volatility

You Can’t Always Get What You Want

© Can Stock Photo / lucidwaters

Wouldn’t it be great to have an easy job with a big salary? Or a hot sports car that was very low-priced? Or a luscious dessert with no calories?

The financial equivalent: an investment with good returns and stable value. Believe us when we say this is a popular concept.

Nearly five decades ago, the Rolling Stones advised that “You can’t always get what you want.” This is surely true of each of the situations described above. You just cannot get those desirable combinations.

But “if you try sometime, you just might find, you get what you need.” On the investment front, many people need their money to grow over time to meet long term goals. Stability of value along the way would be comforting to have. The true need is growth, and the key measure is how much money you wind up with in the distant future.

The real return on truly stable assets is usually low. Some people with a lot of assets relative to their needs can live with low returns. Most of our clients need their money working harder than that—so necessarily must forego stability along the way. (Or, adjust their goals to reflect more modest circumstances.)

We take pride in telling it like it is. Although many sellers promote the false notion that you CAN get good returns and enjoy stable values, we believe you can handle the truth. Markets go up and down—and that’s OK. Whether you were born with effective investment instincts or we had to train and coach you, many of you have shown the ability to live with volatility and invest effectively anyway.

Go ahead, ask us again about that mythical investment with good returns and stable value. We will help you understand that you can’t always get what you want, but you can get what you need. Call or email us if you wish to discuss your situation.


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

Cryptogenic Market Action: How it Can Help You

© Can Stock Photo Inc. / gajdamak

The field of medicine has a pair of terms that mean the same thing. The words describe an incredibly useful concept. The concept has important applications to the investment markets, and other economic and business usage. We were aware of the idea, but previously had no handy term to describe it.

The words are “cryptogenic” and “idiopathic.” They mean ‘of uncertain or unknown origin.’ For example, a cryptogenic stroke is one that has no known causative factors. Sometimes doctors know why something happened, other times they don’t. When they don’t, the diagnosis includes one or the other of these descriptions.

How would this apply to investing?

Every day at the market close, commentators speak or write as if they know exactly why the market did what it did. Despite the market averages being set by millions of people making billions of dollars in transactions for a nearly infinite variety of reasons, commentators boil it down to ONE REASON. “The market rose today over better-than-expected whatever,” or “The market fell today because of poor whatnot.”

We have said as many ways as we know how: the market goes up and down. It just does. To put it in more clinical terms, the market has cryptogenic rallies and idiopathic falls. The short-term action is of mostly unknown or uncertain origin.

According to Investopedia.com, in 1602 the Dutch East India Company issued shares that could be traded on the first stock exchange in Amsterdam. We suspect that at the close of trading on the first day, somebody said something like, “The market rose today because the tulips looked set to bloom early.” And this nonsensical tradition continues to this day.

If we accept the idea of cryptogenic stock market action day to day, we can focus instead on long term trends and fundamentals that may prove more fruitful.

Meet Your Partner, Mr. Market

© www.canstockphoto.com / stokkete

Suppose that you owned a partnership interest in a business, and that your business partner was readily available any day to either buy out your half of the business or sell his half to you—as long as the price was right.

Suppose, though, that your partner suffered from erratic mood swings. He can quote you the price he’ll buy or sell for any time, but his appraisals are always colored by his current mood. When business is good he over-values the business and offers you the moon for your half of the business; when business is poor he becomes pessimistic and offers to sell you his share for pennies on the dollar.

This is a metaphor Warren Buffett uses in his shareholder letters to describe the stock market from the investor’s perspective, dubbing our hypothetical business partner “Mr. Market.” As a stock holder you have an ownership interest of a tiny slice in a business. There is a market to buy or sell shares of the business at almost any time. But the price the market may give you depends on investor moods.

According to Buffett, if you understand the value of a business it’s in your best interest to take advantage of Mr. Market’s mood swings to trade when his prices are at their most irrational. However, he also offers this warning:

“But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence.”

So when the market is in a frenzy of buying or selling, there may be opportunities to profitably take advantage of the stampede—but not to join it.


