Connect the Dots

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Do you remember the “connect the dots” pictures for children? By drawing lines from one dot to the next, the players discover that a coherent picture emerges from a seemingly disorganized collection of dots on the page.

Likewise, our work involves creating a picture that makes sense out of all the things going on in the world. In our version, though, there’s no handy numbering guide to draw our attention to the relevant dots.

Instead there seems to be an infinite number of dots in the world. So our first task is to do some sorting. For example, a vast mass of information is available about the day-to-day movement of the stock market. We can sort out any dots that fit into the category “the market goes up and down”—and then discard them. They are not pertinent for long-term investors.

Time horizon plays a large role in sorting as well. There is a wealth of opinions about nearly any investment alternative. A short-term technical analyst may have an opinion that is useful to a day trader but worthless to investors who are thinking in terms of years or decades.

But our work involves more than sorting out what to ignore. We frequently need to dig deeper—to read SEC filings, to research what happened in prior cycles years ago, and to look up many years of operating results. In other words, we still have to be able to find some of the specific dots we know are needed to complete the picture.

For example, we believe that inflation in the next few years will exceed consensus expectations. There is little information from the past decade supporting this view, in our opinion, but as we dig deeper, the patterns going back many decades suggest we may have it right. (No guarantees.)

Another way of saying all of this is that perspective, context, and background matter as we try to connect the dots. We are fortunate to have time to think deeply—and clients who value our methods and our work are a big plus. Together, we’ll create the picture.

Clients, if you would like to talk about this or anything else on your agenda, please email us or call.


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

Who Controls Your Destiny?

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“You can’t go back and change the beginning, but you can start where you are and change the ending.”
-C.S. Lewis

When we came across this quotation from novelist and academic C.S. Lewis, it made us realize one other trait tends to set you, our clients, apart from others. We have long believed you form a niche market of the mind, sharing certain beliefs about investing and life. Our understanding of your uniqueness is deepening as we go along.

Successful planning—our work–requires all of us to believe that we have some control over our outcomes—that we can start where we are and change the ending. But not everyone believes that.

Do people have control over how things turn out, or do external factors, things beyond our control, govern? Psychologists refer to this dimension of personality as the locus of control. We humans vary in this respect.

Much is beyond our control. Accidents happen, markets move randomly in the short run, others sometimes make decisions we do not like. Yet we try to make the most of what we have to work with. We expect that we can make the future better with the actions we take today.

At one extreme, some believe nothing they do can make a difference. If planning is fruitless, we cannot be of service. At the other extreme, some believe that everything can be controlled. This is a problem too—we do not control the stock market!

We are grateful for your balanced outlook: willing to take action to make a better future, knowing that stuff happens, always looking to make the best of it.

Clients, if you would like to talk about this or anything else on your agenda, please email us or call.


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

Wishing For A Gold Mine?

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We know a fellow who built a gold mine. Whenever we mention this, people usually ask what it was. The answer is…a gold mine. This client worked as a construction superintendent for a very large contractor. He had built coal mines and a gold mine among many other large projects.

This anecdote comes to mind as we prepare to tell you our latest thoughts on investment tactics. We invest time every week looking for the best bargains, trying to figure out emerging trends, thinking about the economy and the markets. In a recent research meeting, Greg Leibman posed the question, “What can we own that might benefit from rising inflation?”

We humans tend to think that recent conditions or trends will persist. This makes it hard to realize the long spell of very low inflation might come to an end, with inflation outpacing expectations.

One way to weather periods of rising inflation is to invest in companies that own things: land, buildings, factories, raw materials, and so on. An oil company already owns the oil in their reserves and the wells to pump it; when prices go up, they get to sell it for more profit but most of their capital expenses have already been baked in.

Miners similarly benefit when the prices of their existing mineral reserves go up. Like oil companies, their stock price tends to move in correlation with natural resource prices, making them a potential inflation hedge. Some mining companies have exposure to the gold market, which some people may see as a particularly important hedge against inflation.

We have had raw material companies on our radar for some time now: they tend to be big cyclical movers, and we have been bullish about the current cycle so far. But we believe that this same sentiment may have created buying opportunities in the mining sector.

We look for potential gaps between expectations and the unfolding reality. That is where profit lives, in our opinion. When Greg posed the question, we put our heads together and started looking at potential opportunities. To summarize,

• Inflation may exceed expectations in the years ahead.
• We believe that some companies within the mining sector are at bargain levels.

