Category: Finding Benjamin

October 23, 2023

These are the days that test all of our patience as investors.  These are the days when we feel compelled to act to stop the pain and avoid the long list of unknown negative things that can happen to our wealth.  Bear markets chip away at our confidence through magnitude and duration of losses, sometimes both.  Needless to say, historically, these are also the moments when real opportunity develops for the next multi year bull market higher.  I find it very helpful during these phases of the market cycle to simply read our emotional state, acknowledge it and work to get ourselves in the right frame of mind.   Let’s do that.

These are some of the emotions and questions you might be asking yourself now.

Why Do I have Anything Invested in the Financial Markets?

Indeed, when cash, money markets and CDs are paying 5% thanks to the Fed’s most aggressive rate hike cycle in history, there is a higher comparative bar of demands for your investments at risk.  As of the close last Friday, the S&P 500 is still down -11.5% from its highs at the end of 2021.  How about bonds?  The Lehman Aggregate bond index is down over -17% from its highs, not in 2021, but August of 2020.  That’s more than three consecutive years of losses in what has been the safest side of the financial markets for decades!  The list of sectors and asset classes that are negative by 4-5% YTD is long.  Meanwhile opportunities to make money in 2023 have been highly concentrated in just a few names that are now giving up ground as well.  Why invest at all?

Several very good reasons:

1. The Fed is ending their rate hike cycle now and the bond market should become a more productive asset class from here.  By more productive, I mean far outperform cash and money markets for the foreseeable future.  Current yield is the best predictor of bond returns and today a 10-year Treasury bond is paying nearly the same rate as the highest cash rate.  However, as recessionary pressures grow, we will also see Treasury bonds rise in price to add to the total return.  Bonds will outperform cash from here.  We added to our 10-year Treasury Bond position today across several strategies this morning.

2. Stocks have historically outperformed cash and bonds. This is a simple fact.  Over time, especially any time period longer than 5 years, stocks have moved up and to the right earning 7-8% on average with positive returns at least 93% of all years  (see chart below).  These are naturally incredible odds of success.  Note that even over any 6-month period, stocks have gone up 70% of the time  I don’t know of any opportunity out there that offers such a high natural probability of “winning”.

And now dear investors, now prices and valuations have reset significantly since 2021 and the probabilities are quickly increasing that we will see an end to this multi-year bear market and the beginning of a new multi-year bull market in the next 6 months.  If bonds find a lasting bottom right here, right now, then stocks may be doing the same.   You must remember that stock prices reflect  the future.  How much of a recession is priced into stocks, select sectors and asset classes?  Quite a bit!  As I mentioned in last week’s Red Sky Report “40% off”, we already have some generational buys developing now.   Historically, gains off of any bear lows will be far higher than “average” historical returns.  Also remember, if you find yourself wanting to sell all to cash now, you might be locking in losses and have the equally difficult decision of when to get back in.   From our seat, this is an incredible time to rebuild (rebalance) a fully diversified portfolio of stocks, bonds, commodities and alternatives as we discussed last week.

 

 

 

 

 

 

 

 

3. Interest on cash and money markets are peaking.

Just when you thought it was safe to go to cash and earn an easy 5%!  With the Fed effectively ending their rate hike cycle having successfully contained runaway inflation, we should see the yields and interest on cash and money market rates begin to taper and eventually fall in 2024.  The same goes for lending rates, bank loans and private credit funds.  These are the days when these types of safe instruments look and sound great but make no mistake, these are the peak days for yields on cash.  Certificates of Deposit (CDs) could make sense for money that wants to live permanently in cash because you can effectively lock in these peak yields for years.  However, please re-read above.  Bonds and stocks outperform cash over nearly all time periods.  CD’s also have penalties for early withdrawals.  For those who missed our annual meeting presentation, this is what inflation has done over the last 12 months.

 

 

 

 

 

 

 

Again, if history repeats, we should all expect to see the interest on cash and money markets,  follow the same path lower, well into 2025.

I’m Tired of Losing Money (or not making money)

We are all tired of losing money.  This is a bear market, and it is what it is.  We are tired of risk; we are tired of politics and wars and the Federal Reserve and the media.  You are in good company believe me.  Losing money with your long-term investment capital is part of the game as markets simply do not go up in a straight line.  I struggle to find anything that is trading above the 2021 highs with the exception of a few stocks and maybe commodities.  It is no wonder we all feel this way and I am truly empathetic to all.   Our active, risk managed strategies, like All Season, Gain Keeper and Income strategies are doing an admirable job of controlling portfolio volatility to less than ½ of their benchmarks.  Controlling volatility helps you sleep at night but does not mean you won’t still experience some losses of course.  The goal is to get to the end of this bear market cycle with the following:

• Your emotional capital intact, ready to buy or deploy cash when the time is right.
• Your financial capital intact or in a “recoverable” position

Age is also an important consideration with risk and investing of course.  We are encouraging our retired clients or those living off their investment accounts in some form, to adopt the two-bucket approach we described in previous updates.  The two-bucket approach allows for a cash bucket to carry two years or more of living expenses beyond other sources of income like social security, rents, etc.  Meanwhile, your growth and income bucket can be left alone to weather bear markets, grow and generate income to replenish you cash bucket when needed.  The two-bucket approach effectively allows you to emotionally separate your needs for cash today from the anxiety of watching your investment balance go up and down.

Younger clients have it easy and can simply look for discounted opportunities like we have developing now, to allocate excess savings from earned income to investment accounts.  Buy low, accumulate shares at discounts, pay attention to taxes, avoid selling much of anything and keep your 20-year goggles firmly in place.  Easy!

That’s it for this week.  Just a little much needed pep talk. 😊

This time will pass, and returns will come again.  Patience is critical now.

Thank you for your continued trust and confidence,

Sam Jones

 

October 16, 2023

40% Off Rack

I went shopping at our local outdoor store this weekend.  They were having their big pre-Winter sale.  I found something very special on the 40% off rack that felt like foreshadowing and opportunity all at once.

 

 

 

 

 

 

 

 

 

Socks

Yes, I found these on the 40% off rack and wow was I excited.  The shop had racks and racks of expensive socks for sale but here in a small basket, I found these Darn Tough , good American socks at 40% off.  No other styles, no other brands, no other colors,  just Darn Tough American socks at 40% off.  This of course was no accident; it was a sign.

I had to wonder, does the shop hate America?  Was there something wrong with these or maybe people just don’t like the look?  Darn Tough is my favorite brand of sock.  They are made in Vermont with a LIFETIME guarantee, no questions asked.  I have never returned a pair because they last forever, made of high-quality Merino wool and just the right thickness.  Full retail is $23 for a single pair of these gems, and I was thrilled to get them for $13.80.  As I walked proudly through the weight room this morning, the compliments and my patriotic pride grew.

But my socks also made me think about market opportunities.

What else can I buy for 40% off in the financial markets?

Turn Fear Into Opportunity

Last week, I talked about the Change of Seasons that is clearly occurring in the markets across all asset classes.  We are shifting into a stagflationary environment.  On Friday, Gold, Silver, Commodities and Energy had one of their best single day performances in several years.  This of course reflects the sticky inflation that we all know and feel.  At the same time, on the same day,  bonds of all types outperformed stocks which reflects the growing weakness in the economy.  How strange that inflationary and recessionary asset classes could rise together…. unless you begin to see, understand and respect the reality that we are entering a stagflationary environment.  Then it all makes sense. Keen market watchers and asset allocators have seen the inflationary sectors outperforming dramatically since last 2021.  But now they are laser focused on the bond market to confirm that the US economy is indeed slipping into recession as it prices in the lagging effects of the Fed’s 11 rate hikes.  If history repeats, we should see bonds find a bottom here and provide some much-needed portfolio ballast against your value, dividend, and high free cash flow stock portfolio (right?).  Bonds are still a trade, but this would be the logical place and time for bonds to rise in price and to see interest rates fall to some degree.  Our allocations to bonds are small and temporary but they do deserve a place at the table now.

When I look across the landscape of stocks as potential investments, I see a bifurcated market.  I see a few overbought and overvalued sectors like technology bubbling around the highs but struggling to move higher now.  I don’t really find anything attractive about any of the broad market indices like the S&P 500, but we’ll still hang on for easy market exposure while the trend is our friend.  Frankly, the vast majority of stocks in the markets today have been in a steep and destructive bear market since late 2021.  As we know, 7 stocks called the Magnificent 7, have held things together in select indices in 2023 but really masked the on-going bear market occurring in the other 493 stocks (in the S&P 500).

But looky here!

The 40% off rack is now filling up!  40% off is a huge discount for anything really.  At the same time, one could argue that anything on the 40% rack is undesirable, broken, or odd in some way.   But today, I looked through the 40% (or more) market rack to see what I could find.  Junk is junk but I was looking for sectors, individual companies, countries, and asset classes that have been good to investors over the decades.  I was looking for long term quality in the bargain bin right next to my good American socks!  Here’s what I found that is now priced 40% or more below the highs in 2021.

• Telecom companies like Verizon, 8.48% and AT&T , 7.34% –  dividends anyone?
• Dows stocks like 3M (MMM), Boeing (BA) and Disney (DIS)
• Mega theme sectors like clean energy (ICLN, TAN) and Biotech (XBI)
• Oversold banks (KRE, KBE, BAC and C)
• Mortgage and equity REITS paying 8-11% dividends
• The retail sector (XRT)
• China and Chinese Technology (MCHI and KWEB)
• Silver Miners (SIL, SLVP)
• Long term US Treasury bonds

I know, I know this doesn’t feel like the stuff you want to bring home now but of course, these are the very things that deserve our attention, especially when they turn higher!  This is some off-season shopping, like buying a pair of skis in August.  Regardless, this is not investment advice and please do NOT run out and buy these today.  I am simply pointing to the hard facts that there are more and more attractive opportunities showing up on the 40% off rack.  This is not a leadership group by any means but when something is on the 40% rack, we know a few things.

First, we know that most, if not all, knowable risks in these sectors, countries, stocks, have already been priced in to a large degree.  Do you remember the movie, “The World According to Garp” with Robin Williams?  Williams is meeting with a realtor to look at a house to buy and a small plane crashes into the home at that very moment.  He gets up off the ground and says, “I’ll take it.  This house will never be hit by a plane again!”

Second, we know that good companies like Disney, Boeing, even 3M are staples in our economy.  They are not going away, and they generate $Billions in annual earnings and revenue every year.  This is the domain of Buffett who tends to buy big established cash cows selling at deeply depressed prices.  In fact, I think I will encourage my kids to consider these names and others for their Roth IRAs now with their 30-year goggles firmly in place.

Finally, on this rack, I see a lot of passive income that is higher than inflation (telecom and REITS) and I see quite a few sectors that are non-correlated to US stocks or bonds.  These are things like clean energy, Silver, China and biotech.  Remember, during periods like this, we want to force ourselves to look for opportunities outside of your basic US stock and bond index ETF options.

Young Investors Get Ready

Bear markets are deceptive and serve one purpose. That purpose is to create long-term value by eventually forcing as many investors as possible to sell out at the lows in fear and capitulation.  Personally, I have been through two of the most devasting bear markets in history outside of the Great Depression.  They are rough to say it plainly.  What we have seen since 2018 are a series of three mini bear markets in stocks (20-26%) and a very significant full and complete bear market in long term US Treasury bonds (now down 50% from the high in 2020).  What we did not see at the most recent lows in October of 2022 was the type of indiscriminate selling and capitulation that typically accompanies the end of a bear market.  Consequently, the potential for a wash out below 3500 on the S&P 500 is still very real to complete this bear market cycle and set the stage for a new multi-year bull market. But young investors should look at this market as an incredible gift.  How lucky are you to potentially buy stocks, or even the stock market as a whole at 40-50% off?  Anyone in their thirty’s or younger has been living in a world where opportunities have been squandered by older generations who vote entitlements, make laws and set policies favoring the old and wealthy.  We collectively have handed our younger generation a land of unaffordability, in housing, food, transportation, education, energy, travel and leisure.  If history repeats, young investors will have some incredible opportunities to buy long term investments at deeply discounted prices.  I’m starting to see those opportunities develop now thankfully.  Is it too much to ask to offer them a viable future?

