrong with hedge funds. Some have actually performed quite well. The problem is that few investors actually understand how they work or what risks they are taking and the new opportunities for marketing them could make the problem worse.

    Hedge funds and their managers have become almost mythical creatures where only the rich and smart get to play. Don’t we all want to get in on the action with them? When they win, it’s great. But when things go wrong - well, not so much. They are certainly not for the average investor.

    Fortune Magazine editor Winslow Jones created the first hedge fund in New York City in 1948 and generated huge returns over the next 20 years. After him came the second generation of hedge fund superstars, George Soros, Julian Robertson, and Michael Steinhardt, who made their debut in the sixties. The third generation of hedge fund rock stars included Paul Tudor Jones and Louis Bacon, who launched funds in the late eighties, when there were still fewer than 200 funds and $25 million was still considered a lot of money. The really big money showed up in the nineties when the pension funds found them.

    After that, hedge funds suffered through many ordeals that followed, including the collapse of Long Term Capital in 1995, the Amaranth blow up in natural gas in 2006, the Lehman Brothers bankruptcy in 2008, and John Paulson's 50 percent draw down in 2011. Today there are over 8,000 hedge funds, thought to manage some $2.2 trillion. Unfortunately for many investors, they no longer have the advantage they used to have.

    There are a few things you should know that will help you steer clear of danger. The first is the name itself. Hedge funds are misnamed. Most of them don’t “hedge” at all. They instead tend to be focused bets on very narrow slices of a sector or industry. They can also be exceptionally broad, giving the investment manager the ability to buy anything on the planet. You need to understand what is allowed.

    Also, hedge funds are typically set up as partnerships where investors become limited partners. Because these are partnership interests, there’s no marketplace where you can go to sell your investment. Usually you have to sell the interests back to the partnership itself, which may or may not want to buy it. Cashing out can be a challenge, especially during difficult times when everybody else wants out also.

    There is a reason hedge fund investments are limited to accredited investors, i.e. investors with higher levels of income and net worth. People should be financially and legally sophisticated before locking up their money in such vehicles.

    If you can’t stand a lot of risk, volatility and lack of liquidity, then steer clear! What’s that music I hear? OMG, somebody get the rope, quick! Thanks for reading.

    Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


The “Odyssey” is one of two major ancient Creek epic poems attributed to Homer. The poem mainly centers on the Greek hero Odysseus and ....

July 2013

  • July 2013: Street-Level Economics

    I know a number of people who earn their living as economists and many who are economics professors in various universities. I always enjoy talking with them and having a little intellectual debate about theoretical versus real life economics. I’ve often joked that I am a “street economist” and how I have to deal with all the information in real life situations. The other joke is that in referencing my past appearances on CNBC, I might say I’m not a real economist but I played one on TV.

    Over the years I’ve given a lot of speeches around the country and talked with many business owners. As much reading and research that I do, it’s also fascinating to learn what’s going on at the individual business level. The questions I ask of them help me further my own research and shed even more light on where we stand in our economy today. In doing so I get a sense of what people really want to know, which is “when will things turn around” or “when will things get back to how they used to be?”

    Some businesses are seeing increased traffic and rising sales, but it’s not anywhere near what it used to be. As one business owner recently told me, “Business is good, there’s just not as much of it.” People want to know about interest rates, possible inflation, and what is most likely to happen to their customer base. This is where I start asking questions of my own.

    What terms are your banks offering for financing? Is your average sale still around 75 percent of what it used to be? Are terms from your suppliers still tight? Are your customers more interested in servicing old items rather than buying new ones? Are your clients fearful? The answers I get lead me to the same conclusions. But first a little background.

    If you look at long term economic cycles you will see that economies go through seasons similar to spring, summer, fall and winter and it happens over an approximately 80 year cycle. And just as spring follows winter, winter follows fall. Actually, while some may not like winter, including me, winter is necessary because that is when nature rests, recovers, purges out the weak and gets ready to start new in the spring. This is where economist Joseph Schumpeter’s famous comment about creative destruction comes into play. It is the time where weak or no longer relevant companies die or get acquired. As much as central banks and governments would like to avoid it, you can’t have spring without a winter first.

    From an economic cycle standpoint, I believe we are in the winter season and it’s not over yet. As I’ve said many times before, we are simply getting used to the new, lower level of activity. More importantly, many of the business people I talk to are, by virtue of the fact that they are still around, the shakeout winter season winners. They just don’t know it yet. They don’t feel like it, and they would never describe themselves that way, but the people I speak to are the ones who have been through the fire of the downturn and lived to fight another day. This is what surviving a shakeout, or winter season, looks like.

    I recently spoke to a group I’ve seen several times over the years. As we talked, the questions revolved around how their businesses might grow in the years to come. At one point I said to a gentleman in the room, “Let me guess… your business has rotated to more service than sales, as clients keep existing equipment longer, and you’ve rearranged your business to do more work with less people… is that accurate?” When he agreed, I said, “Welcome to the future.”

    Shakeout winners are those businesses that have adapted to their new level of sales by adjusting what they make or provide so it is profitable today. These companies are not holding out hope that the business model of yesterday will suddenly work again. They recognized the need to change or die.

    As I talk with business owners, I’m always struck by the same theme. They’ve been through the tough period where you have to fire good people… they’ve adjusted their sales by adjusting their head count... after firing the dead weight, then firing the marginally productive, they’ve fired good people who are competent and hard workers. There is nothing fun about it.

    The good news is that this economic season, this cold economic winter, doesn’t last forever. I think we are six years into a 10-12 year stretch. The companies that are winners, those that have remained flexible and adjusted their offerings to match their sales, are poised to grow dramatically in the next economic phase – the spring season. That’s where the survivors and the strong really take off and prosper. If you’re still standing today, you are likely one of them.

    I look forward to giving more speeches in the years to come, and hearing from audiences about how their cautious ways in the downturn set them up for decades of prosperity as the economy turns back toward growth. Even better, I know I’ll have more examples to share with them about how people like you were able to survive and prosper during the tough years and came out wiser and richer at the end of it. Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


I know a number of people who earn their living as economists and many who are economics professors in various universities. I always enjoy talking....

June 2013

  • June 2013: Are We There Yet?

    If you’re like me and have raised children, you are probably familiar with piling in the family car and heading off on vacation or a day trip. Invariably, hardly any time has passed at all before the kids start asking, “Are we there yet?”

    It seems we might be asking the same question about the stock market. In past columns I have suggested that we are likely about two thirds of the way through a secular (long term) bear market. It might be more properly called a secular sideways market - a market that goes up and down in a wide channel that makes everyone crazy, but ends up going nowhere for a long time.

    Historically, sideways markets have always followed secular bull markets. At the end of secular bull markets stocks become very expensive – their valuations (price/earnings ratios) get very high. With a slow economic growth rate going forward, this one may even last longer than most. In hoping for the end of this sideways market, many have asked me, “Are we there yet?” Probably not.

    Are we seeing signs of a market top? It’s been a rough week for the stock market and the bond market. The concern over when the Fed will begin to dial back its QE-type stimulus is no longer the market's only concern. The U.S. market is beginning to realize that while it remained bullish and confident that the Fed had its back and would do whatever it takes to keep the stock market rally going; significant shake-ups and declines have been underway for some months in commodity prices, in the majority of global economies and markets outside of the U.S. and in the U.S. economy itself.

    Additionally, now the upheavals in the large economies of China, Japan, the Eurozone, Brazil, India, etc., are spreading more obviously to the emerging market countries that were supposed to remain strong no matter what happened in developed countries. Since the beginning of the year, the emerging markets have been looking quite sick. In the last couple of weeks technical factors have been flashing danger signals of an imminent decline being likely. If you have been reading my columns, you know I have been advising caution.

    Let’s take a closer look. Last week the S&P 500 was within 1.5 percent of its peak of May 22, and just found support at its 50-day moving average. So what’s not to like? Not a thing according to investor sentiment, which is still very bullish and confident. A poll by the American Association of Individual Investors shows the highest allocation of assets to the stock market since September 2007.

    Investors are so confident that margin debt, buying stocks with 50 percent down payments, is at a record level. Sound familiar? Does this bring back memories of late 2007 just before the market peaked? According to the latest consumer confidence reports, American consumers are more confident than they’ve been since before the 2007-2009 recession. As Yogi Berra said, “It’s déjà vu all over again.”

    So what’s to worry about? How can the market go anywhere but up with so much bullishness and confidence to support it? And what’s up with the heavy insider selling? What are they worried about? Well, there is the fact that those levels of confidence not seen since 2007 are warnings in and of themselves. Extremes of investor bullishness, consumer confidence, margin debt, and so on, are always present near market tops. That doesn’t mean that it can’t stay that way for quite a while, but it is certainly a warning signal.

    The S&P is overbought above its long-term 200-day moving average to a degree that in the past almost always resulted in a pullback to at least retest the support at the moving average. If that is true this time, it would be a decline to about 1,500. Will that actually happen? Beats me, but it sure gets my attention.

    One might ask, “so what?” One line from Charles Prince, the infamous former CEO of Citigroup, is stuck in my head: “As long as the music is playing, you've got to get up and dance.” That was Prince’s explanation for why Citigroup continued to originate loans even though risks were starting to outweigh returns, and when it should have been obvious to an astute observer that the situation would not end well. We know how that story played out.

    Today investors are dancing because the Fed is “QEing”, if you’ll allow me to make the term quantitative easing into a verb. Right or wrong, the thinking is that as long as the Fed is QEing, stocks will keep going up. Even I have suggested QE is overriding all fundamentals for the time being and as long as that continues, as much as I hate it, you need to be in the game.

    The problem is that everyone feels they can get out before the music stops. We heard this before in the late 1990s. Very few got out. “Dancing” is not investing, it is speculating. One of the problems with QE is that the Fed is forcing people to buy riskier investments than they otherwise would have. Stocks are in weak hands, insuring one great stampede for the chairs when the music stops someday.

    I am not issuing a market timing call as I have no idea when this market will turn. That’s why we always stick with our models for diversification and risk management. When the market is making all-time highs it is easy to become complacent, let down your guard, and let euphoric media headlines go to your head. Don’t dance, invest. As for when we reach the end of our journey in a sideways volatile market, are we there yet? I think not. We’ll see. Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


If you’re like me and have raised children, you are probably familiar with piling in the family car and heading off on vacation or a day trip....

  • June 2013: Fun with Statistics

    Mark Twain is often credited with the famous line, “There are three kinds of lies: lies, damned lies, and statistics." It is a phrase describing the persuasive power of numbers, particularly the use of statistics to bolster weak arguments.

    When I was growing up I used to have fun playing around with statistics and how they were used. Yeah, I know. I’m a little weird. When I told my daughters about this, they looked at me and said, “Dad, you were a geek.” I protested and provided all kinds of facts and figures and macho tales to prove otherwise, to which they said, “You were still a geek.”

    You can learn a lot from dead people. No, I don’t talk to them. But I do learn a lot from statistics about them. As an example, an often quoted statistic says that life expectancy in the U.S. has increased by thirty years since 1900. We hear that people lived, on average, to the age of 48, while today they’re living to the ripe old age of 78.

    Think about that for a moment. That implies that back in 1900 there were no “old” people. That doesn’t make sense so I did a little research. Sure enough, the average age of death for a man in 1900 was 48 and today it is just over 78. A 30 year difference. However, if you look at the rate of death by age, the numbers look quite different.

    Yes, the average age of death in 1900 was 48, BUT over 15 percent of the deaths occurred before the age of five. This enormous number of deaths before the age of five had the effect of dramatically lowering the average age of death in those days. For many of those who made it past five years old, they survived well into their 70s and 80s.

    Interestingly, we commonly attribute the extension of life to advances in health science that allow us to live into old age. While some of that is true, the far bigger reason was advances in health science stopped many of us from dying as children.

     

    This is another example of misleading averages. When you dig just a little deeper it’s obvious that the average age of death in 1900 is a pretty useless number. The same thing happens in the world of investing. Since 1926, the average return on large cap stocks has been around 9 percent. That seems pretty good. I’d like a 9 percent return each year. Wouldn’t you?

    But of course the return is not 9 percent every year; it’s just the average. In fact, the returns are quite spread out. Technically speaking, the returns have a wide dispersion from the mean. So if the average return is 9 percent, but there’s a wide dispersion from this number, then how do we know what to expect each year? Good question. I’m glad you asked.

    Have you ever gone online and used one of those free financial planning programs to calculate what your investments might do in the future? Be careful. Most, if not all, financial software uses normal distributions and standard deviations to calculate expected returns for investments. Without getting too complicated, the software assumes that the returns are normally distributed (like a bell curve), with a set standard deviation (or how far each year strays from the expectation of the average). The average return of large cap stocks may be 9 percent, but the standard deviation is 19 percent. Now that’s a different animal.

    If you want to be 99 percent sure that your estimate of next year’s return is correct, you must be willing to accept a range of returns. In this case, that range is three standard deviations (three times nineteen) above and below the average of 9 percent. To be 99 percent sure – not 100 percent, mind you – that you have a good estimate of next year’s return on large cap stocks, you must be willing to accept a range of returns from 9 percent minus 57 percent (three standard deviations below) to 9 percent plus 57 percent (three standard deviations above). In other words, you could see a range of negative 48 percent to positive 66 percent, or a 114 percent spread around the expectation of 9 percent!

    How do you feel now? What kind of financial planning is that?! Who in their right mind would invest in something with the thought that it’s “okay” to have anywhere from a loss of almost 50 percent to a gain of more than 60 percent each year? That’s crazy! And yet that’s the exact way most financial software operates.

     

    If you suddenly feel less sure about buying and holding equities, and have less faith in the statement that “over the long term, equities go up,” join the club! This suggests a rather dim future for traditional asset allocation strategies.

    There are better ways. Instead of simply plodding along, buying and holding with the hope that it all works out in the end, be proactive! Take an active role in estimating the risk and reward potential of markets, industries, and individual securities. Look across the economic landscape at the different forces that are driving markets at the moment and ask yourself: “Does all this make sense?” If the answer is “No,” then unless you know what you’re doing, you could be set to experience the low end of the expectation range for equities! Not having fun with statistics? Perhaps we can help you. Thanks for reading.

    S. Nick Massey, CFP®, AIF®

    President

    Chief Investment Officer


Mark Twain is often credited with the famous line, “There are three kinds of lies: lies, damned lies, and statistics." It is a phrase describ....

May 2013

  • May 2013: Too Many Things Don’t Make Sense

    Are you as confused as most people with all the conflicting pieces of data and advice from economists and other forecasters? Who do you believe? On the one hand this, on the other hand that. Which is it? To paraphrase Harry Truman, “Somebody please find me a one-armed economist!”

    There is a very funny book about cowboy wisdom entitled “Don’t Squat with Yer Spurs On!” The best piece of advice the book offers is “No matter who says what, don’t believe it if it don’t make sense.” It’s good advice.

    Another line in the book is, “If you’re following a cow, there is a good chance it’s following another cow.” Now that makes sense. Not that I know a lot about herding cattle, but I’ve seen a lot of westerns. If you’re following the herd, you have to have a little faith that the lead cow knows where it’s going. That’s a pretty big leap of faith these days when you apply that logic to the stock market.

    A lot of what you are hearing everyday “don’t make sense” and you shouldn’t believe it either. My “B.S.” detector is going off the chart. We hear that the economy is recovering rapidly, the consumer is back, housing has bottomed, and we are seeing the beginning of the next great bull market. In light of the facts, those arguments “don’t make sense.”

    In 2006 I was on CNBC when I predicted the Dow would hit 14,000 in 2007. At the time, that was a pretty outrageous suggestion. I was right and was actually on the floor of the New York Stock Exchange with CNBC when it hit 14,000 in July 2007. Then I got cocky and said that it would hit 15,000 by the end of the year. Oops! It hit 14,100 in November and that was it. There is nothing like the stock market to humble you now and then.

    I tell you this because the Dow hit 15,000 this week – a new all-time high. I guess I could say I was right about my 15,000 prediction – I was just six years early. So much for timing. Wall Street just about threw a parade over the new high, but many people remain skeptical. There is a saying among technical traders that “the trend is your friend.” It would be better to say “the trend is your friend until it isn’t.” The “isn’t” part is coming. I just don’t know when.

    I could rail against the Fed, the European Central Bank, and the Bank of Japan, as each entity (along with other large central banks) has had a hand in driving equity prices to crazy highs in the face of anemic economic numbers, all the while siphoning off value from savers and bondholders. But you’ve heard all that before. What worries me is what comes next, and what that means to you and everyday investors.

    Stability creates its own instability. It is a weird statement, but it has a lot of power. Economist Hyman Minsky described the process well. Minsky, who died in 1996, was an American economist and professor of economics at Washington University. His research attempted to provide an understanding and explanation of the characteristics of financial crises. Minsky was sometimes described as a post Keynesian economist because, in the Keynesian tradition, he supported some government intervention in financial markets and opposed some of the popular deregulation policies in the 1980’s and argued against the accumulation of debt.

    He pointed out that, over time, stability (or the lack of volatility) creates instability because people become accustomed to the status quo, become over confident and then take on more risk than they should.

    A few examples: The markets are going up again? Of course they are. The Fed is printing $85 billion a month to make sure of it. Are the manufacturing and trade numbers bad? No worries, the markets are going up again anyway; the Fed is making sure of it. The European Union (EU) is in recession? No problem, the ECB has pledged to take care of it, and the markets are going up again.

    At this point we all know the game. Whatever happens, wherever on the planet it happens, the markets won’t go down because the Fed doesn’t want them to. Right up until the system collapses on itself, that is. Right up until people realize that we added jobs, but fewer jobs than the number of people who joined the labor force. Right up until people realize that we added 278,000 part-time jobs because people couldn’t find full-time work. Right up until people realize that unemployment in the EU is now over 12 percent and going higher.

    But until then, the markets are marching higher, propped up by the central banks around the world, who continually tell us not to worry, because they’re here to make sure nothing bad ever happens. The longer this situation goes on, the worse the eventual downturn becomes. This is what eventually creates the “Minsky moment” when people become too complacent. Perceived stability actually creates instability as people take on too much risk before it suddenly blows up.

    Why would central bankers continually do the economic equivalent of feeding drugs to addicts when the obvious but painful choice should be detox? Because no one wants to be the person to pull the plug. No one wants to be the person who acknowledges the actual size and scope of the debt crisis that never went away, but was just pushed under the rug and hidden by trillions of newly printed dollars, yen, and euros.

    With the markets at new highs, now what? How long can central banks keep up the charade? How long will people blindly follow the pied pipers of finance? I don’t know. For now, there is not much choice but to go with the flow. But be careful not to stay at the party too long as there is definitely greater danger ahead. Now THAT makes sense! Thanks for reading.

    S. Nick Massey, CFP®

    President

    Chief Investment Officer


Are you as confused as most people with all the conflicting pieces of data and advice from economists and other forecasters? Who do you believe? On....

April 2013

  • April 2013: Keeping Up With the Generals

    One of the basic rules of military strategy is that when aggressively pursuing the enemy, you have to be sure you don’t outrun your supply lines. If the guys bringing the food, ammo and fuel can’t keep up, it doesn’t take long before bad things happen.

    There is a similar analogy with the stock market. One has to ask how much longer can the Dow and the S&P 500 continue to outrun the rest of the market? There is an old story about a potentially ominous situation when the blue chip stocks continue to make new highs while the rest of the market has possibly topped out or is in some degree of correction. The story suggests that when the generals leading the advance up the hill eventually look over their shoulders and see the troops in full retreat, they soon have to join the retreat. Now what?

    At the risk of being the skunk at the party, I have to ask how much longer can the blue chips (the generals) pretend that everything remains positive for the economy and supportive of higher stock prices when the broad market (the soldiers) and the transportation index (the supply guys) are not?

    Does it matter that new home sales fell 4.6% in February – the biggest decline in 2 years? Or that durable goods orders without aircraft orders fell 2.7% in February? Or that consumer confidence fell from 68.0 to 59.7 in March? Or that consumer sentiment plunged from 79.3 to 72.3 in April (a nine-month low)? Or the ISM manufacturing index dropped from 54.2 to 51.3 in March, its 3rd monthly decline? Or the ISM non-manufacturing (service sector) index also fell sharply in March? Or only 88,000 jobs were created in March compared to a forecast 200,000? Or retail sales fell 0.4% in March – the biggest decline in 9 months? With that as backdrop, what could possibly go wrong?

    Have you noticed in the last few months a divergence between a rising stock market and declining commodity prices? This is a potentially ominous sign for the economy and stock market going forward. A six-year chart of the CRB Index of Commodity Prices shows declining commodity prices usually indicate demand for goods is dropping and the economy is in trouble. The CRB Index fell 15% in the summer of 2010, and the S&P 500 fell 15% in that summer’s correction. In 2011, the CRB fell 15% and the S&P 500 declined 19.5%. Last year the CRB fell again, and the S&P fell 11% to its early June low. So it’s not very comforting that as the Dow makes new highs this spring, the CRB Index is down over 12% so far from its last peak.

    Meanwhile, much has been written about the market being back to old highs and making new ones. But there is more to that story than meets the eye. Maybe the index is back, but not all stocks. Specifically, have the portfolios of buy & hold investors even come close to coming back?

    The market has finally rallied back to the levels of its previous peaks of 2000 and 2007.

    That allows Wall Street to revive its long-time mantra in support of ‘buy & hold’ investing as a viable strategy and that “the market always comes back.” The claim is based on the fact that the market indexes eventually come back, although it sometimes takes 15 to 20 years, as in the 1930’s and 1970’s. But does that mean buy & hold investors’ portfolios have come back?

    Not at all. The stocks that make up the indexes are periodically changed so significantly as to make the market that comes back entirely different than the market that went away.

    For instance, 23% of the stocks that were in the Dow in 1999 were no longer in that index just five years later. They had been replaced by stronger companies that were more representative of the changing economy.

    Don’t get me wrong. This is necessary. The indexes were developed to closely represent the U.S. economy at any given time. Previously dominant companies that lose their importance in the economy are replaced by the newly dominant companies. So a Sears is replaced by a Home Depot, a Kodak by Pfizer, and so on.

    In just the 7 years from 1999 and 2006 there were 109 changes in the stocks that comprise the Nasdaq 100, an index that only contains 100 stocks. In the 11 years from 1988 to 1999 there were 256 changes in the stocks that comprise the S&P 500. Between 2010 and 2012 there were 40 more changes.

    Obviously, the fact that the indexes come back has little relevance as to whether the stocks buy and hold investors need to come back have done so. You have to wonder which popular stocks currently in the indexes won’t be there the next time the market declines and investors wait for them to come back.

    Even many of the stocks that do remain in the indexes do not necessarily come back. The Dow has come back to its previous peak, but of the 30 stocks in the Dow, 11 (more than 30%) are still down an average of 61.2% from their levels of 2000.

    As for whether blue chip stocks are set to fall or the others are set to catch up, could it be that the Dow is correct and all the others are wrong? Perhaps. However, there is certainly a case for being cautious now. Keep your eyes on the generals. To borrow an old phrase from the bomb squad personnel, “If you see them running, try to keep up.” Thanks for reading.

    S. Nick Massey, CFP®

    President

    Chief Investment Officer


One of the basic rules of military strategy is that when aggressively pursuing the enemy, you have to be sure you don’t outrun your supply li....

March 2013

  • March 2013: Consequences of Sequestration Just Beginning

    A new word has crept into our daily vocabulary. Sequestration. Actually it was originally the verb sequester, meaning “to isolate or hide away someone or something.” But since then we’ve turned it into a noun meaning “a general cut in government spending.” Whether noun or verb, I would bet that a large percentage of the population had never heard the word prior to last year. Never underestimate the ability of Congress to come up with new words to explain their behavior.

    So the dreaded “sequester” has gone into effect and we are already dealing with the consequences. If you will remember, the infamous Fiscal Cliff that was in the news last year was a combination of tax hikes and deep across-the-board spending cuts.

    Well, the tax issues have been mostly ironed out. Americans will be paying more in taxes, and no one is particularly happy about it. But at least the uncertainty is out of the way, and we know what we’re facing. As the old expression goes – better the devil you know to the devil you don’t know.

    Now it’s time for the second half of the Cliff, the deep spending cuts collectively called “sequestration.” Judging by the stock market’s recent record-breaking highs, investors don’t appear to be all that worried about the cuts. For all the angst and handwringing we’ve seen over the past year and a half, investors seem to have reached the conclusion that it’s not a big deal.

    So what is the story? Is it a big deal?

    To start, most Americans agree that the government spends too much money, a lot of which gets wasted. But slicing $1.2 trillion out of the budget sounds like a big cut. That is until you look at the details. Only $85 billion is scheduled to take effect this year - in a budget of more than $3.5 trillion. Some would argue that barely makes a dent. The rest is spread out over the next 10 years. We’re talking about spending cuts of less than 2.5 percent, and that assumes Congress and the administration don’t weasel out of it. That’s still a real possibility.

    If the cuts happen as planned, they will probably take about half a percent off of GDP growth this year. And the effects could be worse if they impact business confidence and hiring.

    Still, it’s hard to get worked up about spending cuts unless it affects you directly. Then it is a big deal. Even if the sequester is messy and indiscriminate, it’s better than no cuts at all. The problem, of course, is that one person’s definition of waste or unnecessary spending is someone else’s critical spending. The original idea of sequestration was that across the board cuts would be so draconian that Congress would never actually allow it to happen. Instead of a meat cleaver approach to cuts, rational people would actually sit down and make hard decision about what to cut and what to save. So much for that idea.

    While we all like the idea of cutting government spending, there are short term consequences for doing so. In the long run, there are significant benefits. Much like a family cutting its budget to get a handle of their finances, the short term pain can be worth it for the long term good.

    But what happens when government cuts spending? If you remember your economics 101, the formula for GPD is GDP = G (government spending) + C (private spending) + I (business investments) + E (net exports). You don’t have to be a math major to know that if you cut G, you will have a lower GDP unless one or more of the others increase. So while we all like the idea of less government spending, know that we may well intentionally put ourselves in recession to do it. It’s a little like taking some nasty tasting medicine to get better. Not much fun.

    The real issue is not the current sequestration cuts, which don’t matter much in the long run, but entitlements. Social Security and Medicare are already in deficit now when the vast majority of Baby Boomers are still in the workforce and still paying into the system. But what happens after 2020, when those Boomers born from 1955-1961, the highest birth years, start to reach retirement age?

    If you think we have a deficit problem now, take a moment to think about what’s coming.

    Actually, I can tell you what’s coming - higher taxes along with lower Social Security and Medicare benefits, particularly if you are considered a “high income” retiree. And believe me, what counts as “high income” is probably much lower than you think.

    The bottom line is that we cannot depend on government programs to take care of us in our old age. And this means putting the pieces of a retirement plan together today, while there is still time. Thanks for reading.

    S. Nick Massey, CFP®

    President

    Chief Investment Officer


A new word has crept into our daily vocabulary. Sequestration. Actually it was originally the verb sequester, meaning “to isolate or hide awa....

  • March 2013: The Fate of the Twinkie

    Perhaps no other product has captured the attention of Americans in recent months than the humble Twinkie, whose parent company is in the final stages of its bankruptcy proceedings. If you are like me, you probably haven’t eaten one in years. But there is something about the little yellow cake that is iconic and American.

    So, the bankruptcy of Hostess Brands late last year was a shock for many of us. The immediate cause of the bankruptcy was a labor dispute with the bakers’ union. But Hostess’ problems ran much deeper and point to a much larger trend in the U.S. economy.

    When was the last time you bought a Twinkie? I ask not to belittle the brand but to make a point. The poor Twinkie is a victim of changing demographics. The Baby Boomers bought Twinkies by the millions for their children, the Echo Boomers. The Echo Boomers were the second-largest generation in history (after the Baby Boomers themselves), so satisfying their sweet tooth was a profitable endeavor.

    Unfortunately for Hostess, the Echo Boomers grew up. Most are out of college now, and many have started families of their own. And as a generation, they (along with the smaller Generation X) are a little more health conscience as parents. They are more likely to throw a banana into their child’s lunch box than a Twinkie.

