cyclical markets

World’s Biggest Roller Coaster?

© Can Stock Photo / winnieapple

The biggest roller coaster in the world is Kingda Ka, at Six Flags Great Adventure in New Jersey. Sometimes investing provides a similar experience.

We have written before about the lovely decade of the 1990s, when the major stock market averages more than tripled. When you get up close and really look at what happened, however, it looks a whole lot different. We examined the data for the S&P 500 Stock Index.

During that decade, there were 1,171 trading days when the S&P went down. The total points “lost” on those days adds up to 5,228. Put that in perspective: the decade started at just 353 points! The down days “lost” more than fourteen times the beginning value1.

Who would knowingly stick around if, on the first day of the decade, we knew that 5,228 points would be “lost” on the down days?

There is a reason we put the word “lost” in quotation marks. It might be more appropriate to speak of temporary declines rather than losses. We say this, because of what happened on the other 1,356 trading days in the decade.

On those up days, the market went up a total of 6,344 points—or more than 17 times the beginning value1. If we knew only that piece of the future at the outset, money might have flooded in.

The bottom line is, here is how we got a triple in the market: it went up 17 times its original value, and down 14 times its original value, in totally unpredictable bits and pieces of rallies and corrections. Patient people prospered.

It is hard to argue with a triple. That is a fine result. This is why we talk incessantly about the long term, long time horizons, keeping the faith, following fundamental principles, and not panicking at low points.

During the decade, how many times did 10% corrections have to be endured? 20% bear markets? Were there any 30% or 40% losses? WHO CARES? It didn’t matter to long term investors.

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

Notes & References

1Standard & Poor’s 500 index, S&P Dow Jones Indices: https://us.spindices.com/indices/equity/sp-500. Accessed October 3rd, 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. All indices are unmanaged and may not be invested into directly.

The economic forecasts set forth in this material may not develop as predicted.

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

 

It Works Until It Doesn’t

© Can Stock Photo / joebelanger

Money poured into tech stocks in the late 1990s. Then it went into residential real estate in the middle 2000s. No wonder: prices marched higher, year after year—until they didn’t.

We humans usually believe that recent trends will continue. When friends and neighbors and coworkers are getting in on the action, it is easy to join them.

A powerful narrative that seems to be creating a lot of wealth is hard to resist. “We have entered a new era.” “This time is different.” “You can’t lose money in real estate.”

Popularity pushes values farther and farther away from the underlying economics, and a reversal usually follows. The bubble pops; a great number of people are surprised. Some end up with losses instead of the gains they felt sure about making.

Our analysis suggests that a new kind of bubble is upon us. The zero interest rate policy or ZIRP of the Federal Reserve Board for most of the past decade led to a scramble for yield. This moved the valuation on many kinds of investments that pay income into very rich territory, in our opinion.

For example, we were recently pitched on a “cash substitute” with a 5% yield, in a supposedly liquid form. Sounds great, right? Perhaps too good to be true.

Indeed, when we took the proposition apart, we found it was made largely out of corporate bonds in financially weak companies—junk bonds, in other words. To make matters worse, the manager pursued opportunities in a thinly-traded part of the market—odd lots, small amounts of each bond that are unattractive to other buyers.

This idea will work until it doesn’t. When the next economic slowdown creates cracks in the theory, investors who believed they owned a “cash substitute” may be sensitive about losses of any size. As they cash out, the manager may be forced to sell into a market with even fewer buyers.

The silver lining for us is that dislocations bring opportunities. Prices overshoot in both directions. One of our roles is to try to spot these anomalies, and figure out which ones are attractive opportunities for you. (We have no guarantees of success in this.)

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.

All investing, including stocks, involves risk including loss of principal.

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

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.

 

Prepare for a Changing Market

© Can Stock Photo / kerdkanno

When we began in business twenty-one years ago, we recommended a wide variety of investment products. Over time, our efforts have increasingly focused on platforms in which our investment philosophy and research may be more effectively employed. Most of our time and energy now goes into the investment advisory services we offer through LPL Financial.