Find opportunity in fear and buy Darn Tough America (socks) at 40% off.

Have a great week.

Sam Jones

 

 

 

October 9, 2023

The Last Dance

Last week was big for the financial markets.  An event, or series of events, occurred all in one week, that one could accurately describe as a true change of seasons.  These things do not just happen out of the blue.  They build slowly, discretely, often in the face of widely held beliefs.  And then, the moment arrives when it becomes clear to those of us who are domain experts in cycle work, that a turn is upon us.  For most of the last 6 months, investors convinced themselves and financial media spread the word that a recession was not in the cards, not possible, soft landing and so forth.  With the cumulative events of last week, there is now little doubt that the US economy will be solidly in recession in the first half of 2024.  Consequently, for investment strategies with a dynamic methodology, we have the next few weeks, maybe a month, to make a few changes to your asset allocations.  This is the time to prepare for new asset class leadership and a relatively swift rotation among winners and losers as we head fast into 2024.

Annual Meeting Presentation Key Points

It was a pleasure to see so many of our clients and our complete Denver area wealth management team at the Wellshire Golf Course for dinner and entertainment this week.  Zoom meetings are never an adequate substitute for in person events and we are always glad to host this 22-year-old event.  Thank you to everyone who made it special.

Much of the content of our presentation is especially relevant to this update so I’d like to highlight a few key points made in the session.

*If you would like to receive a copy of the 2023 Annual Meeting presentation please reach out to Kris Dickey at kris@allseasonfunds.com or by calling us at (303) 837-1187.

#1. Higher volatility is the new norm.

This picture pretty much says it all.  What has become obvious to all is that portfolio volatility, both up and down, is increasing and has been since 2018.  In the last five years, we have experienced three bear markets in stocks in excess of 20%.  We have also witnessed the US Treasury bond market fall for three consecutive years losing an average of -7.65% per year from the peak in August of 2020 to last Friday.  The 20-year Treasury bond has flat out crashed and yes that word is appropriate considering the loss of 46% (-17%/ year of the last three years).  Retail investors probably don’t feel the outright pain of those bond market losses as much as larger institutions, but they do feel the increase in portfolio volatility when the “safe” side of your portfolio (bonds) loses more than your stocks.  It would be smart for all of us to remember this moment because this is the direct result of the Federal Reserve’s multi year period of near zero interest rates while simultaneously spraying $Trillions into the economy as “stimulus”.

 

 

 

 

 

 

 

 

 

 

 

 

#2.  Add Alternatives for Higher Returns and Lower Risk

We talked through the benefits of carrying alternatives in a portfolio in order to increase returns and lower risk (or control volatility).  Alternatives are traditionally things that have little to no correlation to stocks or bonds; Things like commodities, gold, hedging and tactical strategies, even real estate when the time is right.  We described this as Asset Allocation 2.0, but this concept is not new.  The same thing occurred in the 70’s and early 80’s. During these years, investors learned how to hedge and clearly recognized the value of risk management and a more dynamic approach to portfolio management.  But sadly, that recognition takes years to settle into the mass of investor psychology and for good reason.  Simply owning a standard blend of stocks and bonds has been a rewarding and carefree experience for most of the last decade.

 

 

 

 

 

 

 

 

If history repeats, then alternatives should earn a rather permanent place in your portfolio.  Today, our Flagship All Season strategy has reduced our stock exposure to 50%, reduced our Bond exposure to 20% and increased our “Alternatives” exposure to 30%.  Over time and especially as we move closer toward a true Stagflationary environment (Inflation with a Stagnant Economy), we expect the results of this allocation to speak for themselves.  Statistically speaking, owning alternatives in any portfolio throughout history has actually produced impressive results.  Consider this study from JP Morgan from 1989- Q1 of 2023.

 

Notice the recommended asset allocation mix in the very top pie chart for higher returns and lower risk (volatility).

50% stocks

20% bonds

30% Alternatives

Sound familiar?

#3 Inflation is sticky – The Stagflation Playbook

               This is the last but most important takeaway from our annual meeting presentation.  The headline goes with a tag line that reads Inflation is sticky…. And the Fed can’t do much about it by raising rates.  These are the real drivers of inflation across the globe.

 

 

 

 

 

 

 

 

As you walk through these self-explanatory catalysts behind secular inflation, ask yourself which of these will be solved by the Fed raising interest rates?  I’ll save you the analysis.  None.  Here’s the important take away.  Inflation of the type we have today, is likely to remain high and higher than desired even when we slip into recession in 2024 (hint).  This again is called Stagflation and it’s a condition we have experience here in the mighty U S of A in the late 40’s and again in the 70’s.

Asset allocation 2.0 would therefore dictate that we “stick” with some inflation beneficiaries among our alternative allocations.  At the same time, we should prepare our investment portfolios for what is now becoming inevitable and that is a recession in the first half of 2024.

Change of Seasons

As I mentioned in the preamble, there are certain moments in market history when we become aware that the tide has turned or on a more timely basis, when the season has changed.  Last week was all about brilliant colors, long sleeve t-shirts and shorts, sunny, awesome.  My wife Sarah in fall Camo last weekend here in Steamboat Springs, CO.

 

 

 

 

 

 

 

 

This week, all leaves are down, temps fall below 30, break out the winter jackets.  And just like that the season turns, gradually, slowly , then all at once.

Last week, several important events occurred that are consistent with a top in the economic and market cycle.

• We saw a potential top in the energy sector (not necessarily all commodities).
• We saw the defensive sectors like Utilities and Healthcare suddenly rise from the ashes. Consumer Staples should be next.
• We saw the bond market complete an exhaustive, waterfall decline in price and spike in yields. This is a natural event that occurs at the top of every economic cycle paving the way for recession.
• We saw a jobs report that was anything BUT strong considering it showed a LOSS of 22,000 full-time jobs and a rise of 126,000 part-time jobs.
• We continue to see the stream of economically sensitive reports like factory orders, shipping rates, credit card and auto payment delinquencies, consumer confidence, falling new home sales, corporate bankruptcies, all pointing to an economy that is simply contracting. The evidence is overwhelming.

Martin Pring, the author of The All Season Investor, and the name sake of our firm, offers this clear chart to illustrate my point.

 

 

 

 

 

 

 

 

 

 

 

 

One can read this chart from left to right showing when we should overweight/ underweight stocks bonds and inflation sensitives in our portfolios depending on where we are in the economic business cycle. Each stage of a real business cycle varies in length and magnitude but the sequence of events repeats.

The US bond market topped in April of 2020 – Stage 4

The US stock market topped in December of 2021 – Stage 5

Inflation sensitives (like energy) may have just topped – End of Stage 6

Today, there is a high likelihood that we are shifting from Stage 6 on the very right-hand side all the way back to the beginning which is Stage 1.  Stage 1 marks the beginning of economic contractions (aka Recessions).  So, what does that mean practically speaking for investors.  Darn it Sam, get to the point!

• This is that time when we want to reduce, but not eliminate, inflation beneficiaries.
• This is the time to reduce stocks to an amount that we can hold through a complete recession.
• This is the time when we want to rebuild our Bond positions, yes that means US Treasuries.
• This is the time when we want to shift to internationals expecting the US dollar to fall.
• This is the time to start bottom fishing for stocks among oversold financials, REITS, banks, utilities, healthcare, and consumer staples sectors.
• This is a great time to rebalance your passive index portfolio which is no doubt light on bonds and heavy on stocks.

All Season Clients* – We do all of this for you of course.

The Last Dance

I named this update the Last Dance for a reason. October and the last quarter of the year tend to be good for stocks.  During the 4^th quarter, I expect we will see the following:

• A quick recovery in stocks from the July-Sept sell off that ultimately gives way to the longer-term bear market in place since December of 2021.
• Bonds should form a bottom here and begin rising stronger than most would expect.
• Commodities and inflation beneficiaries should participate in the year-end rally but lag, especially as we close in on January.
• Internationals should rip higher if the dollar begins to sell off.
• Economic reports will continue to come in weaker than expected this quarter.
• We will see a peak in corporate earnings this quarter.
• We will see a peak in employment and wages.
• We will see real estate prices fall as supply finally arrives.
• There is a high probability that the Fed is done raising rates.

This is the last dance.

I’ll leave you with a note of optimism for the future. Every multiyear bull market is born out of a recessionary environment.  Stocks tend to bottom almost exactly halfway through a recognized recession and the returns from those lows are robust in the neighborhood of 20-30% in the first 6-9 months.  Since 2018, we have not been able to sustain back-to-back years of gains without a great deal of price drama and massive support from the Fed.  A complete recession will give our markets a real chance to rise dramatically over multiple years, with real value at every turn.  Our job between now and then is to preserve principle, keep our risk management goggles firmly in place and make a move to the other side with our emotional and physical capital intact.

I realize this has been a frustrating year for all investors with diversified, risk managed investment strategies. I do wish we had been able to capitalize on more of the relief rally over the last 12 months, but we stick to our disciplined methods, rain, or shine.  From the highs in 2021, we are no better and no worse than the best of the US stock index – down about 10%.  But what happens next as we complete the full economic cycle, is what separates the field.  As our company tag line says, Create Wealth, Defend It.

Best of luck to all investors!

Sam Jones

September 27, 2023

As we work through our fall client reviews, I often hear the same set of questions and have the same or similar discussions.  With that in mind, it seems appropriate to use this update as a means of daylighting these conversations, concerns, questions for everyone’s benefit.  This is a highly emotional time for all investors and I hope we can help guide and set expectations a bit.  We will be discussing and presenting more detailed information on these subjects at our upcoming annual client meeting on October 4^th in Denver.

Q and A

Question #1:

Help me understand – Are we going to avoid a recession like I seem to hear on the media?  Will we have a soft landing?

Answer:

There is some good news and some bad news on this front.  Bad news first.

We are seeing growing evidence that inflation is actually bottoming now and heading higher again after falling from the high of 9% one year ago .  One of the better sources of inflationary data comes from www.truflation.com.

They show that inflation has successfully fallen from over 9% to as low as 2.3% but the rate appears to be climbing again from the lows in July and August.

 

 

 

 

 

 

 

 

While we might applaud the Federal Reserve for aggressively fighting inflation, albeit terribly late to that war, we also need to recognize that ultimately, the sources of inflation are not something the Fed has control over through monetary policy.  These sources of inflation are very sticky, durable and quite difficult to reverse directionally.  Many are still creating great concern at the Federal Reserve.

I will be talking specifically about these sources of inflation at the upcoming Annual Client meeting at the Wellshire Country Club on October 4^th. 

The concern of course is that we are beginning our next stair step higher on what continues to look like the long and formidable decade of the 70’s.  Stocks remained range bound from 1965 – 1982 including four bear markets of 20-40% each.  Today, we have seen three bear markets in stocks of at least 20% each since 2018 (3 of the last 5 years).  It seems somewhat obvious that we are repeating the 70’s style inflation cycle.

The good news is that we may not have a formal recession or at least not something that impacts the entire economy in widespread fashion.  Employment is still strong, wages are high, commodity prices are high, real estate prices are high, and the cost of my breakfast burrito is insanely high!

 $18!  Seriously?

What I see with strong evidence is that the more cyclical segments of the economy are already in recession like luxury goods, technology hardware, sporting goods, discretionary items, consumer retail, and travel. Other areas that command our steady payments like energy, streaming services, insurance, food, housing, rents, services, are still strong almost riding the wave of higher prices.  The strong sides of the economy are really inflation beneficiaries while the weak sides of the economy are suffering badly from inflationary pressures. So, it depends on who you ask whether we are going to have a recession or not.  Some would say “Yes, my company is already deeply in recession!”  Others would say, “Absolutely not, we can’t keep up with demand”. Inflation can be worse than any recession for many.