    Of course, Twinkies are not the only iconic brand that has been on the wrong side of a demographic trend. Consider Harley-Davidson. Imagine the “typical” Harley rider: a white male in his 40s or 50s. When the Baby Boomers entered this key age range two decades ago, it created the biggest boom in the company’s history. But nothing lasts forever, unfortunately. Those same Boomers who once bought Harleys are more likely to buy an RV today. Generation X is not large enough to make much of a difference, and Echo Boomers are still a few decades away from their motorcycle-riding mid-life days.

     

    As investors, it’s easy to get distracted by the headlines and by the fast pace of news that hits us every day. But the truth is that the forces that ultimately matter most to a company’s health - and to the health of the entire economy - are slow moving and very predictable. An understanding of demographic trends would have helped you foresee the difficult times for both Hostess and Harley-Davidson. And they can also help you predict the next boom.

    I expect a new baby boom at the beginning of the next decade that will be very profitable for those investors willing and able to get in front of it. And that is exactly what we intend to do.

    As for me, I’m not ready to give up my Harley yet. In fact, I think I’ll ride my hog over to my favorite pub for a beer and a Twinkie. If I hurry I won’t miss my bedtime. Thanks for reading.

    S. Nick Massey, CFP®

    President

    Chief Investment Officer


Perhaps no other product has captured the attention of Americans in recent months than the humble Twinkie, whose parent company is in the final sta....

February 2013

  • February 2013: Forecast for 2013 is Up, Down and Sideways

    An old bit of advice says, “Never eat at a place called Mom’s or play poker with a man named Doc.” I’ve also been told that if you’re sitting at the poker table and haven’t figured out who the sucker is in the first 30 minutes, it’s you. That’s a joke, but this isn’t: When a cyclical bull market is getting long in the tooth, be careful not to stay too long at the party. This is even more so if you’re late to the party.

    2013 will be full of surprises and perhaps even more challenging than 2012. This bull market is getting pretty old and nothing goes straight up forever. Over the last 110 years, except for the unusual decades of the 1920’s and 1990’s, a bear market has come along an average of every 4.4 years. The last one began December 2007 - five years ago. You know this thing is headed south at some point. You just don’t know when.

    All indications are the next slowdown for the economy and market will likely take place in 2013 or 2014. The improved economy and the size of the government debt load makes it unlikely the imposition of austerity measures and reversal of the Fed’s easy money policies can be delayed much longer. The current long term bear market, which began in 2000, probably has 4 to 5 years remaining. Within that period, there should be one more recession and cyclical bear market. The catalyst being austerity measures to fight the “macro” problem of record government debt. However, I don’t expect the next cyclical bear market to be as severe as the last one in 2008.

    That doesn’t mean there won’t be great opportunities in 2013, but you need to be much more tactical in what you do with your investments. If you are a good trader, 2013 might be a lot of fun. With GDP growing at a feeble 2 percent in 2013, and corporate earnings topping out at $105 a share on the S&P 500, those with a traditional "buy and hold" approach to the stock market will do alright provided they are willing to sleep through some gut churning volatility. A little motion sickness medication might be helpful. Here is my forecast for 2013.

    1. Stocks will finish higher in 2013, but there will be hard work along the way as a classic “sell in May and go away” pattern happens for the 5th year in a row. We start with a ferocious rally that takes us up to the all-time highs or slightly higher, then a heart stopping summer selloff, followed by an aggressive year-end rally. I would guess we go up 10 percent, then down 20 percent, then up 25 percent to give us an up 10 percent year.

    Investors will be slow to comprehend the impact of all of these events and will not get fully invested until March or April – just in time to get hosed again. “Won’t you come into my parlor?’ said the spider to the fly.” By then, the S&P 500 will be at 1,600, the top of a 14-year range, where it always fails in a 2 percent growth economy. Get ready to fail again.

    2. The next leg of the European sovereign debt crisis comes back in the summer triggering the summer downturn. It will be triggered by Spain, but the contagion spreads to Italy and France. This creates a hiccup in China, so the recovery slows there. A nasty, public slugfest in congress over the debt ceiling will further give stock owners ulcers. This triggers recession fears (which won’t happen in 2013) and cuts the legs out from under the market. The way is then cleared for a 20 percent swoon down to 1,300.

    3. Bargain prices in the fall will give us a nice springboard to rally into the end of the year as the Federal Reserve will use any substantial weakness in the market to launch another quantitative easing program. (Somebody please stop the madness!) The European Central Bank can do the same and come up with an LTRO at any time. Japan's new, more aggressive monetary easing and epic public spending should be reaching its stride by then. China seems to always have another $500 billion stimulus budget that they can pull off the shelf at any time.

    4. The Treasury bond market has finally peaked but is not ready to pop the bubble yet. That day is coming but not this year. Bond yields will just move to a higher trading range. The range for the ten year Treasury bond yield was 1.40 percent - 1.90 percent in 2012. We probably move in a new range of 1.90 percent to 2.50 percent, but not much higher than that.

    5. The U.S. government runs another $1 trillion deficit for the 6th year in a row.

    6. Gold is not dead; it is just resting. The Fed’s QE3 is entirely focused on the housing market through the purchase of mortgage backed securities, so the effect on the broader money supply is delayed. However, I expect the effect to start kicking in sometime in 2013 bringing a new high for gold with it. Until then, the pain trade for gold holders is on.

    7. For the economy, the second lost decade continues. I am sticking with a 2 percent GDP growth forecast for 2013, but mostly because of the momentum left over from the 4th quarter of 2012.

    8. Forget about employment. The news will always be bad. At this stage of the economic cycle, we should be generating a robust 400,000 jobs a month, not a paltry 150,000. I believe that the US has entered a period of long-term structural unemployment. Yes, we may grind down to 7 percent, but no lower than that.

    So there you have it. We’ll check back next January and see how I did. I’m reminded of these words from “Les Miserables”, which seem appropriate now. “There was a time when men were kind, when their voices were soft and their words inviting. There was a time when love was blind and the world was a song and the song was exciting. There was a time. Then it all went wrong.” Stay tuned for updates in what will be an important year. Thanks for reading.

    S. Nick Massey, CFP®

    President

    Chief Investment Officer


An old bit of advice says, “Never eat at a place called Mom’s or play poker with a man named Doc.” I’ve also been told that....

January 2013

  • January 2013: My 2012 Scorecard

    Regarding economic forecasting, economist John Kenneth Galbraith once said, “There are only two kinds of forecasters – those who don’t know and those who don’t know

    they don’t know.” Depending on the year, some may suggest that I’m in the second camp.

    I take some comfort in what former Dallas Fed President Bob McTeer once told me. He said that most economists aren’t very good at forecasting, but it is expected of them. “So if you’re going to forecast”, he said, “do it often and do it late.”

    While a humorous comment, there is certainly an element of truth in it as I take my annual look back at what happened in 2012 and what I think might happen in 2013. You might call it my annual victory lap or slow crawl to the locker room, depending on how I did. It’s all in fun and not to be taken too seriously, but I do try to do the best I can with it.

    2012 was another strange year, to say the least. Ironically, it was not as volatile as 2011, with the DJIA trading in a 1,630 point range versus 2,450 points in 2011. From a portfolio management standpoint, less volatility is actually more challenging in terms of getting excess performance. As far as the U.S and global economies are concerned, I don’t think we fixed anything and have mostly sown the seeds for what will eventually be another crisis. Things seem stable now but there is a lot of unfinished business.

    The biggest challenge from a forecaster’s perspective is sorting out all the news and trying to determine what is important and what is just noise. This is especially true when looking at the economy and the stock and bond markets. While these are all certainly related and mutually determinant, they don’t always move together or logically. In fact, they seldom do.

    Here is what I said in January 2012 and what actually happened:

    1. “The European debt crisis continues in and out of the headlines as Europe goes into a recession. Nothing is resolved but they do manage to kick the can down the road a little longer.” True and accurate.

    2. “The U.S. economy does not go into recession in 2012 but continues to limp along at a weak 1 to 2 percent GDP growth rate. Global GDP will be the same.” True.

    3. “U.S. corporate earnings grow, but fail to beat estimates for the first time in more than three years. S&P 500 earnings per share are forecast at $105 but shrinking P/E multiples will result in a lower stock market by year end.” Only partly true. S&P earnings did not grow appreciably but P/E multiples actually expanded, resulting in a higher market.

    4. “The S&P 500 moves up to about 1,370 but probably peaks by April - an increase of 9 percent. Conservative investors may want to be out before that or hedge their portfolios. Aggressive investors may want to short stocks then. Several risk-off events in the 2nd and 3rd quarters will result in a major sell off for 4 to 7 months, taking the S&P 500 down 23 percent from the high to 1,050. As we near election time we will see a relief rally take the market back up, but still finish down about 8 percent for the year at 1,160 on the S&P 500.” Well, I blew that one! The S&P 500 was up 13.41 percent at 1426. I underestimated the Federal Reserve’s determination to continue quantitative easing and all that money had to go somewhere. When will the madness stop?

    5. “Interest rates on the 10 year US Treasury bond decline to historic lows of 1.5 percent on the next risk-off event and then head slightly higher by year end.” Mostly true. Rates went as low as 1.3 percent and finished the year at 1.9 percent.

    6. “The US dollar continues up and the euro down, with the Euro going as low as $1.19 exchange rate. Gold rises at first to $1750 and then falls into summer. Wait to buy gold at $1250.” Pretty close on the Euro but partly missed on gold. The Euro went as low as $1.20 and then recovered to $1.32 by year end. Gold traded between $1801 and $1538, closing around $1650 at year end.

    7. “Oil and commodity prices peak sometime this year and start to decline by late in the year, if not sooner, as the global economy slows and demand falls. Oil is at $100 now and could see a spike to $120 at some point. However, the next risk-off trade or a slowing global economy could take it down to $75 by year end.” In between. Oil traded between $109 in March to a low of $80 in June, closing around $95 at year end.

    8. “Unemployment remains stuck at the 8 to 9 percent level, then goes up again in late 2012 or 2013. GDP growth of 1 to 2 percent is not enough to make any meaningful dent in the unemployment rate.” Partly true. Unemployment dipped to 7.8 percent but mostly due to more people dropping out of the workforce.

    9. “The US government runs another $1.3 trillion deficit.” True.

    10. “The Presidential Election is too close to call.” Aren’t we all just glad it’s over?

    So how did I do? I guess I would give myself a B minus on this one. What do you think? Our portfolios had a pretty good year in spite of it, all without taking excess risk.

    In two weeks I’ll stick my neck out once again with my predictions for 2013. Maybe I should just heed the words of Mark Twain when he said, “It ain't what you don't know that gets you into trouble. It's what you know for certain that just ain't true." Maybe I should, but I just can’t help myself. Thanks for reading.

    S. Nick Massey, CFP®

    President

    Chief Investment Officer


Regarding economic forecasting, economist John Kenneth Galbraith once said, “There are only two kinds of forecasters – those who don&rs....

  • January 2013: After Surviving the Fiscal Cliff Fiasco – Now What?

    Well, we survived the fiscal cliff fiasco. Now what? It appears that Congress must read my articles because they followed the script perfectly.

    In my December 8th Edmond Sun column I wrote, “Of course, I don’t know more than anyone else, but my guess is that at the very last minute, late December, they announce a compromise agreement claiming that they saved the economy and they’ll be all smiles and handshakes. It will actually be fairly minor and do nothing to solve the long term problems. Those will just be postponed again. But the market will love it and spike to the upside because it means the party is back on – for now. By April we’ll be back to talking about the debt ceiling and Europe again. Then we get to repeat the anxiety all over again.”

    “Someday congress will have to set politics aside and finally deal with the problem. But that day is not likely now. It will finally happen when there is no other choice. In the meantime, buckle up for a wild ride.”

    The truth is that nothing was changed and nothing was solved. Oh sure, we agreed to make some of those “rich” people, those making over $400,000 a year, pay a higher income tax rate of 39.6 percent and 20 percent on dividends and capital gains, plus an additional 3.8 percent on investment income for those making over $200,000 a year to help pay for the Affordable Care Act. But for a country running over a $1 trillion budget deficit for the 5th year in a row, that is peanuts and does nothing to address the spending side.

    Everyone who draws a paycheck will see their social security tax go up by 2 percent as it goes back to its normal 6.8 percent instead of the 4.8 percent we have seen over the last year. Of course, when you allow people to keep a little more of their money and then take it back, they don’t like it very much. Is it a tax-hike or not when you “temporarily” lower a tax rate and then move it back up? You decide. Either way, it doesn’t feel very good.

    In any event, unless you’re making a lot of money, or have a lot of money, nothing much changes for you. But as far as the financial well-being of our country is concerned, nothing changed there either. It does nothing to address our growing national debt of over $16 trillion. It doesn’t even make a dent in balancing the budget as we will continue to run $1 trillion plus annual deficits for years to come. And that’s if some of the economic growth projections, which are mostly “pie in the sky” wishful thinking in my opinion, are actually achieved.

    There is, however, a real crisis brewing, and it will ultimately mean that taxes will rise for all of us—and not just those fortunate enough to earn more than $400,000 per year. And no, it’s not the “debt ceiling crisis” that you will soon be reading about. I’m talking about demographics. The House Republicans made a feeble attempt to make reform of Social Security and Medicare part of a Fiscal Cliff deal, but it never amounted to much. And that is a real shame, because it merely postpones the day that we deal with this crisis as a country.

    The Baby Boomers are no longer the spending force they used to be. They are in a different stage of life now, with saving for retirement being a higher priority than buying that new house, car, or large-screen TV they might have bought in years past. Meanwhile, millions of Boomers are retiring every year and starting to draw on the Social Security and Medicare benefits they were promised.

    And here lies the problem. We have a large generation leaving the workforce at a time when economic growth is weak and not looking to get stronger any time soon.

    A demographic tsunami is coming, and it will be tall enough to scale even the highest Fiscal Cliff. As investors, this means that we need to plan on shouldering more of our retirement expenses while also suffering under higher taxes. This will involve planning - real, in-depth financial planning and honest assessments of expected portfolio returns. And it means starting now, if you haven’t already done so.

    Let’s be clear here. We have a spending problem in this country far more than we have a tax problem. Until we address the spending side of the equation along with the income side, all of these “deals” will be meaningless. Eventually our leaders will need to have the guts to make the hard decisions and nobody will be happy with them. Only then will we make some progress.

    I suppose we should breathe a sigh of relief though. After weeks of high drama, our fearless leaders agreed to a non-deal to resolve a non-crisis. Perhaps we should have been calling it the “fiscal slope” because there was no cliff. Now that we have postponed and bought time again, I hope this time Congress will use it wisely and begin addressing the problems instead of waiting for another midnight hour deadline to force another meaningless deal. Thanks for reading.

    S. Nick Massey, CFP®

    President

    Chief Investment Officer


Well, we survived the fiscal cliff fiasco. Now what? It appears that Congress must read my articles because they followed the script perfectly.

....

December 2012

  • December 2012: Shared Sacrifice and Coming Trends

    As we near the end of 2012, certainly a stressful and confusing year, it is appropriate to step back and look at some of the big-picture trends that we will all be living with in the future. One phrase you will hear a lot next year is “shared sacrifice.” Unfortunately, many people miss the “shared” part and like it best when someone else does the sacrificing.

    In analyzing consumer spending trends, one of the most reliable cyclical indicators for American consumers is the restaurant sector. Lately we’re starting to see economic reports that restaurant traffic is slowing down rather sharply and companies are issuing warnings of slowing earnings. It is a sign that families are becoming more cautious in their spending and eating habits. Grocery shopping is up in two of the past three months and double the trend of the restaurant industry.

    Is this an ominous trend or just an aberration? It’s too close to tell at this point but it certainly has my attention. A downward trend in “eating out” has broader implications though. Lately everyone has been focused on the “fiscal cliff” political circus, but it is more appropriate to look at what is happening on Main Street. At times like these, it is important to understand where the real economic power resides and that is with the people. And not just where they shop, but where they eat, in this era of frugality.

    In my opinion, deflationary pressures are still more worrisome than inflation for now. Whatever the ultimate outcome of the fiscal cliff negotiations, you can bet the ranch that taxes are going up and spending will be cut. Of course, how much and in what form remains to be seen. As the tax base gets broadened and entitlement reform takes hold, an enormous amount of shared sacrifice will be required. There’s that phrase again. While everyone likes the idea of less government spending, there are near term consequences. Less government will require a move toward tighter budgets and this will contribute to stress in the job market and after-tax personal incomes, at least for a while. Be careful what you wish for.

     

    Furloughs, layoffs, and now less-generous pension benefits for current public workers and retirees are occurring for the first time ever. Sweeping changes are taking place at the state level as pension trustees and legislatures push for higher monthly contributions to pension plans, a later retirement age and lower annual cost-of-living adjustments for current and retired workers. Unions, at least the ones that don’t make Twinkies, are making concessions because they can see the future - the termination of defined benefit plans in favor of defined contribution plans. Any way you look at it, employee contributions are going up – which is a form of a tax hike. And this will work directly against any upturn in consumer spending when you consider that the state and local government sector employ nearly 20 million people or 15 percent of the nation’s jobs.

    So we will have less government, fewer entitlements and more whisperings that it isn’t just the $250,000+ high-income households that are going to experience tax increases and diminished disposable income growth. This is shared sacrifice. By the way, to think that the nation could have ever gone to war in Iraq and in Afghanistan, putting our troops at great risk, not to mention the emotional toll on their families, while here at home civilians would be allowed to enjoy tax cuts and a debt-financed consumption binge, is outrageous. Remember when if a war was worth fighting everyone did their part. This certainly was not shared sacrifice.

    At all levels of the social structure, starting with households and followed by unions and governments, the US will be swept up in a move to frugality now that the Baby Boom generation has run out of time to speculate. They will be saving the old fashioned way. None of this argues for any significant increase in economic activity.

    The Baby Boomers will, out of necessity, be pursuing a strategy of working longer, saving more and liquidating debt in order to secure a comfortable retirement. At the same time the public sector will also move in the very same direction toward fiscal responsibility. In the case of government, solvency will eventually be restored by reducing non-essential services and severely means-testing entitlements while increasing taxes and user fees. No one will be happy with the outcome.

    One has to wonder what events could provide positive momentum to GDP growth, push corporate earnings to record highs as the consensus predicts as early as next year, or generate any lasting inflation. It’s the people that make these pricing decisions. Businesses can only price up to what consumers are willing to pay. It is households that determine whether or not we have inflation, not some bureaucrat in Washington who believes he has control over some printing press. And when the underlying growth trend is already below 2 percent, one can see that deflation risks are real.

    Yet, many investment analysts are surprisingly upbeat. This all begs the question of what we are supposed to be bullish about, especially since a zero percent interest rate policy rates leaves cash as little more than a tactical asset? Rather than looking for an increase in inflation, it seems far more likely that we could be in for a prolonged period of price stability or modest deflation. I will write more about this in 2013. In the meantime, be patient until the next cycle of growth and global expansion starts in a few years. Thanks for reading.

    S. Nick Massey, CFP®

    President

    Chief Investment Officer


As we near the end of 2012, certainly a stressful and confusing year, it is appropriate to step back and look at some of the big-picture trends tha....

  • December 2012: Will We Go Over the Fiscal Cliff?

    Unless you’ve been living in a cave somewhere, you no doubt have heard about the impending “fiscal cliff.” Some news programs are actually showing a ticking clock with a countdown to the fiscal cliff in days, hours and minutes. I guess a little drama sells news, but REALLY! Is this necessary? As I listen to all this I can’t help thinking of some famous lines from great works of literature.

    “It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way – in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.” Charles Dickens, “A Tale of Two Cities.”

    Or how about a little bit of Shakespeare’s Macbeth:

    “Tomorrow, and tomorrow, and tomorrow, creeps in this petty pace from day to day, to the last syllable of recorded time; And all our yesterdays have lighted fools the way to dusty death. Out, out, brief candle! Life's but a walking shadow, a poor player that struts and frets his hour upon the stage and then is heard no more. It is a tale told by an idiot, full of sound and fury signifying nothing.”

    So what should we make of all this and what will happen? Progress on the negotiations between the Republicans and the Democrats does not seem to be going well and the December 31st deadline is looming. In the absence of some kind of agreement, on January 1st tax rates go back to 2001 levels, defense budget cuts automatically kick in and at least a $600 billion reduction in economic activity will take place in 2013. For an economy that is barely limping along anyway, that almost certainly means recession in 2013.

    The apparent lack of progress in the fiscal cliff talks is being described as a farce and a disgrace by some and by others as a poker game where participants are simply not exposing their cards in the early stage of the game. 

    It’s most definitely not a poker game, a situation where one winner takes it all and the other side loses it all. Neither side in the fiscal cliff talks will feel like the only winner or only loser when a deal is finally hammered out.

    Nor is it a hopeless farce being played out by fools who don’t know what they’re doing. There is no group more highly trained and experienced in the art of negotiating than politicians. Legislation can only be passed or amended through negotiations and compromises that result in enough votes from both sides.

    The foolish part is that it has taken them so long to address the situation, leaving them so little time to get through the process. The risk is they don’t have time for the normal process and go past the end–of-year deadline, or that one side becomes more desperate for a deal than the other and at the last minute grabs prematurely at the last offer.

    A good business deal hammered out in negotiations is considered to be one that does not have a winner and a loser, but one that is fair and acceptable to both sides. And that is certainly what is needed from the fiscal cliff negotiations if both sides are expected to work more closely together for the good of the country for the next few years.

    Unfortunately, political leaders on both sides have become so hostage to the extremes of their parties that they won’t risk compromise for fear of the consequences. It’s time for them to become statesmen and do what’s best for the country and not the party. I think that although it appears hopeless, behind the scenes a compromise is developing.

    So will we go over the cliff? I don’t think so. I’d like to believe that even congress isn’t foolish enough to let that happen. In addition, the market is telling us it won’t happen. Last weekend produced the worst case scenario from the "Fiscal Cliff" front lines - an ultimatum from Treasury Secretary Tim Geithner, followed by finger pointing from both parties blaming the other for the impending economic disaster. News like that would normally send the market down 600 points or so. What did we get? A boring 60 point drop instead.

    When a market fails to go down on bad news, something is going on. It leads me to think a deal is brewing. Have you noticed that each violence-threatening comment from politicians in Washington is generating market dips of diminishing magnitude? Nobody in the investment community believes that the fiscal cliff will not get resolved. The problem is being greatly exaggerated by the media, which is now suffering from withdrawal from the circus that had us all glued to our TV screens during the presidential election.

    Of course, I don’t know more than anyone else, but my guess is that at the very last minute, late December, they announce a compromise agreement claiming that they saved the economy and they’ll be all smiles and handshakes. It will actually be fairly minor and do nothing to solve the long term problems. Those will just be postponed again. But the market will love it and spike to the upside because it means the party is back on – for now. By April we’ll be back to talking about the debt ceiling and Europe again. Then we get to repeat the anxiety all over again. We’ll find out soon.

    Someday congress will have to set politics aside and finally deal with the problem. But that day is not likely now. It will finally happen when there is no other choice. In the meantime, buckle up for a wild ride. Thanks for reading.

    S. Nick Massey, CFP®

    President

    Chief Investment Officer


Unless you’ve been living in a cave somewhere, you no doubt have heard about the impending “fiscal cliff.” Some news programs are....

November 2012

  • November 2012 - Looking for the Smart Money

    Have you ever read an investment report that made reference to the “smart money?” You’ll hear comments how the “smart money” is going into certain stocks or market sectors. My favorite is “watch what the smart money is doing.”

     

     

     

    Well, that sounds like good advice, but how do you know who is smart and who is not? More importantly, what is the standard for smart versus, well, not so smart? And where do you go to watch them? Maybe there is a look-out spot near Wall Street, or a favorite corner, where you can strategically place yourself for an afternoon of smart people watching. Perhaps it’s a lot like bird watching. Oh look! There’s one in a three piece suit.

     

     

     

    Usually it refers to what savvy corporate insiders, institutional investors, hedge-funds, and other professional investors are doing at the time, in comparison to high or low levels of bullish investor sentiment. Unfortunately, the term ‘smart money’ has led to increasing use of the term ‘dumb money’ in some market writing, with the implication that non-professional investors must be dumb.

     

     

     

    That is totally unfair and inaccurate. Individual investors are most definitely not dumb or stupid. That would be impossible just given the fact that they are able to be investors. Individual investors would have to be among the most intelligent, knowledgeable, successful people on the planet to have the success in their chosen careers that provide them with money that can be invested.

     

     

     

    You don’t get to be a successful artist, attorney, doctor, engineer, scientist, business executive, salesperson, small business owner, or whatever, by being anything but knowledgeable, intelligent and sometimes brilliant.

     

     

     

    The term comes from the idea that the so-called ‘smart money’ supposedly buys low, sells high, and thrives from their investing. It also implies that most individual investors lose money over the long-term, or fail to match the gain they would make by simply leaving their money in the bank.

     

     

     

    Numerous studies on the subject seem to verify this. Research firm Dalbar Inc. published a study in 2003 titled ‘Quantitative Analysis of Investor Behavior.’ It showed that from 1984 – 2002 the average annual return on equities was 9.3 percent, while the average annual return of individual investors who invested in those equities was only 2.6 percent over the same period.

     

     

     

    A similar Dalbar Inc. study of bond investors in 2006 showed that over the 20-year period from 1986 – 2005, the Long-Term Government Bond Index had an average annual return of 9.7 percent but the average annual return of individual bond investors was just 1.8 percent.

     

     

     

    So what seems to be the problem for obviously intelligent and smart individual investors? According to other studies, the very fact that they are smart, knowledgeable, intelligent and successful - in whatever is their own field of expertise – may be the problem, as it may cultivate over-confidence when they step into money-management, a field that is not their area of expertise.

     

     

     

    For instance, a survey by the Securities Investor Protection Corporation (SIPC) in 2001 revealed that 85 percent of U.S. individual investors were unable to pass a simple five question investment ‘survival’ quiz. In 2009, the Investor Education Foundation of the Financial Industry Regulatory Authority (FINRA) conducted a similar investor survey. 67 percent of respondents rated their own financial knowledge not just average but high. Yet by far the majority failed FINRA’s test of their knowledge of even the most basic of financial questions.

     

     

     

    In 2012, the Securities & Exchange Commission published a report on financial literacy among non-professional investors. Its conclusion was that “U.S. investors lack basic financial literacy, and have a weak grasp of even elementary financial concepts.” Yet the majority rated their financial knowledge as high.

     

     

     

    It’s obviously a potential problem for investing success when those suffering the consequences don’t even realize they have a problem. Thus, many keep investing the same way in every cycle, making the same mistakes over and over, while expecting the results to be different. (As I recall, wasn’t that Einstein’s definition of insanity?)

     

     

     

    Gerri Walsh, president of the FINRA Foundation says, “There are a lot of people who think they’re good at handling their money, but their results tell you otherwise. Those people are going to be particularly difficult to reach and educate because they don’t think they have a problem.” The market is a great teacher, but its lessons are often not learned. If this describes you, perhaps you need to seek the assistance of a good financial advisor to help you.

     

     

     

    SIPC Vice-President Robert O’Hara said, “We’ve been at this for more than 50 years, and we see the same problem over and over again. Investors are enticed in during bull markets, but then don’t know what to do when things turn sour later. People need to take the time to learn the basics about investing, and how to put them into practice.”

     

     

     

    It sounds like a reasonable suggestion given the statistics. In the meantime, who wants to join me for a little smart money watching? Maybe if we hide in the bushes we can see some walking by. Thanks for reading.

     

     

     

    S. Nick Massey, CFP®

     

    President

     

    Chief Investment Officer


Have you ever read an investment report that made reference to the “smart money?” You’ll hea....

  • November 2012 - Lessons from Leonardo Fibonacci

    “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.” Anne Rice, “The Vampire Lestat.”

     

     

     

    When I was a young stockbroker and commodities trader in the late 1970s, I became aware of a mathematical formula called Fibonacci ratios. What a great Italian name! It just rolls off the tongue like it should be a great Italian dish or a fine wine instead of mathematics.

