Month: July 2016

The Medicine is Worse than the Disease

Monetary authorities took extreme measures during and after the financial crisis. These policies failed in their stated goal. More importantly, they have the potential for much mischief in the portfolios of the unwary in the months and years ahead.

Fed Chairman Ben Bernanke made it clear that the role of zero interest rates and Quantitative Easing was to push money into productive investments (or “risk assets”) that would help the economy grow. Instead, the biggest tidal wave of money ever flooded into supposedly safe assets, like Treasury bonds. Money flows into US stocks disappeared in the crisis, and basically have never come back. Zero interest worked exactly opposite the way it was supposed to. This obvious reality is totally ignored by the central bankers.

Current Federal Reserve Chair Janet Yellen continues to parrot the party line. Progress toward undoing the mistaken crisis policies has been excruciatingly slow. And the potential for damage to safety-seeking investors continues to mount. Similar policies, or worse, are in effect around the world.

Standard & Poor’s recently issued a report stating that corporate debt would grow from a little over $50 trillion now to $75 trillion by 2021, globally. Bonds are the largest single form of corporate debt, which is how investors are affected. This isn’t happening because corporations are investing so much money in new plants and equipment and research. It is merely meeting the demand of safety-seeking investors for places to put money. We think of this as “the safety bubble.” It appears to be the biggest bubble in history.

Standard & Poor’s is warning of future defaults from companies that borrowed too much money at these artificially low interest rates. Our concern is that when interest rates inevitably rise, people locked into low interest investments will see large market value losses even if their bonds are ultimately repaid.

We’ve written about the impact of higher inflation on today’s supposedly safe investments. Now the warning from S&P highlights another risk. The distortions created by counter-productive monetary policy are growing.

Of course, we believe our portfolios are constructed to defend against these risks, and to profit from the artificially low interest rates. We will continue to monitor these and other developments. If you have questions or comments, please email or call 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. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

New Media is Bigger Than You Know

The first birthday of our online communication efforts is upon us. 228main.com was intended to provide us with a means to talk to a lot of clients at once, especially useful in times of stress. There were other objectives as well.

We know that communications influence behavior; behavior influences investment outcomes; and client outcomes are what we are about. The new media lets us highlight each day the thing we find most pertinent or interesting. We can drive home the lessons that help people invest and plan effectively.

If you follow us on Facebook, Twitter or LinkedIn, you know we have created some regular features to help us tell our story. The Junior Staff and Market Haiku show up weekly, along with links to pertinent articles and news.

The most surprising thing we’ve learned about the new media is how useful it has been to people we know, for much broader purposes than business communications. One retiree became acquainted with Twitter to keep up with a grandchild’s college sports team. A sports fan has grown a custom news feed of local print and broadcast sportswriters as well as recruiting clearinghouses, player and team accounts and other knowledgeable fans. A political junkie collects thoughts from candidates, opinion leaders, polling experts and major newspapers. We follow the best minds in the business world. Others pursue news about hobbies or interests.

In other words, Twitter can be a customized information source, tailored by you to your preferences. You choose the sources to follow. Whether or not you register, you can see our daily quick notes and commentary. You do not have to ever post anything in order to use the tool. However, if you do have a message, you can get it out.

LinkedIn, we’ve noticed, is more of a business forum and networking affair. Facebook is popular with many of our clients for many reasons. People see what their children or grandchildren are up to, and keep up with more distant relatives like never before. Facebook also allows businesses to have pages, which is how we can communicate with those who choose to ‘like’ our Facebook page.

Perhaps the biggest misperception among non-users is the idea that the whole world will know what you are up to if you participate. The fact is, you choose what to publish and who to interact with, if anybody. Many people just take in information, and post or publish very little. You might explore these venues to see if they can improve your life. The menu buttons at 228main.com can connect you.

Protection Against Prosperity

Protectionism has been a rallying cry for many disaffected voters this year. Insurgent campaigns on both the right and the left have been calling for higher import duties and economic incentives for domestic industry. Meanwhile, across the Atlantic, protectionist sentiment was a key driver in the campaign for the United Kingdom to leave the European Union.

Protectionism–the idea that you can improve the economy by taxing foreign imports and subsidizing domestic industry–is a comforting notion. We all want a vibrant economy with thriving local industry. But as is often the case with economic policy, regulatory intervention in the form of tariffs and subsidies can be ineffective or even counterproductive.