In sum, in true 70’s style, there is a tug of war between inflation, which is winning at the moment, and recession, which could still become a bigger force as we move through time.  If history repeats, we end up with a draw of sorts, called Stagflation (Inflation AND recession).  I believe we are getting there quickly.

Question #2:

They say inflation is running at 3.67%.  Why does it still feel like everything is still so expensive?

Answer:

As I indicated in Question #1, the things we need are still rising at almost double-digit rates on a year over year basis.  Things we want, that fall into the discretionary pool, are seeing modest falling prices year over year.  Stagflation!   Take a look at the breakdown of August CPI numbers.  The areas in Blue are showing rising prices while those in Green are showing falling prices. Very interesting!  Spend some time with this.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As I’ve said for the last decade, our measures of inflation are highly skewed toward consumer goods and literally exclude things like housing (+7.8%) and food (+ 6%) and energy (actually up 11% year over year now).  So yes, our current and rising cost of living is not represented well by current inflation numbers reported as the Consumer Price Index.  Our advice:  Control the things you can control, like your spending, saving, incomes, debt and taxes.  We’ll work hard every day to make sure your money is as productive as possible given market conditions.

Question #3:

Where are you (ASFA) looking for investment opportunities now?  What is working?

The answer comes back to the 70’s playbook for what made money and what did not.  As I’ve told regular readers in the past, I keep a list of the sectors, asset classes and themes that did the best in the 70’s period of persistent high inflation with bouts of recession mixed in.  Here’s the list (and I’m sure you’re tired of seeing it).

• Commodities – A new super cycle of commodities began in late 2020. Since then, commodities are up 87% versus stocks, up 19% and bonds DOWN -14%.  We have full exposure to commodities across multiple investment strategies. Buy the dips for the foreseeable future.
• Value and high dividend paying stocks – Till I’m blue in the face. Let’s highlight Berkshire Hathaway (BRKB), our largest holding in the All Season strategy.  Berkshire Hathaway represents the essence of value and dividends for those who understand Buffett’s discipline.  The markets began favoring value over growth styles in November 2021.  From that time Berkshire Hathaway is up over 26%, while most “Growth” funds like the I shares S&P Growth ETF (IVW) are down -15% to date.
• Natural resource ETFS, Closed End Funds and MLPs – MLP are Master Limited Partnerships that invest in natural resources and raw materials. Like most of the inflation trades, these funds and stocks are up over 70% since 2021.  MLPs in ETF form like ALERIAN MLP ETF (AMLP) are also up 40% since late 2021 but pay out over 9% in annual dividend interest.  Buy em, hold em and collect $200 as you pass GO.
• Cash – Yes, a higher than average cash position is also fine as long as that money is earning a high yield. High yield in today’s market is around 5%/ year and available via any money market mutual fund, T-Bill or short term Treasury bond.  Cash can be an investment, but usually not a long-term investment.
• Treasury Bonds – But only for a trade. I believe we are approaching that time and place where there is a reasonable opportunity to buy basic 10-year Treasury bonds. They are unnaturally oversold and paying nearly 4.5% interest with growing recessionary threats out there.  Again, US Treasury Bonds are only a trade and not to be bought and held through this whole cycle.
• Internationals – Critical investors might have noticed that international stocks have been marginally outperforming the US stock market since late 2021. Again, this comes down to value as International markets are priced at less than ½ of the US market by almost all metrics.   I expect the performance difference to widen dramatically in 2024.

We will cover this topic at our annual meeting at the Wellshire Country Club on October 4^th! 

Question #4

If the government shuts down at the end of September, will that have a negative impact on the markets?

No, we have had 20 government shutdowns in modern history and the impact on the S&P 500 from beginning to end has been 0.0%.

Question #5:

Are real estate prices going to crash if rates stay this high (or higher) and people can’t afford a mortgage?

Answer:

My sense of gravity and belief in mean reversion says yes, but crash is a harsh word.  I would suggest that a more reasonable description is Deep Freeze.  You have heard and felt the hard facts surrounding real estate and mortgages since the Fed embarked on the most dramatic increase in rates in history (fact).  The impact has been a cliff drop in sales but not so much in price, at least not yet.  Falling sales are tough on one set of our economy and those are real estate agents, mortgage brokers, title companies and everyone associated with a real estate transaction.  I am interested to find out how much of our economy and wealth is tied up in the real estate transaction industry.  I’ll bet it’s a large number considering the National Association of Realtors is the largest lobbying group in DC, spending $84 Billion in grease money in 2022 alone according to Zippia.com.  In the 70’s, real estate prices basically flatlined for almost 14 years while mortgage rates climbed into the teens by 1982.  No one is going to move unless they have to, especially if they need a bigger house and another mortgage.  We will see more supply come on the market as those who failed to lock in long term mortgages are forced to sell or foreclose when their notes are due.  They will be frozen out of the housing market and go back to renting. Other housing supply will come from aging baby boomers looking to downsize with no mortgage but will have to accept less than they want to attract a buyer – possibly much less.  Most will opt to stay frozen in their great big homes, with lots of empty rooms. Finally, home builders will work to meet the demand for homes but building costs are still on the rise making them ultimately unaffordable for most.

It seems pretty obvious that we’re in for a long period of no growth, sideways at best, deep freeze trends in residential real estate.  National home prices over the long term tend to track back to the Consumer Price Index just as they did from 2006 through 2012.

 

 

 

 

 

 

 

 

 

 

 

I expect the same this time without the dramatic drop in prices of 2008/09.  How long will it take for the CPI and HPI lines to converge?  Glacially long.  Our best advice?  Get comfortable.  Learn how to fix up your own home to save money. Settle in for the deep freeze.  Enjoy the process and the joy of learning how your house works.  I installed all new porch lights on our house last weekend.  Super fun.

 

That’s it for this Q and A session.  Again, we’ll be covering a lot of this type of information at our upcoming meeting on October 4^th. There will be dinner, drinks, the company of your peers and our entire Denver area based wealth management team!

Keynote Speaker – David Hansen, Senior Economist for the Colorado Legislative Council.

We hope to see you there!

Sam Jones

 

 

 

 

September 5, 2023

Wealth Accumulation 101

Labor Day weekend marks the beginning of the school year for younger households so let’s take this moment to head back to the school of basic personal finance.  It is important to understand the very purpose of wealth.  For today’s report, I’m going to start by exploring the very purpose of wealth and then borrow heavily from the work of Scott Galloway (aka Prof G) and his newest book, The Algebra of Wealth, to provide a healthy framework for how to accumulate wealth inside and outside of the financial markets.  Timeless wisdom for everyone to remember.

The Purpose of Wealth

I begin each of my semester high school classes posing this question;  What do you think is the purpose of wealth in any capitalist society?  Of course, there is no single answer.  But most students quickly reply … So, we can buy stuff!  Indeed!  But let’s root down into that idea and really discover the very human need that is met when we accumulate wealth.  The answer is choice.

Wealth  = Personal Choice

When we think about a “rich” person, we think about someone who has everything, has nice things, can do what they want, when they want, how they want, where they want.  Most rich people, not all, tend to signal their wealth through very public displays like luxury cars, houses, boats, clothes and other measures of consumption.  They send their kids to elite colleges not because they are materially better (honest truth) but because these schools signal wealth and exclusivity.  But really, rooting in, we find that such displays of wealth are displays of ultimate choice.  Wealth brings optionality to every aspect of our lives in a good and desirable way.  While seemingly wasteful spending is an unattractive behavior to some, it is simply an exercise in personal choice to another.

The choices we make each day generally to fall into three categories.

Things we MUST do

Things we SHOULD do

Things we WANT to do.

Sleep, spending, reading, personal fitness, working, vacationing, visiting with friends, etc.  Everything fits nicely into one of these three boxes every day.  Wealth has the effect of shifting more of our day into the WANT box and away from the MUST and SHOULD boxes.  When we have no wealth, our WANT box is light and tends to be empty, meaning we are not doing things we want to do because we don’t have the financial freedom to do so.

Ok, so let’s get into best practices for wealth accumulation (hat tip to Scott Galloway’s fine work)

Focus

I had an interesting conversation with a remote worker this summer.  He was bragging that he could surf all day and just come in every 30-40 minutes to check his phone tucked under a towel on the beach and still be credited with “working” all day.  Personal opinion – remote work is not going to last much longer if this continues.  Rest assured that employers know clearly who is working remotely and who is “remotely” working.  When the time comes to cut the workforce, the decisions will be easy.

A person who is serious about wealth accumulation is going to work in a focused and non – distracted way for 8-10 hours a day.  They will persistently grind for years especially in the time of early career development.  Remember wealth brings choice but we must create lasting wealth first, right?  I will address the issue of work/life balance in relation to time in a minute.  Bear with me on this thread.

Following a personal talent or passion is great but be clear that we still need to focus that talent on an industry, company or market that will leverage those talents into wealth.  I love to garden and have talent here, but this is not going to be a wealth accumulator for me and will remain forever in my hobby house.

Galloway says to focus on building your skills, degrees and personal certifications early in life.  Get it done!  I couldn’t agree more.  You will not do it later I promise.  Degrees matter, college matters, certifications open doors for you when employers are comparing candidates.

Finally, focus on sectors of the economy that have legitimate potential.  Today, I still hear too many young people thinking they are going to make it big as an influencer on You Tube or some other nonsense.  Influencers are not going to be a thing.  Advertising as a business model, is already on life support and our digital media platforms (Facebook, Netflix, Disney and others) are absolutely saturated with content.  But AI is going to be a thing. Technology solutions to climate change are going to be a thing.  Caregivers to an aging world population are going to be a thing.  Internet of Things (IOT), Biotech, Genetics, Cyber Security, Energy Transition and infrastructure engineers will all be BIG things.  Career work is everywhere but not all pay well.  Focus and apply your talents and interests toward relevant and growing industries that will naturally have high compensation potential.  Be deliberate and thoughtful about your choices-  Think about it, plan for it, execute it.  My door is wide open to any young people struggling with career choices.  Happy to chat any time… really any time.

Stoicism/ Discipline

I can already hear the screams of “Boomers!!!”  I am factually not a Boomer as I was born in 1967 but I do share Professor Galloway’s belief in Stoicism as a standard of behavior.  Personally, I would suggest that discipline is really the driving behavior we’re after, but stoicism and discipline are really twins when it comes to personal finance.  Living within your means seems like a lost art as we all tend to get caught up in the war of outspending each other – whether we can afford it or not.  Living within our means literally translates to spending less than you make every week and every month.  The net result is savings, and those savings must be invested productively and working just as hard as you do every week and every month.

As a point of fact according to CNN in 2022,  only 50.3% of Millennials are earning more than their parents on an inflation adjusted basis.  This is a trend that has been steadily  declining since the early 1940s when more than 90% of children earned more than their parents.    But earnings are only part of wealth accumulation.

 

Stoicism in financial markets also takes the form of disciplined investing with a long-term strategy rather than repeatedly flaming out with a magical day trading strategy in your Robinhood account.  Factually only 5% of day traders make money over any length of time.

Do you know how to make a small fortune trading options? 

Start with a large one!

Today, we are constantly tempted to deviate from our plans, to chase the latest, hottest theme, reaching for a faster, bigger, better return on our capital.  In the last 5 years, we have serially witnessed investment frenzies in marijuana stocks, crypto currencies, Special Purpose Acquisition Companies (SPACs), and now we find ourselves in the grips of the Artificial Intelligence (AI) frenzy.  Each of these themes has sucked in a great deal of investor capital… and destroyed it.  Will AI buck the trend and prove to be the game changer that everyone believes? It seems possible, even likely, but be clear that at this moment, we are witnessing another frenzy and very little money is actually made and retained once the frenzy becomes obvious.