     

     

     

    Actually, it is a theory or formula developed by Leonardo Fibonacci in the 12th century and he unleashed a body of knowledge that would change the world and how people looked at it. Leonardo was a world class geek by the standards of his day, with a passion for mathematics. He also learned to read books in Arabic and translated them back into Latin.

     

     

     

    In an interesting piece written by my friend and hedge fund trader John Thomas, I learned some interesting things about Fibonacci. He particularly liked ancient math books and there he learned that the Arabs had developed a numbering system vastly superior to the Roman numerals then in use in Europe. More importantly, they mastered the concept of zero and the placement of digits in addition and subtraction. The Arabs themselves borrowed these concepts from Indian mathematicians as far back as the 6th century.

     

     

     

    Now, just think about how significant this was to the world of math. Try multiplying CCVII by XXXIV. (The answer is VMMXXXVIII, or 7,038). Try designing a house, a bridge, a computer software program, or just balancing your check book with such a cumbersome numbering system. Imagine our national debt of $16 trillion in Roman numerals.

     

     

     

    Fibonacci discovered a series of numbers which seemed to have magical predictive powers. The formula is extremely simple. Start with zero, add the next number, and you have the next number in the series. Continue the progression and you get 0,1,1,2,3,5,8,13,21,34,55.... and so on. Not surprisingly, the sequence became known as the "Fibonacci Sequence" or “Fibonacci Ratios.”

     

     

     

    The great thing about this series is that if you divide any number in it by the next one, you get a product that has become known as the "Golden Ratio". This number is 1:1.618, or 0.618 to one. Fibonacci's original application for this number was that it could be used to predict the growth rate of a population of breeding rabbits. I guess that was a valuable skill back then. I wonder if we could use it today to predict the growth rate of a population of central bankers. Oh the mind wanders.

     

     

     

    Fibonacci ratios are mathematical relationships, expressed as ratios, derived from the Fibonacci sequence. The key Fibonacci ratios are 0 percent, 23.6 percent, 38.2 percent, and 100 percent. The key Fibonacci ratio of 0.618 is derived by dividing any number in the sequence by the number that immediately follows it. For example: 8/13 is approximately 0.6154, and 55/89 is approximately 0.6180.

     

     

     

    The 0.382 ratio is found by dividing any number in the sequence by the number that is found two places to the right. For example: 34/89 is approximately 0.3820. The 0.236 ratio is found by dividing any number in the sequence by the number that is three places to the right. For example: 55/233 is approximately 0.2361. Got that? We’ll have a quiz in the morning.

     

     

     

    Over the centuries, other great mathematicians experimented with the numbers and discovered a number of interesting applications or coincidences. It turns out the Great Pyramid in Egypt was built to the specification of a Fibonacci ratio. So is the rate of change of the curvature in a sea shell, or a human ear. So is the ratio of the length of your arms to your legs. Upon closer inspection, the Fibonacci sequence turned out to be absolutely everywhere. Coincidence or by design? You be the judge.

     

     

     

    Fibonacci introduced his findings in a book entitled "Liber Abaci", or "Free Abacus" in English, which he published in 1202. In it he proposed the 0-9 numbering system, place values, lattice multiplication, fractions, bookkeeping, commercial weights and measures, and the calculation of interest. It included everything we would recognize as modern mathematics.

     

     

     

    In the early 1980’s I used the Fibonacci ratios to come up with trading patterns and I used it to day-trade commodity futures contracts for myself and clients. When I saw a certain pattern, I would use the ratios to find the ideal potential trade entry point, the ideal target to sell and the ideal point to bail out if things went wrong. I thought I had discovered the magic formula for all times.

     

     

     

    The great news was that it worked almost exactly 61 percent of the time, just like Fibonacci would have predicted. The bad news was the percentage was the average over a one year period or longer. The short term results were all over the place. When it was hot, it was incredible. When it got on a losing streak, the draw down was so bad it took an incredible leap of faith to hang in there. Sadly, most people don’t have the stomach for that kind of trading, including me. Needless to say, my Fibonacci trading days are long in the past.

     

     

     

    Human beings seek certainty. 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. Models, even flawed ones, give us the illusion of certainty. We need to be careful of what illusions we cling to.

     

     

     

    Today, Fibonacci ratios are used by many technical traders as they try to find support and resistance levels for stock and option prices. High-frequency traders have developed computer models to take advantage of it. Knowing where the Fibonacci traders would likely place their buy and sell orders, they place stop-loss orders just under that price to go short and then enter large, rapid-fire sell orders above it to try and drive the price down and trigger the stops. This is not a game for the faint of heart. It’s also why a lot of technical trading theories of the past are not working so well anymore.

     

     

     

    So what does all this mean for most of us today? Probably not much. But it’s a great story and perhaps you learned a little about some of the methods Wall Street traders use. Now you know the rest of the story. As for me, I’ll just have a glass of that Fibonacci wine please. Thanks for reading.

     

     

     

    S. Nick Massey, CFP®

     

    President

     

    Chief Investment Officer


“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....

October 2012

  • October 2012 - What Will the Market Do After the Elections?

    In a little over three weeks, the November 6th elections will be over and we will finally know who will be in the White House and in Congress. Regardless of the outcome, many people will just be glad that it’s over. It is the unknown that bothers people more than anything else.

     

     

     

    Philosopher Freidrich Nietzsche wrote, "To trace something unknown back to something known is alleviating, soothing, gratifying and gives moreover a feeling of power. Danger, disquiet, anxiety attend the unknown – the first instinct is to eliminate these distressing states. First principle: any explanation is better than none… The cause-creating drive is thus conditioned and excited by the feeling of fear …"

     

     

     

    In other words, we like to feel we know what is going on and any explanation is better than none. And the simpler the explanation, the better. We might hear that the market went up because of this, or went down because of that, and we feel better. We think, “I know what happened” even though down deep we know it’s far more complicated than that. Dealing with the unknown can be disturbing so we look for simple explanations.

     

     

     

    I am frequently asked what I think will happen to the stock market depending on who wins the presidential election. The outcome is still too close to call and I’m not going to try and predict that one. We do know, however, that there have been a number of studies done on whether the market goes up or down when a democrat or republican wins, an incumbent wins or loses, which party controls which house, etc.

     

     

     

    There are a lot of theories out there suggesting a particular outcome from the elections, but I suspect much of it is wishful thinking depending on which person or party you are rooting for. However, the facts seem to suggest that over the long term it doesn’t matter much in terms of what the stock market does. The long term effect on the economy is another matter, but we’re talking about the stock market for now. I know, that probably doesn’t match with your personal hope, but I’m just the messenger.

     

     

     

    According to a study by Forbes, they looked at how the market has historically performed during an election year. Of the 23 election years since 1920, 15 were positive, or 66.7 percent. However, ignoring whether or not they were election years, over those 91 years, 62 were positive anyway, or 68 percent. The market was up about 67 percent of the time whether an election year or not.

     

     

     

    Let’s look at this from a political party perspective. Of the 23 election years, the market was up 63.3 percent of the years when a Democrat was in the White House, and 66.7 percent when it was a Republican. In terms of stock market performance during an election year, we can reasonably conclude that it makes no difference which party is in the White House at election time. Therefore, it would not be wise to base investment decisions solely on that statistic.

     

     

     

    This, of course, speaks to longer term trends in the markets. Short term moves in the markets can be dramatically affected by a number of things, most of which are quite unpredictable. It is important to remember that while the economy and the markets are related, fundamentals do eventually matter. However, the stock market can completely divorce itself from longer term economic trends for a while. The current uptrend in the market this year is in many ways being driven by financial stimulus and hope that government and centrals banks are coming to the rescue. Take the hope away, even briefly, and the market can fall quickly. The short term effect of current central bank monetary policy (i.e. quantitative easing), both here and globally, is to drive assets prices up. All of that extra liquidity is going somewhere, and the stock market is one of them.

     

     

     

    So what does the upcoming presidential election mean for the stock market short term? If I had to guess, and it certainly is just that, I think immediately after the elections the market goes up if Obama wins and goes down if Romney wins. Before I get hate mail from all my republican friends, hear me out. Don’t get me wrong, that is not an endorsement of one or the other, but what I think will be the traders’ reaction near term.

     

     

     

    Because of the economic stimulus provided over the last few years, the market has become like a drug addict constantly needing the next fix to keep from going into withdrawal. An Obama win will be perceived as a continuation of stimulus and Ben Bernanke, i.e. continued doses of drugs. While I don’t think it is good for the economy in the long run, the market likes it in the short run and doesn’t want to come off the high.

     

     

     

    If Romney wins it likely means the end of further stimulus, the end of Ben Bernanke in 2014 and the end of QE. Whether you think that is a good thing or bad thing, and I think it’s a good thing, the market reaction will be a short term sell-off as the addict realizes that the party is over and the next fix is not coming. The long term market trend will be the exact opposite for each candidate, but that is a story for another day.

     

     

     

    Of course, after the dust settles in the coming months, economic fundamentals will matter again and we’ll have to see what our policymakers do to get us all out of this mess. As for the short term reaction, we’ll find out soon. Thanks for reading.

     

     

     

    S. Nick Massey, CFP®

     

    President

     

    Chief Investment Officer


In a little over three weeks, the November 6th elections will be over and we will finally know who will be in the White House and in Congress. Rega....

September 2012

  • September 2012 - Blazing Bazookas from the Fed

    I was wrong. Okay, I said it. I thought for sure helicopter Ben wouldn’t actually do it. That is Quantitative Easing 3, commonly called QE3. But he did and I’m appalled! When will the madness stop? Perhaps only when he drives the economy off the cliff. We were driving toward it already. Now it’s “pedal to the metal.” No Central Bank has ever done anything like this in modern times and we are clearly in uncharted territory with this giant experiment. I hope he’s right because he and European Central Bank Chairman Mario Draghi just bet the ranch on it.

     

     

     

    You might recall that in mid-summer 2007, then Treasury Secretary Hank Paulson asked Congress for the authority to buy-up some troubled sub-prime assets if necessary. He said he didn’t think he would need it but “if everyone knows you have a bazooka in your pocket, you won’t have to use it.” Of course, it wasn’t but a month or so later he fired the bazooka.

     

     

     

    This time it’s Fed Chairman Ben Bernanke firing the bazooka. Actually it looks more like a cannon and it’s starting to look like the shoot-out at OK Corral. What the Fed did was actually more than QE3. Call it QE3 plus – a gift that will now keep on giving. No maximum. No time limit. The Fed also lowered the bar on what it will buy going forward, for even more intervention. I think he just cleaned out its ammunition shed.

     

     

     

    I recall a funny sign someone had in their office years ago that said, “The beatings will continue until morale improves.” That’s what this round of QE feels like. Instead of doing a certain amount of QE, or for a certain time period, this time it is open ended. They will keep doing it until things get better. What does that mean? More importantly, what if it doesn’t? Do we keep going until the “mother of all bubbles” finally explodes? This is pretty scary stuff.

     

     

     

    It seems that all major central banks of the world have basically said they will never face the music and allow economies to seek their natural levels. Instead, they will continue to print money, i.e. expand their balance sheets, until things get better or the market no longer lets them get away with it.

     

     

     

    QE adds money to the system. It also lowers the value of money and drives asset prices up, especially commodities, oil, food, gold and the stock market. They wish it would drive up real estate prices but that is not working so well. It does nothing to improve the economy. It hopes that higher asset prices and the so-called wealth effect will make people feel better, spend more money and cause business profits to expand and thus create the need for hiring people to produce all the things they are buying. It hasn’t worked so far.

     

     

     

    What is not addressed here is liquidity is not the problem. Lack of demand is the problem and that is not changing anytime soon until the demographic headwind we are all facing, and the deleveraging of excess debt runs its course. This only postpones the problem. Banks have plenty of money to loan. But most of the people the banks would like to loan to don’t want or need a loan. And many of the ones who want a loan don’t qualify under today’s tougher lending standards.

     

     

     

    Much of the idea of the Fed buying mortgage backed securities is to help the housing market with cheaper loans, but average mortgage rates are currently 3.7 percent and that has not created significant additional home buying. If 3.7 percent can’t get more people to buy homes, will 3.2 percent? Maybe some, but not much.

     

     

     

    It will probably create another round of refinancing, but it doesn’t help the housing market. It does nothing for the person who can’t qualify for a home loan, or is underwater on their home mortgage and would love to refinance but can’t. Until that problem is solved, the housing market is stuck. The harsh reality for the housing market is the backlog of homes with negative equity, and the demographic headwind of downsizing baby boomers, is so ferocious that the Fed is unable to push against it.

     

     

     

    One thing significantly different this time is the Fed’s policy is very explicitly tied to the labor market. “If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability,” the Fed said in its official statement. In other words they will keep doing this until the job market improves substantially. That could be a long time. As I said, we are now in uncharted waters here. Did I mention that I’m really ticked off about this?

     

     

     

    However, this is a game changer for investors and the “risk on” trade is back with a vengeance. All of the money is going to go somewhere and the stock market is one of those places. This is not about fundamentals. This is about money looking for a place to go. All bets are off and the direction of the stock market is definitely up for the time being. Oh, for sure 2013 still looks very precarious and nothing about the U.S. or global economy has really changed or is likely to change anytime soon. But in the meantime, if you’re an equity investor and can stand the volatility, buckle up and go for the ride.

     

     

     

    One other thing QE3 does is take money from savers. Why? Because as Willie Sutton is famous for saying, "That's where the money is." Ben Bernanke needs your money. He wants your money and he is taking your money. He recognizes he is taking your money. In fact, he addressed this exact thing in the press conference on September 13th. One of the three concerns he addressed before taking questions was how these programs hurt savers. Bernanke noted that those who invest in CDs or other short term safe investments were earning nothing. However, he added, “Surely the Americans are better off by a rebounding economy with higher stock prices, higher home prices, and falling unemployment.” Huh? I missed the connection he made.

     

     

     

    Let’s see. He takes money from savers by forcing interest rates lower than they would otherwise be. He introduces a program that makes the cost of living (food, energy, etc.) go higher. The combined effect of these two things is a falling standard of living. Yes, there is no doubt that this causes a rising stock market, but are conservative investors gambling their wealth on equities? Every report I have seen shows fewer individuals involved in the stock market, not more. And rising home prices? Really? Falling unemployment? Yes, in some areas, but only with the creation of lower paying jobs. Somehow I don't feel better about this. I’ll bet you don’t either.

     

     

     

    When Ben Bernanke became chairman of the Federal Reserve in 2006 he promised a significant change. He has certainly kept his promise. Please stop the madness Ben. And please stop playing with that bazooka. You’re making me nervous. Thanks for reading.

     

     

     

    S. Nick Massey, CFP®

     

    President

     

    Chief Investment Officer


I was wrong. Okay, I said it. I thought for sure helicopter Ben wouldn’t actually do it. That is Quantitative Easing 3, commonly called QE3. ....

  • September 2012 - Welcome to September – Here We Go Again

    You can learn a lot about life and the world by watching old movies and reading classic works of literature. Great lines can sum up thoughts and emotions in a few words. In the 1942 classic WWII film Casablanca, Claude Rains as Captain Renault uttered the immortal words, “I’m shocked, shocked to find gambling going on in this establishment!” That was shortly before the croupier approaches him, hands him a wad of bills, and says, “Your winnings sir.” It’s a funny moment that makes me laugh every time.

     

     

     

    If you listen carefully to the dialogue in that movie you start to get a feeling that they were not only talking about the world at war back then, but also about the world in chaos today.

     

     

     

    I get the same reaction every time I hear someone in the world of Wall Street expressing shock and dismay about new revelations of someone gaming the system. Who would have thought that gambling, speculation and manipulation would be going on in the financial markets? Be still my heart.

     

     

     

    When Spanish Prime Minister Mariano Rajoy and French President Francois Hollande (both extreme socialists) were elected to office, it reminded me of the character Rick Blaine's final words, "Louie, I think this is the beginning of a beautiful friendship."

     

     

     

    After only a few months, regarding the relationship between these two world leaders, we know that the electorate now understands that more of the same does not result in a different outcome. Therefore, in Europe unemployment continues to rise, housing deteriorates, and hope declines.

     

     

     

    People can grasp Rick's confusion when asked why he came to Casablanca as he responded "My health, I came to Casablanca for the waters." Renault replied "The waters?" "What waters?" "We're in the desert." Rick answered, "I was misinformed." So too is the world misinformed, as the same failed policies of the past are repeated again and again and again.

     

     

     

    Most people have absolutely no clue about high-frequency trading, mark-to-model, or a dozen other tactics and techniques that create fraudulent and manipulated financial markets. However, if people were informed they would probably respond in the following manner. Signor Ugarte: "You despise me, don't you?" Rick: "If I gave you any thought I probably would."

     

     

     

    Every day as the world crumbles, the same corrupted names come to the top of the list. Again and again, the fines are levied, the wrists are slapped, and business continues as usual. From Goldman Sachs to Morgan Stanley and from J.P. Morgan to Bank of America, it's always the same.

     

     

     

    Captain Renault: "Major Strasser has been shot. Round up the usual suspects." I could talk about "all the gin joints in all the towns in all the world," or even the phrase from Casablanca, "play it again Sam." Yet, as the optimists hope for something that really "doesn't amount to a hill of beans in this crazy world," perhaps the most appropriate ending is "here's looking at you, kid."

     

     

     

    As so now we arrive in September. After an August that may go down in history as one of near terminal boredom, the fireworks are about to go off again. Governments and central banks have pushed many decisions off to this month with hints and promises through the summer of being ready to come to the rescue if needed.

     

     

     

    Fed Chairman Bernanke did so again recently, but increased the level of assurances enough so expectations are high for action from its FOMC meeting this month. Economic reports in the euro-zone continue to weaken, putting still more pressure on officials to act. Moody’s has put the European Union’s triple-A credit rating on a negative outlook. The number of unemployed workers has surged to a record 18 million, or 11.3%, and both consumer and business confidence is at a three-year low.

     

     

     

    Officials are back from their vacations and this is the month of various meetings in Europe that are also supposed to finally come up with meaningful solutions. First in line is the European Central Bank’s meeting, which is expected to decide to what degree the ECB will back its President Draghi’s promise a month ago that the ECB “will do whatever it takes to save the euro. And believe me, it will be enough.”

     

     

     

    But European stock markets are uncertain and still waiting. Unknown is what kind of fiscal agreements Spain and others will have to agree to in order to have access to the program. Spain has said it will not take the required next step of requesting a bailout until it knows the details of what will be involved. Here’s a note to officials on the relationship between the rescuer and the one being rescued – you don’t get to gripe about not getting a window seat on the life boat. Just a thought.

     

     

     

    Will central banks end the summer’s uncertainties with positive actions that will disrupt the history of September being rough on investors? We’ll soon know. The big day to watch is September 12th when a number of critical decision may be announced and no one is really sure which way it will go. Buckle up for a wild ride. Of course, some people are just worn out and may want to borrow another great movie line. “Frankly my dear, I don’t give a damn.” Thanks for reading.

     

     

     

    S. Nick Massey, CFP®

     

    President

     

    Chief Investment Officer


You can learn a lot about life and the world by watching old movies and reading classic works of literature. Great lines can sum up thoughts....

August 2012

  • August 2012: Bull Market, Bear Market – Which is it?

    In the 1933 movie “I’m no Angel”, Mae West famously said, “I used to be Snow White – but I drifted.”  Some portfolio managers might need to say the same thing.  Long gone are the comparatively easy investment days of 1982 to 2000 when all you had to do was just buy and then hold through the occasional market downturn.  Now, performance seems to be just drifting as everyone tries to figure out what to do.

     

    Such is the nature of a secular (long term) bear market.  That’s why, after all the dramatic ups and downs over the last twelve years, the market has basically gone nowhere.  Just when it looks like things are getting better, it rolls over; and just when it looks like everything is heading straight south, it starts back up again.  Get used to it because this is not likely to change for a few years.

     

    Since its peak in 2000 the market continues to remind me a lot of 1970’s.  Yes, I was there.  Little did I know at the time that years later I would be reminded of it.  In 1969 the market topped out into a serious bear market, then recovered in an impressive three-year cyclical bull market back to its previous high in 1973, only to plunge to a lower low as the 1973-74 recession began.  At the time, that recession and the accompanying bear market were the most severe since the 1929 crash and Great Depression.  (Despite some rumors, I was not there for that one.)

     

    In our current market, after the 2000-2002 bear market, the market rallied back to its previous high and slightly higher in 2007 in an impressive four year cyclical bull market, only to also plunge again to a lower low in the 2007-2009 financial recession and bear market.  It also set a new record as the worst recession and bear market since the 1929 crash and Great Depression.

     

    And here we are today in another cyclical bull market that began when that severe bear market ended in March 2009, just like the market launched into another cyclical bull market in 1975 as that long-term sideways secular bear market continued.  The big question is whether this secular bear market will also continue the way 1970’s did until 1982.

     

    Long time readers know that I think we have been in a secular bear market since 2000 and probably have about another four to six years to go.  It has been my projection that the market would experience another correction this year and then a rally late in the year and into early 2013.  That, of course, depends a lot on the upcoming election, what the Fed does or doesn’t do, the global economic slowdown and what happens in Europe.

     

    After that I think we face the prospect of at least one more cyclical bear market and recovery before this secular bear market finally ends near the end of this decade.  That would follow the pattern of the last 100 years, in which secular bear markets lasted about 17 to 18 years.  Long-term problems still remain that will require another washout to complete the recovery.  Those problems mostly revolve around the massive government debt throughout most of Europe and in the U.S.  The good news is then we set the stage for the next 18 year secular bull market and unimaginable new market highs.  You just need to be careful not to do too much damage to your portfolio in the meantime.

     

    Mae West also said that “too much of a good thing is a good thing.”  Not so with excesses in the financial world.  Bubbles happen when things go to extremes, and crashes wash out the excess as the bubbles burst.  All bubbles eventually burst.  It’s just a matter of when.

     

    The 2000-2002 bear market resolved the last stock market bubble.  The 2007-2009 recession resolved the housing and financial bubble created by the easy money policies that helped end the severe 2000-2001 recession.  And now we’ll need one more burst to correct the debt bubble.

     

    To combat the debt, economy-crippling austerity programs are already underway in much of Europe. They’re only in the beginning stage in the U.S., but I expect the cutbacks to become more intense after the election.  How that is done will, of course, be the subject of intense political debate.

     

    Over the last 110 years there have been 25 bear markets, or one an average of every 4.4 years.  The current bull market has now been underway for 3.3 years.  It will be 4.4 years old next summer, which will also be the beginning of the often negative first two years of the next Four-Year Presidential Cycle.  Something to think about.

     

    The stock market doesn’t seem to be worried though, and that’s why you should worry.  Now we have global economies worsening, many already in the early stages of recessions, investor sentiment quite bullish and confident (usually a contrary indicator), and corporate insiders selling.  Government debt has reached record levels and governments are unable or unwilling to go further in debt to provide more fiscal stimulus. In fact, pressure is intense for them to begin cutting spending to lower debt.

     

    The Fed and other central banks have pretty much used up all the monetary ammunition they had, putting out the fires in the summers of 2010 and 2011.  They’re now trying to get as much mileage as possible from promises to come to the rescue without actually taking much action.  The next few months will be quite interesting.  For now, it looks like we’re still drifting. 


In the 1933 movie “I’m no Angel”, Mae West famously said, “I used to be Snow White – but I drifted.”  Some....

  • August 2012: I’ll Have What They’re Having

    In the 1989 romantic comedy movie “When Harry Met Sally”, actress Meg Ryan tries to convince actor Billy Crystal that not all "verbal cues" women give men are honest ones.  After Ryan makes her case with a rather unique demonstration of, shall we say “faked emotion”, the classic line is given by an adjacent woman diner who is asked what she would like to order.  She nods at Ryan and says “I'll have what she's having.”

     

    Many people might have a similar comment when considering what they think might be a reasonable expectation of investment returns.  We hear that the long term average annual return of the stock market since 1930 is, depending on who you believe, somewhere between 9 and 11 percent.  Even if that is true, people don’t live and spend on averages over 80 years.  During that period, there were some really great years and some that were just downright awful.

     

    One of the challenges in managing any portfolio is setting realistic expectations.  When we were in a secular bull market from 1982 to 2000, it was easier to achieve higher returns.  However, in a secular bear market like we’ve been in since 2000 and probably have another 5 or 6 years to go, it’s much harder.  Can you achieve higher returns in today’s market, perhaps 10, 15 or 20 percent?  Of course you can.  But doing it will require much higher levels of risk and active trading.  What if it doesn’t work out?  Can you stand the volatility or afford the loss?

     

    As investors, we can’t afford to turn a blind eye to risks, especially not to asymmetrical risks. We can’t afford to take risks that may work, but are likely to wipe us out if they don't work.  Understanding your potential reward is worthwhile.  Understanding your potential risk is everything.

     

    So let’s look at investment performance from a real world view.  If asked how your investment portfolio has performed, that should prompt a question, “compared to what?”  You see, if you were to measure your performance against the S&P 500, which is up about 9 percent year to date, you might not have done as well if you had been quite conservative with your investments.  What if you were conservative and only made 4 percent?  Is that bad?  Well, if you compare it to the overall stock market, yes.  But how many people would actually have their entire investment portfolio in the stock market?  Very few.

     

    However, if you compare it to the risk-free rate of return, that was pretty good if you didn’t take a lot of risk doing it.  The “risk-free rate of return” is a term analysts use to identify what you could have earned without taking any risk.  Typically that is something like short term T-bills or CDs.  In a time not too long ago, you could have earned 3 percent in T-bills or perhaps 4 or 5 percent in a one year CD, all guaranteed and no risk.

     

    If you could make 4 percent on a risk-free investment (and were happy with that), but instead you invested in a diversified portfolio of stocks and bonds and earned 5 percent - well, that’s not too impressive.  In fact, it’s pretty awful given the extra risk you had to take to make 1 percent more.

     

    Today, however, the risk-free rate of return in T-bills, money market funds and CDs is almost zero.  Given that scenario, if you managed to earn 4 percent in your portfolio and you took a minimal amount of risk doing it, then you might consider that fairly significant excess performance.

     

    Bill Gross of Pimco Funds coined the term “new normal” a few years ago.  Perhaps we should call it the new abnormal instead.  For reasons I have talked about extensively, I believe we are likely stuck in the new abnormal, i.e. lower average returns, for the remainder of this decade.

     

    Let’s consider what it might take to achieve something like a 7.5 percent return in a given year.  I use that number because that happens to be the assumed rate of return that the actuaries are using for most pension funds, including Oklahoma.  If the investment mix of the portfolio was 60 percent fixed income (bonds) and 40 percent equities (stocks), which is fairly common, what return would you have to achieve in each part?

     

    Let’s assume that you could achieve a total return of 4 percent in the fixed income portion.  That would be pretty generous in today’s market, but bear with me.  If you did, you would then need to earn a total return of 12.75 percent on the equity side to get the entire portfolio to a 7.5 percent return.  Given the precarious condition of the U.S. and global economy now and for the foreseeable future, what do you think are the chances of that happening?  If you only earned 3 percent on the fixed income side, you would need to earn 14.25 percent on the equity side.  That’s a pretty tall order.

     

    What if you decide to get more aggressive than a 60/40 mix, say 40/60?  Then the equity side would have to earn 10.5 percent, but you would have a bigger portion of the portfolio exposed to more risk if anything goes wrong. 

     

    Whatever mix you decide, try averaging that for 10 years or more to meet the actuarial assumptions, or your personal target return, and you now see the difficulty you are facing in today’s world.  In my opinion, that kind of total return is not going to happen for most people without taking on tremendous risk.  It might work out, but if you have any kind of bad year, it all blows up.  Can you stand the risk?  I think I’ll have what they’re having. 


In the 1989 romantic comedy movie “When Harry Met Sally”, actress Meg Ryan tries to convince actor Billy Crystal that not all "verbal c....