There are no guarantees. What we think of as bargains sometimes have the dismaying tendency to get cheaper after we buy them. But we think we have identified potential investment opportunities that may be appropriate for some portfolios. Clients, if you would like to talk about this or anything else, please email us or call.


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 this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

The Inflation Powder Keg

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A few weeks ago, the Federal Reserve issued a policy statement greenlighting more interest rate hikes despite fears of inflation.1 For years the Fed has struggled to keep inflation up to its target rate of 2%, and now that it is there, it looks likely to us that the Fed may overshoot the target entirely.

Interest rates and inflation tend to go hand in hand. When interest rates are high, borrowers can earn more money to spend, creating upward price pressures. When inflation is high, lenders try to raise rates to keep ahead of inflation. As rates continue to rise, you can often expect inflation to do the same.

Worse, there are other pressures looming on the horizon that we think may contribute even more to inflation. A strong economic cycle and robust jobs market may often bring higher inflation. As unemployment drops, workers become harder to find. Many companies might have to offer higher wages to get the employees they need, forcing them to raise prices—at the same time that workers have more money to spend from higher wages. Rising prices and rising wages equals inflation.

We also expect more price pressure to arrive from overseas. The trade war that the current administration seems bent on fighting shows no signs of cooling off. When you raise taxes on a product, such as a tariff on imports, inevitably the price may go up to pay for the taxes.

Tariffs create knock-on effects, as well. Many products manufactured inside the U.S. use materials imported from overseas that are subject to tariffs, so domestic products may also face rising prices. And domestic companies that are fortunate enough to dodge the tariffs entirely may still raise their prices opportunistically: with the prices of other goods rising, they have an opportunity to increase prices and profits without hurting themselves as much competitively.

Once again, where you have rising prices, you have inflation. Put it all together and the economy may be sitting on a powder keg of explosive inflation pressure. We do not know when or if the powder may exploded, but we cannot afford to ignore it.

We have gotten so used to low inflation rates in the past decade that it is easy to pretend they will last forever. Sooner or later, we expect some investors to be burned by this mindset. We want to do what we can to avoid being among them. Clients, if you have any concerns about how inflation may affect your portfolio or investment strategy please call us.

Notes and References

1:Press Release, Board of Governors of the Federal Reserve: https://www.federalreserve.gov/newsevents/pressreleases/monetary20180613a.htm. Accessed June 28, 2018.


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 this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

 

Modern Rationality and Ancient Wisdom

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The modern age is largely a product of the Scientific Revolution. Scholars date the beginning of that period to the 1543 publication of the Copernicus treatise, On the Revolutions of the Heavenly Spheres.

Developments in mathematics, physics, astronomy, biology and chemistry changed our view of the world. It seemed that all the secrets of the universe could be unlocked by the scientific method. The idea of reason or rationality arose from this: an objective reality may be discovered by observation, experimentation, and logical thought.

It is comforting to think that everything can be figured out—and probably wrong.

Modern philosopher Nassim Taleb has argued that the role of randomness in our world is underappreciated. There is much that cannot be known until we find out: whether a company will struggle or thrive, whether a market will advance or decline, which bird of two sitting on a branch will be the first to take flight.

Before rationality, going back to ancient Greece, there was wisdom—expressed in the word sophrosyne. This ideal of character included traits such as moderation, prudence, and self-control. Think of it as wisdom.

It strikes us that wisdom helps investors fill in the gaps where rationality fails us. The idea of diversification is a way to deal with uncertainty: if we could rationally determine which holding was going to go up the most, who would need to diversify? And self-control plays a role in our methods. “Avoiding stampedes” takes quite a bit of it, for example.

We are big fans of quantifying the things we can quantify. Doing the math is a large part of our work. Reason—rationality—is key. But it also makes sense to exercise moderation and prudence when facing uncertainty—which is nearly always.

Modern rationality and ancient wisdom are a powerful combination. Clients, if you would like to discuss this or anything else on your agenda, please email us or call.


There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

No strategy assures success or protects against loss.

Our Exorbitant Privilege

© Can Stock Photo / yanc

Financial firm founder Barry Ritholz says that the vast majority of people in the investment business spend most of their time chasing new business. Finding clients or trades consumes most days and a lot of nights—it is their main job.