Clients, many of you have assets outside of LPL Financial. We believe it is time to re-examine these arrangements and determine whether they are still appropriate. We might have recommended strategies in the past that may not be the best ones for the future.

• A generous bull market over the past decade meant that other arrangements generally remained beneficial to you, in our opinion.
• But market conditions are likely to become more hectic, sooner or later.
• We have greater flexibility to seek bargains, avoid stampedes, and pick our spots when assets are in the LPL Financial platform, instead of another institution.

The better off you are, the better off we are likely to be—this has been a guiding principle at 228 Main. Our motivation is to be in the best position to keep your portfolio responsive to changing conditions.

If we may possibly improve your situation by taking a more active role in managing your assets, we welcome those duties. If you decide that outside investment accounts remain your best option, we’ll still be happy to work with you on that basis.

We would like to talk, having no pre-conceived notion about what is best for your specific situation. 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. All investing involves risk including loss of principal.

What’s Your Story?

© gajdamak / www.canstockphoto.com

Thinker Morgan Housel wrote recently about the power of narrative in “The Greatest Story Ever Told.” The essay focused on the narratives that affect the whole economy, the big-picture themes. The future of the country didn’t change much from 2007 to 2009, but employment, wealth, and the markets all got slammed. What caused it? The central narrative, how we understood our economy, changed dramatically from the peak of the boom to the bottom of the bust.

Investment manias have a story at their core. They may come true or not, but while the story holds sway, real values are driven by the story. Housel summarized it this way: “this is not a story about something happening; something is happening because there’s a story.”

Stories are how we organize and understand the world and our place in it. “Stories create their own kind of truth,” as Housel wrote. We believe the same idea shapes the lives of individuals just as certainly as it shapes economic and societal trends.

At 228 Main, we have stories. About people who save diligently and achieve financial independence. About folks who invest with increasing confidence and less worry over the years. About investors who learn to live with volatility, and hold on through the downturns. (These are stories, not promises or guarantees—you long-time clients know your own realities.)

I would not be able to work with you as effectively without those stories—and more importantly, the narratives of my own life.

I have a story about a vibrant business in the face of steep personal challenges. I have a story about working to age 92. I have a story about new ways of doing business in the 21st century.

These stories have enabled me to thrive while dealing with major issues, live healthier than I have for decades, communicate more effectively with you than ever before, and make plans for the decades ahead while some of my contemporaries coast toward retirement.

It feels to me as if the stories I have crafted in turn have shaped my life. I am not done creating stories; life goes on and things change. We do not know the future. But if we take control of our stories, we may be able to influence our futures. No guarantees.

How about you? What’s your story? Are there aspects of your narrative that we could help you with? Clients, please email us or call if you would like a longer discussion.


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 Coming Boom?

© Can Stock Photo / devon

We wrote more than a year ago about the steady if slow growth of the economy. Just as a slow-burning fire might last longer than a raging conflagration, we expected that the economic expansion would persist longer than some commentators believed.

Another way to say it is, a bust is less likely without a boom first. The excesses that build in boom times usually contribute to the bust that follows.

For the first time in a decade, conditions may be ripe for a boom. The improvement in small business sentiment and increased money flowing into the equity markets had us on the lookout for signs of a boom. Then the tax law passed.

The tax law has pro-cyclical features that may strongly encourage economic growth now, but plants the seeds for a later slowdown. There may be political aspects that contribute to this syndrome, too.

Businesses investing in long-lived capital investments will be able to deduct the full cost up front, instead of taking smaller depreciation deductions over many years. This increases the financial attractiveness of projects; capital spending is likely to rise. A dramatically lower tax rate on corporate income, combined with a feature to bring overseas money back to the US, are further inducements for more business activity.

For two administrations in a row, the signature achievement of each has been done on a partisan, party line vote. When the minority party becomes the majority party, that achievement gets attacked and the unwinding begins. We’ve seen it with the Affordable Care Act; some Democrats are pledging to undo the tax law as soon as they are able.

So the favorable treatment of capital spending begins to phase out in a few years, and corporations may ‘get while the getting is good’ before the law gets weakened or unwound. These conditions might begin to affect things precisely when excesses from the boom have created more potential for a slowdown.