Anecdotally, clients have recently asked why our risk managed investment strategies have lagged the markets in 2023, specifically select indices like the Nasdaq 100 or any other technology only benchmarks.   They lag because we remain stoic and disciplined in our risk management methodologies and we’re proud of it.  These strategies maintain an appropriate mix of asset classes including stocks, bonds and now a full-size position in commodities and internationals.

In today’s market, a stoic and disciplined investor would have only a modest, even minimal exposure, to most of the mega cap technology companies found in the Nasdaq 100 despite very recent performance.  But wise investors would remember that these names are still down the most since the peak in late 2021 when we said goodbye to our last positions held in the mega cap technology trend.  Risk management is a practice of allocating capital to areas of the market with the most attractive risk to reward characteristics and most of these lagged big techs in the first half of 2023.  However, value-oriented investments are already coming back now in the second half of the year, and we remain quite confident that our risk managed strategies will continue to generate high risk adjusted returns for our clients especially in 2024.  This is a critical time and place to avoid temptation and stick with your discipline.

Stoic and disciplined wealth accumulators also remain diversified not just with their investment portfolios but in all financial decisions.  As an in-house rule of thumb, we coach our clients not to have more than 10% of their investment capital exposed to any one company or stock.  If you are lucky enough to have one of those lottery type wins with a 3000% gain, do yourself a favor and work to trim that thing back to 10% over time, taking gains off the table, even it means paying some of your growing long term capital gains tax bill annually.  But diversification is not just about investments.  Think about your career and where you invest your savings.  If you are a real estate agent and you invest only in real estate with your savings, then you are not diversified.  Your income and the fate of your real estate investment results rise and fall  together with real estate cycles.

Personally, I love the idea of diversifying income streams across non-related sectors of the economy, but that is pretty tough as we tend to be good at just one thing at a time.  When I was 24 years old,  a good neighbor invited me to participate in his new coffee shop and co-working space in downtown Longmont Colorado.  He only needed another $5,000 to get it started and I happened to have  saved about $5,000 at the time.  I thought this was a great idea to get involved in a small business outside of my own work.   We wrote up a promissory note where he would pay me 20% of profits for 5 years and then repay the $5,000 at that time.  By his estimates, I would double my money in five years.  Sounded great!  In year two, the coffee shop closed permanently, and my neighbor sheepishly tried to pay back the note counting out small stacks of 10 and 20 dollar bills on my porch every month.  A painful experience all around.   He returned about $2000 in total if I remember right.  At that point in my life, I did not even remotely have enough capital available to consider such a thing.  Stay diversified and avoid concentrated financial bets on anything.  As Scott G says, this is your personal Kevlar against the high probability of unfavorable outcomes.

Time

Time is a powerful wealth accumulating tool if we really understand the incredible power of compounding.  I won’t beat the dead horse here but let’s all remember that starting early with our saving and investing has a far greater impact on our wealth than trying to catch up later with a higher savings rate.  Consider this handy chart from JP Morgan’s Guide to Retirement.

 

We should all strive to be Susan who smartly saves a total of $50,000 in the first ten years of her working life and ends up with more than twice the wealth of her peers who started later and tried to catch up with higher savings amounts.  Compounding works incredibly well when time is on your side.

Earlier I mentioned the issue of Work/ Life Balance. Let’s say that maintaining a work/life balance is important to us.  I completely but conditionally, respect that choice for the benefits of mental health, relationships, life experiences and happiness.  But there is a consequence to every decision.  In most cases, those who choose a career with a healthy work/life balance often forego higher incomes in earlier career years.  Having more savings and investments at an early age allows compounding to work to your advantage as the chart above illustrates.  Again, no judgement but be aware that the ultimate wealth accumulation is directly a function of time.  Starting to save later with less capital really just creates bigger challenges down the road when you really want to pursue some life balance (aka retirement).

Last thought on time and wealth accumulation.  Dividend paying investment strategies with reinvestment of dividends to additional shares, provides an automated way to embrace compounding to its fullest.  Cash dividends paid monthly or quarterly, form a drip of new investments back into additional shares of the very thing that is creating the dividends.  Our shares pay dividends that become more shares that create more dividends and so forth as the great compounding machine winds up our wealth.  Our MASS (Multi-Asset Income) strategy currently has an incredibly high dividend rate of 11%/ year.  These dividends are reinvested in shares of securities that are also trading at a steep and discounted level thanks to the Federal Reserve smashing prices with 11 rate hikes.   Think of the dividends, the reinvestment potential into discounted shares and the compounding that is happening with that dividend yield over a 20-year time frame.  I apologize for the infomercial but oh my, we believe this is an exciting opportunity for wealth accumulation.  We’ll be covering this and other unique opportunities in the current market environment at our upcoming annual dinner on October 4^th.  Please RSVP soon if you plan to attend!

Happy September to all , my favorite month of the year.

Cheers

Sam Jones

July 31, 2023

This seems like a perfect moment to educate our readers about the realities of market volatility.   Today’s update will focus on this evergreen subject followed by a highlight of our Gain Keeper Variable Annuity strategy which is now breaking out to a new all-time high.  I’ll finish with an important notice regarding our view of Macro – Economic changes happening now.

The Merciless Math of Losses

This is one of those timeless graphics that I keep in my lecture material for my high school financial literacy class.  Not many people really understand the math behind portfolio losses and recovery percentages.  For instance, why is it that Facebook lost -76% from the all-time highs in 2021 to the lows in 2022, is up +266% from those lows, but still sits -15% below the highs.  How is that possible?

Simple math would say -76 + 266 = 190 right?  Facebook should be trading way out at an all-time new high, right?

Well, no, because we are dealing with percentages and the loss of investment capital, not straight numbers.  Let’s break it down to a simple example.  Let’s say I give you $100, you go to Vegas, and you come home with $50.  That is a 50% loss of capital.  Now, how much of a percentage-based return does it take to get back to $100?  9 out of 10 people would quickly answer  – You need to make 50% to get back to your break even of $100.  Unfortunately, that is just bad math.

$50 + $X = $100

X = $50

$50 represents a 100% (not 50%) return on our remaining capital of $50.  If we lose 50%, it takes a 100% return just to break even!  Now consider the parabolic and merciless math of losses chart below.

It is sort of amazing to me how many companies with Billions, even Trillions of Market capitalization (value of all outstanding stock) lost more than 70% in 2022.  Tesla (-73%), Meta/ Facebook (-76%), Netflix (-73%).  Many of the Covid Unicorns lost 80-95% in 2022!  Looking at the chart above, a 90% loss needs a 900% gain just to break even.

Best Practices for Managing Portfolio Volatility

 We all make mistakes and experience losses with our investments.  This is the nature of business.  Trying to avoid losses altogether is not recommended.  You will spend a crazy amount of time and effort doing so and discover that your performance is very poor over time.    Smart investors understand this reality and work to control, respond or even capitalize on losses when they come.  Most of the old guys (and gals) in this business will tell you to keep your losses small if possible and capitalize on volatility (aka losses) to your advantage.  Here are some of the best practices.

1. Harvest bigger losses for taxes and reinvest immediately.

This is a big one but only applicable to investments held at a loss in TAXABLE accounts.  Let’s say we bought Peloton at the very height of the Covid scare in late 2020 and have subsequently watched the stock fall -94% to the current lows. Ouch!  In a taxable account, a smart investor would sell the position and bank that capital loss as a credit against income (up to $3k/yr.) or offset future realized capital gains.  Capital losses can be carried into future tax years indefinitely or until they are used up.  The proceeds of that sell can and should then be reinvested in another speculative growth name of your choice in order to hold that space in your investment portfolio.  It’s not wrong to own speculative stocks, just keep your allocation size small and appropriate for you!  In a tax deferred account like an IRA, we are sort of stuck with the position and might wait 10-15 years for the stock to recover or move it to something with better prospects for sustained growth.

2. Limit your Portfolio Volatility by maintaining diversification and appropriate asset allocations.

Hopefully we all know about this best practice, but rarely do I see it effectively maintained.  One of the hardest things for investors is to take profits on a position that seems to just go up and up and up.  Mega Cap technology names have sucked in so much investor money that the top 7 names represent over 40% of total market capitalization in the US stock market today.  No one is selling because the experience of being overweight Mega Cap Tech has been so rewarding looking backwards.  What I see today are way too many portfolios that have 40-60% allocated to Tesla, Amazon, Apple and Microsoft and the remainder in a mix of stock index funds that have the very same names in the top 10 holdings.  This is not a diversified portfolio.  What I regularly see are portfolios that are way out of balance and typically don’t own asset classes that have little or low correlation to their stock holdings.  It is critically important that we work to maintain diversification and that means owning things that ZIG when other parts of our portfolio ZAG.  You may or may not have noticed that bonds and stocks are now positively correlated since we entered the New Environment in 2020 (please read last week’s RSR).  Now US Treasury bonds and US stocks ZIG and ZAG together in the same direction at the same time.  No Bueno!  Meanwhile Commodities are becoming a new and welcome source of true diversification  – More on this in a minute.  The point is we all need to weed and replant our investment garden periodically and make sure we don’t have too much or too little in our prescribed portfolio asset allocation holdings.

3. Add to your investment portfolio at lows.

This one also seems obvious but so rarely followed as a best practice.  We try, you know we try, to tell you when it is a good time to add to your investment portfolios.  In the current market recovery, we have seen three great windows to do so in October of 2022, December of 2022 and again in March of 2023.  When I look at volume figures for the market, I see nothing but quiet selling at these three intervals with very little net new buy side trades coming into the market.  Now, the market is up 20-30% off the lows and the buy side volume is really picking up.  In fact, in the last two weeks, we have seen some of the heaviest inflows into stocks in several years.  Investors are buying high because there is a perception that risk is gone, recession is not going to happen,  prices are going higher, and the Fed has whipped inflation.   But, given earnings, interest rates, valuations and the new 5% risk free rate on money markets, even the most bullish of market analysts are saying the S&P 500 could go as high as 4700 by the end of the year.  Today the S&P 500 is trading at 4566.  So, we’re talking about maybe 2.9% higher from here?  It is safe to say that there will be a better time to add to your portfolios than right now if one is looking for opportunities to buy low.   Personally, I have found that any stock market environment trading more than 15% below the highs is a signal or trigger for me to identify new investment money and start looking for entry points to add to my investment portfolio.    Today, the US stock market is roughly 5% below the all-time highs.  The strategy of adding to your portfolio at deeper discounts works incredibly well but does take some guts and some discipline.  Undisciplined investors sell at the lows and move to cash in fear.  This is devastating to your portfolio and wealth accumulation over time and yet it happens time and time again.

Gain Keeper Annuity Within 2% of All Time New Highs

In the context of our discussion on managing volatility, I want to take a second to highlight our long-standing Gain Keeper variable annuity strategy at Nationwide.  We run this investment strategy inside a variable annuity which offers investors unlimited tax deferral outside of a retirement account with after tax dollars (please inquire for more details).  2022 was a losing year for nearly all asset classes including US stocks down -19% and US treasury bonds down -16%.  Our Gain Keeper annuity also had a negative return of -7.04% net of fees.  7% is a relatively easy loss to recover from (see above) and it won’t take more than a few more days for this strategy to nose out to a new all-time high.   Gain Keeper attempts to remain fully invested but this is a strategy that can go where it needs to go in order to find true diversification, overweight opportunities and underweight obvious risk areas of the market.  This is one of our longest standing dynamic asset allocation models that uses all of the methods described above as a means of limiting losses and capitalizing on market volatility.  Today we are less than 50% in stocks and have recently sold down our bond allocation to build an overweight allocation to commodities and gold.  A great investment strategy is built and run with great design and execution.  Gain Keeper proves to be a strategy for All Seasons once again!