July 2012

  • July 2012: "We Don't Need No Stinkin' Rules"

    “Rules?  We don’t need no stinkin’ rules.”  Many people have heard this funny line.  The actual famous quote from the movie “The Treasure of Sierra Madre” was, “Badges?  We ain’t got no badges.  We don’t need no badges!  I don’t have to show you any stinkin’ badges!”

     

    The revised popular version is a fun variation of the original and a quote with attitude.  Attitude is what I always liked about Bob Farrell.  As a young stockbroker with Merrill Lynch in the late 1970s and early 1980s, I recall how we all used to look forward to Bob’s comments.  Bob was Merrill Lynch’s market analyst and commentator throughout the late 1960s and up to the early 1990s.  A true legend on Wall Street, he was funny and articulate, and sometimes totally irreverent in his commentary.  He retired as Chief Stock Market Analyst in 1992 but continues to write occasionally.

     

    With all the current volatility in the stock market, and no shortage of opinions as to what is going on, I thought it might be a good time to trot out some of his best lines for your enjoyment and education.  They have aged well over time and are as true today as they were when he first wrote them.  Many people still quote them.  “MarketWatch” gathered some of Farrell's more famous observations, and republished them as “10 Market Rules to Remember.”  With a little help from Barry Ritholtz and his blog “The Big Picture”, here are Bob’s rules.

     

    1. Markets tend to return to the mean over time.  When stocks go too far in one direction, they come back.  Euphoria and pessimism can cloud people's heads.  It's easy to get caught up in the heat of the moment and lose perspective.

     

    2. Excesses in one direction will lead to an opposite excess in the other direction.  Think of the market baseline as attached to a rubber string.  Any action too far in one direction not only brings you back to the baseline, but leads to an overshoot in the opposite direction.

     

    3. There are no new eras -- excesses are never permanent.  Whatever the latest hot sector is, it eventually overheats, reverts to the mean, and then overshoots.  Look at how far the emerging markets and BRIC nations ran over the past 6 years, only to get cut in half.  As the fever builds, a chorus of "this time it's different" will be heard, even if those exact words are never used.  And of course, it -- Human Nature -- never is different.

     

    4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.  Regardless of how hot a sector is, don't expect a plateau to work off the excesses.  Profits are locked in by selling, and that invariably leads to a significant correction -- eventually.

     

    5. The public buys the most at the top and the least at the bottom.  That's why contrarian-minded investors can make good money if they follow the sentiment indicators and have good timing.  Watch Investors Intelligence (measuring the mood of more than 100 investment newsletter writers) and the American Association of Individual Investors survey.

     

    6. Fear and greed are stronger than long-term resolve.  Investors can be their own worst enemy, particularly when emotions take hold.  Gains "make us exuberant; they enhance well-being and promote optimism," says Santa Clara University finance professor Meir Statman.  His studies of investor behavior show that "Losses bring sadness, disgust, fear, regret.  Fear increases the sense of risk and some react by shunning stocks."

     

    7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.  This is why breadth and volume are so important.  Think of it as strength in numbers.  Broad momentum is hard to stop, Farrell observes.  Watch for when momentum channels into a small number of stocks.

     

    8. Bear markets have three stages -- sharp down, reflexive rebound and a drawn-out fundamental downtrend.  I would suggest that even with the market rally since March 2009, we have yet to see the long drawn out fundamental portion of the Bear Market.

     

    9. When all the experts and forecasts agree -- something else is going to happen.  As Bob Stovall, the S&P investment strategist puts it: "If everybody's optimistic, who is left to buy?  If everybody's pessimistic, who's left to sell?"  Going against the herd as Farrell repeatedly suggests can be very profitable, especially for patient buyers who raise cash from frothy markets and reinvest it when sentiment is darkest.

     

    10. Bull markets are more fun than bear markets.  This is especially true if you are long only or mandated to be fully invested.  Those with more flexible charters might squeak out a smile or two here and there.

     

    So there you have it, the wisdom of Bob Farrell.  Even after all these years, he still makes sense.  I guess we could use a few stinkin’ rules afterall. 


“Rules?  We don’t need no stinkin’ rules.”  Many people have heard this funny line.  The actual famous quote....

  • July 2012: What the LIBOR Scandal Means to You

    It seems there is no shortage of financial scandals to write about these days.  By now you have no doubt heard about the latest financial scandal involving LIBOR, the London InterBank Offering Rate.  From a writer’s standpoint, this is like the gift that keeps on giving.  You can’t make this stuff up.  Barclays Bank admitted to manipulating LIBOR in 2008, at the height of the financial crisis. Their excuse? Not only did they get the hint from the Bank of England that they should hold LIBOR lower than it would otherwise be, but they said almost everyone else was in on the game too.  Well, maybe not everyone.

     

    For those not familiar with it, many bank loans around the world use LIBOR as a benchmark for the interest rate charged on a given loan.  It will usually be expressed as LIBOR plus a certain percent.  Trillions of dollars in loans are tied to LIBOR in some way.  So why is this scandal such a big deal?  Borrowers who have loans outstanding at LIBOR or LIBOR-plus got a good deal. This includes many Americans who financed their homes on an adjustable rate, which was usually the prevailing LIBOR plus some number, like 2.25 percent.  With LIBOR held lower, borrowers paid less interest.  For a borrower, this is a good thing.  However, if you were the lender, it was not so good.

     

    Many of these types of loans are included in securitized baskets of mortgages that were bought up by pension funds, insurance companies, and others.  These institutions became the lenders to many of the borrowers - the homeowners.  So as homeowners got the gift of paying a lower interest rate than they should have, the lenders – the pension funds and insur­ance companies – got less than they should have received.  So we have pensioners, insurance contract holders, and other fixed income investors that basically had their interest stolen from them.

     

    Borrowing some dialogue from Groucho Marx in the movie “A Night in Casablanca.” - “Groucho: You know I think you’re the most beautiful woman in the world?

    Woman: Really?

    Groucho: No, but I don’t mind lying if it gets me somewhere

     

    The magazine “The Economist” recently wrote that Bob Diamond (Barclays CEO)...retorted in a memo to staff that “on the majority of days, no requests were made at all” to manipulate the rate.  This was rather like an adulterer saying that he was faithful on most days.”

     

    Attempts to manipulate free markets invariably end badly.  From the Tulip Mania of the 1600s, to the Eerie War of the 1860s through the soybean market in 1977-78, the Hunt Brothers’ ill-fated attempt to corner the silver market in 1979-80 and fur­ther attempted corners in the tin market (1981- 82 and 1984-85) as well as Enron’s interference with energy pricing in 1985 and various attempts to manipulate the Treasury markets, all these episodes ended badly for those perpetrating them.

     

    The very fact that these episodes were brought to light is always one of the main reasons that most people inherently disbelieve in conspiracy theories.  After all, how can a manipulation of such size or scale evade the harsh light of truth?  Well, of course, it can’t.  The only difference is the length of time they remain in darkness.

     

    To borrow a common line from the infomercials - But wait; there’s more!  When Barclays CEO Bob Diamond got thrown under the bus, he decided he wasn’t going alone.  It now seems that a giant conspiracy has been going on for years to rig LIBOR, involving the Bank of England and many major banks. There is never just one cockroach.

     

    Let’s take a look at how LIBOR works.  LIBOR is actually not just one interest rate.  It is the name for rates calculated in 15 currencies for loans of 10 different maturities, ranging from overnight to 12-months.  The setting of LIBOR begins each morning in London when someone in one of the designated LIBOR panel banks enters a number into a piece of Thomson Reuters software that asks the question: “At what rate could you borrow funds, were you to do so by asking for and then accepting interbank offers in a reasonable market size just prior to 11am?”

     

    Without going into extreme boring detail, suffice it to say that numbers are submitted by many banks and the highest and lowest 25 percent are thrown out.  The middle 50 percent are then averaged, producing a figure that is published as that day’s LIBOR.  Think about this for a moment and notice the obvious.  Given that almost half the reported inputs that help establish the LIBOR rate are discarded immediately, Barclays simply could not have manipulated the LIBOR rate alone.  Plenty of people were in on the scam.  It also seems that a lot of winking has been going on and this was the dirty little secret that everyone inside knew about.

     

    If you were trying to manipulate LIBOR alone, to effectively insure the rate is set at the price required, you’d need to not only establish the highest and lowest 25 percent of prices, but then insure the remaining 50 percent average out to the required rate.  Based on the fact that there are 16 banks that submit rates, about 13 of the 16 involved would need to be complicit.

     

    At best this is a cartel, at worst it is outright fraud on a scale that is completely unprecedent­ed.  Which is it?  OK... I guess that answers that question.

    Forget “too big to fail.”  Was this was “too deep to prove?”  Let’s all shout the Latin phrase “Fiat Lux” – Let There Be Light!

     

    You can expect lots of fireworks from this situation in the weeks and months ahead, and expect it to “jump the pond” to the US as we see our American banks pulled into the fray.  Stay tuned.  What does it mean to you?  Most likely a financial sector under more pressure and one more reason to cast a wary eye towards the equity markets. 


It seems there is no shortage of financial scandals to write about these days.  By now you have no doubt heard about the latest financial scan....

June 2012

  • June 2012: Fed Adding to the Financial Problems of Cities and States

    To paraphrase Newton’s third law of motion, for every action there is an equal and opposite reaction.  Newton was talking about physical laws, but I like to think that in the world of finance and economics there are similar laws.  Some might call them unintended consequences.  This past week, as the Federal Reserve contemplated an extension of operation twist or some other form of expansive monetary policy, their actions have been causing unintended consequences for cities and states around the nation.

     

    For those not as familiar, an extension of  "Operation Twist,'' in which the central bank sells bonds with maturities of three years or less and buys securities with maturities of six years and longer, is seen as a less extreme step than outright purchases of new securities. However, in leaving the door open for further action, in the Fed’s post-meeting statement, the Fed said it is "prepared to take further action," a stronger sign that there may be a third round of quantitative easing, or QE3 coming.

     

    The Fed has broad mandates to maintain stable prices (low or no inflation), moderate interest rates, and full employment.  Along with these goals, the Fed was given broad powers to affect money in the US.  Unfortunately, the goals and the tools to do so don’t exactly match.

     

    How does monetary policy lead to jobs?  Only by the 3rd or 4th derivative.  This means the Fed lowers interest rates or expands money supply, hopes that these actions lead to increased borrowing and therefore spending, and hopes that the spending leads to business expansion, and that leads to jobs.  Yeah right!  As we have seen with QE1, QE2, Operation Twist, and other various programs, reality is often much different than theory.  However, in this reality, such programs do create outcomes, even ones you don’t necessarily want.

     

    As the Fed has continued to push on the string of economic activity, it has continually worked toward a lower interest rate environment.  This has pushed 30 year mortgages down to 3.53 percent, lowered the cost of borrowing for the US government and corporations, and even made buying a car cheaper.

     

    And then there is the other side of the coin.  Not considering individual investors for the moment, large investors, like pension plans, have seen their fixed income returns fall like a rock.  This means that these funds have to work hard to make up what has been lost to lower interest rates, which usually involves seeking out higher return alternative investments.  That also means higher risk.  In the meantime, public pension funds have two all-important numbers they must keep in mind – their assumed rate of return and their discount rate.

     

    The assumed rate of return for a pension is exactly that, the rate the fund expects to earn over the long term, smoothing out annual gyrations.  The discount rate is the interest rate used to determine the present value of estimated fund balances.  The higher the expected rate of return, and the higher the discount rate, the less a pension fund has to put away today in order to meet its future obligations.  Of course, if interest rates are going lower, then things get dicey.  If interest rates stay low, so that funds earn less than they projected and they also have to determine present value with a lower discount rate, then the current funding status of pension funds fall off a cliff.  Welcome to the cliff.

     

    We are in year five of the financial crisis, where liquidity has been uneven and only financial engineering from central banks has boosted markets.  Financial repression – the artificial suppression of interest rates – is the order of the day and will be with us for at least two more years.

     

    The outcome?  According to a study just released from the Pew Center, using 2010 fiscal year data, state pension and healthcare funding has imploded, with the underfunded number ballooning from $1 trillion in 2009 to $1.4 trillion in 2011.  Only Wisconsin has a fully funded pension fund.  Oklahoma is 56 percent funded, although that number has improved somewhat with steps taken over the last two years.  No state has fully funded healthcare.  Unfortunately, some states are making matters even worse.  In 2010, only 19 of the 50 states made their full pension contribution.

     

    The good news for us locally is that the City of Edmond has always been fiscally responsible and city pensions are fully funded.  At the state level, because of the leadership of State Representative Randy Brogdon on pension reform, we are heading in the right direction.

     

    The truth is these funding numbers are all fantasy numbers anyway.  The interest rate environment is low, and will be for years.  States are reporting paltry earnings on their fixed income investments and on their overall portfolios.  So what do many states do?  They continue to assume a 7.75 - 8.00 percent rate of return, of course.  If states actually dropped this number to a more realistic 4.5 – 5 percent rate of return, then the funding gap would grow by another 40 percent, leading to a $1.96 trillion dollar gap.  Ouch!

     

    None of this is exactly news.  The reason for pointing out where we are is to bring up the question of, “What’s next?”  If states and cities do not have the funding for their pensions and healthcare, which I have been ranting and raving about for many years, then what is the outcome?  On the provider side, it shows up as higher taxes, less service, more layoffs of employees, less funding for universities, etc.  On the recipient side, it will require higher contributions and lower benefits.

     

    All of this is leading to a situation where reality is finally acknowledged and these generous plans are recognized as unaffordable.  Then the pain of what that reality means sets it.  It’s all called austerity, and it soon will be coming to cities and states that failed to act properly.  Another reason you can be glad you live in Oklahoma. 


To paraphrase Newton’s third law of motion, for every action there is an equal and opposite reaction.  Newton was talking about physical....

  • June 2012: Greek Economics in the Real World

    As you know, I have been writing about the economic situation in the Eurozone, and Greece in particular, for some time now.  I thought it would be interesting to view the situation there from a real life perspective – sort of a “man on the street” commentary.

     

    A friend of mine runs an international investment firm from what some would consider paradise.  He lives and works on a small South Pacific island called Vanuatu.  Seriously!  How cool is that?  I love seeing pictures of his office.  Anyway, he recently took a trip to Greece and Hungary.  Sensing an opportunity, we asked him to report back on what he saw and his general impressions of the two countries.

     

    He offered some rather interesting observations about Greece and a comparison to Hungary, where the Forint has dropped dramatically in value, making the country a bargain for travelers.  I was particularly interested in Hungary because my wife and I visited Budapest last summer and observed a wonderful country but one struggling to overcome many economic obstacles.

     

    In talking to people in Budapest during the two weeks he was there, a general comment he heard from many Hungarians was they thought they had no future.  There was a general feeling of resignation that this was just how it was going to be.  This is particularly sad for them since they had suffered so much at the hands of the Soviet Union and were finally starting to enjoy prosperity in the free world.

     

    When they had to travel outside Hungary, or buy goods from other places, or pay mortgages denominated in other currencies like the Euro or Swiss Franc, the cost had gone up substantially due to their falling currency exchange rate.  On the other hand, from a foreigner’s perspective, it was an amazingly cheap place to visit and live since the forint had fallen approximately 33 percent in the last five years.

    Athens, Greece was another story.  My friend arrived the night of the recent elections and there were police on almost every corner.  Things looked pretty normal until you looked closely and noticed how empty the place is and how many shops are vacant.  His first impression was that there was nothing wrong with the place and the media hype was just that.  But then he took a closer look and was shocked.  The Hungarians may think they have no future but Greece is the poster child for no future.

    He was on a tour for three days with a group of 66 people.  The combined cost of the diesel fuel (which is not cheap) to keep the bus running and the bus driver was cheaper than the money being paid to the unionized tour guide.  A major problem for Greece is fixed labor costs in a declining economy.

     

    He found the service in restaurants to be really slow and incredibly overpriced.  A 500ml beer in Hungary cost 1 Euro but was 5.7 Euros in Greece for a 375 ml beer.  When he ordered a meal at a restaurant at 7:00, he got it at 11:00.  Needless to say, service in many parts is severely lacking.  Perhaps no one cares anymore.

     

    In downtown Athens, roughly 33 to 50 percent of the stores were closed and out of business.  This is a major city.  Imagine walking around New York City and every second or third store is out of business.  The tour guide said that before the financial crisis, taxis were always moving and sometimes two or three people had to share a cab.  But now many of them were sitting idle and it was no problem getting a taxi.

     

    An interesting comment from many of the cab drivers was that they were certain the immigrants were the problem.  They think the country will leave the Eurozone soon and go back to the drachma, and then investment in the country will return when the Euro and the “illegals” are gone.

     

    Hmmm.  Seems like I’ve heard that argument somewhere before.  Perhaps here?  It couldn’t be because they spent beyond their means, or had pension commitments that they can’t meet, or incurred debt beyond what they could ever pay could it?  But I digress.

     

    One thing interesting was when he went to a dinner and folk-lore show where the whole show was in Greek.  They sang in Greek, danced Greek dances and served Greek food but the singer sang one song in English.  Ironically, the song was “I Will Survive” by Gloria Gaynor.


    There was some good news though.  The outer islands like Hydra are still booming and there were no noticeable empty shops and the beer and food was much cheaper.  But even that is a different world now.  On one busy corner there were three restaurants - a TGI Fridays, which was doing well; there was a McDonalds and then there was a Starbucks.  Some things are just universal.

     

    Greece is known for its many ancient ruins.  It is very sad, but it may also become known for a number of modern day ruins as well.  This is economics in the real world.  I’m afraid that the people of Greece are going to have to endure many years of difficult times before things recover. 


As you know, I have been writing about the economic situation in the Eurozone, and Greece in particular, for some time now.  I thought it woul....

May 2012

  • May 2012: With Investing, Slow and Steady Wins the Race

    Did you hear the one about the dog and the economist scratching at the back door to get in?  When you finally let them in, what’s the difference?  The dog stops whining.  (Drum roll please.)

     

    Okay, I confess to being guilty also.  I’ve been accused of being a little negative more than a few times, although I like to think I’m just being realistic.  The BTW (Beautiful and Talented Wife) might suggest otherwise though, and I’ve learned that it’s never good to disagree with someone with superior knowledge.

     

    Economics has been known in some circles as the “dismal science” and there is probably good reason to whine a lot, especially in the world we live in today.  I’m not a real economist though.  I like to say I’m a street economist.  I live out here in the real world trying to figure what it all means to real people and real investors.  To borrow loosely from an old TV commercial, “I’m not a real economist but I played one on TV.”

     

    In Lewis Carroll’s Alice in Wonderland, Alice asked, "Would you tell me, please, which way I ought to go from here?"
    "That depends a good deal on where you want to get to," said the Cheshire Cat.
    "I don't much care where . . . " said Alice.
    "Then it doesn't matter which way you go," said the Cat.
    ". . . just so long as I get SOMEWHERE," Alice added as an explanation.
    "Oh, you're sure to do that," said the Cat, "if you only walk long enough."

     

    That little piece seems to sum up what a lot of investors and economists do with their investments.  While just whining about it and without a plan for where you are going, you’re sure to get somewhere if you walk long enough.  The problem for some has been that even when you thought you knew where you were going, it turns out the directions might have been wrong.  Such may be the case with an investment process commonly called Modern Portfolio Theory.

     

    Modern Portfolio Theory (MPT), more properly called Mean Variance Optimization, grew out of the research of Nobel Prize winner Harry Markowitz in the 1960’s.  It became the darling of Wall Street in the 1980’s and just about became gospel in the 1990’s.  As is the case with most theories, it works until it doesn’t.  And since the beginning of this century, it hasn’t worked well at all.

     

    While too complicated to go into much detail in this short article, the basic premise of MPT is that one can mathematically define levels of risk in a portfolio and from that create portfolios that offer the most potential reward for a given level of risk.  Notice it does not suggest that this prevents someone from losing money.  It only attempts to reduce volatility within a given level of risk.  Unfortunately, this idea is often sold to investors as the fool proof way to manage investments.

     

    It also suggests that investors who are willing to take on greater risk can expect greater reward.  But is that true?  Does greater risk, if you can stand the volatility, actually result in greater returns over time?  A new study recently released by veteran quantitative-investment analyst and economist Robert Haugen suggests that less risky stocks, as measured by volatility, actually outperform more risky or more volatile stocks over the long term.

     

    Haugen studied every stock market in the world from 1990 to 2011 and found that the average return of the least volatile stocks outperformed the most volatile stocks by an average of 17 percentage points. For U.S. equities, the study found that the least volatile 10 percent of stocks had an average return of 12.2 percent over the period, while the most volatile 10 percent combined for an average decline of 8.8 percent.

     

    Clearly, this flies in the face of MPT and certainly argues for a less risky equity portfolio for the long term.  Sure, there are times when the stock market is surging up and riskier stocks tend to do better in that environment.  But keeping those gains assumes you know when to hold and when to sell.  Very few investors are actually very good at that.

     

    Research in this area, which can be traced back to at least five decades, shows that stocks with lower volatility over the long term consistently outperform stocks that are more highly correlated to market risk.  Unless you can time it just right, the research shows that risky stocks don't enjoy higher returns.  It doesn't seem to matter which time period or what part of the world.

     

    So next time you’re considering whether you might be missing out on greater portfolio returns and are tempted to up the risk factor, you might think again.  When it comes to equity investing, it appears that slow and steady still wins the race.

     

    As for economic theory, do you know why economists were put on the earth?  To make weather forecasters look good.  Okay, I’m whining again.  I’ll quit now. 


Did you hear the one about the dog and the economist scratching at the back door to get in?  When you finally let them in, what’s the di....

  • May 2012: Here We Go Again

    Well I hate to say I told you so, but I can’t help myself.  Actually, I don’t hate to say it at all because I’ve been ranting about this kind of thing for years.  In case you have not heard, JP Morgan bank had a little trading problem recently that resulted in a $2 billion loss.  Oops!  But hey, what’s a measly $2 billion among friends?

    At least they say the problem is “contained.”  Oh wait, isn’t that what Fed Chairman Ben Bernanke said in 2007 about the subprime mortgage problem before it blew up?  And wasn’t that what every bank and investment bank said in early 2008 before they finally confessed to having a problem?  And isn’t that what they said after Bear Sterns collapsed and just before the sushi hit the fan at Lehman Brothers?  But this time is different because we know better now.  Yeah right!  The inmates are still running the asylum and putting us all at risk again.  Nothing has changed and we’re still putting the global financial system at risk with financial institutions speculating with depositor money.

    Perhaps JP Morgan just gave us a glimpse of the next financial crisis.  A surprise, hidden $2 billion trading loss in a bunch of exotic financial instruments at an offshore branch of one of our premier banks was certainly not what the markets wanted to hear right now.  To be fair, a $2 billion loss for an institution as large as JP Morgan is more of an embarrassment than a serious problem, assuming that is all there is to it. 

    But it begs the question that if one of the most sophisticated banks in the world can screw up this badly and get caught on the wrong side of a trade, what else is out there among institutions of lessor abilities?  Mark my words; this is just the first of many revelations to come in this area of trading by major financial institutions.  There is never just one cockroach.

    I don’t want to beat up on JP Morgan.  Plenty of other people are doing that.  The problem is much bigger than just them.  This is precisely why I have argued since 2008 that we need to bring back some version of the 1933 Glass–Steagall Act which separated commercial banking from investment banking.  These two businesses have completely different risk characteristics and capital requirements.

    Prior to the late 1980s, most investment banks were private partnerships and not publicly traded corporations like they are today.  That meant when they worked on any kind of deal, or engaged in any kind of speculative trading, they were risking the partners’ own money.  You can be quite certain that they considered risk very carefully then.  As publicly traded corporation today, they are risking shareholder money, only some of which is theirs.  That’s a different ballgame.

    Traditional commercial banking is fairly tame and predictable.  You pay interest on deposits, which are FDIC insured, and then loan the money out at a higher rate.  The difference,  i.e. the spread, is your potential profit.  It’s not very exciting or sexy, but as long as you don’t do anything too stupid and you closely manage the credit risk (like not lending to people or companies that can’t pay the money back), there is not a lot to go wrong.  Of course, that is way over simplified, but you get the idea.

    Investment banking and trading, on the other hand, can be quite exciting, glamorous and highly profitable if you do it right.  It is also a lot more risky and even the best and brightest sometimes get caught going the wrong way and can suffer serious losses.  That’s why capital requirements are so different and risk management so important.

    Prior to the great depression, commercial banks and investment banks were usually one and the same.  After the financial crisis of the depression, the 1933 Glass-Steagall Act directed that commercial banks and investment banks be separate.  You could be one or the other, but not both.  Of course, these powerful players almost immediately set to work to get around it.  It worked pretty well for about 65 years until the act was repealed in 1999 under great pressure from financial institutions.  It only took about 8 years after that for them to completely mess things up again.

    The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law in 2010.  It was supposed to prevent a lot of the problems that led up to the recent great recession.  Actually what it ended up doing, among other things, was pass a lot of very unnecessary and costly regulations onto local and regional banks, which were mostly not part of the problem in the first place.  Most of the things that would have addressed a lot of the risk problems associated with Wall Street were either removed or watered down to the point of being useless.

    The so-called Volker Rule, as proposed by former Fed Chairman Paul Volker, was to prohibit banks from speculating for their own account with depositor money.  Wall Street is fighting that one with all they can and JP Morgan has led the fight.  Dodd-Frank was a thin coat of paint over a cracked and broken banking system.  Since it failed to accurately diagnose the causes of the financial crisis, it was a dud and a nuisance from day one.

    So what did JPMorgan actually do?  As far as we can tell, it used the market for derivatives - complex financial instruments - to make a huge bet on the safety of corporate debt, something like the bets that the insurer A.I.G. made on housing debt a few years ago. The key point is not that the bet went bad; it is that institutions playing a key role in the financial system have no business making such bets, least of all when those institutions are backed by taxpayer guarantees.  Here we go again. 


Well I hate to say I told you so, but I can’t help myself.  Actually, I don’t hate to say it at all because I’ve been rantin....

April 2012

  • April 2012: Don’t Ever Mess With the Wolfman

    Some of you might remember a colorful DJ from the 60s and 70s who went by the name Wolfman Jack.  He spoke in a raspy voice and became known for some pretty outrageous comments for the day.  I could hear him late at night on AM radio when he broadcast out of Mexico with a super powerful signal that would skip across the country.  My mother wasn’t a fan and I used to hide the transistor radio under the covers and listen.  He would often close his show with a few rules, the last of which was always “Don’t ever mess with the Wolfman.”

    One of his favorite satirical commercials went like this: "You say ya kids ain't got no clothes; ya ain't got no food in the frigerator – then buy yourself a color TV baby!”  The Wolfman would get a big laugh today if he were alive to see how the joke has come true with individuals and government living beyond their means.

    Along the same theme comes a great poem from former Dallas Federal Reserve President Bob McTeer.  “My house is under water, for sure.  My car is upside down, you bet.  But I’m getting me a consolidation loan and finally getting out of debt.”

    We have become so accustomed to debt that we think it’s normal.  Even the stock market has gotten to the point where just the suggestion of a reduction in debt and monetary stimulus sends the market plummeting.  That’s exactly what happened when Fed Chairman Ben Bernanke recently hinted that he might not be doing another round of quantitative easing (known by many as QE3).  QE, in case you forgot, is a way the Fed increases the size of its balance sheet by printing more money to create more monetary liquidity.

    My friend Harry Dent likes to use the analogy of the economy being like a drug addict on crack.  The addict never wants to face the pain of withdrawal and constantly needs more crack to avoid it.  Our economy has become stimulus addicted and just the suggestion of coming off sends investors for the exits.  There is just too much money floating around and that inflates asset prices.  It hurts consumers and tax payers, but it inflates asset prices.

    Sooner or later, the insanity has to stop because this is unsustainable.  Maybe we have reached the intersection where two streets cross – perception and reality.  Or where trust matters more than hope.

    Most of the recent stock market news has been about short term expectations.  Is this the start of a correction or a crash?  Big one or little one?  Who knows?  Let’s step back for a moment and look at the big picture instead.  In my mind, there is no question anymore about the market being in a secular (long term) bear market since the market peaked in 2000.