Boom, then bust. We know how this works. Clients, we will continue to monitor all of this, and work to take advantage of our thinking. No guarantees.

If you would like to discuss any of this in more detail, or have something 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.

The opinions expressed in this material do not necessarily reflect the views of LPL Financial.

All investing, including stocks, involves risk including loss of principal.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

 

About Those Good Old Days

© Can Stock Photo / Chuckee

A client recently expressed a desire to return to the good old days, when we didn’t have all this turmoil and trouble. Wouldn’t we all like that?

But we human beings have some quirks. One of them is the universal sense that, back in the misty past, things were normal, or stable. This idea may not stand up to scrutiny.

If we confine our study just to the economy and markets, the history we’ve lived through has this to say:

1. In the early 1970’s, a mania centering on big blue chip stocks hit the market. It was thought that you could just buy them at any price, and own them forever while they went up and up—“one decision stocks” they were called. Prices ballooned to extremely high levels. The major stock market averages peaked, then sold off more than 50%1.

2. The 1970’s also saw a pair of Arab oil embargoes that resulted in spiking gasoline prices, shortages, gas stations out of gas, and rationing. Over the course of the decade, inflation rose, eventually going over 10%. Unemployment went over 10% in the mid-decade recession2.

3. The early 1980’s began with back-to-back recessions, 15% mortgage interest rates, and inflation at unprecedented levels. The unemployment rate went over 10% again. Long term bonds declined in price as interest rates rose. A mania in oil stocks that began in the 70’s ended badly early in the decade3. The biggest one-day plunge in the Dow Jones Industrial Average ever—22% in a single day—happened in 19871.

4. The 1990’s began with the cleanup from the savings and loan crisis. The Federal deposit guarantee fund had gone broke, along with thousands of financial institutions. The value of housing, which began to fall nationwide in the late 1980’s, didn’t recover until 19924. The bond market suffered its first annual loss in seventy years in 1994.

5. Clients, most of you remember the bursting of the tech bubble in 2000, the attacks on 9/11, and the so-called Great Recession of 2008-2009. You already know the fine points; it was not good fun for investors.

6. The current decade, free of recessions so far, has had a lot of ups and downs. The downgrading of US Treasury debt and the recurring Greek financial crisis were two of the main events. The zero-interest-rate policy of the Federal Reserve distorted prices in some sectors of the investment markets, some observers believe.

The resilience of the equity markets over these many decades is astonishing to us. We had all these challenges and issues, and somehow the country came out on the other side, every time. We suspect this general trend will continue. The problems of today will give way to solutions– and new problems–tomorrow. That seems to be how it works.

In the meantime, financial strategies that have worked through the decades may be the best way to approach the future. There will be winners and losers in every change and challenge. We may not be able to get back to those mythical good old days, but we can make the most of what we have to work with.

Clients, if you wish to discuss this, or your situation, please email or call.

1S&P Dow Jones Indices, https://us.spindices.com/indices/equity/dow-jones-industrial-average

2Federal Reserve Economic Data, Federal Reserve Bank of St. Louis, Unemployment and Inflation

3Federal Reserve Economic Data, Federal Reserve Bank of St. Louis, Oil Prices

4Federal Reserve Economic Data, Federal Reserve Bank of St. Louis, Housing Prices


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.

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

Stock investing involves risk including loss of principal.

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.

The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.

The “Crash” of 1987: A Contrarian View

© Can Stock Photo / konradbak

The 30th anniversary of The Crash of 1987, the biggest one day drop in the stock market ever, recently passed. Mainstream commentary made much of the 20+% loss on the day, the panic, the shock, and whether such a drop could happen again.

People sometimes learn the wrong lesson from experience. (In our opinion, many investors learn the wrong lesson.) The so-called crash is another case in point.

First let’s put the event in context. The S&P 500 stock index went from 242 at the beginning of the year to 247 by the end of the year, with some commotion in between1. There was no apparent damage to long term investors when the dust had settled—provided one adopted sensible time horizons by which to judge it.