Change in Macro-Economic View

Admittedly, in March of 2023, it seemed fairly obvious to us that a recession, perhaps a very hard landing recession, was in the works and treasury bonds were offering a very attractive entry point.  The Fed did their thing to curb inflation and successfully brought inflation back to the current 3% level  – from 9% last June.  Naturally, we would expect recession to follow such a move and we still believe that outcome is inevitable.  Unfortunately, treasury bonds have gone nowhere and here’s the twist.  By many measures, it appears that inflation is now bottoming again and even poised to push higher lead by commodities and other inputs.  Oil is now back above $80!  Copper just made an all time new high.  Timber and agriculture commodities are making a run at the old highs again.  And industrial metals are attracting some very large inflows from institutional investors.  I found this article from Global X very compelling regarding the underinvestment and rapidly rising demand for metals at the center of the clean energy transition to electric vehicles.   Please do take a few moments to understand this profound change in demand for raw materials that is happening regardless of our position in the economic cycle.

https://www.globalxetfs.com/ten-questions-about-the-disruptive-materials-at-the-center-of-the-clean-energy-transition/

Additionally, Crescat Capital, who offers some of the best macro research out there, suggests we are now in the trough of the next wave HIGHER in inflation like that of the 70’s.  That would be quite a shock to global stock markets that are just now ringing the inflation death bell and expect the Fed to start dropping rates soon.

We take our clues from the market leadership and it is noteworthy that commodities are one of the best performing asset classes since the end of June.  Is this the next wave higher in a rally that began in 2020?  Perhaps we should not be so quick to assume that short term interest rates will come down.  Perhaps instead we might remain open to the possibility that long term interest rates RISE from here and eventually solve the inverted yield curve conundrum the hard way.  Darwinize your portfolio!

Stocks can continue to do well if inflationary pressure and catalysts continue as they have been for over two years.  Our job is to own those groups, styles and investment themes that have pricing power and continue to thrive and survive.  Macro-econ is a dismal science, but it can help to set the stage for decisions we might make regarding our allocations and security selection.  The markets are telling us a story that conflicts with investor expectations and the drumbeat of the financial media.    These are important moments to watch and respond to what IS happening, not what we expect WILL happen.  Stay tuned.

That’s it for this week.

Health and happy family reunions to all!

Sam Jones

 

 

July 24, 2023

Let’s begin with our old friend Charles Darwin who famously said,

The New Environment

Regular readers know the high-level assumptions we are making regarding “The New Environment” .  Specifically, we have highlighted almost exhaustively, about the Big Three Investment Themes (Value, Commodities and Emerging Markets) that emerged as new leadership beginning in October of 2020.  These themes developed as a clear response to the New Environment we live in today.  So far in 2023, just like the summer of 2021, we have witnessed a short counter trend move, where things like speculative tech and overvalued growth names take the lead.  But, make no mistake, the primary trend leadership, dating back to 2020, remains with Value and Dividend Stocks, Commodities and Internationals.  Let’s unpack the New Environment to help us understand the importance of adapting our portfolios with an eye toward “survival” and finding the right balance of risk and reward.

These are the clear features of the New Environment that began in late 2020:

• Rolling manias where investors are chasing the latest craze in order to make a quick buck. Rolling manias are indicative of a type of desperate and undisciplined investor who is struggling to make money and trades like a gambler.  Manias always end badly and destroy wealth for the vast majority of those who choose to play in this sandbox.  At the same time, manias can produce some lasting investment value if one is patient enough to find the real value these companies bring to the world. The short list in chronological order;

Bitcoin – still the domain of chaos investors, but Blockchain might be a lasting value.

Marijuana and Pot Stocks – Was very hot and now very dead

SPACs – Blank check Special Acquisition Companies – nothing left to see here.

COVID Unicorns – like Virgin Galactic, Peloton, Stitch Fix, Carvana, Chewy, etc.

Meme Stocks – Read all about it  https://www.nerdwallet.com/article/investing/meme-stocks

And now Artificial Intelligence (AI) – Real AI is not what we see today.  But it is coming.

• Labor Costs are Permanently Higher

This is a good thing and a long time coming.  Nationalism trends are putting an end to the benefits of globalization (aka cheap labor overseas).  Stuff we buy looking forward will cost more as labor costs to mine it, assemble it, serve it, deliver it, solve it, are not going back to $7/hr.

• Costs of Shelter are Higher for Longer

For those looking for Real Estate prices to collapse in hopes that they can afford something… anything, you’re going to be in for a long wait.  Rental prices are falling thankfully but will not likely return to pre-2020 levels.  Homeowners do not need to move, do not need to sell and have no interest in trading in their 2.7% mortgage for a 6.6% mortgage.  Meanwhile, we have an entire generation of young people who want to buy real estate but still can’t afford it.  Prices will therefore remain high unless and until we have a very serious economic contraction or an historic burst of supply.

• Costs of Capital are Higher for Longer

The Fed has been pretty clear about this, and they are likely to raise rates again on Wednesday.  They are working to get inflation down, but they are swimming against a 25-year tide of massive money printing, unlimited stimulus, and uncontained debt spending.  Our monetary system is going to be less friendly for the next 7-10 years if we are to find any form of sustainable balance again.  Be prepared for the fact that mortgage and loan rates (still stuck at 6.5%) will stubbornly not fall with stated inflation (now 3%).

• Underinvestment in commodities and raw materials

This is a topic, maybe THE topic, that just doesn’t get enough press in my mind.  Globally, we have not invested enough in the production of raw materials (think base metals, timber, oil and gas, silver, food commodities, etc.) to serve our global economies, even when they are barely growing as they are now.  The world is in short supply of raw materials and commodities  – I’ll provide more evidence in future updates.  Commodities prices are also far below levels that reflect these worldwide shortages.  Oil is moving back toward $80.  Did you notice?   Invest in Scarcity!

• Climate Adaptation is Inflationary

Our man-made climate problem is coming home to the bottom lines of corporations, homeowners, municipalities and our own Government (think FEMA).  To be clear, the costs are coming fast and hard from our need to respond to the natural environment we made for ourselves – heat and cold extremes, drought, wildfire and flood extremes all at the same time.  Select Insurance companies can’t afford to operate in entire states like California and Florida anymore.  And of course, crumbling or inadequate infrastructure can’t handle most of what’s happening as we’ve seen in places like Texas.  Adapting to climate change, is and will be, a very expensive and inflationary catalyst for the foreseeable future.

In summary, all that has happened since 2020 is not solely a response to and from COVID, but rather a culmination of variables that have been accruing since the late 80’s.  The New Environment is one that is persistently and stubbornly inflationary interrupted by rounds of soft economic data, even short recessions.  We are living this reality that folks in the 70’s would remember as a Stagflationary environment.  This is when the economy and most asset classes become stagnant, while inflation roots in at higher than desirable levels.

Darwinize Your Portfolio

Adjusting one’s investment portfolio regardless of the time frame, is necessary.  There is no such thing as set it and forget it as much as our industry would love for you to do that (good for fee revenue and no work for them!).  Our constant exposure/ passive investment strategies, called Wealth Beacon, do make changes but on long-term time horizons. These adjustments take the form of rebalancing, tax loss harvesting, possible upgrades to positions with lower costs and/ or tilting the portfolio toward asset classes and styles with better long term risk reward properties.  We do remain fully invested in all market conditions, however. Ultimately, with our passive strategies, we are working to keep client assets earning a market return with very high tax efficiency.  This is not a paired objective as many of our clients simply want a portion of their portfolio earning the full market’s return and are willing to accept the associated volatility.  Others are more focused on generating long term capital gains, so it works for them too.   The point is that nothing is truly passive, changes are necessary.

If we consider our dynamic asset allocation strategies, our New Environment offers investors some very attractive opportunities that will increase returns, increase true diversification, and reduce risk of large losses with only a few minor changes.

Adding Full Exposure to Commodities to our Dynamic Asset Allocation Strategies

A picture (chart) is worth a thousand words so consider this two-year chart ending 7/21/2023.

Yellow line – (PDBC), A complete Commodities ETF with no k-1

Purple line – (GLD), A gold bullion ETF

Light Blue line – (SPY) The S&P 500 Index

Green line – (AGG) Ishares Aggregate Bond ETF

Red Line – (AMZN)  Amazon Stock

What do we see?

We see that over the last 24 months, in the New Environment, Commodities and Gold are the best performers compared to stocks, bonds and the mother of all investments owned by all,  Amazon.

Perhaps this is just an anomaly and one of those cycles that favors a bizarre asset class like commodities or gold.  Or dare I say these dangerous words; This time is different.  If we are willing to open our eyes to what is happening, we see that stocks in general are again approaching one of the highest valuation levels in history.  Bonds are caught between the Fed and the hard place.  Amazon and company is becoming a low profit consumer staple stock.  Meanwhile commodities and gold are in short supply with very high demand with extremely low empirical valuations and paying out attractive dividends to shareholders.  We are bound only by our imaginations to consider a somewhat permanent allocation to both commodities and gold now.

Let’s do some quick math for a traditional 60% stock/ 40% bond portfolio since the end of 2021 when the New Environment was first recognized.  I’ll even use the Dow Jones Industrial Average as the best performing index as the “stock” proxy.  For bonds, let’s use the AGG bond index.

Total returns since 12/31/2021 – 7/21/2023 for different asset mixes

60/40                   -4.32%

What if we had more stocks and less bonds, say 80% stocks and 20% bonds

80/20                   -2.16% (OK but could be better!)

Now what if we added 15% Commodities and 5% gold to the mix?

60 (stock)/ 15% (commodities)/ 5% (Gold)/ 20% (bonds)

The results are a positive 0.62%

But importantly the very worst portfolio drawdown you would have experienced in 2022 was approximately -2.5% in late September. 

I can see the future with perfect hindsight!  Kidding.  Of course, this begins to look like an exercise in building the perfect portfolio with past performance.  Also note that the same mix of stocks, commodities, gold and bonds would only be up 5% YTD versus the Dow which is up 8%.  What we are not trying to accomplish is a manic race to generate high returns or even beat one index versus another.

What we are after is the following:

• A Darwinian portfolio that is adapting to the New Environment.
• A portfolio designed to survive in a stagflationary environment that doesn’t have 20-30% periodic losses every year or two.
• A positive return that doesn’t depend on the Fed coming to the rescue.
• A portfolio that allows us to sleep at night regardless of the headlines we wake up to every morning.

Why Should Our Clients Care?

Please excuse the shameless promotion but this is the type of analysis and portfolio management that we provide to our clients in their managed accounts.  We make adjustments as needed, when needed within each strategy.  Every client has a mix of strategies that is designed to meet their financial planning goals, cash flow needs, tax considerations and general expectations.  Our clients should not feel the need to call with questions like – What do you think of AI stocks, or Should I just put everything into a high yielding savings account?  Our investment strategies adjust to both risk and return opportunities as environments dictate.  Some move very slowly, others move faster.  We relieve you of the need to wonder if you’re in the right place with your hard-earned investment dollars.

I offer this commentary as an example of the type of adaptations we are making on your behalf.  This is why you pay us, and this is part of our value as your holistic wealth manager.

Enough with the infomercial!

I hope you are well and enjoying the HOT, HOT summer.  Wow, hot.

Regards,

Sam Jones

July 17, 2023

The Alternative to Being a Landlord

It seems that everyone I speak to these days is looking for passive income, usually in the form of a rental property.  Of course, real estate of any kind is now in short supply, with historically high prices and heavy carrying costs.  Let’s peel back the shell of owning hard asset real estate for investment purposes and consider the alternatives.