    To refresh your memories, a secular bull market is a long-term bull market of ten to twenty years duration.  Within that long-term uptrend there are cyclical (shorter term) bear markets lasting six months to a year or two; but when they end the long-term uptrend continues to ever higher new highs.  1982 to 2000 was the last secular bull market.

    A secular bear market is a long-term sideways pattern of ten to twenty years, in which there are periodic cyclical bull markets that carry the market back to previous peaks.  It goes up and down in a big wide sideways channel.  Just when it looks like things are about to break out and hit new highs, it rolls over and heads down again.  We are nearing the top of that channel now.

    Secular bull markets are wonderful for ‘buy and hold’ investing, since the market soon recovers from the periodic cyclical bear markets and rockets up to higher highs.

    On the other hand, secular bear markets are great for traders and market-timing, providing repeated opportunities to make profits from the uptrend in the cyclical bull markets, and then from the downside in short-sales and inverse trading vehicles in the subsequent and frequent cyclical bear markets.

    Obviously, it is critical to recognize which investing environment we’re working in and to adjust strategies accordingly.  The last 111 years were clearly divided into three completed secular bull markets and three completed secular bear markets.  I believe we are currently in a fourth secular bear, which began at the peak in 2000.

    The real question we need to answer is whether it is close to ending or has further to run.  The previous three secular bear markets lasted an average of 18 years. The current one is in its 13th year.  If this one hits the average, we have another 5 years or so of running up and down in a big sideways channel.  It still looks like a reasonable expectation for the next peak to be just after the end of this year.

    Everyone is aware there is a huge problem lying somewhere ahead that is likely to prevent good times for the economy and stock market from returning on a permanent basis for a few years yet.  We just don’t know exactly when it will hit.  That problem of course is the need to eventually unwind the easy money policies and record government budget deficits and debt.  That’s going to mean higher taxes and sharp cuts in government spending at some point in the future (no matter who wins the next election).  I know.  Nobody wants to hear that, but it’s true.  Can you handle the truth?

    Before he died in 1995, Wolfman Jack had another great quote where he said, “I started out as an opportunistic renegade.  By now, I've lasted long enough to become sort of an American Original Respectable Renegade.”  Maybe there’s hope for me yet. 


Some of you might remember a colorful DJ from the 60s and 70s who went by the name Wolfman Jack.  He spoke in a raspy voice and became known f....

March 2012

  • March 2012: Why is the Japanese Yen Rising?

    What’s up with Japan – the currency that is?  Since the global financial crisis of 2008 the Japanese yen has been one of the strongest major currencies in the world.  This is surprising because it should be a weak currency.  Now that the European debt situation is off the headlines (for now), we should look at another area that has been moving under the radar.

    Let’s look at the dollar/yen exchange rate.  In late 2008, a dollar would buy you 110 yen.  Today, a dollar will only buy you 82.  And remember, the dollar has been relatively strong over the past four years.  The yen’s performance against the euro or British pound would be even more dramatic.

    This is surprising because Japan is the most heavily indebted major country in the world.  Isn’t everyone trying to avoid sovereign risk these days?  Japan’s sovereign debt is currently 220 percent of GDP and getting worse by the day.  By comparison, the U.S. is approximately 100 percent of GDP.  Japan’s annual budget deficit has routinely been in excess of 10 percent of GDP.  On top of that, investors are not really getting compensated for holding yen.  Japanese short-term rates have been at or near zero for almost 20 years, and even their 10-year bond yields a measly 1 percent.

    So what’s going on here?  Have currency traders gone blind?  Not likely.  For many years, the yen was the primary funding currency for the carry trade that so many hedge funds participated in.  In a typical carry trade, a trader will borrow money in a low-yielding currency like the yen and invest the money in a higher yielding currency like the Canadian or Australian dollar or, until recently, the euro or pound.

    The trader would make money in two ways.  First, they earn an interest rate spread, the difference between their borrowing rate and their lending rate.  This is how banks operate in the lending markets as well, borrowing cheaply and lending at a higher rate.  But there is also a secondary benefit.  These activities of traders tend to create trending markets.  Low yielding currencies trend downward and high yielding currencies trend upward.  So, in addition to the interest rate spread, traders also enjoy gains from an improving currency exchange rate.  With massive buying of the Japanese yen going on, the yen shot up in 2008 and early 2009, causing the yen to gain on all major world currencies.

    Of course, this begs the question, why didn’t the yen decline in the years that followed?  Here, the answer is less clear, but a few reasons are likely.  First, the carry trade lost its appeal after a lot of traders got burned.  Many found out that going the wrong way when the carry trade reverses can get really ugly.  It is a lot harder to do now and many came to view it as picking up nickels in front of a steamroller.  Too much risk for too little return. And secondly, the attention of active currency traders shifted to Europe and its sovereign debt crisis, giving the yen some breathing room.

    But more fundamentally, the yen now has a lot of competition as a funding currency from other low yielding currencies, not the least of which would be the dollar.  In a world in which nearly every major currency yields close to zero, the yen is no longer unique as a funding currency.

    Even with all of this as explanation, the yen’s persistent rise is a mystery, particularly when you consider that Japan’s exports are down and the economy is limping along.  As some of my favorite technical analysts would say, “When you see a trend like this that is hard to explain, you might want to question its sustainability.”

    Financial writer John Mauldin referred to the Japanese economy as “a bug in search of a windshield” in his recent book Endgame and that is a pretty good metaphor.    Japan’s huge debts and deficits have only been possible due to the country’s historically high savings rate - a savings rate that has been trending downward in recent years and may well turn negative soon.  The Japanese have been great savers and have tended to be patriots who bought their own government debt.  Now that their population is getting much older, they are now spending down their savings.  Who will buy Japanese government debt when a large portion of their population is spending their savings in retirement, not increasing it?

    When Japan has to turn to the international bond markets to fund its deficits, it’s not going to enjoy a 1 percent yield on its 10-year obligations.  No one, outside of the Japanese themselves, would lend Japan money at 1 percent.

    In the rolling global debt crisis, Japan will be the next major domino to fall.  When it finally has to access the international bond markets, its yields will rise to punishingly high levels, just like Greece, Italy, Spain and Portugal recently.  At that point Japan will have one of two choices, both of which will almost certainly result in a hyperinflationary meltdown - default or use the government printing presses to meet current obligations.

    The bottom line?  If you are a long-term investor, I would suggest you stay out of all Japanese assets.  The risks simply aren’t worth it given the attractive options you can find in the United States and Europe.  If you are a short-term trader, get ready.  At some point in the next 1-3 years, Japan could prove to be the best shorting opportunity of your trading career.


What’s up with Japan – the currency that is?  Since the global financial crisis of 2008 the Japanese yen has been one of the stron....

  • March 2012: Unemployment Falling But Wages Falling Also

    In a recent column I talked about the confusing way unemployment is reported in the U.S.  However measured, if you are affected by it, life is not fun.  This week I want to talk about the real world effect on individuals and the economy.  It’s not a pretty picture.

    A much bigger issue is looming over the US economy, one that will have lasting negative effects on consumer demand, the US savings rate, the ability to pay down debt, and even the possibility of qualifying for future loans in order to buy cars or homes.  The issue is the wages earned by those who rejoin the workforce after a period of unemployment.  This is not the typical issue of unemployment.  This is the problem of the lower wages earned by those going back to work after losing a job.

    This group consists of millions of workers and the loss of income can be over 50 percent.  How would your life change if your income fell by 50 percent?  The tremendous restructuring in the US has led to an imbalance in the number of workers available for each job, creating pressure to keep wages low and even drive them lower.

    I have written about this before, but could only speculate about what might happen.  Now we have great data from a 2011 report entitled “Out of Work and Losing Hope: The Misery and Bleak Expectations of American Workers,” by Zukin, Van Horn, and Stone.  This paper is the fourth study of 1,202 people who lost their jobs between September 2008 and August 2009.  The authors attempt to re-survey the original respondents and have successfully reached over half of them in subsequent surveys.

    The outcome of the survey suggests that not only are many of those who lost their jobs during the downturn still unemployed, but of those who have found new jobs a significant number have had to take pay cuts.  Keep in mind that this reflects how people are doing today, two and a half years after the Great Recession ended.  Over 40 percent of the people who suffered unemployment at some point between September 2008 and August 2009 are still unemployed.  17 percent of those who lost their jobs are not looking for a new one.

    Without jobs to be had, some have simply given up.  Others are trying to reinvent themselves through education or starting their own business.  A further look into the numbers reveals that of the 43 percent of this group who list themselves as currently employed, only 27 percent are full time; another 6 percent are self employed, 7 percent are part time, and 3 percent are part time and in school.  Over half of those who report having full time work also say that their position is not long term, as it depends on sales goals or is project work.  If every single one of the self-employed are able to make a go of starting their own business, that would result in only 20 percent having a position with long-term prospects. This is not just bad news, it is horrendous news.

    When looking at the age and education of those hit hardest, the picture gets worse.  While younger workers or workers with less education are definitely experiencing the pain of unemployment, the surprising fact is that long-term unemployment has been harder on college graduates and those from ages 30 to 59.

    The picture emerging here is one of America’s middle class in crisis. The educated group of 30 to 59 year olds has been hit hard by the Great Recession and there isn’t much relief in sight.  This group is the foundation of the US economy in many ways.  Not only does this group include peak spenders (ages 46 to 50), but it also includes those who should be marching toward peak spending (ages 35 to 44) and those who should be peak savers, between 54 and 59 years of age.  If large numbers of people in each of these age ranges are unemployed, then their ability either to lead a rebound in consumption that would lift the US out of its economic slump, or to save and pay down debt in meaningful ways as they approach retirement is not just remote, it is nonexistent.

    As if the factors above were not enough, the problem of falling wages is growing.  Of the 43 percent of respondents in the survey who found full-time employment, 52 percent took a pay cut to regain a full-time job.  Unfortunately, the pain is not equally shared.  For the over-50 set the most common level of pay cut was 31-50 percent.

    This brings us back to the question, “How would your life change if your income fell by 50 percent?”  Be thankful if this is not you.  With millions of Americans out of work and the number of jobs available still at 1 job per 4 people unemployed (November 2011, US Bureau of Labor Statistics), the experience of taking a large pay cut to return to work is likely to continue.  While the economy is improving in general, millions of fellow citizens are still hurting.  This trend will adversely affect our economy for a few years to come.

    However, the US economy is not falling into a black hole.  Instead, our contraction is far more modest, but will be persistent.  Expect the credit markets to continue shrinking as consumers pay off debt and look for personal spending to remain subdued.

    As government efforts of the past three years wear off, I hope the years of 2012 or 2013 will be the time when the US and other governments acknowledge and account for the large forces that are shaping global economies - aging populations and shifting consumer demands.  Artificially low interest rates that punish savers, or further government money printing (the Keynesian argument) for economic stimulus, is not the answer when the current trend is inevitable.  Instead, governments should get out of the way and get it over with sooner rather than later so we can get back to economic growth again. 


In a recent column I talked about the confusing way unemployment is reported in the U.S.  However measured, if you are affected by it, life is....

February 2012

  • February 2012: Abbott & Costello Explain Unemployment

    Mark Twain once said, “There are three kinds of lies: lies, damn lies and statistics.”  There is probably no better example of this than government reporting on unemployment.

    There has been a great deal of discussion the last few years over the subject of unemployment – and for good reason.  Things have been improving recently and the hope is that trend will continue.  But anyway you look at it we still have a long way to go to get back anyway near where we were before the “Great Recession” started.

    We also know that a lot of games get played with the unemployment numbers.  You and I would think that if you don’t have a job and you want one, you are unemployed.  But the government doesn’t look at it that way.  They have a variety of measures for unemployment and it’s important to know which one they are talking about.

    The Bureau of Labor Statistics (BLS) calculates six alternate measures of unemployment, U1 through U6, that measure different aspects of unemployment.  U3 is the official unemployment rate and is the number of people who are without jobs and have actively looked for work within the past four weeks.  U4 is U3 plus discouraged workers, or those who have stopped looking for work because current economic conditions make them believe that no work is available for them.  U5 is U4 plus other "marginally attached workers", or "loosely attached workers", or those who "would like" and are able to work, but have not looked for work recently.  U6 is U5 plus underemployed part time workers who want to work full time, but cannot find a full time job.

    Typically, when the BLS talks about unemployment, they are referring to U3 unemployment.  As of January 2012 that rate was 8.3 percent.  The U6 unemployment rate was 15.1 percent.  That’s a big difference.  The reason is that if you are unemployed but haven’t looked for a job in the past 4 weeks, or haven’t looked because you got discouraged and thought there was nothing there for you, or you are working part time but really wanted a full time job – according to the government official U3 figures you are not unemployed.  You are not even counted.  I suspect that if you fall into one of those categories, you know you’re there and you think you’re unemployed.

    Of course, unemployment is not funny, especially if it is you.  But sometimes it’s worth a good laugh or two when we make light of the games government statistics play when trying to put a happy face on all this.  Such is the case with the following post from “In the News Today” by Jim Sinclair on February 4th.  In a take off of the famous Abbott and Costello comedy routine about “Who’s on First”, he pokes great fun at the confusing statistics for being out of work versus being unemployed.  With all credit to Sinclair, I quote it entirely.

    “Employment statistics as taught by the two revered classical economists, Abbott and Costello.

    COSTELLO: I want to talk about the unemployment rate in America.
    ABBOTT: Good Subject. Terrible Times. It’s 8.3%.
    COSTELLO: That many people are out of work?
    ABBOTT: No, that’s 16%.
    COSTELLO: You just said 8.3%.
    ABBOTT: 8.3% Unemployed.
    COSTELLO: Right 8.3% out of work.
    ABBOTT: No, that’s 16%.
    COSTELLO: Okay, so it’s 16% unemployed.
    ABBOTT: No, that’s 8.3%…
    COSTELLO: WAIT A MINUTE. Is it 8.3% or 16%?
    ABBOTT: 8.3% are unemployed. 16% are out of work.
    COSTELLO: IF you are out of work you are unemployed.
    ABBOTT: No, you can’t count the "Out of Work" as the unemployed. You have to look for work to be unemployed.
    COSTELLO: BUT THEY ARE OUT OF WORK!!!
    ABBOTT: No, you miss my point.
    COSTELLO: What point?
    ABBOTT: Someone who doesn’t look for work can’t be counted with those who look for work. It wouldn’t be fair.
    COSTELLO: To whom?
    ABBOTT: The unemployed.
    COSTELLO: But they are ALL out of work.
    ABBOTT: No, the unemployed are actively looking for work… Those who are out of work stopped looking.  They gave up and if you give up, you are no longer in the ranks of the unemployed.
    COSTELLO: So if you’re off the unemployment rolls that would count as less unemployment?
    ABBOTT: Unemployment would go down. Absolutely!
    COSTELLO: The unemployment just goes down because you don’t look for work?
    ABBOTT: Absolutely it goes down. That’s how you get to 8.3%. Otherwise it would be 16%. You don’t want to read about 16% unemployment do ya?
    COSTELLO: That would be frightening.
    ABBOTT: Absolutely.
    COSTELLO: Wait, I got a question for you. That means there are two ways to bring down the unemployment number?
    ABBOTT: Two ways is correct.
    COSTELLO: Unemployment can go down if someone gets a job?
    ABBOTT: Correct.
    COSTELLO: And unemployment can also go down if you stop looking for a job?
    ABBOTT: Bingo.
    COSTELLO: So there are two ways to bring unemployment down, and the easier of the two is to just stop looking for work.
    ABBOTT: Now you’re thinking like an economist.
    COSTELLO: I don’t even know what the hell I just said!”

    So there you have it folks – unemployment properly explained.  Confused?  Good.  Then they accomplished their goal.


Mark Twain once said, “There are three kinds of lies: lies, damn lies and statistics.”  There is probabl....

  • February 2012: OMG - The Twinkie Takes Another Hit

    I used to think I was a pretty “with it” kind of guy; pretty much staying up with the latest in technology and cultural trends.  That was until several years ago when text messaging became a popular form of communication.  I wasn’t an early adopter and for awhile really didn’t see the point.  I was converted when the BTW (my beautiful and talented wife), who is not known for “technological enlightenment”, taught me how to text. 

    I was hooked.I really saw the light when I became “cool” to the kids and grandkids and could text back and forth to them.  Of course I sent notes with perfect grammar and punctuation, thinking that was the thing to do.  I thought I was pretty hot stuff until I started getting what looked like foreign language messages.  That’s when I discovered text message abbreviations.

    What a different world that is!  Of course, being a good researcher, I had to find out more.  Did you know there are actually text message abbreviation dictionaries?  There is even a Webopedia with over 1400 of them.  I think I knew five of them.  Wow!  I felt like Indiana Jones discovering the code to the Forbidden City.  (For those too young to know Indiana Jones, Google it.)  Now I can write in this new secret language.  The only problem is all my friends my age don’t know what it means either.  Sigh.  It’s tough being a pioneer.  LOL, ROFL and BIO.

    As you know from past columns, I love economic stories related to demographics because so much of what goes on in the economy can be tied back to the number of people in various age groups doing what they do at various stages of their lives.  I have written about Harley Davidson motorcycles in the past as well as the poster child for junk food – Twinkies.

    I wrote back in early 2009 that Hostess Brands, makers of Twinkies, was making a comeback after emerging from Chapter 11 bankruptcy in 2004.  Cause for celebration for sure.  But alas my friends, it looks like they might be going down for the count again as privately held Hostess Brands again filed for Chapter 11 bankruptcy protection in January.

    According to the Associated Press, the maker of Twinkies, Sno Balls and Wonder Bread is trying to lose the fat – the financial fat that is.  Rising labor costs and increased competition has been taking its toll on the company.  But that’s not the biggest problem.  Health conscious Americans are starting to favor yogurt and energy bars over the dessert cakes they craved 30 years ago.  Twinkies were no longer cool.  As the 78 million Baby Boomers have aged, they tend to eat less junk food - whatever your definition of that is.  While that is probably great for our middle-aged figures, it’s not so great for Hostess Brands.

    The New York Times reminds us that “Twinkies—love ’em or hate ’em—are about as emblematic as junk food gets.  With 39 ingredients, 150 shamelessly empty calories and, officially, a shelf life of about three weeks, the Twinkie is a cream-filled symbol of American culture.”  Someone once told me that if there is ever a nuclear holocaust, the only things that would survive would be cockroaches and Twinkies – oh, and perhaps Keith Richards of the Rolling Stones.

    One of America's best known and most loved snack cakes, Twinkies have been tantalizing taste buds and filling lunch boxes since 1930.   Twinkies are the stuff of legends and have achieved the status of cultural icon.  President Clinton put one in a time capsule and the American Society of Media Photographers mounted a photo exhibition featuring Twinkies.

    Twinkies have a bit of an image problem though.  They got a bad rap with what became known as “The Twinkie Defense.”  Twinkies gained notoriety in American courts in 1979 when the media widely misreported the claim that Dan White, who was on trial for shooting San Francisco mayor George Moscone and city supervisor Harvey Milk, asserted that his consumption of junk foods such as Twinkies “had left him with diminished capacity for reason.”  That could be just a statement about the wisdom of consuming them in the first place, but what do I know.

    In researching this article I also learned that, according to Hostess Foods, it takes forty-five seconds to explode a Twinkie in a microwave.  It probably takes far less than forty-five seconds for a mother to hit the roof in response.  I haven’t tested the microwave theory, but I think I will just take their word for it.  You might want to keep this column away from your children who will undoubtedly want to see for themselves.  Please don’t hold me responsible for an outbreak of Twinkie explosions.

    For all you Twinkie lovers out there, I’m told you need not worry.  Whatever happens with Hostess Foods, they or someone else will continue to manufacture Twinkies because demographics are starting to swing back in their favor.  Births are again in a solid uptrend, meaning that there will be a lot more school lunch boxes with room for a Twinkie.  And the prolonged recession has made consumers more cost conscious than before, meaning that the humble Twinkie may appear to be a sensible alternative to the $5 Starbucks muffin.  That cream-filled symbol of American culture may indeed be poised for a comeback.

    I can’t remember the last time I ate a Twinkie, but suddenly I have this overwhelming urge to hop on my motorcycle and ride over to the store to buy one.  Just one wouldn’t hurt would it?  BBFN.


I used to think I was a pretty “with it” kind of guy; pretty much staying up with the latest in technology and cultural trends.  T....

January 2012

  • January 2012: 'The Future Ain't What it Used to Be'

    You probably know that famous quote comes from a great philosopher of our time, Yogi Berra. While a humorous comment, there is certainly an element of truth in it as I take my annual look at what happened in 2011 and what I think might happen in 2012.

    I have heard that some people have started calling me Edmond’s Dr. Doom. I try not to be negative, but sometimes you just have to call it like it is. I’m not a “perma-bear” though. At times in the past I have been accused of being too optimistic. Go figure. The truth is that I don’t really care if the markets go up or down as long as I’m on the right side of it to protect my clients.

    The global economy, as I see it, is in a period between two crises with a respite from the chaos. Unfortunately, we didn’t fix anything and have mostly sown the seeds for what will eventually be another crisis. Things seem stable now but there is a lot of unfinished business. The calm on the surface belies the turmoil underneath.

    It has been said that those who ignore history are doomed to repeat it. Unfortunately, I am sorry to tell you that we are about to endure 2011 all over again with extreme volatility and uncertainty.

    The biggest challenge now, from a forecaster’s perspective, is sorting out all the news and trying to determine what is important and what is just noise. This is especially true when looking at the economy (locally, nationally and globally) and the stock and bond markets. While these are all certainly related and mutually determinant, they don’t always move together or logically. In fact, they seldom do.

    Here is what I said in January 2011 and what actually happened:

    1. “The stock market works its way higher in a volatile fashion to a top sometime in the fall, possibly to 12,800 on the Dow, before rolling over late in the year.” Mostly correct. The Dow hit 12,876 in May and fell to 10,404 in October, and then finished slightly up for the year at 12,217. The S&P performed similarly, in a range from up 9 percent to down 11 percent, but finished unchanged for the year at 1,257.

    2. “Gold, oil and commodities in general continue higher with gold hitting $1,500 an ounce and oil $100 a barrel.” Oil hit $114 in May and then down to $75 in October, and then finished the year at $99. Gold hit $1,925 an ounce in September, up from a low of $1,321 in January, and then finished the year at $1,567.

    3. “Interest rates on long term Treasury bonds spike in late 2011 creating a great buying opportunity in bonds again.” Oops! I blew that one. I had not counted on the Federal Reserve’s insanity of QE2 and Operation Twist. 10 year Treasury yields went down to 1.77 percent from a start of 3.36 percent in a giant flight to quality from the European debt crisis.

    4. “Predictions of 4 percent GDP growth by some analysts are likely way too optimistic. Look for GDP at 2.0-2.5 percent at best. Unemployment will remain above 9 percent.” GDP figures thru 3rd quarter were 1.8 percent. 4th quarter figures, not released yet, will likely move the number back into the 2.5 percent range. Unemployment remained over 9 percent for most of the year and was revised downward in late December to 8.5 percent. However, most, if not all, of that was due to people dropping out of the workforce and not counting anymore; not because they found a job. The real number is closer to 12 percent.

    5. “Home prices on a national average fall another 10 percent.” The Case-Shiller housing index thru October showed a 3.4 percent average price drop nationally. Many of the major housing markets where the biggest bubble occurred fell between 6 and 8 percent.

    6. “U.S. Municipal bankruptcies become headline news. More cities that are technically bankrupt are contemplating the idea of making it official.” Partially true, but not as big a story as I thought. A few declared bankruptcy, but many are still hanging on and praying for a recovery to bail them out.

    7. “The sovereign debt crisis in Europe will put the Eurozone under more pressure. Their problems have not gone away and several countries will be forced into massive austerity programs or the European Central Bank will be forced to print money and devalue their currency.” Bull’s eye! This became the dominant story of 2011.

    8. “China’s economy is overheating and they are raising interest rates as rapidly as possible to stop runaway inflation. This will eventually pop their real estate bubble, slow their economy and put pressure on commodity prices.” Partially true. This story is still evolving.

    2012 will be one of transition; politically in the US with the presidential election; financially in Europe with the potential breakup of the monetary union; and economically in China as the debate finally gets settled over soft-landing versus hard-landing risks. It also looks to be a year when tactical asset allocation will need to be emphasized at least as much as longer-term strategic considerations.

    One thing seems reasonably certain; the global economy is going to endure a significant deleveraging cycle as we move through 2012 – one that will affect most if not all parts of the developed world. It will be accomplished by some combination of default and write-downs, debt repayment and rising savings rates. All this promises to be very deflationary and we will have to invest with that prospect in mind.

    Now is when demographic trends I have talked about for so long really start to bite and overwhelm the health care requirements and pension funds obligations for the 78 million baby boomers. The median age of the US baby boomer (and mostly everywhere else in the developed world) is 56 and the oldest are now in their mid-60s. For those who were betting on elevated portfolio returns to deliver adequate retirements savings, time has run out. They will have to save the old fashioned way at some point.

    We are reaching the end of the Debt Supercycle, a term coined by Hamilton Bolton of the “Bank Credit Analyst” and further discussed by John Mauldin in his book “Endgame.” Essentially, the Debt Supercycle is the decades-long growth of debt from small and manageable levels, to a point where bond markets rebel and the debt has to be restructured or reduced. A program of austerity must be undertaken in order to bring the debt back to acceptable levels. If we are not already there, we are getting very close.

    A term that you are going to hear a lot this year is “Risk On/Risk Off.” Risk on means putting risk back into your portfolio for potential bigger gains. Risk off means investors trying to reduce risk in fear of possible portfolio losses. Last year, and probably this year also, institutional investors jumped back and forth between the two and that is one reason we saw so much volatility.

    One thing I should point out is that while all of this predicting is fun to do, it is important not to take it too seriously. Even more important, as much as I might believe my predictions or anyone’s predictions, I would NEVER make a major bet on one or a few areas. Neither should you. It is in uncertain times like these where diversification among asset classes and risk management is even more important than ever. We are just trying to figure out what we ought to believe in order to end the coming year in the best possible situation. That is, which belief is least likely to be fatal and which is most likely to pay off?

    You should also know that the local economy is often much different than the national or global economy and may have different outcomes. So what happens next? Here are my thoughts for 2012:

    1. The European debt crisis continues in and out of the headlines as Europe goes into a recession. Nothing is resolved but they do manage to kick the can down the road a little longer. The Eurozone does not break up but inches closer to fiscal union, only because the breakup would be even more painful. One reason for creation of the European Union was to keep from going to war with each other every 50 years or so. Now they just kill each other economically.

    2. The U.S. economy does not go into recession in 2012 but continues to limp along at a weak 1 to 2 percent GDP growth rate. Global GDP will be the same. 1st quarter GDP will look good as it carries over from 4th quarter 2011, but will slow significantly after the 2nd quarter. QE3 from the Fed is unlikely, and will be too late if they try.

    3. U.S. corporate earnings grow, but fail to beat estimates for the first time in more than three years. S&P 500 earnings per share are forecast at $105 but shrinking P/E multiples will result in a lower stock market by year end.

    4. The S&P 500 moves up to about 1,370 but probably peaks by April - an increase of 9 percent. Conservative investors may want to be out before that or hedge their portfolios. Aggressive investors may want to short stocks then. Several risk off events in the 2nd and 3rd quarters will result in a major sell off for 4 to 7 months, taking the S&P 500 down 23 percent from the high to 1,050. As we near election time we will see a relief rally take the market back up, but still finish down about 8 percent for the year at 1,160 on the S&P 500. Few on Wall Street would agree with this assessment. We’ll see.

    5. Interest rates on the 10 year US Treasury bond decline to historical lows of 1.5 percent on the next risk off event and then head slightly higher by year end.

    6. The US dollar continues up and the euro down, with the Euro going as low as $1.19 exchange rate. Gold rises at first to $1750 and then falls into summer. The longer term target for gold is $2300 but is too speculative here except for long term investors. Wait to buy gold at $1250.

