Anatomy of a Bubble


The above chart was formulated by Dr. Jean-Paul Rodrigue in 2006, in the middle of the developing housing bubble. It illustrates the general pattern that most market bubbles tend to follow.

Early on, a small number of money managers and other sophisticated investors begin speculating that a given asset may be undervalued and establish small investments in the hopes of future gains. As these initial investments start to pay off, other managers begin to notice their success and follow suit, slowly ramping up prices. There may be one or more temporary sell-offs as early investors decide that their speculation has paid off and pull out of assets that they now perceive as overvalued.

Sometimes, this is as far as a price fluctuation will go. When a rising price starts to attract media attention, however, it creates the potential for a true bubble. At this point the price may already be significantly over asset value and the original “smart money” investors’ reasons for buying no longer apply. But as the general public becomes more aware of the success stories that the rising prices have created, more and more people buy in. This drives the price up even further, reinforcing the public perception that an easy money-making proposition has been discovered.

As the bubble nears its peak, wise investors quietly pull out as it becomes clear that the price is unjustified and unsustainable. Latecomers with little understanding of their holdings invent new explanations to rationalize the extreme overvaluations the bubble has created. They believe the old rules no longer apply and the inflated price is the new “normal.”

At some point, reality sets in and triggers a cascade in price. The bubble begins to deflate, although bullish investors may try to deny that this is happening. They see the initial decline as a buying opportunity, creating short-lived recoveries before the bubble goes into its final plunge. Often, the aftermath of the bubble leaves the asset so despised it becomes badly undervalued, creating buying opportunities for savvy investors—which may eventually generate the start of the next bubble, many years down the line.

We already know the lesson here: avoid the stampede. When we hear everyone else is buying something, it’s tempting to join in. But even when it seems like the price just keeps going up and up, we know what’s eventually around the corner.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.

The Next Recession is Coming!

© Can Stock Photo Inc. / svanhorn

The next recession is always coming—and the next recovery, and so forth. Like the seasons and the tides, the economy runs in cycles. But after reviewing all the evidence, we don’t think it will arrive any time soon.

LPL Financial’s Research Department put together a useful summary on this issue. This is the short version, with other thoughts on the topic.

The first thing to understand is that two of the most popular fears about the cause of recessions are unfounded. The growth part of the cycle does not end because of old age. And the start of interest rate increases usually marks the midpoint, not the end, of the growth cycle.

So what are the causes of recession? LPL Financial believes that imbalances are the culprit. “In a healthy economy, there is a balance of responsible levels of borrowing, confidence, and spending.” So recessions are likely to occur after we see over-borrowing, over-spending, and overconfidence.

LPL Research has actually constructed numerical indicators to test for these three “overs” and calculated back through history. But it doesn’t take a rocket scientist to know that confidence is poor and spending has been weak. Borrowing has not gotten anywhere close to danger levels, either. Their conclusion is that the probability of a recession in the near future is unlikely.

The LPL “Over” Index agrees with another set of recession warnings we monitor, the Four Horsemen: home building, auto sales, business investment, and inventories. When one or more of these areas becomes overheated, trouble may ensue. All four are all at fairly subdued levels, or close to long term averages—not overheated.

There is one other indicator which may be both instructive and profitable. The price of raw materials usually peaks at around the same time the economy does, near the onset of recession. Crude oil, iron ore, copper and other natural resources tend to rise during expansions. But the prices for these goods have been falling for more than four years. We expect to see a sustained move up prior to the next recession.

We look at the facts and act accordingly, after considering all the pertinent information we can find. Our conclusion is that optimism is warranted. We will continue to follow our principles: search for bargains, “own the orchard for the fruit crop,” and avoid stampedes in the markets.

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.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Investing involves risk including loss of principal.

Putting the Security Back in Social Security

© Can Stock Photo Inc. / CBoswell

There is a recurring concern that comes up when discussing retirement planning with clients. When we sit down with someone to break down various sources of retirement income, sometimes they will stop me and say “Mark, I don’t want to count on Social Security because I’m pretty sure it will be gone by the time I retire.”

It’s an understandable concern. We see headlines all the time calling for Social Security reforms (meaning cuts), throwing around scary words like “default” and “insolvent.” However, it is important to remember what these words really mean. If someone owes you $100.00, and they can only pay you back $99.97, they are technically insolvent. But you’re not really going to miss those three cents all that much.

The Social Security trust is short more than a couple of pennies, but the concept is the same: the program has merely enough funding to meet most of its obligations rather than all of them. You might hear estimates that the Social Security trust fund will “run out” within 20 years, but this does not mean the end of Social Security. Even without the support of the trust, the Social Security program is projected to have enough revenue to continue paying out approximately 75% of its obligations after the trust runs out (according to the latest annual report of the trustee board at

This is still a problem, obviously. No one wants to wake up in 20 years and hear their benefits have been cut by 25% because Social Security ran out of money. Thankfully, the fixes are not onerous. The math behind the Social Security trust, as with any pension fund, is based on the principle of compound interest—something that Albert Einstein is said to have called the greatest force in the universe. Staving off that future 25% drop can be accomplished by a smaller 13% decrease in benefits or increase in revenues today (representing a payroll tax of about 2%.)