My Personal Disaster

Scott met me at our newly purchased Sherman Street office building in a vintage yellow Mercedes Benz.  It looked like something his grandmother gave him.  I was working to rent the office before moving All Season Financial Advisors into the space in 1999.  Scott needed some short-term office space for his new thriving business on the world wide web.  We signed a quick lease for 6 months and it didn’t take long for me to discover that “Scott” also needed a place to live and had a very healthy on-line gambling habit.  Scott paid the first month’s rent but that was the last of it.  I tried to evict him with attorneys but alas Colorado state law favors the tenant, and he stayed rent free for over a year.  He trashed the place and vanished in the end.  My total rent for a year was one month’s rent and his damage deposit.  Costs to me all in were over $8000 with attorneys, replacing the carpet, and deductibles for a water damage claim.  In addition, my taxes doubled that year as new owner of the property as did my homeowners insurance after making the claim.  It was an amazingly poor experience with a negative “return” on my investment and a year of high blood pressure.  I felt trapped in a losing situation with an expensive asset and that is a bad feeling.  I’m sure others who are better at this than I, know how to find good tenants and keep a rental property spinning profitably.   Personally, I’m a bit scarred from my landlord experience and probably won’t ever do it again.

Real estate also has a growing Total Cost of Ownership (TCO).   After nearly 30 years of historically low carrying costs like mortgage rates in the 2’s (%), utility costs that are lower than your weekly coffee budget, and taxes that don’t seem significant, we have been conditioned to just focus on the purchase price of any real estate.  But those days are really over now.  Tax assessments in 2023 were shockingly high after the run up in prices over the last few years.  Homeowners insurance is also ramping up 20-30% over the last couple years as they attempt to socialize the rising costs of climate disasters in vulnerable areas.

This happened on Thursday if you hadn’t heard:

(The Hill) – Farmers Insurance will end its home, auto and umbrella coverage in Florida and curtail coverage offerings in California due to ongoing risks from environmental disaster, the insurer announced Tuesday.

If you happen to need a new roof, or some work done on your house this summer, you know that finding a contractor is nearly impossible and then the cost to get anything is truly unbelievable.

All things considered, when we look at the affordability index (below),

and combine this with the rising Total Costs of Ownership, it seems pretty obvious that investment property and rentals are not going to generate much passive income for investors until the situation changes rather dramatically.  To be clear, we’re not talking about your primary residence or other personal use property but rather the prospect of buying property in order to generate rental income.

A Real Alternative

Now, if only there were a way to buy a commission free, diversified pool of income producing real estate with daily liquidity,  positive and dependable income, and no troublesome tenants, taxes or insurance.

Wait there is such a thing!  Real Estate Investment Trusts (REITS!)

REITS Offer High Total Returns and Staying Power

Let’s look backwards for a minute noting that past performance is not guarantee of future results.  REITS have outperformed stocks for at least the last 20 years.  Certainly, we have to consider the strong tailwind of falling interest rates over this time period and temper our future expectations.  But the facts are what they are.

I want to present this information using the Dalbar study on real investor returns.  First consider that over the last 20 years, REITS have outperformed nearly all other asset classes (ex-Gold).  Who knew? REITS generate a total return that is a combination of price change and dividend payments.  Today, we are finding REITS in many forms that are paying 7-10% dividends despite the trend of prices.  If you look at the Dalbar chart above, you might notice the yellow “Average Investor” bar that shows a relatively poor 20-year return of only 2.9%.  Remember this is a study of actual investor portfolios conducted by Dalbar every year with a 20 year look back.  Now I want to explain why owning a REIT paying 7-10% interest can help investors avoid the negative behavioral effect we see so often.

Behaviorally speaking, the reason why investors do so poorly is that they have a strong and repeat tendency to buy high and sell low.  Buying high isn’t as much of a problem as selling low.  But why does our silly lizard brain ultimately drive us to sell low?  Well because the human brain is preprogrammed to avoid pain and the pain of loss at bear market lows simply becomes “unbearable” (unable to withstand a bear – Ha!).  But, but, but, if we were getting paid 7-10% in dividends on our holdings, despite the prices of these securities being down 15-25%, we have much better staying power.  That is why I have over 50% of my personal net worth in our MASS Income model which has an estimated dividend yield of 8.8%.  If I focus on price alone, I might get sad.  But then I see multiple dividends of $500-$800 + come to me in waves around the end of each month and I think “ at least I’m getting paid really well to wait for prices to move higher again”.  Emotionally, when we are receiving regular high income on our investments, we are much less prone to reacting to our fears.

REITS:  Why Now?

After a bloody 2022 on the price side, REITS are now very attractively priced again and paying historically high dividend rates.  Several of our positions like AGNC Investment Co (AGNC) and Annaly Capital (NLY) already cut their dividends by over 20% in the last couple years as cash flows from operations fell.  But they are still paying over 13% in annual dividends with improving balance sheets and rising revenues.  Price trends also appear to have bottomed with the market in October of 2022, but gains have been somewhat muted against continued pressure and chatter from the Fed.  REITS are highly reactive to changes in interest rates and the Fed has not been a friend since March of 2022.  But with inflation having completed a full return to pre-pandemic levels, the Fed is likely done with their rate hike cycle.  Historically speaking, when the Federal Reserve ends their rate hiking cycles, it tends to be a very good environment for interest sensitive sectors like REITS, banks, financials, etc. REITS look good now, especially compared to the risks and rising costs of purchasing hard asset real estate now.  REITS importantly offer incredibly high liquidity especially when we can purchase them using closed end funds and ETFs.  They pay very high dividends, and most are now trading at 10-12% discounts.  The second half of 2023 should be an excellent environment.

For those invested in our Multi-ASSet Income strategy (MASS Income), REITs represent a little more than 40% of our 42 holdings.  The remainder is held in credit funds, preferred securities, bank loans, business loans (BDCs), fixed income and select high dividend paying stocks.  I think of MASS Income as a REIT strategy but really it’s far more diversified than just that asset class.  Our goal is to remain fully invested in all markets in order to generate secure annual dividends and income in the 7-10% range.  As our investors know, there is plenty of price volatility in this strategy, but the income keeps rolling in, month after month after month.

As always, my intention with these updates is to set expectations, guide good behavior as investors, and present timely solutions for you to consider. Stay tuned as there are new opportunities (and new risks) as this relief rally in the stock market matures.  I’ll be guiding you through the changes in the economy and the markets more frequently now, moving toward weekly updates.

I hope everyone is enjoying the very belly button of summer!

Cheers,

Sam Jones

 

July 3, 2023

It’s been a wild first 6 months of the year with big winners and big losers inside all asset classes.  As I look across the landscape at all market indices, as well as our own strategies, looking back to the top of the bull market in December of 2021, I see that nearly everything has arrived at the same place in terms of performance.  This is the yin and yang of market cycles where we recognize that adding risk to one’s portfolio often just leads to adding volatility and not necessarily long-term returns.  Of course,  timing is everything.  Let’s dive into the details and some performance numbers and I’ll finish with some opportunities developing for the second half of 2023.

My First Investment

My first investment was a total loss, nearly 100%.  When my girlfriend (now wife, Sarah) and I got out of college, her parents gave us an unthinkable amount of “starter” money – $10,000.  We were working day jobs and didn’t need it immediately. My smart 22-year-old self, called a broker friend from Wachovia bank and asked what I should invest in that will make big returns!  At the time, 1990, Trimble Navigation (TRMB) was a company on fire; satellites were big business, and they were going to the moon.  I put all $10,000 into TRMB and paid a $280 commission for the shares.  The stock topped out a month later and fell 83%.  I panicked and sold right at the lows and lost the majority of our nest egg.  My broker friend waived the sale commission because he felt bad.  I never told my wife but felt the utter shame and frustration of my first catastrophic investment failure including the consequential loss of confidence and financial freedom.  But that wasn’t the end of my pain.  TRMB went to climb to new highs the next year and has made 15%/ year on average for the last three decades through last week, without me. I learned that timing matters.  I learned that I am human and prone to making bad decisions even with good companies.  I learned that there must be a better way to balance risk and return.  I learned about true diversification.  Today, I hope to bring 30 years of experience to the management of our client’s assets, always working to find that right balance and avoid catastrophic, unrecoverable losses.  This is what we do for all clients of All Season Financial in all forms.

See You on the Other Side!

It was October 5^th, 2022, when we stood in front of our clients at our annual meeting at the Wellshire Country Club and offered this summary slide.  We called the pending rally in stocks and bonds, a “Relief Rally”.

Few in the room believed it.  After all, the S&P 500 was down -26% at that meeting.

Five days after our meeting, global stock and bond markets bottomed.  Good call!

But let’s look a little deeper into the market to understand what has happened since those lows.

As we would expect, the biggest winners on our relief rally since last October, have come from the same side of the market that was decimated in 2022.  Mega cap technology companies like Netflix, Meta (Facebook), Google and Amazon were down 30-75% at their worst in 2022.  But they have recovered a majority of those losses thus far in 2023.  Comparatively, other areas of the market like Value and Dividend payers which lost almost nothing in 2022, have gained almost nothing in 2023 but remain steady just below the all-time highs.  Looking back at a two-year chart (below) we see two paths to the same destination.  The red line is the iShares Dividend Growth ETF (DGRO), and the green line is the Nasdaq 100 ETF (QQQ) or mega cap growth index.  Obviously the two worlds have come together in terms of performance with the Nasdaq 100 simply going about it the hard way.  I’ll see you on the other side!  As I said in the introduction, adding risk has simply added volatility to your portfolio, not returns, if you are willing to look beyond the last 6 months.

Of course, what happens next matters a great deal in terms of comparative performance.  Stay tuned as we are very likely at an important inflection point for market leadership.

From the Top

Looking back at the last two years, a similar comparison can be made looking at different investment strategies and methods.  Our passive strategies called Wealth Beacon represent different mixes of stock and bond indices.  As we would expect, these strategies fell harder in 2022, but have recovered stronger in 2023, just like the green line above.  Our active, risk management strategies like our flagship All Season strategy, experienced mild losses in 2022 but have not gained much ground thus far in 2023, just like the red line above.  In the end, after a full market cycle, we see the two coming together in total returns.

From the top of the market on 12/31/21 to present we see the losses (or total returns) are very similar for all strategies as well as the broad market averages over the period.  Strategy performance numbers presented below are preliminary, unaudited and based on model accounts net of all fees as of the writing of this update (6/26/2023).

Returns (losses) from the top of the market 12/31/21 – 6/26/2023.

S&P 500 Index                                                                    -9.18%

Wealth Beacon Aggressive (passive)                        -10.14%

Wealth Beacon Moderate (passive)                          -9.70%

Wealth Beacon Conservative (passive)                    -9.59%

All Season (Risk Managed)                                            -9.88%

Again, what happens in the second half of 2023 will provide more clarity on leadership and strategy advantages. But as of this midyear checkup, it’s all the same.

Opportunities and Risks for the Second Half

If I had to pick just one thing that represents the greatest systematic risk to investors today, it is the overwhelming concentration of wealth in just a few names, 8 of them to be exact.  These are names that you hear every day in the media.

Microsoft

Apple

Google

Meta (Facebook)

Netflix

Nvidia

Amazon

Tesla

These are great companies make no mistake, but from a valuation, revenue growth, free cash flow, price to book and price to earnings basis, they are now some of the most expensive, overpriced securities in the world today.  Crescat Capital does some incredible work on the state of Mega cap technology stocks.  They point to the fact that the median Year over Year sales growth among “FAANG” names has just gone negative for the first time in two decades.  Focus on the last 5 years of the chart below.

Priced to perfection is an understatement.  Beyond valuations, there are significant headwinds coming now from changes in privacy regulations, diminishing dollar volume of on-line advertising, anti- trust regulations, global tensions, and competition.  The AI frenzy offered a nice boost in recent months, but I’m not convinced these same names will be the leaders in the end.  Fun fact from Seeking Alpha last week with data as of 6/23/23; the 8 names listed above account for slightly more than 100% of the gain YTD in the S&P 500.  The other 492 stocks in the index have an average return of -1%.  Wow!

Most investors don’t realize how much exposure and concentration of their wealth is in these names by way of simple mutual fund or ETF index ownership.  Factually, these mega cap names are in the top ten holdings of nearly every fund and ETF within these investment categories:

Large Cap Growth

Large Cap Value!