Dialing the phone, putting on seminars, networking, joining boards, sending spam email…there are a lot of ways to meet people.

That Ritholz Wealth Management needs to do none of these things is what he calls “our exorbitant privilege.” We feel the same way.

My vision when I was forty was to find and retain a circle of clients who, if I took care of them, would take care of me. I did NOT want to wake up at sixty, needing to run up and down the highways to find a deal to pay my bills. The vision became reality.

You know our business objective is to strive to grow your buckets, and have them serve you as you need. The interesting paradox is that we have grown since we stopped looking for new business.

We frequently mention how important you are to the process. You saved the money to begin with, you share our philosophy of investing, you do the right thing even when it is difficult to do so. Clients may not be retaining nearly as much money if they routinely sold out in panic or insisted on buying into fads.

Now we have a better way to express our appreciation for you. It is our exorbitant privilege to serve you as we do.

Clients, if you would like to talk about this or anything else, please email us or call.


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

Steering the Herd

© Can Stock Photo / carla720

One of our core investment principles is to “avoid the stampede.” If you read this site regularly you have heard us say this over and over again, but we think it bears repeating.

As part of our work we talk to many product representatives who want a slice of our business. There are countless product providers out there competing for our attention, and your money. There are limited amounts of both to go around, so inevitably most of the wholesalers that talk to us are going to be disappointed. However, we still like talking to them as they do us a vital service: they tell us which way the stampede is going.

We are contrarians by nature. When we hear someone tell us that a lot of people are buying something, our instinct is not to line up alongside them. When a lot of people tell us that a lot of people are buying the same thing—our instinct is to run far, far away.

Lately, what we are hearing from the product wholesalers is that everyone is piling into exotic alternative investments. Everyone is looking for exciting new products that are not correlated to stock market returns, and boy, are the product providers ever ready to sell it to them.

We live in uncertain times, and it is understandable to be spooked at some of the troubling headlines we see. We understand the desire to seek safety. But, we believe that safety is not to be found from following the herd. Omaha is famous for its stockyards and slaughterhouses; we know that when the cattle are all getting steered together, it rarely ends well for the cattle.

We know there are always uncertainties with the economy and the markets. But the sales pitches we hear for everything non-correlated to stocks makes us feel a lot more secure in our traditional equity investment philosophy. There may come a time when the herd starts stampeding back towards equities and it will be time for us to look elsewhere. For now, though, our equity focus puts us in lonely company when it comes to wholesalers—and that is just how we like it.

If you want to talk about any market trends or sales pitches you may have noticed, please feel free to call or email 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.

Gradually And Then Suddenly

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In the novel The Sun Also Rises, author Ernest Hemingway gives us an insight into an interesting mechanism. One character asks another how his bankruptcy happened. The reply? “Two ways. Gradually and then suddenly.”

It seems to us that many things in the economy and markets happen the same two ways. Prices rise slowly at first, then gain momentum. Or a market stalls and declines slowly for a time, then falls swiftly. Or business activity, at the bottom of a recession, begins to tick higher, almost imperceptibly, until it takes off.

And in our own affairs, we see the same situation. We talked recently with a client in her middle 70’s, who noted she now had higher income than at any point in her working years. Compounding builds wealth only gradually for a long time, then (it seems) suddenly.

(People who are liquidating investment balances with overly large withdrawals see the same thing, in reverse. Balances decline gradually, then suddenly.)

An important part of our work is helping people visualize those inflection points for trends that are nearly imperceptible at first. When we first begin to save a small amount each payday, it is hard to see the fortune that might emerge over time. And when markets seem to be just slogging through the mud month after month, positive changes are tough to imagine. Our role is to help people see how this works.

The same mechanism applies to our work in researching investments. For example, there are sectors that have done well in recent years, with abundant liquidity in a period with easy monetary policy. But we have seen this movie before: liquidity dries up gradually, then suddenly. This specific issue is on our radar.

The challenge is that investment prices and economic indicators have a lot of volatility in the normal course of events, most of it meaningless. Most years, the major stock market indices rise about half of all days and fall about half of all days. Not everything is a trend happening gradually at first, then suddenly. Some of it is just noise. We work hard to sort it out.

Clients, if you would like to talk about this or anything else, please email us or call.