Capitalism rests on a simple premise: mutually beneficial exchanges make us all richer. When foreign goods show up at our ports, they’re not accompanied by warships forcing us to take them at gunpoint. We buy imported goods because we perceive a benefit in doing so. If we can buy a $100 foreign-made widget instead of a $200 widget manufactured locally, that leaves us $100 richer.

Protectionists argue that buying these cheap imported goods is short-sighted and self-destructive because it harms domestic industries. To be sure there are winners and losers in this scenario, and cheap foreign competition will hurt domestic widget makers. If we take an even bigger view, though, it becomes difficult to see how it benefits us to prop up inefficient industries at the expense of everyone else. Raising the cost of importing widgets helps out widget manufacturers, but it hurts consumers who have to pay more to buy widgets. Worse, it hurts industries that use a lot of widgets. And worst of all, it actually hurts all U.S. export industries.

Tariffs hurt our exports in two ways: first, and most obviously, other countries are not going to be happy with us, and will eagerly retaliate by levying their own tariffs against us. But beyond that, money that gets sent overseas to pay for imports is not “lost”, as enriching other countries helps create markets for our own exports. We would not be able to sell as many exports to other countries if we weren’t buying their imports as well. Again, commerce makes us both richer.

More subtly, subsidizing industries creates economic inefficiencies through distortion. If the domestic widget industry is failing, ultimately the solution is not to pump money into widget manufacturers to sustain an unsuccessful industry, it’s to reinvest those resources into other industries (such as ones that benefit from having access to cheap foreign widgets.)

To be clear, we realize that there is a lot of real hardship involved in this process. This is true of any economic progress: the horse-drawn carriage industry was devastated by the invention of the automobile, for example, but the solution was not to tax automobiles to save carriage makers’ jobs. Adapting to economic changes may be painful, but the pain is eased by having a vibrant, efficient economy—which we believe is ultimately incompatible with protectionist trade policies.

Deflated Inflation Expectations

We’ve written before about inflation and its corrosive effect over time. The topic has become much more timely because of two developments:

1. The prospects for inflation have gone up with the large increase in the price of oil and other forms of energy. We could potentially see annual inflation indicators top 3% within the next six months.

2. Money continues to flood into long-term low rate fixed income, as safety-seekers buy bonds yielding in the 1 and 2 percent range.

It appears these trends are in for quite a collision. Our first principle is ‘Avoid stampedes in the markets.’ So we suspect that the safety-seekers may not end up with what they were seeking. If today’s 2% bond is repriced in a 3% world, capital losses may result.

Human tendency is to expect current conditions and trends to continue. So the prospects for inflation are pretty much ‘out of sight, out of mind,’ since we have not had much inflation for quite a while. But the large increases in the price of oil and other raw materials could potentially generate annual inflation rates in excess of 3% over the next few months. Crude oil, for example, bottomed at $28 per barrel in February 2016. Current prices in the $40’s, if they persist until February 2017, will exert a lot of upward pressure on inflation.¹

One would expect that investors locked in at 2% yields when inflation is running at 3% will not sit still for it. The mystery is, will the stampede of money into bonds come stampeding back out if safety-seekers find losses on their supposedly safe investments?

The potential for profit lives in the gap between expectations and unfolding reality. We believe inflation expectations and corresponding investment yields are off the mark. We have no guarantees, but our opinion is inflation will be up and bond prices will be down in the months and years ahead. If you would like to talk about the ramifications on our portfolios or yours, write or call.

¹_{Oil prices retrieved via Federal Reserve Bank of St. Louis}

Bond yields are subject to change. Certain call or special redemption features may exist which could impact yield.

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

The Robots Are Coming!

Some forecast that there will be no jobs in the future, as software and robots and other forms of mechanization take over more and more tasks now performed by actual people. To understand the issue, we need context and background.

Manufacturing output in the US is near record levels, up 30% from the recession levels of 2009. Yet manufacturing employment peaked in 1979 at 19 million workers. The total today is around 12 million workers¹. One might say ‘The robots are already here.’

While seven million manufacturing jobs were lost, fifty million jobs were added to the total. Manufacturing jobs were not the only ones that disappeared, however. Millions of other jobs became obsolete. File clerks, telephone operators, laborers with shovels, elevator operators, secretaries, and farm workers were displaced by new machines and new methods.