Mid Cap Growth

S&P 500 Index funds

Total Stock Market funds

Every 401k plan and every standard asset allocation portfolio seems to own the same mix of the funds above.  Is this a diversified portfolio when all funds own the same securities in bulk?  Hardly.

What’s the point?

As your asset manager, our job is to allocate your money into securities, sectors, countries and asset classes that offer favorable characteristics in terms of risk and reward.  Conversely, our job is not to pile your hard-earned money into overbought, overvalued, overhyped investments just because they are winning the popularity contest (Trimble Navigation!).  The time to buy mega cap technology was October of 2022.  Now, may very well prove to be the time to take profits.

What do we find attractive now?

Now that we have clearly identified where risk lives, let’s put our fingers on three real opportunities for the second half of 2023.

#1 Small Cap Value

I’m intrigued by this style and size category for future investment.  Take a look at the returns of the basic I Shares Small Cap Value ETF (IJS).

While the 1-year numbers are still negative (-7.08%), look at the 3 yr. numbers of +24.95% annualized.  IJS also posts an average P/E of 10.5 and Price/ Book ratio of 1.25 which is less than ½ the very rich valuation of your basic S&P 500 index fund and 1/3 the valuation of the Nasdaq 100.  And under the hood of Small Cap Value, you will not find any mega cap tech – wink!  Today we have significant allocations to small cap value which are only up +4.95% YTD.   We remain disciplined and patient as we expect this style box investment to begin outperforming in the second half of 2023.

#2 Internationals/ Emerging Markets

No need to wait for performance here.  Internationals have been outperforming the US stock market since the lows last October.  Consider the following total returns from 10/11/2022 – 6/26/2023:

Dow Jones Industrial Average (DIA)            +17.61%

S&P 500 (SPY)                                                       +23.48%

Europe/Far East/ Asia (EFA)                            +31.21%

All Country Word Index ex US (ACWX)       +25.67%

Regular readers know that internationals, like small cap value, are priced at less than 1/3 of the valuations we see in the broad US large caps today.  Stronger performance at 1/3 the price.  Sounds good!  We remain fully allocated to internationals and emerging markets.

#3 REITS, High Dividend and High-Income securities

Admittedly, it’s been a rough go for this group of investments in the last 6-12 months.  The Fed pushing up short term interest rates by 5% in the shortest time period in history, has been a headwind to say the least.  Now it appears they are done raising rates and are likely to pause for the better part of the next 6 months (TBD). Inflation is sticky and inflation is still real, but they have done a tremendous amount of damage to the banking system, real estate, credit markets and lending since March of last year.  The Fed has poured gallons of water into the gas tank of our economic engine and now they are waiting to see if and when our car will stop. It will stop.

IF, and this is a big IF, the Fed is actually done raising rates, we will see the market begin to accumulate and bid UP the prices of securities that are highly impacted by interest rates.  Since the last Fed meeting on June 14^th, I have witnessed a new level of buying interest in this space, so we see the opportunity developing now.  As time goes on and we move into the second half of 2023, this could become a huge total return opportunity especially if recessionary pressure continues to build.

Our Multi-Asset Income strategy is still down over 19% since the all-time highs in 2021 on a total return, net of fee basis.  I know it and feel it, because this strategy remains my personal largest holding by a long shot.  It is frustrating to see growth investments with no dividends and crazy valuations rocketing higher while REITS, preferred securities, Bank loans, credit funds and direct lending securities paying over 8% in aggregate, sit on the sidelines of the performance charts.  Maybe Warren Buffett and I are the last investors who like their investments to pay high income.  I like income because it pays rain or shine and lets the magic of compounding work to our advantage.  8% annual income is very attractive to me and when the price trends turn higher, we get into double digit total returns in a hurry.

Our Value to You

The main points we want you to take away from this update are simply this;  You have entrusted us to manage your money by allocating your assets appropriately to sectors, countries and asset classes that offer attractive risk and return characteristics.  We do this across all investment strategies in our company.  Today the markets are rewarding only a very thin slice of the investment landscape that now has poor risk reward characteristics looking forward.  We understand that it’s difficult to watch the market run up as it has while your portfolio seems to be lagging.  This is one of those times when emotions get in the way of rational, disciplined, needs based, investment decisions.  Fear of Missing Out (FOMO) is loud, we get it. Please excuse us while we choose to stay disciplined and follow our system as we have done for the last 30 years.  Patience now is critical as the second half of 2023 is queuing up to be very different than the first half.

Beyond allocating your assets appropriately, our other main value as your advisor is to set expectations and offer you a clear and honest assessment of conditions whether it is popular or not.  Our fiduciary loyalty is to our clients and meeting your long-term objectives for cash flow and financial independence as identified in the financial planning process.  Hopefully, this type of communication helps set those expectations and guides your understanding of what we are doing with your investment assets toward that end.

As always, we appreciate your continued trust and confidence in our firm, and we look forward to serving you to the greatest extent possible.

Sincerely,

Sam Jones

President, Chief Investment Officer

 

 

 

June 12, 2023

This seems like an important moment in time for a little investor education.  We’re going to talk about Recency Bias and apply the principle to a growing list of extended trends (both highs and lows) in today’s financial landscape.  I’ll finish with some evergreen recommendations to focus on the things you can control.  Here we go.

But first, what is Recency Bias? 

*Gratefully written by Chat GPT because I’m in the airport and a little jet lagged.

Recency bias is a cognitive bias that affects individuals’ decision-making processes, including those of investors. It refers to the tendency to give more weight or importance to recent events or information while disregarding or downplaying older or historical data. In other words, people tend to believe that what has happened recently is more relevant and representative of the future than what has happened in the past.

For investors, recency bias can lead to several risks:

Overemphasis on short-term trends: Investors influenced by recency bias may focus too much on the short-term performance of an investment, such as the stock market’s recent gains or losses. They might assume that these trends will continue indefinitely and base their investment decisions solely on recent performance, ignoring the long-term fundamentals of the investment.

Chasing performance: Recency bias can lead investors to chase after investments or asset classes that have recently performed well, assuming that the trend will continue. This behavior can result in buying at high prices, when assets may already be overvalued, and selling at low prices, when assets may be undervalued. Such performance chasing can lead to buying at the top and selling at the bottom, resulting in poor investment outcomes.

Failure to diversify: Recency bias can make investors overly focused on the most recent successful investments or sectors, causing them to neglect diversification. Diversification is an essential risk management strategy that involves spreading investments across different asset classes, sectors, and geographic regions. Neglecting diversification due to recency bias can expose investors to concentrated risks if a particular investment or sector experiences a downturn.

Me again.

Pretty ok commentary from Chat right?  And as generic as we should expect (wink).

If seasoned investors know one thing about the markets, it is this;  Change is the only constant.  Trends that seem forever persistent, are never persistent.  Investment strategies that have worked for years, ultimately stop working.  Stocks that always go up, eventually stop going up.  Nothing is forever, nothing is guaranteed in the world of finance.

So, let’s point to some obvious recency bias embedded in our financial psychology.  Some of these are short term, some are longer term, but for this update, I’m going to concentrate only on areas that appear especially prone to reversal in the coming months.

Bonds

I know boring.  Bear with me.  Now that congress has pushed the debt ceiling issue out for another 24 months (applause), we can turn our attention to Treasury Bonds to look for opportunities.  Recency bias wants us to believe that bonds will continue to do what they have done in recent history.   We recognize that Treasury bonds, especially longer-term Treasury bonds, have been very poor performers over the last 18 months.  In 2022, Treasury bonds lost roughly 16% and have continued to chop lower in 2023.  Investor surveys confirm that bonds are expected to be the worst performing asset class for the next 12 months.  And thus, in true contrarian fashion, the table is set for Treasury bonds to post impressive results, beginning on the next Fed meeting on June 14th.  As the current pockets of recession (talk to your local retailer or restaurant owner) spread and expand to the US economy at large and real inflation dives below 3%, Treasury bonds will become very attractive again.

Real Estate

Recency bias in real estate is an amazing juggernaut now.  I hear words like “unbelievable” and “Crazy.”  Indeed!  Toll Brothers, one of our nation’s largest home builders has been raising prices on their new homes for the last three months!  Prices are seemingly steady and strong at historically high and unaffordable levels.  This is happening as the 30-year fixed mortgage rate seems to be settling around 7% again.  There are only two explanations for what’s happening.  People have lost their minds or there is a lot more money out there than we think.  The answer is probably both.  My outsiders’ opinion is that the only people who can afford to buy homes at the moment are those who are economically insensitive (aka very wealthy), and most are paying with cash.  Outside of these select high profile deals, the real estate market is frozen, like ice age frozen.  High prices and high mortgage rates cannot coexist for any substantial length of time but sands in this hourglass are nearing the end.  Keep an eye out for something to break here.  Prices are quietly down double digits in 2023 in more than a few counties across the country with the West leading lower.

Technology

Well, here we are again. Technology seems to be the only game in town, literally the only thing up significantly in 2023.  As a sector, it is also the most overvalued and overhyped focus of investor attention I have seen since the dot com days of 1999.  Artificial intelligence is driving the frenzy.  Anything AI gets a boost and an absurd valuation today.  Nvidia is now a $Trillion company with a market enterprise value larger than the entire semiconductor industry in aggregate.  Ridiculous.  I’ve seen this movie before, several times actually.  I won’t be that guy that tries to call a top, because these things can go further and higher than our imaginations.  But I will say, buyer beware from this day forward. Recency bias says semiconductors of the Nvidia and AMD type are going to the moon.  Recency bias gets angry when we see these gains and wonder why we don’t have huge exposure to this sure thing.  Recency bias says this is just the beginning and we had better get on board.   But recency bias will again be the root of investor pain, especially those who are late to this party.

Value is Not Dead

Last month, I suggested we banish our Lizard Brains and consider the real possibility that stocks could move higher in aggregate against a backdrop of very sour investor perspectives.  Well, now we see it happening (finally).  Style and size investments in small-caps, mid-caps,  value, dividend payers and internationals, which dominate our risk managed strategies have been sitting on the bench for most of 2023.  Now they are waking up in a big way.  Recency bias thinks value investing styles, in the intrinsic sense of the word, is dead.  Value is a long way from dead and now offers investors another overdue opportunity.

Cash is Calling

Cash earning a free and easy 5%/ year is probably the greatest recency bias appeal of the year.  I certainly can’t argue that everyone’s cash should be earning 4-5% at this point.  That means your bank savings or any other form of cash that must be available on short notice. But let’s unpack the idea that one should sit in cash instead of stocks, or bonds or any other form of investment right now.  First, this is the top of the cycle for rates – the Fed is done raising rates and thus the interest earned in money markets and short-term bonds is also at the top.  These rates will drop back toward 2-3% in the next 6-9 months.  Also, when we choose cash as an investment, we have timing considerations.  When do we sell to cash, when will be buy back in?  Not so easy.  Sitting in cash with “investment” dollars also assumes that one knows the future of the markets and the economy and has determined with clairvoyance that cash is going to be the best option.  Maybe, but history has proven otherwise.  Alternatively, why not consider any number of stocks or funds paying 4-5% in dividends – best of both worlds, right?  How about buying some bonds trading at a discount and paying 4-5% interest as we head into a recession?  How about we just stick to our program and long-term investment strategies and let the markets, diversification and our tactical strategies handle those pesky risk and reward decisions.  Cash looks great right now, I get it.  But never, in my career have I been happy sitting in cash with my investment dollars for any period of time.  Bespoke offered this data point over the weekend.  Interest in buying investment securities is almost at an all time low!

I suspect the competition from higher yielding cash must have something to do with this but low interest in financial products has typically been an excellent longer term buy signal for everything outside of cash.  We will see!