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 this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

Animal Spirits

© Can Stock Photo / cynoclub

More than eighty years ago, economist and thinker John Maynard Keynes wrote that “most, probably, of our decisions to do something positive…can only be taken as the result of animal spirits—a spontaneous urge to action rather than inaction…”1

The term animal spirits dates back to the Middle Ages as a way to refer to the vagaries of human activity. Keynes used it to describe concepts such as consumer confidence and the willingness of businesses to invest capital.

In recessions, animal spirits are subdued; during economic expansions, they are said to be stirring. The idea of animal spirits helps explain the booms and busts of the markets and economy.

As contrarians, we seek to discern when the dominant trend has gone too far, either from excess optimism or an overabundance of pessimism. A simpler way to say this is that we seek to avoid stampedes. We believe these things run in cycles.

More recently, we found another use for the concept of animal spirits. History suggests that rising tariffs and trade barriers around the world are a detriment to economic growth and prosperity. These kinds of trade troubles could emerge from the current discourse among nations. And there are differences of opinion on the economic impact here in the U.S.

Some analysts have calculated that the actual amount of goods and services directly affected by proposed trade actions is some very tiny percentage of the overall economy. Their conclusion is that the potential for economic mischief from trade issues is small.

At the same time, business leaders are becoming concerned about the possibility of reduced export sales and lower incomes and sales in the U.S. due to these same trade issues2. These concerns could dampen the animal spirits. Facility expansions, hiring, orders for inventory or raw material…all these things could be affected.

If business activity declines, jobs and personal incomes will not be far behind. The economic impact would be negative. You see, the effect on animal spirits, a second-order effect of trade disputes, could have a much larger impact than the direct effects.

We do not change our principles or strategies based on headlines of the day. Of course, we are always looking for ways to improve our tactics. If you would like to talk about this or anything else, please email us or call.

Notes and references:
1John Maynard Keynes. The General Theory of Employment, Interest and Money, 1936.
2Business Roundtable, CEO Economic Outlook Survey Q2 2018. https://www.businessroundtable.org/resources/ceo-survey/2018-Q2


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 this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

The Antiques Roadshow

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Everyone knows what junk is: discarded items of little use or value. Yet from time to time some fabulous treasure gets pulled from a trash bin or purchased at a second-hand store for a few bucks. We see these items on the long running television series, the Antiques Roadshow.

This reminds us of our work with a different kind of junk. The polite euphemism for bonds issued by relatively weak companies is ‘high yield.’ Just between us, let’s call them by a more accurate term: junk bonds. From time to time, at rare intervals over the past seventeen years, we have found something we believed to be investable hiding in the junk pile.

A perfect storm may be brewing in the junk bond world. Federal Reserve Bank statistics indicate that the size of the junk bond market has doubled in the past decade, to nearly $2 trillion outstanding. Adding in another category, junk-rated floating rate bonds, puts another $1 trillion on the pile.

1. When financial conditions tighten and corporate results weaken (as they will sooner or later), higher quality bonds may also be marked down to the junk category.

2. The capacity of dealers and other market makers to deal with waves of selling has been dramatically reduced by financial regulations1. Large banks were once players, but trading for their own accounts has been curtailed. Formerly, they stepped in at market extremes to support prices. In the next crunch, they are not likely to be there.

3. We believe some fraction of junk may be held by people who may not realize they own it—hidden in other financial products sold to investors.

4. We have characterized the movement into the apparent safety of bonds over the past decade as a stampede, based on the size of cash flows and the ridiculously low interest rates. (That’s just our opinion.) If that money stampedes out…prices may plunge to lower levels.

Clients, we strive to deal with reality as we see it. The next downturn in the economy is out there somewhere. Our holdings will continue to fluctuate in value, and we will have a down year at some point. But we are excited about the opportunities that may arise in the years ahead.

Junk bonds may not be appropriate investments for all clients. If you would like to talk about this or have something else on your agenda, please email us or call.

Notes and References

1Regulatory Changes Impacting High Yield Liquidity, Pensions & Investments. http://www.pionline.com/article/20151228/PRINT/151229939/regulatory-changes-impacting-high-yield-liquidity. Accessed June 11, 2018.


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 this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Floating rate bank loans are loans issues by below investment grade companies for short term funding purposes with higher yield than short term debt and involve risk.

High yield/junk bonds (grade BB or below) are not investment grade securities, and are subject to higher interest rate, credit, and liquidity risks than those graded BBB and above. They generally should be part of a diversified portfolio for sophisticated investors.