    7. Oil and commodity prices peak sometime this year and start to decline by late in the year, if not sooner, as the global economy slows and demand falls. This, of course, would not be true for oil if further conflict breaks out in the Middle East. Oil is at $100 now and could see a spike to $120 at some point. However, the next risk off trade or a slowing global economy could take it down to $75 by year end.

    8. Unemployment remains stuck at the 8 to 9 percent level, then goes up again in late 2012 or 2013. GDP growth of 1 to 2 percent is not enough to make any meaningful dent in the unemployment rate.

    9. The US government runs another $1.3 trillion deficit. Current government debt is now over $15 trillion, up over $1 trillion just in the last year. This is unsustainable and something that is unsustainable will eventually stop. At some point we will stop the insanity voluntarily, or the bond market will force us to stop.

    10. The Presidential Election is too close to call. Who wins and what decisions are made by policy makers now and next year will matter significantly for the long term, making the future better or worse depending on the economic choices made. However, it won’t matter at all for the short term as far as the economy is concerned. A recession and stock market decline is already “baked in the cake” for 2013 and there is not much either party can do about it at this point. The good news is that the worst of all this is probably behind us by the end of 2014 and we start growing again.

    When times become extremely uncertain (as they are now), investors want to reach for more certainty. Since capital gains or losses represent uncertainly, then what can we focus on that is certain? The answer in part is cash flow. Interest income and/or dividends from an array of investments options can help reinstate that certainty that so many of us desire for our portfolios.

    This will be part of our over-riding theme for 2012. Our purpose, as always, is to serve our valued clients in a responsible fiduciary manner. Our hallmark, our over-riding theme, will always be that “we want to win by not losing.” A focus on principle protection helps provide principle preservation, which will serve our clients for not just this year, but for the many years to come.

    So there you have it. Am I right? We’ll see when we review it again next year and see how I did this time. Perhaps we should borrow another quote from Yogi. “When you come to a fork in the road, take it.”


You probably know that famous quote comes from a great philosopher of our time, Yogi Berra. While a humorous comment, there is certainly an element....

  • January 2012: The Real Story behind Election-Year Stock Markets

    “Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.”  John Maynard Keynes, 1936.  We might say the same about being slaves to the International Monetary Fund (IMF).  Christine Lagarde, the current IMF Chief, recently said something to the effect that “Rescue of the Euro must involve all nations.”  Uh Oh.  When the head of the IMF makes a statement as broad as this, it is time to worry. 

    The IMF is a relic of a previous era, born out of the Bretton Woods agreement in 1944.  Interestingly, the US made the first contribution to the fund using the money that President Franklin D. Roosevelt stole from those that held gold in 1933.  Roosevelt declared it illegal to hold gold in May 1933; then once all physical gold was confiscated, he promptly re-priced gold higher and the US dollar lower.  This meant that the gold FDR had taken from individuals was suddenly worth more, creating something of a nice little government slush fund.  Part of this fund ended up as the initial US contribution to the IMF, and part of it was used by President Clinton to rescue Mexico in the 1990s. 

    But I digress.  The US is one of 187 countries in the IMF, but is responsible for 17.7 percent of the funding for the organization.  The next biggest contributors are Japan and Germany, both at just over 6 percent.  So when the leader of the IMF makes a statement about “all nations” being responsible for the rescue of the euro, you can bet that she will use her position and her organization to make that happen.  The fact that US taxpayers foot about 1/6th of the bill is worrisome to say the least.  It’s not like we’ve got a lot of spare change sitting around to help out with. 

    Then there is the stark reality that the euro crisis is nowhere near a resolution.  People in positions of power are well aware that a group of countries carrying way too much debt can’t possibly solve a crisis of confidence with more debt.  What a surprise.  Isn’t this a little like trying to drink yourself sober? 

    This leaves investors sitting on a powder keg and facing a tough decision. The choices are fairly grim – either be willing to move at a moment’s notice or simply withdraw from the game completely, taking a fixed income approach and letting the markets do what they will.  It isn’t pretty, and it isn’t fun, but it is where we find ourselves at the start of 2012. 

    Speaking of 2012, there is no escaping the fact that we are in a presidential election year and the political knives are already coming out.  In addition to all the economic uncertainty that we are facing, we also have the uncertainty of what effect a presidential election year has on the stock market.  Of course, we have all heard that the stock market is almost always positive in presidential election years.  Right?  At least that assurance is one of those supposed truism we have heard for many decades, and repeated as fact each year in numerous interviews and financial columns. 

    It makes sense doesn’t it?  After all, the four-year presidential cycle (which I have discussed in past columns) has an unusually consistent pattern of the market experiencing most of its serious corrections in the first two years of a presidential term and most often making a substantial recovery in the last two years. 

    The pattern was interrupted when the financial crisis hit in 2007 and 2008, the last two years of the Bush Administration, and we experienced a serious bear market.  But the circumstances were unusual, and the few times over the last hundred years that the cycle did not hold true to form did not affect the long-term percentage of the cycle.  It also makes sense that election years would be positive as each Administration pulls out all the stops to make sure the economy and stock market are positive when re-election time arrives. 

    This is all nice election-year theory.  The problem is that it’s just not true.  In looking at a study of all 23 election years since 1920, just 15 were positive, or 67.6 percent.  However, ignoring whether or not they were elections years, over those 91 years, 62 years were positive anyway, or 68 percent.  It seems a fair conclusion that the market was up in 68 percent of years overall and 67 percent in election years.  Whether it was an election year or not seemed to have had no effect on the market’s performance.  Whatever happened was likely to have happened anyway. 

    Of the 23 election years, the market was up 63.3 percent of the years when a Democrat was in the White House, and 66.7 percent when it was a Republican.  One could also conclude that it makes no difference which party is in the White House at election time; at least with respect to the direction of the stock market. 

    Will a presidential election drive the stock market up in 2012?  Maybe, maybe not.  For those of you looking for an “election year indicator” to guide you, I’m afraid you’ll need something a little more conclusive.  Perhaps even economic fundamentals.  What a novel idea that is.  But what do I know?  Be sure to look for my next column on January 21st where I discuss my forecast hits and misses from 2011 and my new predictions for 2012.


“Practical men, who believe themselves to be quite exe....

December 2011

November 2011

October 2011

  • October 2011: Is This The Beginning Of The Buying Season?

    ‘Tis the season again. Well, almost anyway. No, not that season. The season of the stock market when you need to come back. Last April I wrote a newsletter about an old Wall Street saying that says “Sell in May and go away.” (Go to www.nickmassey.com to see it.) Then you’re supposed to come back and buy again in November. Does it really work? Not always, but more yes than no.

    The market has a proven tendency to make most of its gains between November and May, and it experiences most of its losses in the remaining months. Obviously, a positive market move does not begin and end on the same day each year. That’s just the general time frame. Some people dismiss the idea as an interesting theory that doesn’t always work. But it’s not a theory; it’s a proven fact. In spite of the few years when it has not worked, investing over the long-term based on the market’s seasonality significantly outperforms the market, and with much less risk.

    In that column I suggested that while it doesn’t always work, 2011 was setting up to be a classic example of being one of those years that it would work. Now, a little over five months later, we know that it worked very well this year. After the S&P 500 hit a high for the year of up approximately 9 percent in April, we are now down about 11 percent for the year and down 20 percent from the highs. People are quite worried. If only we had known for sure, most people would love to have a do-over and sell everything back in May. Unfortunately, life and markets don’t work that way. Congratulations to those who had the courage to sell or hedge their portfolios.

    The big question now is what will happen in October (statistically the worst month for the market) and then in November, when the theory says you should buy again? Of course, I don’t know for sure. Nobody does. But I’m inclined to think that we’re setting up for it to work again, at least for awhile.

    The year has been going pretty much as expected. If it continues that way, it means more bad news for awhile, but eventually good news. The first part of the sell theory continues to play out. We are now in a significant market correction and probably a bear market (down 20 percent or more). All twelve of the world’s biggest economies are in a bear market, with declines of up to 35 percent, and no signs their declines are over. The U.S. market just hit the 20 percent down mark. Will we be the only one to buck the trend? I doubt it.

    There is some good news though. I think this correction is going to be followed by a substantial rally off the lows to produce a positive year. Not a new high, but a small number with a plus sign in front of it.

    Why? While the economic slowdown in the U.S., and the European debt crisis, continue to worsen, and the downside target on this correction is still quite a bit lower, some of the serious negatives have begun to reverse. Investor sentiment, which just 6 months ago was at an extreme of confidence and bullishness, is moving toward the level of despair and bearishness seen at important lows. It’s not quite at extremes yet, but one more big sell-off will put it there. When sentiment hits extremes, either positive or negative, there is often a reversal not long afterwards.

    The Economic Cycle Research Institute recently notified its clients that a recession is now unavoidable, saying, “The vicious cycle is underway where lower sales lead to lower production, which leads to lower employment, which leads to lower income, which leads back to still lower sales, and the cycle feeds on itself.” While I agree with them to some extent, I don’t think recession is in the cards for 2011. For now, corporate earnings are still pretty good. 2012 is another story though.

    Even though the U.S economy is limping along at stall speed, there are signs of improvement in some areas, and we are seeing consumer spending picking back up in some sectors. This is likely a temporary phenomenon, but it might be enough to see a slight improvement in GDP for the 4th quarter. Unless there is a complete meltdown in Europe, which is not likely yet, this might be enough to cause the year end rally that seasonality would predict. If Europe blows up this year, all bets are off. We shall see.

    While no one can be certain, if I had to guess I think the market will break to lower levels sometime in October, possibly as low as 10,000 on the Dow and 1,040 on the S&P 500, and find the low for the year there. That could be the buying opportunity for the year end rally. If it doesn’t break, the buying opportunity will be at current levels.

    What should you do now? If you are still invested in the market and haven’t been scared out yet, unless you are a very nimble trader and willing to get out and back in again quickly, it’s too late to do anything now. Ride it out and re-evaluate at the end of the year or early 2012. If I’m right, you’ll be glad. If I’m wrong, most of the damage has been done already and it won’t matter.

    Seasonality could be even more important this year than in other years. So, will this strategy work again this November? I think maybe yes. What should you do? Here’s a better idea; if you’re not already a client, call me and I’ll help you. Thanks for reading.


‘Tis the season again. Well, almost anyway. No, not that season. The season of the stock market when you need to come back. Last April I ....

September 2011

  • September 2011: Will Hungary Need The Guardian Angels?

    Several years ago I was riding the subway in Chicago when two young men wearing red berets got on. They call themselves the Guardian Angels and they ride public transportation in major cities to protect regular people from the gangs. At first I felt safe knowing they were on the train looking out for me. But then I wondered what they needed to protect me from. What did they know that I didn’t know? Suddenly, I didn’t feel so safe anymore.

    We might be seeing something similar in the global banking system when central banks from England, the U.S., Japan and Switzerland recently promised to provide truck loads of dollars to any bank finding itself temporarily short of greenbacks. This is not a loan, per se; just an agreement to provide dollars in exchange for the currency of the bank in need.

    Like my Guardian Angels above, I guess this is a nice thing to do. But then, you have to wonder why this is suddenly necessary? What do they know that we don’t know? Central Banks don’t do that sort of thing unless something is up; and something is most certainly up. Money market funds are getting nervous and have been pulling their funds out of short-term debt in European banks, thus creating a shortage of dollars necessary for global trade. Hmmmm. Makes you wonder doesn’t it?

    In the eurozone, an unfolding Greek tragedy is careening towards its final brutal act. In our inter-connected global economy, that spells trouble everywhere with the odds shortening by the day on a return to recession. Of course, they all say there is nothing to worry about. Bernanke said that in 2008 also. But as said in a funny quote from a British television comedy, “The first rule of politics is to never believe anything until it is officially denied.”

    All the recent talk about debt issues in Europe have focused on Greece, Portugal, Italy, Ireland and Spain. But less talked about, and equally problematic, are the same problems faced by Eastern European countries. A decade of excess lending, wage and price growth, and large current account deficits has created major imbalances. To make things worse, most of the borrowing by the Baltics, Romania, Bulgaria and Hungary was in foreign currencies.

    My wife and I spent four days in Budapest, Hungary this summer. It is a beautiful country with wonderful people who could not have been nicer to us. But sometimes I can’t help myself and the closet economist in me comes out and I had to do some research on the effects of debt issues facing the Hungarian people. I’m afraid that they too are in for a rough time.

    You may have heard of a financial term called the “carry trade.” Recently this usually referred to the Japanese carry trade. In essence, investors exploited Japan’s very low interest rates by borrowing in yen and using the funds to buy assets in another country, such as the U.K. or the U.S., to earn a much higher rate of interest. (Remember those days?)

    Much less discussed though, was the Eastern European carry trade. After the fall of communism in 1989 among many Eastern Bloc countries, rapid growth among these countries was also accompanied by high inflation rates and high interest rates. Hungary’s interest rates reached 12.5 percent in 2004 to try to combat a rising inflation rate that eventually peaked out at well over 7 percent.

    That was great for savers but made borrowing in Hungary very expensive. In neighboring Austria, the banks there had started to offer loans and mortgages denominated in Swiss Francs at rates as low as 0.5 percent. Since this was a huge difference from lending rates in Hungary, this became very popular.

    Suddenly, people who were unable to afford a mortgage in Hungarian forints (the Hungarian currency) were able to get a seemingly great deal in Swiss francs or Euros. Property prices exploded and so did the economy. It was not long before almost 2/3 of the debt in Hungary was denominated in a foreign currency.

    As we have all learned, there is no such thing as a free lunch. Sure, you can borrow much cheaper in a foreign currency and save a lot of money. But what happens if the currency exchange rate goes against you - something the average borrower never considered?

    Imagine as a Hungarian you borrowed money in Swiss Francs to buy a house in Hungary. If you earned your income in Hungarian forints, you needed to exchange your money into Swiss Francs to make payments. If the Hungarian forint weakened significantly against the Swiss Franc, you would have to exchange more forints to pay back what you owed in Swiss Francs. Exchange rates can move fast and far, and they did. The debt almost doubled overnight as the forint weakened in late 2008. It’s even worse now as the Swiss Franc has been one of the world’s strongest and most expensive currencies.

    Hungary has had austerity measures in place from as early as 2006 as the government fought to reduce a swelling budget deficit to be ready to comply with European Union requirements. But now we are seeing “reform fatigue”, which is fairly common in response to tough economic medicine. This is a little like going on a diet. It starts out with good intentions, but the sacrifice gets old very fast. Austerity sounds great until about a year or two into it and taxpayers start to grow weary of the struggle and governments find it harder and harder to maintain taxpayer resolve.

    That is the problem Greece faces and many other European countries will soon face. Sovereign risks remain very real. We should not be so complacent as to think austerity programs agreed to in countries like Greece and Ireland will be the end of the matter. If we watch Hungary, we will have a good idea how things will play out in many other parts of the world.

    It’s a little off the radar for now, but Hungary and other Eastern European countries will be important to watch as this debt crisis plays out. The country will remain a potential economic hand grenade in the European region. It wouldn’t take much to kick off a wave of defaults in Hungary, which would mean grave problems for European banks, on top of all the other problems they have. And as we have learned throughout this crisis, when banks have a problem, we all have a problem.

    How will this all play out? Who knows? As Yogi Berra once said, “When you come to a fork in the road, take it.” Investors are now at that proverbial fork in the road and the economic noise is advising that they take it. The question never answered is which way to go. I think we are seeing the beginning stages of the Euro cracking and the dollar soaring. You could say that rumors of the dollar’s death are greatly exaggerated. For you dollar bears and gold bugs out there, I think you are about to get whipsawed. Maybe we should call in the Guardian Angels. Thanks for reading.


Several years ago I was riding the subway in Chicago when two young men wearing red berets got on. They call themselves the Guardian Angels and th....

  • September 2011: Who Will Rescue The Rescuers?

    In the 1978 “Superman” movie, Lois Lane falls out the window of a tall building, on her way to certain death. Superman swoops in at the last moment to save the day. Superman proudly says, “Don’t worry Lois, I’ve got you.” Of course, Lois replies with that great line, “You’ve got me? Who’s got you?”

    Perhaps that is a question we should be asking as we continually look to the government and Federal Reserve for financial rescue. Unfortunately, there is only so much they can do and at some point we have to ask who or what will rescue them? Rather than dealing with the problem of too much debt and too little growth, we expect to be rescued from ourselves and postpone the inevitable as we hope for a miracle. Here’s a news flash - the tooth fairy is not coming and neither is the miracle. We have to deal with the debt issue and it won’t be pretty.

    One of the most pronounced trends in the global economy over the last 40 years has been the growth in the use of credit. In the 1960s, if I wanted to buy something I could spend money I had in my pocket or I could write a check against money I had in the bank. The one thing I could not do was spend money I didn’t have. (What a quaint custom that was!) As a result, I had no way to buy things I could not afford.

    Around 1967, Bank of America came out with the first modern day credit card, the “BankAmericard”; and First National City Bank countered with “The Everything Card.” The challenge in those days was to convince retailers to accept the card. Before this, the credit cards in circulation consisted mostly of travel and entertainment cards – American Express, Diners Club and Carte Blanche – and they had to be paid off each month. They were generally limited to people in the upper income brackets. It was only in the last forty years that BankAmericard turned into Visa and The Everything Card into MasterCard. With these cards consumers were able to maintain an outstanding balance. It then became easy for people to buy things they couldn’t afford. And so they did.

    At the risk of sounding like some old geezer, in those days it was important to “establish credit” somehow, but there was quite the “catch 22” to do it. You needed to have good credit to get a credit card, but you first needed to get someone to give you a loan that you could pay on to prove your credit worthiness. Something easier said than done. I recall how in the late 60s I applied for a credit card from every major gasoline company and was repeatedly turned down until Texaco showed mercy on me and gave me a credit card. I used it for all my gas and paid it off religiously so I could prove that I was a worthy credit risk. I would imagine that many of you my age have similar stories. Now, of course, they send credit card offers to you in the mail completely unsolicited.

    I also recall that owing money was considered undesirable and debts were generally expected to be paid off. When people bought homes, they put down 30% and took out thirty-year mortgages to finance the rest. They made level payments that included a substantial principal component that grew over time. They eventually paid off their debt and invited their friends over for mortgage-burning parties, owning the home free and clear in time for retirement.

    Attitudes have since changed and consumer credit has exploded. Anyone with five dollars and a pulse could get a credit card and creative mortgages allowed anyone to own a home whether they could afford it or not. Of course, that is partly what led to the recent financial crisis and that is the debt many people are trying to pay off now.

    But it is not just consumer debt. There has been massive growth in corporate debt and sovereign (government) debt as well. Even the commercial paper market, where companies could access loans measured in days, exploded on the assumption that the paper could always be rolled over. That is until it couldn’t and the market froze.

    Most debt, outside of mortgage and consumer debt, is seldom amortized, i.e. payments covering interest and some of the principal so the debt is eventually paid off. Instead, bonds, whether corporate or government, and commercial paper are loans for fixed time periods where interest is paid along the way, but the principal is returned at maturity. And then, more often than not, the note or bond is rolled over into a new one. This has the effect of keeping huge amounts of debt in circulation that is seldom paid off. It becomes a form of rolling permanent capital to some corporations and governments and all they have to do is be able to pay the interest.

    This is all fine and good until a bondholder says, “No thanks. I don’t want to roll it over. I’ll just take my money please.” If enough people do that and the corporation or government or bank doesn’t have enough money to pay the principal back, we have a serious problem. That’s where we are today with sovereign debt issues. If you were at all concerned about your bond investment being paid off at maturity, would you opt to roll it over again or would you take the money and run if you could?

    Now look at it another way. In much the same way as consumers, credit has been available to governments deemed creditworthy without limit and without concern for the fact that many countries were constantly spending more than they were taking in, their deficits were growing relative to GDP, and their national debts were expanding relative to GDP. In other words, repayment of principal is not even in the cards. They are just hoping to be able to pay the interest and get the debt to roll over. This is where the U.S. is right now.

    Ultimately, the security of capital providers comes not from the borrower, but from the continued willingness of other capital providers to roll debts in the future. It was their occasional refusal in 2007-08 that caused the worst moments of the financial crisis. This is a house of cards that falls apart rapidly if the debt cannot be rolled over.

    With no one asking how debt could be repaid, nations were allowed for decades to increase their deficits and debt relative to their GDP. And then suddenly people started asking serious questions about how the debt might get repaid. Unfortunately, many are finding that they can’t.

    That’s what happened in Greece and suddenly nobody wants to loan to them anymore. And then people took a look around at other European countries and saw more of the same. The European Central Bank is desperately trying to keep the whole thing from coming unraveled. Today, although the situation is nowhere near as dire, they’re also looking at the U.S. and some of its states. The U.S. has run deficits almost every year since World War II, with prominent surpluses only in 1998-2001.

    Here is the undeniable truth: Quoting from “This Time is Different” by Reinhart and Rogoff, “We have learned that excessive debt accumulation, whether by the government, banks, corporations, or consumers, poses greater systemic risks than we realize during a boom period. Infusions of cash can make a government look like it is providing greater growth to its economy than it really is. Private sector borrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels, and make banks seem more stable and profitable than they really are. Such large-scale debt buildups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short term and needs to be constantly refinanced. Debt-fueled booms all too often provide false affirmation of a government’s policies, a financial institution’s ability to make outsized profits, or a country’s standard of living. Most of these booms end badly.”

    We all wish things were different today. But wishing that something is so doesn’t make it so. This problem will eventually require massive debt restructuring, much like a gigantic chapter 11 bankruptcy process. No one wants to hear that because it would mean losses for banks, bondholders and stock holders. The truth is that they already have the losses. They just have not admitted it yet.

    In the broadest sense, monetary and fiscal policies have failed because government financial transactions are not the key to prosperity. Instead, the economic well-being of a country is determined by the creativity, inventiveness and hard work of its households and individuals. So once again I ask the question, “Who will rescue the rescuers?” Ultimately, it will be all of us and it won’t be easy. Where is Superman when you need him?


In the 1978 “Superman” movie, Lois Lane falls out the window of a tall building, on her way to certain death. Superman swoops in at th....

August 2011

  • August 2011: Don't Fight The Fed!

    There is an old saying in the investment world that says, “Don’t fight the Fed.” What it means is you need to be sure that your investment positions are not at odds with what the Federal Reserve is trying to do with monetary policy. After all, they’ve got the biggest check book and they’ve got the money printing press too.

     

    Well, it appears you shouldn’t fight Bill Gross and Mohamed El-Erian either. I have always had great respect for the opinions of these two gentlemen from Pacific Investment Management Company (PIMCO). They have consistently proven themselves in difficult economic times, and are pragmatic and unemotional about their assessment of the investment world today.

     

    They coined the term "The New Normal" in assessing the economic outlook for many years to come. Get used to it. At the same time, they have sometimes been criticized and ridiculed for the views they hold, with some analysts calling the new normal "idiotic", "fatalistic", and other colorful terms. Gross and El-Erian now get the last laugh because they were right.

     

    A recent story from Bloomberg News headlined: "Bill Gross was Right After All." Former White House economic advisor Larry Summers, and former chairman of the U.S. Council of Economic Advisors Christina Romer were quite critical of the term. Well-known money manager Ken Fisher called the concept “idiotic.”

     

    Idiotic? Really Ken? Not according to Bloomberg. They have been vindicated by Fed Chairman Ben Bernanke who recently said the economic recovery is “considerably slower” than anticipated following the biggest stock market loss since December 2008. Even Blackrock co-founder Lawrence Fink, who said last January that he didn’t believe in the “new normal,” is now forecasting growth of 1 to 2 percent for much of the next decade.

     

    When Summers and Romer were recently asked about their position now, they were “unavailable for comment.” Are you surprised? Me neither.

     

    As the Federal Reserve propped up the markets with two consecutive rounds of "Quantitative Easing", known affectionately as QE1 and QE2, to try and revive the markets (notice I didn't say economy) and the stock markets took off on a Federal drug induced high, the criticism of PIMCO’s views strengthened. In April Romer said that the jobless rate “is not the new normal.” Fink said he never shared PIMCO’s view on the post-crisis economy. He said in January that “We were always talking about a U.S. economy growing at three-plus percent.”

     

    Of course now we have the GDP growth numbers for the first two quarters of this year - 1.3 percent annual pace in the second quarter, which was considerably less than forecast by most economists. The economy almost stalled in the prior quarter, growing at a 0.4 percent pace, the weakest three-month period since the "recovery" began in mid-2009.

     

    Ben Bernanke recently said he expects a "somewhat slower pace of recovery over the coming quarters," adding that "downside risks to the economic outlook have increased." Additionally, he said there has been "deterioration in overall labor-market conditions in recent months" and household spending has "flattened out." He also intimated that the Fed had more tools in its toolbox and they would use them "as needed" to help get the economy going in the right direction. Sounds familiar doesn’t it? Looks to me like the boys at PIMCO were right and what I have been telling you for quite some time has been right also. I hope you have been listening.

     

    One final thought - the following comes from investment analyst Gary Kaltbaum. It’s just too good to pass up. “Imagine Warren Buffett getting a call from a company who asked Warren to invest $2 billion in that company. This company then went on to tell Warren that the $2 billion had already been spent and that they could not account for how well that $2 billion was spent. Therefore, that $2 billion would be of no help to the future of the company. This company went on to tell Warren that there was massive fraud and waste in the company and that the people that ran the company get payoffs in order to make decisions to help those doing the paying off. They also told Warren that their company was running massive deficits. In fact, total deficits ran 8 times the amount of revenue and that the company was doing nothing in order to stop those deficits. On top of that, those deficits continue to grow leaps and bounds with no end in sight. May I also add that most of the people running the company had never run any companies prior to running this company? Bottom line – there is no way in this lifetime that Warren would invest a dime in this company. So Warren, please stop telling others that they need to.”

     

    Of course, you can guess what this imaginary company is. Pretty scary isn’t it? So why is everyone so bullish? Beats me. I guess we’re all just optimists. Can I borrow those rose-colored glasses?

     


There is an old saying in the investment world that says, “Don’t fight the Fed.” What it means is you need to be sure that your ....

  • August 2011: After Debt Ceiling Debate, Focus is Back on the Economy

    Well they finally did it – raised the debt ceiling.  Now everything is cool again and we can all go back to enjoying life and watching the economic recovery unfold.  Well, maybe not. While everyone was focused on the political circus in Washington and our self-inflicted shot in the foot, it seems that the stock market went back to focusing on things that matter - like a slowing U.S. and global economy and sovereign debt issues that just won’t go away.

     

    When it was announced that a “deal” on debt reduction and the debt ceiling had been reached, the stock market exploded about 150 points to the upside.  Unfortunately, the euphoria lasted about an hour before people realized that the underlying economy continued to deteriorate, and the stock market has been mostly in free-fall since.  To use a technical economic term – this so-called economic recovery pretty much sucks.  This may not be as useful as Ben Bernanke’s comment last year that “things are unusually uncertain.”

     

    While the world was fixated on the debt ceiling debate, first and second quarter GDP figures were released on July 29th and they were not pretty.  First quarter GDP had previously been reported at a disappointing 1.9 percent when most economists were looking for something over 3 percent.  Remarkably, the market just yawned and nobody seemed to care.  Economists started to revise second quarter GDP estimates down to 2.7 percent.

     

    Second quarter GDP actually came in at a shocking 1.3 percent.  At this stage of an economic recovery we should be growing at close to 4 percent.  But even worse than that, the first quarter GDP figure was revised down from 1.9 percent to a snail pace .4 percent.  On top of that, fourth quarter 2011 GDP figures were revised down from 3.1 percent to only 2.35 percent.

     

    This is shocking and quite worrisome.  All the money in stimulus and quantitative easing that has been thrown at the economy and that’s it?  Almost two years after the recession “officially” ended, the economy has still not recovered back to pre-recession levels.  Clearly, QE1 and QE2 have been dismal failures.  Maybe government leaders will finally bury Keynesian economic theory.