In a dynamic economy, we perpetually do more with less. In the year 1900, 40% of Americans were engaged in producing our food². When that declined to under 2%, we didn’t end up with 38% unemployment.

There is another way to look at it. Tens of millions of people are now engaged in occupations that did not exist forty years ago, near the peak in manufacturing employment. Similar change happened between 1900 and 1940, and 1940 to 1980. Why would we doubt that 2010 to 2050 would be any different?

A recent report in the European Parliament concluded that “Humankind stands on the threshold of an era when ever more sophisticated robots, bots, androids and other manifestations of artificial intelligence (‘AI’) seem poised to unleash a new industrial revolution, which is likely to leave no stratum of society untouched.” This presents more opportunity for society than danger, if history is any guide.

It’s going to be exciting. Please call us or write with questions or concerns.

^1,2_{Federal Reserve Bank of St. Louis}

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

Traveling by Miracle

Next month I will be traveling again, to and from a conference. I’ll be going by miracle.

More specifically, air travel. I’ll fly on planes that cost about $80 million each. The planes are part of an airline company fleet that cost about $19 billion dollars. Of course, planes are useless without airports—and we spend another $19 billion per year on airport capital improvements in this country.

The planes and airports would not do us any good without the people who fly them, load them, change the sparkplugs, and do everything else it takes to run an airline. My airline spends $6 billion on the help each year. (OK, maybe planes do not have sparkplugs, but you get my drift.) Another $4 billion goes for fuel.

I’ll have breakfast in Nebraska and lunch in San Diego. A few days with colleagues and consultants, experts and peers, listening and presenting (a first for me, this year!): a priceless experience. Then back to Nebraska.

If I had to drive or take the train, the travel would take days and days. Instead, I get the use of these billions of invested capital and all those talented people to do the trip in hours instead of days.

All this for a few hundred dollars. It is traveling by miracle. The company that serves me lives in mortal fear that the next company will figure out a way to serve me better for less money, so it is on a perpetual quest to provide even better value for my buck. As a customer, I’m really doing well in this transaction.

If I choose, I can be more than a customer. I could also be a percentage owner of the aircraft maker, the energy company that provides the fuel, and the airline itself. I could lend these companies money by buying their bonds, and collect interest from them.

On my journey, I will probably meet at least one person who complains about the service, or a slight delay, or the crying baby, or the security procedures. But I’ll be counting my blessings that I was born to this place and age, and enjoying the miracles around me.

Zen and the Art of Investing

We’ve read that one of the central tenets of Buddhist philosophy is the idea of non-attachment. Attachment, according to the Buddhist worldview, is the root of all suffering. We want and expect certain things and become upset when we don’t get them. Freeing ourselves of our attachments to things alleviates our suffering and allows us to experience the world with a clear mind and a joyful heart.

I suspect I would make a pretty poor Buddhist in practice, but the concept resonates with some of what we do here.

Suppose, for example, that an investor watches their portfolio gain 5% in a single week. They will probably be overjoyed, but now they’re attached to the new value. If their portfolio retreats 3% the following week, many investors will be unhappy about its performance—even though they just made a very appreciable gain of 2% inside of 2 weeks.

It works both ways, too. If the market hits a bump and their portfolio goes down 5% they might be upset, even if they’ve watched their portfolio weather many such bumps and know it has a history of rebounding to their benefit. Even after they watch it rise back up, they may resent it for having dipped in the first place.

Now we’re not about to sit here and tell you that you should be happy when your portfolio underperforms—that’s not what we’re about. Non-attachment does not mean you stop caring about things, it simply means you put them in perspective. This frees you to make more effective decisions for the long haul instead of being swayed by emotions about the short term. An investor who trades in and out based on feelings about day to day performance is likely to do himself financial harm.

In the real world, of course, investing requires careful thought and analysis, not just philosophy. Thankfully, we are equipped to provide both. Give us a call or email us if you want to talk about your situation and how we can help.

This is a hypothetical example and is not representative of any specific investment. Your results may vary.

228Main

News and Views from 228 Main

Month: July 2016

The Medicine is Worse than the Disease

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Protection Against Prosperity

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Deflated Inflation Expectations

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The Robots Are Coming!

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Traveling by Miracle

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Zen and the Art of Investing

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