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

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

Things Warren Buffett Never Said

© www.canstockphoto.com / meikesen

Warren Buffett may be the most famous investor in the world. The annual meeting of his company is known as ‘Woodstock for Capitalists,’ and is attended by 40,000 people. Countless articles, essays, and books have been written (including by us) about the things he has said.

As far as we know, nobody has ever written anything about things Buffett NEVER said. But here are our top three things Buffett never said:

1. “The stock went down, so I sold it.” Buffett knows the market goes up and down. He studies companies, not stock ticker symbols. When the fundamentals are in place, he buys. Then he holds. Then he holds some more. If the price declines, he typically buys more. This is what ‘buy low, sell high’ is all about.

2. “I’m waiting to invest until we get more economic data to clear up the uncertainty.” In his seven decades of investing, Buffett has noticed that uncertainty is always with us. He reads and studies ceaselessly, and when he finds something to buy, he buys it. Frequently, this turns out to be when the price is depressed because of temporary factors. Others are paralyzed by uncertainty when Buffett is taking action.

3. “A lot depends on what the Federal Reserve does next month.” Buffett has run his company for more than five decades, while seven different people held the chairmanship of the Federal Reserve Board, through innumerable cycles of Federal Reserve tightening and loosening. He can tell you what he paid for his stake in Coca Cola and when it was purchased. He probably cannot say what the Federal Reserve did at the meeting before, or the meeting after, the transaction. Why? Because it doesn’t matter in the long run.

Warren Buffett does not wear a halo. He is a human being and that means he makes mistakes. But he has made more money investing than any other human being on the planet. We think it pays to listen to the things that he has said. But there may be even more value in understanding the things he never said.

If you would like to discuss these concepts or your specific circumstances at greater length, please write 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. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. Stock investing involves risk including loss of principal.

The Next Recession is Coming… Again

chart from research.stlouisfed.org

Regular readers will recognize this headline. The next recession is always coming. Human nature being what it is, the economy will always have cycles just as the world will always have seasons. The excesses that build up in good times lead to imbalances that get corrected by economic downturns.

The most notable feature of the current economic expansion is its slow, plodding pace. Most people with jobs or in business are familiar with one of the reasons for this: unprecedented expansion of the regulatory state. Our shop and many others in many lines are coping with new kinds of nonsense that hampers production or service. (We are not arguing for a Darwinian, regulation-free society, of course.)

The silver lining in our plodding economy is the lack of a boom in any major sector that could create a big downturn. New home construction has not really exceeded the sixty-year average. According to the National Auto Dealers Association, vehicle sales–while near a record–only replaced 1/15th of our vehicle fleet last year. It seems to us that the peak in auto sales lies ahead of us. Capital spending and business investment, which has at times gotten too inflated in the past, has remained extremely subdued.

Energy, of course, did boom—and then busted. But our diverse and dynamic economy has largely absorbed the job losses, and consumers and businesses are enjoying unforeseen low gasoline and energy prices. Corporate earnings have not been great, but should strengthen in the quarters ahead.

The Index of Leading Economic Indicators points to near-term trends in economic growth, and it has flashed a steady positive reading for years. The bond market speaks to us about economic conditions through the yield curve, which remains encouraging and positive. LPL Research publishes a Current Conditions Index which measures economic vitality right now—and it has remained in positive territory. LPL Chief Economist John Canally draws mostly comforting conclusions from the latest labor market statistics (ht.ly/v7Co3003MvP )

So yes, the next recession IS coming. We just do not think it will arrive soon. Our plodding plow-horse recovery continues, no boom—but no bust either. This is good news for investors.


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. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

The Benefit of Being Picky

© Can Stock Photo Inc. / Farina5000

Suppose you had the opportunity to attend a fancy catered gala. When you get to the dessert table, a dizzying array of delicious looking pies are spread out for you to sample, too many to choose from. Not knowing which ones might be the best, a fellow next to you tells you he’s going to sample a little bit of everything and offers to help load up your plate the same way.