     

    But at least things are good now because Congress has reached an agreement on how to reduce our deficit, right?  Not likely.  As I understand it, the compromise calls for $2.4 trillion in spending cuts over the next ten years.  We need at least $4 trillion over 10 years to come anywhere near to keeping the debt level from increasing, and some would argue that is just a start.  It doesn’t stop the growth of government debt or reduce it.  It just slows down the rate of growth and will certainly not fix the problem.

     

    Many of the cuts being discussed are not cuts from current amounts being spent, but cuts in projected spending increases.  As Congressman Ron Paul pointed out, “this is akin to a family "saving" $100,000 in expenses by deciding not to buy a Lamborghini, and instead getting a fully loaded Mercedes, when really their budget dictates that they need to stick with their perfectly serviceable Honda.”

     

    While there is no question that we need to reduce spending, nobody wants to talk about the effect doing so will have on the economy for at least the next decade.  As my friend and hedge fund manager John Thomas points out, a $2.4 trillion reduction in government spending over 10 years is 16.6 percent of GDP, or an average of 1.6 percent a year.  Unless that is somehow offset by an equivalent amount of growth in the private sector, which is not likely, we will guarantee minimal economic growth for at least that period and worse if anything goes wrong.

     

    The Federal Reserve has a current forecast of 3 percent GDP growth.  That is highly unlikely.  But even if that somehow happens, taking 1.6 percent away from the economy means a paltry 1.4 percent GDP growth rate.  A rate that low will do absolutely nothing to reduce overall unemployment.  As the old saying goes, “be careful what you wish for because you just might get it.”  I’m not suggesting that cutting government spending is wrong.  I’m just suggesting that we need to understand the consequences and not lose the faith along the way.

     

    On top of all this, European sovereign debt problems have not gone away and seem to be getting worse.  (See my June 25th Edmond Sun column on Greece.)  As I write this, the European Central Bank (ECB) has just announced that they need to buy more debt from countries such as Greece, Portugal, Spain and Italy.  European bonds promptly took a nosedive.

     

    The ECB is basically stuck.  Their banks hold so much of weaker country sovereign debt that they can’t afford to let them fail without serious damage to their own capital and solvency.  It’s a little like loaning money to your deadbeat brother-in-law.  You know you’re not going to get the money back but you do it to keep peace in the family.  But that only goes so far.  Unfortunately, in this case there are several other relatives asking for the same thing.  The question is how long can it go on?

     

    Keep in mind that an agreement to raise the U.S. debt ceiling and reduce government spending, or kicking the European debt crisis further down the road will not have any effect on the current global economic slowdown.  It only provides temporary relief.  Once the relief runs out, as it is now, the reality will set in that the global economy continues to slow and government spending cuts involved in any agreement will be yet another negative for the slowing economy to deal with.

     

    What does all this mean for the stock market?  While the economy and the stock market are certainly related, they don’t always move together.  We may well be experiencing a long overdue correction that may run its course soon, leaving us with a possibility of a year end rally.  We’ll see.  Economist Dave Rosenberg says that the possibility of the economy going back into recession is clearly back on the table.  Whether it will or not remains to be seen.  One thing is for sure right now – we don’t have much room for something more to go wrong.  Thanks for reading.


Well they finally did it – raised the debt ceiling.  Now everything is cool again and we can all go back to enjoying life and watching t....

July 2011

  • July 2011: Start Me Up!

    “If you start me up; if you start me up I'll never stop.  If you start me up; if you start me up I'll never stop.  I've been running hot.  You got me ticking, gonna blow my top.  If you start me up; if you start me up I'll never stop.  Never stop, never stop, never stop.  You make a grown man cry.  Spread out the oil, the gasoline.  I walk smooth, ride in a mean, mean machine.  Start it up.”

     

    That 1981 bit of prose and wisdom came from one of the great philosophers of our time – Mick Jagger of the Rolling Stones.  Maybe these words would be better used by our current economist rock star, Federal Reserve Chairman Ben Bernanke, as he pleads with the economy.  I’m having a little trouble with the mental image, but rocker Ben has been trying everything he can think of to get the economy going again.  What the heck.  QE1 and QE2 didn’t work.  Why not get the country rocking?  Start me up Ben.

     

    Speaking of rock stars, hedge fund managers, the rock stars of the investment world, are not having a good year either.  These are supposed to be the smartest guys and gals around.  According to HSBC’s private bank, of the 300 hedge funds they track, only nine are up double digits, and most of those are narrowly mandated technology funds.  Almost every fund lost money in June.  And oh how the mighty have fallen, with the biggest funds producing the soggiest performance.

     

    Bruce Kovner is off by 3.88 percent this year, Paul Tudor Jones is down by 2.25 percent, Louis Bacon took a 2.84 percent hickey, and Fortress Capital has dipped 2.44 percent.  Emerging markets have done worse, with Brevan Howard taking a 4.64 percent hit.  Paulsen & Company, considered by some to be the superstar legend, pursued a bullish strategy in the banks and lost an eye popping 20 percent.  Ouch!

     

    So why such a tough year for all these smart people?  For a start, you can blame the almost complete absence of any clear trends this year.  The S&P 500 was up 7 percent in the first half of the year, with the entire move occurring only during the last three days.  Until then, we spent all our time inside a narrow 120 point, 9 percent trading range.  Same thing for Treasury bonds, which are up only 3 points on the year with a yield so small you need a magnifying glass to find it.  Uh, wasn’t quantitative easing supposed make everything better?  How is that working out Ben?

     

    How about the Euro?  You would think the never ending European sovereign debt crisis would present great shorting opportunities?  Nope.  The European currency is up 7 percent this year.  Unless something fundamentally changes, it can’t defy gravity forever.  But so far Sir Isaac Newton would be amazed.

     

    What about commodities?  Did copper, the only metal with a PhD in economics, open its wallet for “hedgies” this year?  Not a chance.  Copper is actually down 1 percent.  Maybe it should go back to night school for another course in macroeconomics?

     

    Perhaps precious metals were the hot ticket.  Negative again.  Despite all of the fear, angst, and forecasts of doom seen this year, gold has managed a modest 4 percent gain; while silver, after a lot of sound and fury, delivered a middling 8 percent increase. Platinum and palladium are dead unchanged on the year, thanks to the deflationary impact of the Japanese earthquake on the global auto industry.

     

    Far be it from me to brag, but perhaps you’ll allow me a moment of totally shameless self-promotion.  Much of what has happened this year so far is what I wrote in my annual predictions column on January 29th.  And so far it looks like I’m beating many of the hotshot hedge fund gurus.  How cool is that?

     

    I think the rest of the year will be pretty crazy also.  Worry, worry, worry.  Is rock star Ben going cold turkey and swearing off the hard stuff – quantitative easing?  Or will it be back at the first sign of trouble?  Who knows?  After all, there is an election year coming and old habits die hard.  Perhaps this really is the year when cash is king for investors.  Sounds to me like the best thing to do may be to just go to the beach.  Or just call me.


“If you start me up; if you start me up I'll never stop.  If you start me up; if you start me up I'll never stop.  I've been runnin....

June 2011

  • June 2011: What Happens If Greece Defaults And Should We Care?

    You have no doubt heard the concerns over Greece and whether they might default on their government debt.  Their bonds have been downgraded to junk status by S&P and the interest rate on short term Greek bonds is over 20%.  When a country has to pay over 20% to borrow money, you know there is extreme worry that the money will not be paid back.  Until this happened, I used to joke that the only people who got more than 20 percent on a loan was the mafia.

     

    The question for many people is whether Greece will default on its debt.  In my opinion, it’s not a matter of “if” Greece will default but “when.”  I see no way out of this for them and they will eventually have to default or restructure their debt obligations.  Perhaps they will have a nice pleasant word for it and call it something else, but the end result is the same.

     

    Many people think this is just a problem for Greece or the Eurozone and really doesn’t matter to the rest of us.  But is that really the case?  What might be the effect on the global economy if Greece were to actually default on the debt?  Savers all over the world and U.S. retirees would likely be impacted in some way.  We could get a domino effect if things really get out of control.

     

    Greek banks are heavily exposed to their own sovereign debt and a default would require many of them to seek new capital to make up for the losses.  This would likely trigger a run on the banks by Greek depositors.  If you were a Greek citizen with money in the bank, what would you do?  You can be quite sure that anyone with any kind money in Greece is trying to get it out of there.  It is very likely that the Greek government would be forced to declare a "bank holiday" to prevent a run.  Eventually, the most exposed Greek banks would have to be nationalized.

     

    Europe's banks are big holders of Greek debt. They are holding approximately $53 billion with France, Germany and the U.K. the most exposed.  If bondholders were required to take a 40 percent 'haircut', i.e. reduction in what they will get paid - a figure thrown out by many analysts - this would translate to losses of about $22 billion in U.S dollars.  This would cause many of these banks to be undercapitalized, which is why they desperately want to keep propping up Greece in the hopes that this problem will somehow go away.  It won’t.

     

    Remember the term “Credit Default Swaps?”  Most people had never heard of them before the AIG blow-up.  A Credit Default Swap, or CDS, is basically a financial institution selling an insurance policy on a bond that would pay the holder the value of the bond if the issuer defaults.  They are traded in private transactions and no one really knows for sure how many are out there, who the counter-parties are, and what kind of collateral exists to be sure the issuer can actually pay off if there is a default.

     

    According to economist Kash Monsori, in looking at a detailed report from the Bank of International Settlements, U.S. banks have sold about $120 billion of credit default swaps to European banks.  A default would trigger a "credit event" payout on these insurance contracts.  Remember AIG?  They were issuing CDS’s on mortgage backed securities and were on the hook for far more than they could pay when it all blew up.  Let’s think about that for a minute.  When, not if, Greece defaults, U.S. banks are going to have to dip into capital to pay those commitments.  Capital that should be available for loans to businesses but will have to be paid to European banks instead.

     

    If doubts about the stability of financial institutions with direct and indirect exposure to Greece spread, it could lead to another global credit crunch.  Banks may hesitate to extend credit to each other out of fear about exposures.  Many would require counter-parties to hand over additional collateral, forcing assets sales.  In a repeat of the aftermath of the bankruptcy of Lehman Brothers, global credit markets could seize up.

     

    It’s not just Greece though.  Ireland and Portugal are facing years of slow economic growth as their governments attempt to bring down debt levels and stabilize their banking systems.  A default by Greece - especially if brought about by a popular uprising - could encourage these countries to default.  If Greece can force creditors to take a haircut, why should Ireland and Portugal pay in full?

     

    The turmoil across Europe may shake the government in Germany.  The German people strongly oppose bailouts of what they view as less responsible countries.  Any moves by the German government to alleviate the crisis caused by Greece could be met with a political revolt in the already shaky government of Angela Merkel.

     

    U.S. consumer confidence is already at record lows.  A global credit crisis would likely convince U.S. consumers to reduce spending and increase savings.  This could drag the already slowing American economy nearer to a recession.

     

    I could go on and on, but you get the point.  Will any of what I described actually happen?  Who knows?  It is certainly possible and something to be aware of.  Any way you look at it, this is not just a little problem in Greece.  It affects all of us and you need to understand the implications of it for your investments.  If your financial advisor is not telling you how he or she is going to deal with this, you need another advisor.  Perhaps even me.


You have no doubt heard the concerns over Greece and whether they might default on their government debt.  Their bonds have been downgraded to....

  • June 2011: Getting To The Bare Facts In Brazil

    A recent Associated Press headline read, “Late Credit Card Payments Hit 15-Year Low.”  Late credit card payments are at their lowest levels since the late 1990s - the last time our economy was in a full-blown boom!  The rate of payments 90 days or more delinquent dropped to 0.74 percent in the first quarter.  This is a reduction of almost half from the highs seen in the first quarter of 2009, during the peak of the meltdown and credit crisis.   
     
    Given that unemployment remains near multi-decade highs and that million of Americans are in debt trouble or underwater on their mortgages, you would wonder, “How is this possible?”  Is the crisis over?  Not exactly.
     
    When something sounds too good to be true, it generally is.  As is always the case with economic data, you have to read between the lines.  Yes, credit card delinquency is at its lowest levels since 1996.  But a major reason, according to Moody’s, is that the banks have written off $74.5 billion in bad credit card debts over the past few years.  It’s not that delinquent borrowers got religion and started making payments.  No, the banks simply gave up and wrote off the debt as a loss.  Debt that gets written off is no longer “delinquent.”  It just disappears, along with a corresponding amount of shareholder equity.
     
    Continued consumer deleveraging has also played a large part.  Americans, and particularly the Baby Boomers who see retirement looming in front of them, underwent a major psychological shift over the last few years.  With their home equity and stock market investments decimated by the crisis, they have reacted prudently by cutting back on their spending, paying down their debts, and building up their savings.  As a result, the average credit card balance has dropped from $5,165 to $4,679 over the past year - a drop of 9 percent.
     
    Consumers aren’t the only ones with a newfound sense of responsibility.  The banks have significantly raised credit standards.  Most mortgage lenders require substantial down payments now, and credit card lenders have become far more cautious about who gets a card and how large a credit line they get.
     
    So, while a reduction in credit card delinquency should be viewed as a positive, it’s important to understand the underlying parts and what they mean for the economy.  Writing off bad loans reduces banks’ capital and their ability to extend new credit.  Every dollar that a consumer decides to save is a dollar that does not get spent growing the economy.
     
    On a lighter note, I have exciting news!  You know that your fearless forecaster scours endless sources of information, leaving no stone unturned in an effort to bring you all the economic insight you can use.  There is no end to which I am willing to go to understand the future direction of the global economy.
     
    In doing so, I discovered what might be the ultimate economic indicator for inflation.  When I learned that the price of a bikini wax in Brazil was going through the roof, I had to sit up and take notice.  Recently, the price of this popular beauty treatment has soared by 16.6 percent to 35 Reals, which is about $22.  I have to confess to not having any first hand knowledge about this sort of thing, but I guess that is expensive.  I considered a quick trip to Brazil to personally investigate on your behalf, but decided to just take their word for it.
     
    I know.  You’re thinking that I have finally lost it.  But this is no joke.  One of the ways most countries, including the U.S., attempt to measure inflation is to constantly monitor the prices of a basket of various consumer services to see if those prices are going up or down.  Well, it seems that the Brazilian government includes the removal of body hair in the most strategic of places in their basket of consumer services to help determine the country’s inflation rate, which is now estimated at 6.5%.  Apparently this has nothing to do with the opposite-gender.  It is one of the few measures they track which can’t be manipulated by economists or government officials.  No splitting hairs here.  You either get the treatment, or you don’t.
     
    The big picture here is that inflation is getting worse, not only in Brazil, but also in other emerging markets like China, India and Vietnam.  This is why the yield on one year Brazilian bonds is at sky high double digit rates as the government tries to slow inflation.  It is also why the People’s Bank of China’s efforts to control inflation through higher interest rates and higher bank reserve requirements are likely to get worse before they get better.
     
    So who says economics is boring?  This is economics you can use.  An economic indicator in the hand is worth two in the bush.  Perhaps if I take a trip to Brazil I can find an indicator for other inflated assets.  Maybe that would be stealth inflation.  Oh, the mind wanders.


A recent Associated Press headline read, “Late Credit Card Payments Hit 15-Year Low.”  Late credit card payments are at their lowe....

May 2011

  • May 2011: To Raise Or Not To Raise The Debt Ceiling

    “I’ve always depended on the kindness of strangers.”  So said Vivian Leigh in her role as Blanch in the Tennessee Williams play “A Streetcar Named Desire.”  We might say the same thing in the U.S. as we have depended on foreign countries to buy our debt and finance our excessive spending.  Now the problem is coming to a head as we wrestle with how to deal with it.  One of the discussions front and center now is the debate over the debt ceiling and whether to raise it or not.  For those who like political dog fights, this is like the Super Bowl.

     

    Recently, Treasury Secretary Tim Geithner notified Congress that the public debt limit will become binding soon and Treasury will no longer be able to borrow additional funds.  Nevertheless, Congress is taking its time on raising the debt limit with some lawmakers still saying they will not vote for an increase under any circumstances.

     

    There is no question that we need to reduce government spending, balance the budget and reduce government debt.  If you have been reading my columns you know I have been ranting about this for years.  However, the debt ceiling is a separate subject and should not be confused with how we balance the budget and reduce government debt going forward.  The debt ceiling involves money already spent or obligations made.  Like them or not, existing debts and obligations need to be paid.

     

    If you had $100,000 worth of obligations this year and your income was only $80,000 you are going to need to find $20,000 somewhere.  You will either need to find additional income to make up the shortfall, or borrow the money, or default on some of the obligations.  If your personal debt ceiling is $100,000 and you can’t borrow anymore, and you can’t bring in additional income, you will default.

     

    Is this the solution we are suggesting for the U.S government?  I certainly hope not because the consequences are unthinkable.  We would lose our AAA credit rating.  Many countries and entities would no longer be allowed to buy our debt.  Interest rates would skyrocket and the cost of renewing current debt would go up.  All other interest rates would move up also and immediately put a halt to our current weak economic recovery.  Recession is too mild a word for what will happen.

     

    The federal budget deficit and debt didn’t just suddenly happen.  It has built up for many years.  There is no shortage of people to blame, but that is not what is important here.  I have no problem with political maneuvering to reduce spending and reduce government debt.  But the debt ceiling is just a number and it’s important not to get bogged down in this and lose site of the goal.  Playing chicken with the economy and the debt ceiling is political grandstanding and quite reckless.

     

    It’s reckless because failure to raise the debt limit not only threatens a default that could potentially destabilize the entire world financial system, but could potentially deprive federal workers of their salaries, deny payments to businesses for goods and services sold to the federal government, renege on Social Security benefits to retirees,  and shortchange savers who depend on interest income.

     

    It is difficult to comprehend the vastness and variety of payments the Treasury must make everyday.  Here are just a few samples.  On May 2nd it paid out $6.4 billion in interest on the debt, $4.5 billion to retired federal workers, $3.7 billion to military retirees, $2.6 billion to house the indigent, and $1.6 billion in federal salaries, among other things.  On May 3rd, the Treasury paid $21.8 billion to Social Security recipients, $1.6 billion to Medicare providers, and $1.6 billion to vendors that sold supplies to the Department of Defense.

     

    On most days, the Treasury does not take in enough in taxes to cover its payments. On May 2nd it took in almost $26 billion, but on May 3rd it took in less than $4 billion.  Through May 3rd the Treasury had received a little less than $1.3 trillion in taxes for fiscal year 2011, but had made payments of almost $7 trillion. The reason the payment number is so large is because it includes funds that were paid to Treasury’s lenders, whose bonds matured and needed to be paid off.  Redemptions to owners of Treasury bonds eat up a vast amount of its cash on a day to day basis.

     

    Because the federal government runs a budget deficit, the Treasury must borrow a little more on most days.  On May 2nd, there was a net increase in Treasury borrowing of $33 billion, on May 3rd the increase was $11 billion. This is how much the national debt increased on those days.  As of May 3, the total amount of debt outstanding was $14,280,140,000 and the debt limit is $14,294,000,000.

     

    Some have argued that as long as it has sufficient monthly cash flow from taxes to pay monthly interest on the debt, then the Treasury can just stop making other payments.  That could include payments to doctors and hospitals that provide Medicare services, stop paying salaries to federal workers, stop paying vendors that provide food and ammunition for our troops in the field, and stop paying Social Security benefits.  Are you kidding?  Does anyone really want to go down that path?

     

    The real issue with the debt limit isn’t whether the government should run a budget deficit or if the deficit is too large.  That is a big problem that needs to be fixed.  But the debt ceiling is about cash flow and making sure that the Treasury has enough on a daily basis to pay its bills and neither inconvenience nor break faith with those who sold goods and services to the government, loaned it money, or depend on federal programs for life and health.  The word “irresponsible” is inadequate to describe those in Congress who use doubletalk to justify refusing to raise the debt limit.  They are playing with fire and are going to get us all burned.   


“I’ve always depended on the kindness of strangers.”  So said Vivian Leigh in her role as Blanch in the Tennessee Williams p....

  • May 2011: The Inmates Still Run The Asylum

    Some things just never change.  A few years ago the major financial firms created a devastating financial crisis and meltdown that harmed the country and global economy.  This wasn’t the first time of course.  Think about the S&L crisis in the early 90’s and many others before.  Once again investigations were held but no one was punished, and once again regulations were promised that would prevent it from ever happening again.  And once again those regulations were so watered down that nothing much has changed.

    A couple of years ago I said that this would happen.  The stock market has recovered and has investors excited and no longer focused on or caring about how the system operates.  Life is good again.  Even the watered-down regulations that did survive are being pushed aside so the major financial firms can carry on as before.  And no one cares or protests.

    For example, new regulations require that trading in contracts involving currency derivatives must be made on exchanges where regulators and others can see them, rather than in secret as was previously happening.  Many feel this was a significant part of the problem in the recent financial system meltdown.

    Treasury Secretary Geithner recently announced he had decided to exempt major banks and financial firms from the ruling and allow them to continue trading certain contracts “over the counter” (i.e. not on an open exchange) and out of sight as before.  According to the Treasury Department, the contracts that Geithner carved out from the rules account for $30 trillion of the global market for such derivatives.

    Why would they want to do that in private and not on an exchange?  The fact that they can create all kinds of exotic products, put up far less collateral, charge much higher commissions and be subject to less regulation wouldn’t have anything to do with it, would it?  I am aghast.  Who would have thought that the greedy SOB’s would put their own self interests ahead of doing what’s right!

    New financial regulations were also supposed to prevent abuse of investors in IPO’s (initial public offerings).  Basically, investment banks have used their influence over IPO’s to allocate IPO shares to the executives of their investment banking clients and others they wanted to do favors for, with only tiny portions available to the investing public.  The investing public could then go after the shares in the open market after the offering, which often doubled and tripled the price in a matter of hours or days, allowing the favored few to sell their shares into the frenzy and thus make huge profits.

    A few weeks ago, a section of the regulations requiring that investment bankers have no involvement or influence, directly or indirectly, in how the shares of IPO’s are allocated was removed from the new regulations by the SEC.  What a surprise!  Coincidently, this is happening just as Wall Street firms are preparing an unusually high number of IPO’s of internet companies related to the hot new areas of social-networking, online gaming, and music downloading.  Looks like we’re back to business as usual and the inmates still run the asylum.  And they wonder why the public doesn’t trust them anymore.

    On another note, have you noticed the ongoing evolution of investments in agricultural products, metals, and foreign currencies?  They enable an investor to invest in a variety of asset classes that the general public could not easily do before.  The question is should the average person be investing there at all?

    There are now ways to invest all types of agricultural commodities, as well as ways to invest in German, Italian and Japanese sovereign-bond futures.  Many of these are even leveraged two or three times, which significantly increases the potential return or loss.  Retail investors can now place their bets on volatile farm prices and the credit worthiness of assorted countries, and leverage themselves to the hilt in the process.  It looks like a train wreck waiting to happen to me.

    To each their own I guess.  For the life of me, I cannot understand why a retail investor would want to dabble in these types of investments.  You’re making a high-risk bet on the direction of a commodity, or currency or sovereign bond, on which you have no special insight or information.  And you’re entering a market full of well-informed insiders who often do have special insights or information.  This is not investing.  It’s gambling.

    As a retail investor, do you feel you have better information on, say, the corn market than the pit traders in Chicago, or than professional international currency traders?  This is like one of us going one on one with a NBA player.  It’s not even a contest.

    I know a guy who makes his living as a professional Texas Hold ‘Em poker player.  He says the world of poker is a Darwinian fight for survival in which “sharks” (the

    professionals) feast on the “fish” (the amateurs).

    I can think of no better analogy for this area of the investment world.  The entry of legions of new inexperienced fish into commodities, currencies, and bond futures will keep the sharks in New York and Chicago well fed for years.  My recommendation?  Play a game you can win.  Invest in companies and sectors you understand that are attractively priced and backed by durable macro trends.  Over time, you’ll come out on top.


Some things just never change.  A few years ago the major financial firms created a devastating financial crisis and meltdown that harmed the ....

April 2011

  • April 2011: Is This The Beginning Of The Selling Season

    ‘Tis the season.  No, not that season.  The season of the stock market when you need to go away.  Well, almost anyway.  There’s an old saying about a trading pattern on Wall Street that says “Sell in May and go away.”  Then you’re supposed to come back and buy again in November.  Does it really work?  Yes and no.

     

    There is certainly something to it though.  The market has a proven tendency to make most of its gains between November and May, and experiences most of its losses in the remaining months.  Some people dismiss the idea as an interesting theory that doesn’t always work.  But it’s not a theory; it’s a proven fact.  In spite of the few years when it has not worked, investing over the long-term based on the market’s seasonality significantly outperforms the market, and with much less risk.

     

    Don’t take my word for it.  Academic studies provide clear evidence.  For instance, a study published in the 2002 American Economic Review concludes, “We found that this inherited wisdom of Sell in May to be true in 36 of 37 developed and emerging markets.”  It went on to say that, “A trading strategy based on this anomaly would be highly profitable in many countries.  The annual risk-adjusted outperformance ranges between 1.5% and 8.9% annually depending on the country being considered.  The effect is robust over time, economically significant, unlikely to be caused by data-mining, and not related to taking excess risk.”  Another study in 2008 at the New Zealand Institute of Advanced Study, which focused solely on the U.S. stock market, concluded that “All U.S. stock market sectors, and 48 and out of 49 U.S. industry sectors, performed better during the winter months than summer months in our sampling from 1926-2006.”

     

    Of course, it doesn’t work every year, but let’s put that into context.  To begin with, no strategy, particularly a buy and hold strategy, works every year.  And that is also true of seasonality.  For instance, it underperformed in 2003 and 2009.  In those years the market made gains in the winter months, and then, fueled by massive government stimulus programs, continued still higher during the summer months when a seasonal investor would have been in cash or invested in something other than stocks.

     

    But the seasonal investor did not lose money by being out of the market in the unfavorable season in those years.  He or she merely missed further gains.  But when an investor is in the market in unfavorable seasons in which the market experiences the serious declines that most often take place in unfavorable seasons, that investor actually loses money.  Those losses can be substantial, with investors giving back much, if not all of the gains made in the previous favorable season.  For instance, from May 1st to its low during the summer months, the S&P 500 lost 22% of its value in 2001, 24% in 2002, 38% in 2008, and even 16% in the early summer correction in the positive year last year.  Those are the experiences that created the “lost decade” that buy and hold investors experienced but which seasonal investors avoided.

     

    Seasonality could be even more important this year than in other years.  There are negative factors working against the economy and market to a degree not seen in a number of years.  They include rising inflation; global central banks raising interest rates to ward off inflation, which is also likely to slow their economic growth; signs of the U.S. economy slowing again (sharp declines in home sales, durable goods orders, and consumer confidence); the coming end of the Federal Reserve’s QE2 stimulus efforts in June; and the austerity measures Congress will be forcing on the country in efforts to bring the record budget deficit under control.

     

    Then there is the high level of investor bullishness usually seen near market tops.  For instance, the Investors Intelligence Sentiment survey shows bullishness has jumped up to 57%, while bearishness has fallen to just 15.7%.  That spread of 41.6% is considered to be in a danger zone.  The last time it reached 40% was in October, 2007 as the market topped out coming into the 2007-2009 bear market.

     

    The traditional seasonality maxim, ‘Sell in May and Go Away’, calls for buying November 1 and selling on May 1 of the following year. Those dates were the basis for the academic studies mentioned earlier.  But obviously a positive market move does not begin and end on the same day each year.  That’s just the general time frame.  Depending on what is going on, the sell date could be as early as mid-April or as late as mid-June.

     

    So, will this strategy work in 2011?  Beats me.  But given the negative items I listed above, and a market that has experienced a substantial rally since March 2009, it certainly is something to be aware of.

     

    One closing topic I want to share with you.  It’s totally unrelated to the subject of this article but I just can’t resist.  I have written before how gold may well be in a bubble.  Here is one more indicator.  It appears now that the Islamic Republic of Iran, that bastion of cutting edge modern finance and economic theory, has recently converted a significant amount of its currency reserves into gold in order to avoid holding the dollars of the Great Satan.  According to WikiLeaks, the gold buying was an attempt to avoid currency seizure by hostile powers.  You can’t make this stuff up folks.