In fact, the next year saw a gain of 12% in the S&P 500, plus dividends1. The five years following 1987 notched a cumulative gain of 76%, plus dividends. This is why it might make more sense, in our opinion, to refer to The Great Buying Opportunity of 1987.

Those with unproductive perspectives measure the loss in the crash from the high peak the market reached earlier in the year. The S&P had jumped 39% in just a few months, even though interest rates were rising sharply and corporate earnings had stalled. From that frothy peak to the lowest closing price after the ‘crash’ was a drop of 36%1.

Clients, many of you were evidently born with the common sense to know that your perspective on events is a matter of choice. You choose productive, effective ways to consider things. Some of you weren’t born that way, but were able to learn how. Our work is intended for you who may benefit from it, not those who insist on counterproductive investing attitudes and behavior.

We believe the productive way to think about 1987 is as a year where the market saw a modest gain, before rising more significantly in subsequent years. The wealth-corroding way to think of 1987 is as a terrifying rollercoaster with damage so great no one could stay invested. You choose your perspective.

The true lesson of 1987 for effective investors: avoid stampedes in the market. Go placidly amid the noise and haste. That you are able to do this is why we believe you are the best clients in the whole world. Email us or call if you would like to discuss your situation in more detail.

1S&P Dow Jones Indices, http://us.spindices.com/indices/equity/sp-500


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.

Stock investing involves risk including loss of principal. The payment of dividends is not guaranteed. Companies may reduce or eliminate the payment of dividends at any given time.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

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

Bargain Hiding in Plain Sight

© Can Stock Photo / mrivserg

Imagine a product that has these uses1:
• Vital part of every home and building.
• Goes into every vehicle; hybrids and electrics use up to four times more.2
• Needed for manufacture, installation and use of solar panels and wind turbines.
• Key requirement in making batteries.

One might imagine that demand for this product will rise in coming years, as technology changes our power grid and transportation, and the world continues to modernize.

Now consider the supply side. It takes billions of dollars and four years or more to create a new production facility. The industry that produces it went through a depression as prices for the product got cut in half from 2011 to 20163. Revenues disappeared, losses mounted, spending got slashed. New projects were cancelled.

Rising demand, constricted supply: we know how this works. Prices will rise, revenues and earnings for producers will go up, stock prices may follow. No guarantees, of course, and the timing is always uncertain.

The product is COPPER. There is no replacement for it. The question we face as investors is, can we get involved on a favorable basis?

We know companies that produce a lot of copper, along with other resources. Their stocks are traded on the New York Stock Exchange. The valuation on their shares seems compelling. A dollar of profit in one trades for a third less than that of the average stock; the other one carries a two-thirds discount. One is trading at one-third of its all-time peak a few years back, the other is discounted even more.

Both stocks have been about twice as volatile as the average stock. (This is measured by a statistic called ‘beta.’) We don’t care. Downside volatility is wonderful if you are trying to buy bargains. But owners should be prepared for the roller-coaster.

Clients, we are telling you this story for a reason. When you hear that ‘the market is too high’ or things are at some unsustainable peak, remember that at 228 Main, we are pounding the table and jumping up and down about the bargains we are finding. If you would like to discuss this or anything else at greater length, please email us or call.

1The World Copper Factbook 2014, International Copper Study Group

2The Electric Vehicle Market and Copper Demand, International Copper Alliance

3Federal 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. All performance referenced is historical and is no guarantee of future results.

Investing involves risk, including possible loss of principal.

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

We Work Hard for the Money

© Can Stock Photo / lunamarina

Clients are familiar with our work in high yield corporate bonds. Since 2001, we have identified eight opportunities in the sector. We put more than $10 million to work by purchasing more than $20 million of bond face amounts at a discount, issued by these eight companies.

To be clear about the terminology, ‘high yield’ is a polite way to say ‘JUNK.’ Bonds do not sell for 70 cents or 30 cents on the dollar unless there are some issues that place the outcome in doubt. The conventional wisdom says that people should not purchase individual issues of junk bonds because of the risk involved.