These changes will undoubtedly cause some pain and there will be resistance to Social Security reforms. None of us knows what the future may bring, so it may be foolish to treat benefit projections as hard and fast numbers. But it seems clear to us that Social Security will likely survive in some form.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Weighing the Bad and the Good

© Can Stock Photo Inc / gunnar3000

If a salesman came up to you on the street and offered you an investment that had only a 54% chance of making money, would you think it was a good bargain? Probably not.

Over the past 65 years the S&P 500 index has had a positive daily return less than 54%. With odds like that, one might think that some skepticism in stock investments was warranted. And yet, over the course of those 65 years, the S&P has risen over 12,000%. Even though it has lost money almost half the time, taking that 54% bet over and over again turned out to be very profitable. At times, market movements feel like they’re going one step forward, one step back—or at times even one step forward, two steps back. But over time, stepping forward 54% of the time is enough to build a great track record.

Past performance is certainly no guarantee of future results. We can only hope that the next 65 years are as good for the market as the past 65. The potential is there, though. And obviously, market volatility does pose obstacles. If you have $10,000 today and you really, really need to make sure you have $10,000 tomorrow, investing in a market that goes down 46% of all trading days is not a very good idea. Investing in volatile markets takes a certain mindset and a longer term investment timeframe. Call or visit us to discuss what investments would be suitable for you.

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.

It’s the Journey, Not the Destination

© / chbaum

When we think about our lives and plans, milestones are a useful concept to help organize our thoughts. In ages past, the mile markers on the roads of the Roman Empire let travelers know of the progress of their journey.

The same is true of the milestones in our lives: birthdays, anniversaries, graduations and retirements are points on the journey, not the destination. The road continues on, after we reach each milestone. They are memorable accomplishments worthy of celebrating, a natural time to reflect and take stock… but not the destination.

Thus it is with our business anniversaries. We’ve been at 228 Main in beautiful downtown Louisville for fifteen years, as of November 1st. Larry is wrapping up one year in our shop already; Greg will soon mark his sixth anniversary. Next year, our firm marks twenty years in its current form.

But we measure our progress by the people we’ve helped. The staff, systems, experience and resources we put together to do our work for you more effectively are our true milestones. Hiring a third member of the team, having a dedicated staffer to help with the technology clients use, building out our 24/7 communications in the New Media, allocating more time to research and portfolio management: these are the recent milestones we care about.

In other words, our true milestones are the ones that help us help you make sense of your journey.

Take Me Out to the Ball Game

© Can Stock Photo Inc. / dehooks

Thirteen years ago, Oakland manager Billy Beane turned the world of professional baseball on its head. As depicted in the movie Moneyball, Beane knew that the Oakland Athletics didn’t have the budget to compete head to head with better-funded teams from larger markets. He looked to advanced statistics to give him an advantage, realizing that baseball’s conventional wisdom did a poor job of judging player performance. Traditional baseball skills like speed and contact hitting were being overvalued, while game-winning skills like patience at the plate and slugging power were being undervalued. By focusing on what really mattered over what was popular, Beane was able to find the best bargains in the baseball universe.

While many baseball franchises grudgingly followed suit after Beane, traditionalist manager Ned Yost has stuck to the old wisdom. Under him the Kansas City Royals have broken every rule set forth in Moneyball, emphasizing speedy contact hitters who will swing at anything to get the ball in play and steal bases at the slightest opportunity. Despite that, he’s taken the Royals to two consecutive championships and a long-awaited World Series pennant, leading some fans to hail his success as the death of Moneyball-style statistics.

In fact, Ned Yost apparently took to heart the one true lesson behind Moneyball: never follow the crowd.

The Oakland Athletics were able to win because they turned aside from what “everybody knew” about baseball. After their successes were highlighted by Moneyball, what “everybody knew” changed. When everybody else started chasing after the same statistics that led the Oakland A’s to victory, they started undervaluing old-fashioned baseball skills like speed and contact. Ned Yost ignored what “everybody knew” about those old baseball skills and built a great team around them.

Billy Beane is fond of comparing the baseball world to investment markets, and the comparison is an apt one. Both baseball and investment markets are prone to cycles as people chase after the crowd—creating opportunities for those who avoid the common wisdom of what “everybody knows.” The Royals’ pennant is a testament to the value of going against the grain.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Why Life in the 21st Century is So Grand

© / binik

People know why financial advisors invest time and effort studying the economy, markets and specific opportunities. The case for commenting and writing and posting in the 21st century media may be less clear. But there is a compelling reason why we are so engaged, one that has to do with your financial wellbeing.