If you happen to be deathly allergic to peanuts, you would ask your helpful friend to skip the peanut butter pie and just get you some of the rest.
“Nonsense,” he tells you. “You never know, the peanut butter pie might be the best of the lot.”

“But if I eat it I’ll go into shock and might die. I can’t even let it touch the rest of the dessert on my plate.”

“You don’t know the future. Just because you’ve had an allergic reaction before doesn’t mean that you’ll have one now,” he says, handing you a plate with a slice of peanut butter pie smack in the middle. Instead of getting to enjoy your dessert you’re left unhappily trying to pick around the edges of the uncontaminated slices of pie.

This situation sounds absurd, and it is. And yet it resembles a commonplace practice within the investment industry. There is a portfolio strategy known as asset allocation that says that since we can’t know for sure which assets are going to go up or down, investors should aim to own a slice of everything. Because different asset classes move in response to different economic pressures, when one goes down it will hopefully be balanced out by a different asset going up. The goal is to try to reduce volatility through diversification.

However, just like our unhappy party-goer in the example above, there are probably some slices you don’t want any of—period. Tech stocks during the dot-com bubble in 2000 and mortgage based securities during the real estate bubble of 2007 were two slices of the investment universe that were very dangerous to your financial health.

Proponents of asset allocation dismiss this notion as market timing, saying that you can’t predict when the bubble will burst and that you miss out on potential gains by staying out of the bubble. But if we’re allergic to the pie, we don’t care how delicious the pie might be—we don’t want a slice.

Our approach may or may not be the right one. Nevertheless, we believe that being picky about the slices we take may bring us better results than blindly grabbing a bit of everything. If you want to talk about how this may apply to your portfolio, please 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. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

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. Asset allocation does not ensure a profit or protect against a loss.

Poking Holes: Find Your Strategy

© Can Stock Photo Inc. / actionsports

“It’s easy to poke holes in every single investment philosophy or strategy. The trick is to find the one with flaws that you’re comfortable with.” –Ben Carlson, Ritholz Wealth Management

This concise statement makes it clear: every investor faces tradeoffs.

Current Income or Long Term Growth? Some strategies focus on growth in capital over time, others focus on current cash flow. Many investors need some of each. A pure growth portfolio probably won’t pay your bills, and a pure income portfolio may not have the growth to stay ahead of inflation.

Stability of market value or long term growth? This is where we live! We have written about the high price of stability. And we have constantly communicated in every way we know how about the link between long term returns and short term volatility. Everybody we know would prefer having both stable values day to day and wonderful long term returns.

You cannot have all of both—the best we can do is some of each. But it helps to resolve this tradeoff if you make sure your income and emergency funds are sufficient for your needs. If you own the orchard for the fruit crop, you don’t need to care what the neighbor would pay you for the orchard today.

Reliability of Income or Stability of market value? This dilemma is not even recognized by most people, and rarely discussed by investment professionals in our experience. Nevertheless it is a vital point. At one extreme, the kinds of investments that assure stable values have delivered wildly varying income over the years. In the early 1980s one could gain interest of 1% a month on money in the bank. More recently, it has been difficult to get 1% per year. So the person that retired on bank deposit interest of 12% saw a lot of volatility—and deterioration—in their income over time. Meanwhile, anything you can own that produces reliable income over extended periods will definitely fluctuate in market value, sometimes sharply.

Putting it all together: As you can see, every investment strategy has flaws. The trick, as Carlson says, is to find the one with flaws that you’re comfortable with. So we need to understand what is required in the way of stability, current income, reliability of income over time, and long term growth. We can build a portfolio that strives to balance those attributes with tradeoffs that are both acceptable and likely to be successful.

Please call if we may be of service in this regard, or to update our understanding of your situation.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss.

Volatility Versus Risk

© Can Stock Photo Inc. / webking

In the investment world, we often speak of the riskiness of an investment in terms of volatility: if an asset’s price changes rapidly and unpredictably, it tends to be spoken of as risky, and if the price tends to stay the same, it is usually regarded as “safe.”