This arena is a contrarian’s dream. We human beings know how to take things too far—it is one of the things we do best. To illustrate, when the price of oil fell from $140 to $100 to $60 to $30, the news was full of predictions that the price would fall to just $9 per barrel. Bonds issued by an oil exploration and production company fell to 30 cents on the dollar, then fell even more.

You already know we believe the crowd can be wrong, and the stampede is to be avoided. Our analysis of the company financial statements said that even if the oil company went broke, at $9 oil then bondholders would still probably recover 30 cents on the dollar in a liquidation. Since negative sentiment about oil prices had gone way too far, in our opinion, we concluded that oil was NOT going to $9 per barrel anyway.

Oil bottomed, the bonds bottomed, both rose. Clients, you noticed this in your 2016 statements. When we find an anomaly between what we expect will happen and what the market has priced in, profits may result.

What you do not see is the process by which we found the eight opportunities over sixteen years, and how we go about finding the next one. We recently found 199 high yield bonds offered for sale by 29 different issuing companies that met our first criteria. We seek 10% or higher yields, and 25% or greater discounts from face amount.

Smaller companies or issues of bonds that do not trade with sufficient liquidity are thrown out. Companies that lack an asset base from which creditors might gain a recovery are ruled out. And certain industries are judged too risky, based on the economic cycle.

The bottom line is, we need to understand how we would get our purchase money back even in the event of liquidation. If a bond issuing company ultimately cannot pay back the whole dollar, it goes broke. Creditors including bondholders get paid first, before stockholders. So if we buy in for 50 cents on the dollar and receive 75 cents back in a liquidation, we make money.

For each bond issuer, we need to understand the capital structure of the company. This tells us where the bonds rank in liquidation priority. We need to analyze the financial statements. What assets would be available for liquidation? Would the company make money if its debt was recalibrated to market value? We also must consider company management, and think about how well it would maneuver through a reorganization.

The title above says we work hard for the money. What we are talking about is the recent exercise where we looked at the 199 bonds of 29 issuers, went through our analysis to see if we could find a new opportunity…and came up empty. This is usually what happens.

We have looked at thousands of bonds issued by hundreds of companies over the years. Eight times in sixteen years, the stars lined up for us (and for you.) The search goes on, the next opportunity will pop up sooner or later. If you would like to talk about this or any other issue, 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.

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.

Investing in mutual funds involves risk, including possible loss of principal.

A 10% Correction is Coming!

canstockphoto2807017

There is an amazing thing about the performance of the stock market this year. Looking at the S&P 500 Stock Index, it has hardly dipped more than a few percent from its peaks. There has been a little wiggling, but far less than usual.

We human beings have a remarkable capacity to get used to current conditions, and expect them to persist. This could make trouble for us when the 10% market correction does eventually come around.

Long time clients know we believe that these market drops can neither be predicted nor traded profitably. Many of you call when the market does drop, seeking to invest in any bargains that appeared. We know how this works!

(Of course, we do not own ‘the market.’ Our holdings—and your account balances—sometimes deviate from the direction of the market. In 2016 we were fond of the difference. 2017 so far, the market is a little ahead of us. The point is, the market wiggles up and down, and our performance relative to the market also moves around.)

Commentator Morgan Housel recently wrote “every past market crash looks like an opportunity, but every future market crash looks like a risk.” Our experience after the 2007-2009 downturn demonstrated the first part of that statement. It is the next market crash that we must be concerned with.

Our research process is focused on finding bargains. We’ve taken steps in many portfolios to dampen volatility by changing holdings. Cash levels are generally higher, too. But none of these things will eliminate the temporary fluctuations that are an integral and necessary part of long term investing.

The market will decline. Our portfolios will decline. These declines will seem like a risk when we are going through them; we may see later that they really were an opportunity. The relative calm we’ve experience recently will give way to more volatile times—we know this, and should not be surprised by it.

We’re working to be in position to profit from opportunities that arise. Clients, if you would like to discuss your situation in greater detail, 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 indices are unmanaged and may not be invested into directly.

Investing involves risk, including possible loss of principal.