One of the biggest factors in investment outcomes is investor behavior. The average investor (and some advisors) behave in counterproductive ways. They tend to buy at high prices in times of euphoria and sell at low prices in times of general despair or panic. We believe our clients are far from average, however, and we would like to keep it that way.

Our theory is that more communication leads to understanding, understanding leads to effective behavior, which in turn usually results in better outcomes. We have no guarantees about the future, but we are pretty sure the wealthier our clients are, the better off we will be.

If we take time to write down one or two of our stories every week, we can post them for any client to read any time, 24/7, at their convenience. There aren’t enough hours in the day to tell a story a hundred times in a week, but a hundred people can read the story at the same time here in the 21st century.

More communication is better communication, and there is a terrific side effect. Since some fraction of clients get some fraction of their information from our new media efforts, we have more time to talk one-on-one when that is needed. Whether you follow on Facebook or Twitter or subscribe to the blog, we have more time to talk.

More communication, more time, potentially better investment outcomes….life in the 21st century is incredibly grand. We’re glad you are with us.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Investing involves risk including loss of principal.

Buyer Beware: 4 Tricks to Inform Yourself With

© / bradcalkins

Investing offers a seemingly infinite range of approaches, methods, products, services, and theories. The abundance of alternatives can be confusing, or even paralyzing. We can equip you with four ideas that may help you to winnow the choices down to ones that are more likely to help you.

  1. Some of the highest-cost products attract the most persistent sales people. If you are being pursued by a seller who is willing to spend a great deal of time and effort and travel to connect with you, assume that there is a very healthy paycheck in the deal and know that you’re ultimately the one who will pay for it.
  2. Sellers love to spend a lot of time with the glossy sales brochures that are full of hope and promise, not the prospectus. You will learn about the dangers and risks and conflicts of interest and the costs from the prospectus, not the brochures. Two things to do: read the front cover of the prospectus, and have a knowledgeable third party review the whole document. If you encounter resistance to the idea of studying the prospectus, you know there is information in there that you should have.
  3. Some financial firms have gotten into the business of manufacturing their own ‘house brand’ products. These products may be impossible to move from that firm should you later elect to do business elsewhere. And companies that manufacture and distribute products have conflicts that independent firms do not. Beware of house brands.
  4. Second opinions do not cost, and may reward you. If you have any questions or concerns about a product being sold to you, call us for a complimentary review.

Bottom line, avoid being “sold.” Take advantage of the legally required disclosures in the prospectus. Beware of house brands. Seek second opinions.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

The Ant and the Grasshopper, Revised

© / smithore

Most of us are familiar with Aesop’s fable of the ant and the grasshopper: the hard working ants slave away all summer building nests and storing food while the lazy grasshopper idly eats and makes merry. Each one calls the other foolish: the grasshopper tells the ants they should relax and enjoy life, while the ants admonish the grasshopper to work harder and prepare for winter. In the end the ants have the last laugh when winter comes and they have food and shelter while the grasshopper has none.

It should be noted that Aesop was not a bug expert. If he was, he might have realized that grasshoppers only live a few months and do not survive long enough to even see winter. Knowing this, the grasshopper was actually quite wise to ignore the ants’ advice. He lived his life to the fullest, with no time wasted on unnecessary labors.

The true moral of the story is this: it is equally foolish to hoard wealth we’ll never use as it is to squander wealth that we’ll need in the future.

None of us knows the date that is going on our death certificate. We should strive to emulate both the ant and the grasshopper, because we never know which one we’ll wind up as. Like the ant, we should work hard and save wisely to prepare for the future. But like the grasshopper we should also enjoy what we have, while we have it. We need to have a little fun every day, because we never know how many days we have left.

The Times, They Are A-Changing

© / kgtoh

Forty years ago, poet Bob Dylan wrote a song that echoes a universal theme, the idea of constant change. One may trace this concept through all of history, from the ancient civilizations of Greece, Rome, Egypt, India and China down to our day. Dylan’s lyrics borrow from both the Bible and Aesop’s fables.

Yet there is a tension between constant change and our very human tendency to believe that current conditions and trends will continue. It is appealing to believe that we can know the future by extending past trends. When gasoline first hit $4 per gallon a few years ago, the media was full of predictions that the price would rise to $7.

We call this tendency “straight line thinking” because it involves looking back over a limited time to identify a straight line that can be extended into the future. Gasoline was $1.50 in 2002 and $4 in 2008; anybody could see the trend and many concluded that $7 gas was coming.

Yet nature abhors straight lines. When you open up your view to take in a longer time frame, you see cycles of up-down, up-down. Like the tides or the seasons, cycles seem to offer a more useful way to think about the world.

So our quest is to find good values, bargains, that may be due for a change in direction as the cycle turns. This contrarian method of investing is no guarantee of success. All of our clients have had the experience of owning a supposed bargain that became cheaper or even much cheaper. Yet it is the most promising way to approach investing, in our opinion.

Why is this? The first one now will later be last, the slow one now will later be fast, and the times… they are a-changing.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.