‘Tis the season.  No, not that season.  The season of the stock market when you need to go away.  Well, almost anyway.  T....

  • April 2011: From Fugitive To Central Banker

    Depending on your point of view, you may or may not be too happy with Fed Chairman Ben Bernanke and all the money printing going on at the Federal Reserve.  If you think he’s unpopular, consider the case of John Law, the Scottish adventurer who, as France’s first central banker in the early 1700s, became the most powerful man in international finance—and the wealthiest man in the world—before having to flee penniless into exile and obscurity.

    Law presided over one of the greatest financial spectacles in history: the Mississippi Land Scheme, which was aided and abetted by the creation of the first modern central bank in Europe, the French Banque Generale (later re-named the Banque Royale).  Law was an interesting character; a gentleman gambler with a taste for wealth, wine, women and power.  His financial career began in the gaming halls of Europe after escaping a death sentence in England for killing a man in 1694, allegedly over the affections of a woman.

    John Law was born in 1671 to an Edinburgh goldsmith.  Goldsmiths were the foundation of the early European banking system, performing basic deposit and lending functions.  They would take deposits of gold and issue paper certificates which could be redeemed at any time for the gold they represented.  Learning the basic tricks of the trade from his father—and having a gift for calculating odds that made him dangerous in Europe’s casinos—Law was exceptionally well positioned for a career in finance.

    Law spent nine years on the run in Continental Europe after escaping England and amassed a small fortune before returning to Scotland (English warrants were not honored in Scotland at the time).  The Scotland that Law returned to was in the midst of a financial crisis after a disastrous colonial venture in Panama that wiped out the savings of much of the country’s citizenry.  Law’s proposal to get the Scottish economy moving again—which was defeated by the Scottish parliament—was the issuance of paper money backed by the land owned by the government.

    Monetary conditions in the wake of the crisis were extraordinarily tight.  Given that there was a shortage of physical gold (as most of it was lost in the Panama debacle), banks and private citizens alike were hoarding what little cash they did have.  The money supply was diminished and the velocity of money was in free fall.  (Sound familiar?  It should.  A collapse in the velocity of money is a common occurrence in nearly all post-bubble crises, and the American housing and debt crisis of 2008 was no exception.)

    Law believed that paper money was preferable to gold or silver coinage for several reasons.  Paper money is highly portable, making it more convenient than gold or silver as a medium of exchange and facilitator of economic activity.  Law was correct in this observation and noted—as Adam Smith would write more than 70 years later in “The Wealth of Nations —that a country’s wealth should be measured by its output, not by its holdings of precious metals.  Unfortunately, paper money can also be printed at will, as we are learning all too well lately.

    Though rejected in Scotland, Law’s ideas soon found a home on the other side of the English Channel.  Upon his death, Louis XIV had left France virtually bankrupt.  As it turned out, building Versailles and spending decades at war cost money—a lot of money. 3 billion livres, to be exact, while annual tax revenues were only 145 million livres.  To keep this in perspective, the U.S. debt-to-income ratio is about 4 times, while the ratio that Louis XIV bequeathed to his son was an almost unfathomable 21 times!

    The interest payments on the debt took up 120 million of the 145 livres in revenues—leaving a mere 25 million to finance the rest of the French government’s expenses.  Given that annual expenses were 142 million livres, the French crown depended on further access to credit to keep afloat.  Suffice it to say that France was a bad credit risk.

    Then along came John Law.  Because Louis XV was only a young boy when his father died, his uncle Philip II, the Duc d’Orleans, became the Regent of France.  Philip was in a bind and was willing to try anything to avoid default and collapse.  And John Law appeared to have the answer—the creation of new money by a powerful government-chartered bank that would be used to pay off the existing debts.  Law would issue stock in the new bank and would use the proceeds of the IPO to buy back government debt.  He would also take deposits in coin but issue loans and withdrawals in paper.  How is that for quantitative easing?  What a sweet deal - if you’re the bank.

    The rest of the story is quite complicated and too long for this column, but a full telling of the story can be found in Niall Ferguson’s “The Ascent of Money.”  The short story is basically that the French government declared all taxes must be paid with notes issued by Law’s bank, thus making them legal tender.  Law didn’t want to drive up the price government bonds he was purchasing, so he solved the problem by offering bank shares exclusively in exchange for the government bonds.  Unbeknownst to the buyers, this retired much of the existing government debt, which they couldn’t pay anyway, for something of far worse credit quality.

    Law built trust in his new paper money by making it redeemable for the full value in gold coin and went so far as to say that any banker unable to meet redemptions on demand “deserved death.”  His rhetoric worked.  The French bought into the scheme completely.  Of course, there was this little problem of not having anywhere near the amount of gold necessary to back up the paper, but Law figured nobody would ever call his bluff.  Never let the facts get in the way of a good story.

    In a truly unusual sign of the times, Law’s paper currency actually traded at a 15% premium to comparable gold coins one year into the scheme.  As Law anticipated, the jolt in both the money supply and the velocity of money jump-started the French economy.

    France might have prospered had Law stopped there, gradually paying off its debts through a mixture of economic growth and mild inflation, but he got cocky. To pay off the country’s remaining debts in one grand swoop, Law launched the next phase of his scheme.

    Law convinced Philip II to back a trading company with monopoly trading rights over the Mississippi River and France’s land claim in Louisiana.  Shares in the new company would be offered to the public, and investors would only be allowed to buy them with the remaining billets d’etat on the market [i.e. the existing French Crown junk bonds].  So began the famed Mississippi Scheme.

    Law’s new venture, which would come to be known as the Compagnie des Indes, was granted all the possessions of its competitors—the Senegal Company, the China Company, and the French East India company—giving it exclusive French trading rights for the Mississippi River, Louisiana, China, East India, and South America.  Law’s enterprise also received the sole right to mint royal coins for nine years; it was allowed to act as the royal tax collector for the same amount of time; and it was granted a monopoly on all tobacco trade under French rule.

    Immediately after the initial public offering, applications for shares in the Compagnie des Indes started coming in from all levels of society.  So many, in fact, that it took the staff at the bank weeks to sort through all the applications.  Traders, merchants, dukes, counts, and marquises crowded into the little rue Quincampoix and waited for hours to find out if their subscriptions had been granted.  When the final list of subscribers was announced, Law and his awaiting public learned that the shares had been oversubscribed by a factor of six. The immediate result?  Shares in the Compagnie des Indes skyrocketed in value.

    The Compagnie des Indes—popularly called the Mississippi Company—was France’s answer to the Dutch East India Company, but with one critical difference: the Dutch company actually had profitable trading routes.  (Who knew that you needed a profitable business model??)  The French trading company had the mosquito-infested bog we today call Louisiana and little else.

    The investors that piled in were buying shares in a company without any real business model.  How exactly Law intended to make money in Louisiana—a land of tepid swamps, not mountains of gold—was never fully explained.  Though we can shake our heads at the Frenchmen in retrospect, it is easy to understand their enthusiasm.  They were trading in rather junky junk bonds for an exciting opportunity in the New World—an investment that, while ridiculous in retrospect, was no more absurd than buying inflated tech stocks in 1999 or Miami condos in 2005.  The “animal spirits” that characterize all financial bubbles was fueled by an exceptionally loose monetary policy, with predictable results.

    Impressed with the success of the original paper banknotes, Phillip II decided to expand Law’s operation.  He renamed the Banque Generale the Banque Royale, made it an official organ of the Crown, and proceeded to expand the money supply by 16 times its previous amount—by literally printing money—and later increasing it by even more.  Suddenly, Ben Bernanke’s much maligned “QE2” would seem tame by comparison!

    Much of the new money went directly into shares of the Mississippi Company.  In a matter of months, the share price rose from 500 livres to 10,000 livres, creating a new class of “millionaires.” A cycle developed whereby demand for the Mississippi shares would create demand for new paper currency with which to buy them.  And Philip and Law were only too happy to oblige.

    Law’s central bank allowed investors to borrow money at low interest rates using their Mississippi shares as collateral.  (Sound familiar again?)  This would be like the Federal Reserve lending you money directly to buy shares of a new, unproven technology start-up company and using your existing shares of the company as collateral, creating something of a self-contained Ponzi scheme.

    In the later stages of the scheme, the Banque and Mississippi Company were effectively merged and there was no discernable difference between bank notes, Mississippi shares, and the old government debt.  The system evolved from a paper system backed by a gold standard to a paper system backed by Mississippi shares which were in turn “backed” by land in Louisiana. (How the currency would be redeemed for land was, again, never really explained.)

    The entire scheme began to unravel when Law attempted to deflate the bubble, which had already led to hyperinflation throughout the French economy and which had spread to neighboring England as well.  The surge in liquidity created by Law’s scheme spilled across the English Channel and helped to inflate the South Sea Bubble, which had its own excesses nearly as legendary as those of France.  Perhaps the most notorious was the successful IPO for “a company for carrying out an undertaking of great advantage, but nobody to know what it is.”  It’s hard to imagine anyone actually buying shares in something this ridiculous, but then, is it really any more absurd than lending money for a technology company with no assets and no earnings, or a no-doc “liar loan” on a generic Miami Beach condo?

    The French bubble was roughly twice the size of the British, measured by the share price appreciation of the Mississippi Company relative to the South Sea Company.  Law’s company rose by a factor of 20, whereas the South Sea Company rose by “only” a factor of ten.  For this, we can credit John Law’s willingness to liberally offer central bank credit for the purchase of shares!

    When French investors attempted to redeem their banknotes for gold, it quickly became obvious that there was not enough gold to back the banknotes in circulation. The bank stopped payment on it notes, the economy collapsed and Law was forced to flee the country in disgrace.  Shares in the Mississippi Company fell all the way back to their issue price, destroying both the newly rich and the established order alike.

     The only thing more painful than hyperinflation is the inevitable deflation that follows. When the credit markets seized up, the supply and velocity of money plummeted as desperate Frenchmen scurried to dump their worthless banknotes and shares.  France and her middle and upper classes were ruined, and the Monarchy was discredited—setting the stage for the bloody French Revolution a generation later.  The French developed a strong distaste for banking and capital markets that arguably lingers to this day.  The debacle set back the development of modern capitalism in France by decades.

    As for the investors, they endured a bear market that would make modern investors shudder.  What followed was 70 years of secular bear market conditions.  Stocks did not meaningfully rise again until the 1790s.  So much for “stocks for the long run” or “buy and hold” investing!

    What lessons can we learn from this?  One point on which nearly all market historians would agree is that the bigger the bubble, the bigger the bust that follows.  Bubbles almost always return to the level at which they started.  This was the case in the Mississippi Scheme—the share price rose from 500 livres to over 10,000 livres before collapsing back to 500—and it will likely be the case in the American real estate markets most affected by the bubble of the mid-2000s.

    Perhaps the most important lesson would be that credit-fueled bubbles always end badly.  This was certainly the case with the spectacular collapse of the U.S. housing bubble—which led to the destruction of the banking system—and to the collapse of the Japanese “miracle economy” at the beginning of the 1990s, to give two recent examples.

    It is popular these days to lay all blame at the feet of the Fed for keeping interest rates artificially low.  In the U.S. housing bubble, this is not really accurate or fair. The Fed played its part, of course, but so did irresponsible bankers, mortgage brokers, real estate agents, speculators and even the home buyers themselves.

    The Fed’s actions in the aftermath of the bust are what have generated the most controversy.  The Fed has always engaged in “open market operations,” buying and selling U.S. government securities in an attempt to regulate the money supply.  But this has evolved from a purely monetary objective to becoming a de facto funding mechanism for the U.S. government.  The government is effectively printing money at the Fed in order to lend it to itself when the Fed uses that money to buy bonds that it will likely never sell.  Though not quite as egregious as the Mississippi Scheme, whereby money was printed to buy inflated shares, there are obvious parallels.

    The question on everyone’s minds is “what happens when the Fed eventually has to reverse course?”  When the Fed takes the punchbowl away, bond yields should rise and most risky assets—like stocks—should fall.  But when?  And by how much?  The volatile stock correction that started in late spring 2010 coincided with a lull in the Fed’s easing.  Given that stocks have had an unusually good run in recent months, we might expect a similar decline once the effects of QE2 wear off, or perhaps something much worse.

    Regardless, we should learn from the lessons of history.  Quantitative easing is dangerous and does not “fix” a bad economy.  It does, however, generally lead to destabilizing asset bubbles.  The quantitative easing following the “dot com” bust helped to create the conditions that made the housing and mortgage bubble possible.  And today, we have incipient bubbles in gold and food prices forming.  Again, using history as a guide, the most likely outcome is a prolonged period of deflationary conditions and slow growth.


Depending on your point of view, you may or may not be too happy with Fed Chairman Ben Bernanke and all the money printing going on at the Federal ....

  • March 2011: Looking At The World Sideways

    Oscar Wilde once said, “Experience is the name everyone gives to their mistakes.” If that is true, many people have gained a lot of investing experience over the last 10 to 20 years. In a previous column I discussed the significance of secular (i.e. long term) bull and bear markets. Contrary to what you might think, secular bear markets don’t really trend down as much as they move sideways for long periods of time, with lots of mini bull and bear markets bouncing around in between.

    Let’s look at a stock such as Wal-Mart and see what takes place in a sideways market. (This is just an example and not a recommendation to buy or sell Wal-Mart.) Over the past 10 years, the stock has basically gone nowhere. However, during that time Wal-Mart’s earnings almost tripled from $1.25 to $3.42 per share, growing at an impressive rate of 11.8% a year. This doesn’t look like a stagnant, failing company. In fact, it’s quite an impressive performance for a company whose sales are approaching half a trillion dollars. Its stock chart would lead you to believe otherwise.

    The reason for this unexciting stock performance was valuation – the P/E (price/earnings) ratio – which declined from 45 to 13.7, or about a 12.4% decline a year. The stock price has not gone anywhere because much of the benefits from earnings growth were canceled out by a declining P/E ratio. Even though revenues more than doubled and earnings almost tripled, all of the return for shareholders of this terrific company came from dividends, which did not amount to much. This is exactly what we see in the broader stock market.

    Let’s zero in on the last secular bear market the U.S. saw from 1966 to 1982. Overall stock market earnings grew about 6.6% a year, while P/E ratios declined 4.2%. Thus stock prices only went up about 2.2% a year. Of course there were lots of brief up and down cycles during that period, called cyclical bull and bear markets. That time period had five cyclical bull and five cyclical bear markets. Two forces worked against each other. The benefits of earnings growth are wiped out by P/E ratio contraction.

    Secular bull and bear markets tend to last about 15 to 18 years on average. As I have written before, I think we are currently in a secular bear market that began in 2000 and probably has another six to eight years to go. We saw a similar trend in P/E ratios in the 1966 to 1982 period. Since 2000, P/E ratios declined from 30 to 19, a decline of 4.6% a year, while earnings grew 2.4%. This explains why in 2010 the stock market was pretty much where it was in 2000, despite 10 years of earnings growth.

    Historically, though earnings growth fluctuates in the short term, it generally mirrors the growth of the economy, averaging about 5% a year. If P/E ratios never changed and always remained at an average of 15, we would not have bull or bear markets at all. Stock prices would simply go up or down with whatever earnings were. That is what would happen in a utopian world where people are completely rational and unemotional. Of course, there is no utopian world and people are not rational.

    The change of P/E ratios from one extreme to the other through market and economic cycles is largely responsible for sideways and bull markets. P/E ratios moving from low to high levels cause bull markets and P/E ratios moving from high to low cause the roller coaster ride of sideways markets.

    Secular bear markets occurred when you had two conditions in place; a high starting P/E ratio and prolonged economic distress. Together they are a lethal combination. High P/E ratios reflect high investor expectations for the economy. Economic problems such as runaway inflation, recessions or severe deflation, declining or stagnating earnings, a credit crisis or a combination of these things destroy those high expectations. Instead of an above average economy, investors find themselves in an economy that is below average. Suddenly, a bear market has started. That is where we are today.

    What about a cheerier subject - the bull market? We saw a great example of a secular bull market from 1982–2000. Earnings grew about 6.5% a year and P/E ratios rose from very low levels of around 10 to the unprecedented level of 30, adding another 7.7% to earnings growth. Add up the positive numbers and you get incredible compounded stock returns of 14.7% a year. Add dividends on top and you had even more incredible returns of 18.2% over almost two decades. No wonder everyone thought they were stock market geniuses in the late 1990s. Not anymore.

    Mean reversion is a statistical term for things going back to what could be considered normal. Mean reversion is the Rodney Dangerfield of investing: it gets no respect. Mean reversion is as important to investing as the law of gravity is to physics. As long as humans come equipped with emotions like fear and greed, market cycles will persist and the pendulum will continue to swing from one extreme to the other. Prices never stop at the mean. They always overshoot on the way up and on the way down. When P/E ratios hit the extremes is when the next bull or bear cycle starts.

    So what does this mean for investors today? It means that if we are in fact in a long term bear market for the next several years, we are not likely to see major advances in stock prices even with improving earnings. I am often asked how stock prices can go down or stay flat even when company earnings are improving. It is because of P/E ratio contraction and it is very important for investors to consider whether we are in a bull or bear market when considering their investment decisions. Short term, I think we’re in a brief bull market cycle. But we may be just whistling past the graveyard. Longer term, I think we’re still in a secular bear market with several more years to go. You’ll have to decide what you think.


Oscar Wilde once said, “Experience is the name everyone gives to their mistakes.” If that is true, many people have gained a lot of inv....

  • January 2011: Risking It All With Vern

    Risk is a funny thing. Everybody loves it when it works out, but it can be quite painful when it doesn’t. I learned a lot about risk from a cat named Vern. Vern was a cat I had years ago; or I should say that Vern had me. He wasn’t anything special; just an ordinary gray barn cat. But he was special to me and made me smile and laugh a lot. I loved that old cat.

    Vern was a house cat meant to live his life protected indoors. The problem was that Vern didn’t seem to know that and never missed an opportunity to be out hunting for whatever it was that he liked to hunt. Unfortunately, in the real world the hunter can sometimes become the hunted.

    As long as Vern hunted during the day, the risks were fairly small. He almost always managed to come home about dinner time carrying his trophy from the hunt, much to the dismay of my horrified daughters. But night time was a different matter. The big hunters came out at night and the risks got a lot higher and the odds changed against him. As hard as I tried to prevent it, Vern often managed to find the right moment to bolt out the door and he was off for the night. He always came home; although more than a few times he looked like he got the worst end of a fight. At least he made it home.

    I never understood why he would never abandon the thrill of the hunt in exchange for the comfort of watching TV and eating snacks with me in the easy chair, but that’s just the way he was. The good news is that Vern was lucky and lived a long and happy life.

    This is not a story about Vern though. This is a story about risk. More specifically, it’s about asymmetrical risk; when the risk in one direction is far greater than the other. This is the risk/reward equation people talk about but rarely consider. An example of asymmetrical risk is catching a plane. If you arrive too early, you waste some time sitting in the airport. This is unfortunate, but it’s tolerable. If you arrive too late, you miss the plane altogether. This can be expensive and very inconvenient.

    Asymmetrical risk has nothing to do with the odds of a given risk, but everything to do with the consequences of a given risk. In Vern’s case, the odds that a coyote would kill him were relatively low and the odds were hugely in his favor. For example, let’s say the odds were 50-to-1 in his favor. But the consequences of that risk were incredibly asymmetrical. In our hypothetical 50-to-1 risk, Vern returns home alive 50 times out of 51. But one time in 50, the coyotes kill him. By the numbers, that's a good risk. In reality, that's a horrible risk. No investor would take a bet like that...at least not knowingly.

    As investors, we can’t afford to turn a blind eye to risks, especially not to asymmetrical risks. We can’t afford to take risks that are likely to work, but are likely to wipe us out if they don't work. Understanding your potential reward is worthwhile. Understanding your potential risk is everything.

    We hear a lot about risk versus reward. If someone were to ask, “How did you do last year?” (with your investments), an appropriate answer might be “Compared to what?” You see, if you were to measure your performance against the S&P 500, which was up 12.88% in 2010, you might not have done as well if you had been quite conservative with your investments. What if you were conservative and only made 5%? Is that bad? Well, if you compare it to the overall stock market, yes. However, if you compare it to the risk-free rate of return, that was pretty good if you didn’t take a lot of risk doing it.

    The “risk-free rate of return” is a term analysts use to identify what you could have earned without taking any risk. Typically that is something like short term T-bills or CDs. In a time not too long ago, you could have earned 3% in T-bills or perhaps 4% in a one year CD, all guaranteed and no risk.

    If you could make 4% on a risk-free investment (and were happy with that), but instead you invested in a diversified portfolio of stocks and bonds and earned 5% - well, that’s not too impressive. In fact, it’s pretty awful given the extra risk you had to take to make 1% more.

    Today, however, the risk-free rate of return in T-bills, money market funds and CDs is almost zero. Given that scenario, if you managed to earn 5% in your portfolio and you took a minimal amount of risk doing it, then you might consider that fairly significant excess performance. Oh sure, making 12% in the market is far better; but you have to consider the extra risk it would have required you to take to achieve that. In retrospect, if you had done that in 2010, it would have worked out and you would have been quite happy. But what if it didn’t? In January 2010 you didn’t know for sure that was going to happen. In fact, there were many times during the year that it didn’t look like that was going to happen at all.

    The point is no matter how much we try to ignore it, risk versus reward is a factor we constantly have to measure. Big returns are nice, but how would you feel if the opposite happened? Many people experienced that first hand in 2008 and found out the thrill of victory may not be enough to offset the agony of defeat when it comes to investing. Unless you’re truly an aggressive investor who can stomach occasional big losses, don’t measure your investment performance against the stock market. Measure it against the risk-free rate of return and stop driving yourself crazy. In the words of Bobby McFerrin’s song, “Don’t worry, be happy.” My pal Vern beat the odds. You may not be so lucky.


Risk is a funny thing. Everybody loves it when it works out, but it can be quite painful when it doesn’t. I learned a lot about risk from a c....

  • February 2011: Is That All There Is?

    “Is that all there is, is that all there is? If that's all there is my friends, then let's keep dancing. Let's break out the booze and have a ball.” Perhaps those words from Peggy Lee’s 1969 hit song “Is that all there is?” are an appropriate opening for my annual predictions column. The investment mood has changed along with a general feeling that the worst is behind us, things are getting better, and maybe things were not so bad after all.

    Or perhaps not. I hate to rain on everybody’s parade, but maybe that’s not all there is. The global economy, as I see it, is in a period between two crises. In 2007-2008 we had the global credit crisis, the private sector banking crisis and the bursting of the real estate bubble. Now we are in a period of clean up with a respite from the chaos.

    Unfortunately, we didn’t fix anything and have mostly sown the seeds for what will eventually be another crisis. Things seem stable now but there is a lot of unfinished business. Sadly, we swept it under the rug and transferred the problem from the private sector to the public sector, i.e. you and me. We bailed out different institutions and people who had positioned themselves incorrectly. We created “too big to fail” instead of “you have an opportunity to succeed or fail.”

    As Yogi Berra famously said, “Predictions are tough, especially when it concerns the future.” In 2009 I was right on 100% of my predictions for the markets and the economy, and in 2008 nearly so. And for 2010? Well, not so hot. Maybe I should follow cowboy logic: “If your horse dies, I suggest you dismount.” I don’t think the horse is dead yet, so your fearless forecaster continues on. Having said that, I could use a little extra ketchup on that crow I’m eating.

    Here is what I said in January 2010 and what actually happened:

    1. “The Dow climbs to 11,300 but heads lower in the second half of 2010, falling back to the 8,500 level by year end.” I got the first half right but missed on the 8,500 part. I had not counted on the Fed throwing another $600 billion into the market in the form of quantitative easing, commonly called QE2. I still think I’m right on the second part, but it looks like I’m about a year or so early.

    2. “The housing market improves slightly in the first half of the year and then falls again by late 2010 as a tsunami of Alt-A and Option ARM mortgages reset this year, leading to another surge in foreclosures and home prices falling another 10%.” Mostly correct.

    3. “The national unemployment rate remains stubbornly high and exceeds 11% by late 2010.” Missed on this one. Unemployment dropped to 9.4% but is still exceptionally high and most experts, including the Fed, think it will remain high for several years.

    4. “The U.S. federal budget for 2010 runs another $1.5 trillion deficit. U.S. Government debt hits 94% of GDP.” Right on this one! Our number one problem is too much spending and too much debt, so we’re fixing it with more spending and more debt. Huh?

    5. “Oil prices inch higher in 2010 and hit $100 a barrel, further depressing the U.S. economy.” Almost, but not quite. Oil hit $91 but the resulting increase in gasoline prices has already taken $67 billion out of household income. Higher energy prices are great if you’re a producer, painful if you’re a user.

    6. “U.S. economic recovery continues with positive GDP growth in 1st and 2nd quarter, mostly due to inventory rebuilding. The recovery stalls and we see the early signs of a double dip recession by the end of 2010.” Half right. Double dip is probably off the table until 2012 because of continued government spending and stimulus.

    7. “The Fed raises interest rates earlier than expected. The 10 year Treasury bond yield hits 4.7% by late 2010.” The Fed has not raised interest rates but the bond market did it for them to some extent with 10 year rates going from 2.3% to 3.5% in the last quarter.

    8. “The U.S dollar explodes higher in 2010. Although we have lots of problems, the world realizes that we’re not as bad as they thought and everyone else is not that great.” Correct.

    9. “Gold will likely fall below $900, although it could go to $1300 first.” Gold corrected to $1,050 but never saw $900. It got to a high of $1,432.

    10. “Over 500 U.S. banks fail in 2010, up from 150 in 2009. Several major European banks fail due to defaults in former Eastern block countries and the weak links in the Eurozone, the so-called PIIGS (Portugal, Ireland, Italy, Greece and Spain), triggering the next leg down in Europe.” Correct on Europe but wrong on U.S. banks. 157 banks failed in the US in 2010, up from 150. There are still over 800 U.S. banks on the FDIC’s watch list of troubled banks.

    So what happens next? Here are my thoughts for 2011:

    1. After a brief correction early in the year, the stock market works its way higher in a volatile fashion to a top sometime in the fall, possibly to 12,800 on the Dow, before rolling over late in the year or early 2012.

    2. Gold, oil and commodities in general continue higher with gold eventually hitting $1,500 an ounce and oil $100 a barrel.

    3. Interest rates on long term Treasury bonds spike in late 2011 creating a great buying opportunity in bonds again.

    4. GDP figures continue to show improvement in the 1st and 2nd quarters before turning down again in the second half of the year. Predictions of 4% GDP growth by some analysts are likely way too optimistic. Inventory rebuilding, which was over half of the GDP growth in 2010, is largely over. Fiscal stimulus from the U.S. Government runs out and state and local governments have to make major cut-backs to balance their budgets. Look for GDP at 2.0-2.5% at best. Unemployment will remain above 9%.

    5. Home prices on a national average fall another 10%. If home prices stay flat or continue to fall, the level of defaults will accelerate and the banks finally will have to admit to and deal with massive levels of bad loans. Another round of mortgage resets is on the horizon in mid-2011.

    6. U.S. Municipal bankruptcies become headline news. More cities that are technically bankrupt are contemplating the idea of making it official. This will finally force a major shift in dealing with public unions and the funding of public pensions. The first major city to go bankrupt will cause a huge stir in the municipal bond market.

    7. The sovereign debt crisis in Europe will put the Eurozone under more pressure. Their problems have not gone away and several countries will be forced into massive austerity programs or the European Central Bank will be forced to print money and devalue their currency.

    8. China’s economy is overheating and they are raising interest rates as rapidly as possible to stop runaway inflation. This will eventually pop their real estate bubble, slow their economy and put pressure on commodity prices.

    So there you have it. No guts no glory, right? We’ll review it again next year and see how I did this time.


“Is that all there is, is that all there is? If that's all there is my friends, then let's keep dancing. Let's break out the booze and have a....

December 2010

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