In the short term, this is reasonable. If you have $100 today and you know that you will need $100 a week from today, the only sensible move is to put your money someplace where you know its value won’t change. Investing it in a volatile market means you might make a few extra percent your original money, at the unaffordable risk of coming up short when you actually need your money.

When we start to look at investing for the long term, though, we can start to see the difference between volatility and risk. Suppose you take your money and bury it in a hole in the ground for 30 years: this is about the least volatile “investment” you can possibly make. You can reasonably expect that the value of your buried money will stay nearly constant. Yet, because of the existence of inflation, it is almost a certainty that your money will lose a lot of purchasing power over the course of 30 years. Essentially you have a 100% chance of losing value over the long haul despite having virtually no day to day volatility.

On the other hand, if you took your money and invested it for 30 years, you can afford a lot of up and down movement during those 30 years—as long as the final value is higher than what you started with. If your investment has a daily gain 51% of the time and a corresponding daily loss 49% of the time, you can be fairly confident in your eventual profit—even though you’re watching the value go down several thousand times over the course of those three decades.

None of us know the future: there is no such thing as a guaranteed investment, and every investment incurs some form of risk. But it’s important to understand the difference between an asset’s volatility and its risk. For long-term investors, looking past day to day volatility can help you find bargains that are not as risky as you might think.


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 the loss of principal.

Why Busts Turn Into Booms (and Vice-Versa)

© Can Stock Photo Inc. / Coprid

We know that the markets are cyclical. They go up-down, up-down.

Listening to the news, you’d never know this. When gas hit $4 a gallon several years ago, headlines said it would go to $7 or more—but instead of doubling, prices fell by half. This shouldn’t be a surprise, especially for those of us old enough to remember the oil crisis of the 1970s. The glut of oil we see today is really just a symptom of the shortage a few years back.

When gas is scarce and prices are high, nobody wants to use any. People drive less, take fewer trips, and buy more efficient cars. At the same time, oil producers start falling over themselves to drill everything in sight. Eventually, the high prices cause demand to shrink and supply to grow.

We know what comes next: oversupply and plummeting prices. Now producers are spending too much money pumping cheap oil and have to close down plants. At the same time, people get used to cheap gas and start burning it freely. Truck and SUV sales go through the roof and people drive more miles. We think we know how this one ends, too.

Every glut plants the seeds of the next shortage, and every shortage plants the seeds of the next glut. We can see this happening in real time with oil and other natural resources such as iron and copper. It holds just as true with every other market in every other age—cattle, corn, and cars, smartphones and other gadgets, even abstract “goods” like movies and music.

Timing is nearly impossible to predict, and investments can be volatile and difficult to own. But by understanding how the process works, patient investors may profit. Today’s bust may be tomorrow’s boom.

Behavioral Economics and The Price of Stability

Stone wall with gold letters spelling out STABILITYThe first theory of economists was that human beings act rationally. When they realized they needed a new theory, the field of Behavioral Economics was born.

One of the key findings of Behavioral Economics is that the pain of a loss is twice as great as the pleasure of a corresponding gain. Rationally speaking, if you earn $5 it should feel just as satisfying as if you earned $10 and then lost $5 of that—but we still feel the sting of the loss harder, even though the outcome is the same.

If people weigh these two otherwise identical outcomes differently, when it comes time to invest they will wind up paying more for $5 earned in stable investments than they would for $5 earned in volatile investments. There is no shortage of expensive products designed to pander to this tendency by selling the promise of stability at a premium.

The necessary conclusion we see—the one nobody else seems to—is that if the price of stability is too high, the potential rewards for enduring volatility must be larger than they otherwise should be.

These concepts shape our work, our strategies, and our tactics. “The pain of a loss” is determined by one’s mindset, training, and understanding. Many great investors (and many of our clients) feel no pain over short-term losses. Some are even gleeful at the chance to buy securities at bargain prices. One of our roles is to help you develop more productive and effective attitudes about investing, and we believe that by training yourself out of irrational pain over short-term volatility you can perform better in the long run.


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

The illustration is hypothetical and is not representative of any specific investment. Your results may vary.

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