Control What You Can

I’ll keep this brief and to the point:

A rational person who is free of recency bias would be doing the following:

1. Looking for ways to cut costs and unnecessary expenses in a world that is still under inflationary pressure.
2. Continue adding to investment portfolios on regular intervals and resist the urge to sit on piles of cash.
3. Consider spending some time, money and energy getting comfortable in your home. You’re going to be there for a long time.  Start budgeting for a remodel, landscaping, new deck, furniture, or super energy efficient appliances?
4. Reach out to your favorite friends and family. Stay connected and make plans.  Relationships are the only things that we remember in the end.
5. Remain patient with investments. You do not need to make money every day, every week, and every quarter.  The dominant direction for stocks throughout time is sideways with brief periods of time pushing out to new highs.  You will be hard pressed to find a stock index trading above where it was in January of 2021.  Patience is something in your control.
6. Become the MVP in your workplace. Employment is not a right, it is earned.  Stay in control of your income by staying employed as we head into recession.

Bonus commentary – Europe is Thriving

I’m writing this commentary on a return flight from Spain where I just spent a wonderful week with my wife Sarah, celebrating our 30 years together.  San Sebastián on the northern coast of Basque country is amazing with long sandy beaches, rich food, amazing history, and kind people.  We walked and biked everywhere, stayed in a beautiful hotel for a few days and a charming Air BnB apartment in old town.  We hadn’t been to Europe in a while and I found myself amazed.

Europe is thriving and cheap, at least Spain is cheap.  If you read the daily headlines in the US, you might think that Europe is in trouble, at risk with a Russian led energy crisis, struggling with leadership and immigration problems.  I found just the opposite.  Europeans, especially in Spain have completely recovered from COVID and don’t seem impacted by the war in Ukraine.  By my estimates, outside of petrol, the cost of living are about 40% lower than the US even after the exchange rate.  The best cup of coffee is 1.75 Euros versus $6 at Starbucks.  Dinner for two at a very nice restaurant – 60 Euros.  A super cute, two bedroom, centrally located Airbnb with all new everything, 160 Euros/ night.  People are very healthy, fit and find time every day to enjoy each other attending local futbol or having a glass of Rioja (or three).  The work culture is strong and vibrant, people are busy.  Taxis arrive on time with chatty drivers.  The brick and cobbled streets which are wet cleaned each and every night, are filled with children going to school, learning to ride bikes, laughing.  Recycling is like an Olympic sport and a point of pride.  Most of the locals seem happy and calm, at peace with one another and welcoming of tourists.  Comparatively, I don’t feel that in the US these days, especially our cities.  You know what I’m talking about.  There is friction everywhere; socially, economically, politically with a flagging sense of hope.  If quality of life is important, we would be wise to follow the lead of our brothers and sisters across the pond.  They certainly have what we desperately need; peace and prosperity for all.

Happy Summer!

Sam Jones

 

May 12, 2023

My apologies for posting this monthly report late. I wanted to get a better feel for earnings and hear what the Federal Reserve had to say last week before posting anything I would regret. There are a lot more positive developments in the markets than what we all feel and hear in the way of forecasts and consensus views on the future.

So Much Pessimism

I think regularly readers might have come to understand that I am most comfortable making recommendations and forecasts (please don’t make me) when I am in the minority of popular opinion.

Without boring you with stats and evidence, these are the very strong and broad views in the financial world today:

Stocks are still in a bear market, and they will finish lower on the year, perhaps by a lot.
Less than 20% of all investors expect a positive year in 2023.
Surveys show nearly 100% expectations for a recession to begin in late 2023 or early 2024.
Real Estate will remain in a deep freeze due to high mortgage rates.
The Fed is going to drop rates by either 3 or 4 times before the end of 2023.
The debt ceiling issue is likely to lead to a US Treasury default for the first time in history creating calamity in the market, a debasement of the US dollar and widespread panic.
We will see more and more bank failures and eventually regional banks may cease to exist.
Commercial real estate is going to drag down the entire banking system and leave our cities a ghost town.

So….. hmmmm

That is a tremendous amount of negativity. Our lizard brain (Amygdala) responsible for fight or flight responses is swollen, red and angry. And for good reason! There is plenty of compelling evidence suggesting these outcomes are possible, probable, even likely.

But meanwhile, today, what is happening in the markets, earnings and the economy is simply not telling the same story. This is what is happening, whether we want to believe it or not.

The US stock market just put together two of the best quarters in recent history (+7.04% and +7.42%). This does not tend to happen in a bear market.

Home builders are making all time new highs – not exactly a recessionary thing.
Consumer discretionary, biotech, technology and communications services are leading the markets higher – again not a typical thing to see if we are about to go over the cliff.
Growth and speculative stocks are charging higher while defensive, value and dividend payers are lagging and negative YTD.

Interest rates not controlled by the Fed are falling steadily and quietly stable.

Consumers? Out spending with healthy incomes.

International markets? Well hopefully you’ve heard me say they are the place to be with an overweight position. We are wildly overweight internationals for the record.

Every year, there are winners and losers in the financial markets, and I can certainly find a few negative sectors and asset classes in the Bespoke Report card below (small caps, dividend payers, natural gas, China, and financials). But I also see a lot of green YTD.

www.bespokepremium.com

The Coast is Not Clear

I don’t want to set the expectation or give the impression that I am long term bullish or suggest to anyone that this a great time to load up on stocks and swing for the fences. I am simply stating the obvious and considering the realities of what is actually happening today outside of our fear and emotional state. Specifically, there is so much negativity already baked into the markets that it’s actually going to be tough for any of the End-of-Days, Great Unwinding, Forth Turning, crowd to be vindicated, at least not now. This may be just a timing thing. It would make a great deal of sense for the markets to do what the fewest number of participants expect and that is to push all the way up to the old highs and suck in a lot more money before actually failing. Remember the S&P 500 is still nearly 14% below the peak set in early 2022 and many more individual names are still trading 50-60% below their highs.

In the short term, price patterns in many sectors and indices, both domestic and international, look very constructive toward higher prices. It simply is what it is. Our equity strategies remain 100% invested because there are plenty of investments in uptrends and we want to capitalize on opportunities as they present themselves. If prices roll over, or start to show a change of trend, we can become much more defensive. But for now….

Recession Still Looms

The Federal Reserve increased interest rates again last week and will now pause with any policy changes in the foreseeable future. A moment of your time for a brief history lesson.

My database only goes back to 1989 but let’s look at the pattern of rate hike cycles since then.
We have seen four substantial rate hiking cycles beginning in 1989. Each of them varied from a minimum of nine rate hikes to as many as seventeen. In 2006, the hiking cycle didn’t end until rates were pushed up to 6.25%. In the year 2000, the same happened. Rate hikes did not end until we hit 6%. As of this week the Fed Funds rate is 5%. Is that enough to kill inflation in keeping with the history of the Fed? Maybe. But more to the point, after each of the last four rate hike cycles, the Federal Reserve has paused, made no changes to rates, for the following time periods (shown as market days, not calendar days)

Summary statement: We should be prepared for the Fed to “pause” for the next 7.25 months (218 calendar days/ 150 market days) because that is their shortest “pause” in modern history.

7 months is a long time. During these “pause” periods it the past, we didn’t exactly see prices run away higher with huge gains but neither did we see a lot of price damage. It wasn’t really until the Fed started to drop rates (2024?), that the aggregate US stock market ran into trouble. So again, our expectation remains for a recession, and we do expect stocks to pay the price when it happens.

Technology Revaluation is Still a Problem for The Markets

Simply put, the US stock market is going to follow the path of large cap technology because technology represents over 40% of the US stock market (if we include communications services companies like Meta and Google). No mystery here. Technology is up, so the US stock market is up. When technology fails, the US stock market fails. Let’s not make this complicated.

If we back out a bit and look at the big picture, the US stock market is still in a phase of revaluation, especially in the large cap technology world. Crescat Capital offered this chart again in April. It’s pretty self-explanatory. The revaluation process for mega caps relative to current GDP is a lumpy and bumpy affair. Today, it appears that these companies are back, leading, charging, bullet proof. But history would argue that large cap technology will ultimately become a smaller part of the market and the economy. Large cap technology stocks are very likely experiencing a rebound rally within a longer term downtrend. It’s still going to be a good idea to sell into this rally in my opinion especially if you still have a high concentration of your portfolio here.

The Debt Ceiling Thing is Real

Looking ahead by only 30 days, the Debt Ceiling debate also has the capacity to be highly disruptive. We clearly have a bipolar congress with a heavy dose of crazy in the House that seems very willing to push us over the edge in June just to flex and be in the spotlight. Default on Treasuries is a net zero probability this time. They will expand the debt ceiling, make no mistake as they have for the last 100 years without fail, but the markets may not like the uncertainty and time it takes to get there. What if congress and the white house can come to an agreement – tomorrow? Stocks would rip higher by 5% in a hot second.

Big opportunities now and themes that are still working!

I want to spend a little more time giving you some opportunistic thoughts and provide a backdrop for where we are seeing positive spending across global economies. There are many investments, sectors, countries, and asset classes moving higher now, certainly enough for us to remain 100% invested and well diversified.

Thematic investing is getting good traction. Thematic investing focuses on a style of investing or a trend that incorporates players from multiples sectors of the economy. I’ll give you a few examples. If we follow the money, we begin to see enduring positive trends, regardless of where we are in the economic cycle. Infrastructure spending is a big one that includes machinery, raw materials, water, utilities, and manufacturing. Obviously, the growing reality of crumbling and dysfunctional infrastructure after decades of neglect and deferred maintenance is forcing spending, investment, and profits in this sector. You’ll never see such political harmony, cooperation, and bipartisan behavior as when the water turns off, sewer lines break, or the room goes dark. Yes, yes let’s fix that stat, all in favor.

Speaking of infrastructure spending…

Investment in energy Transition just exceeded $1 Trillion in 2022 surpassing all investment in fossil fuels. Regardless of your politics, ignore this mega shift toward clean energy at your own financial peril.

Raw materials, especially rare earth metals that are in very high demand from energy transition technologies for batteries, storage and electrification of power are poised for a significant move higher. At this magical moment, we have the perfect investor trifecta (High Demand, High Scarcity and Low prices).

Worldwide Sectors and New Power are our primary strategies for direct thematic investing, but these ideas find their way into most of our other strategies indirectly through our investment selection process.

The Best Buy in over a decade is coming.

As you might have guessed, it seems likely now that we have more volatility ahead in the markets before we might find a more lasting and durable bottom to this bear market. These are the tough times, when we are psychologically weak, we have suffered some losses and wonder when (and if) the good times will ever return. Volatility is the price we pay for higher returns. If one wants to avoid volatility all together than necessarily, you will also avoid significant returns in the future. Today, we can focus on areas of the market with more opportunity, leadership, and relative strength. Tomorrow, in our risk managed strategies, we could find ourselves positioned much more defensively as the markets actually give way to recession. Once we see prices wash out and valuations reset to more attractive levels, perhaps in 2024, we will be faced with another one of those generational opportunities to dramatically improve the wealth and lifestyle of your family. Many will miss it. Many will not have their emotional or physical capital intact enough to add to their investments at the lows. The vast majority will wait until prices are up 100% or more before feeling like the coast is clear. Our job as your wealth manager is to take all of this off of your plate and to allocate your investments according to what is happening today, not what our lizard brain tells us should happen in the future.

Please trust that you are in good hands. We see the risks; we see the opportunities and have decades of experience allocating investor money appropriately.

My best to all.

Sam Jones

April 6, 2023

Since 2020, we’ve been banging the drum regarding The Big Three Investment Opportunities of the decade.  Regular readers know what I’m talking about but you can read all about it HERE.  They are all three playing out nicely now giving smart investors a full plate of investment options and a clear path to asset allocation.  As we highlighted on November 9^th of last year, international investments are taking flight as the 3^rd of the Big Three.  The trend is now accelerating relative to the US financial markets.  This is that time to go big with your international allocations.  Let me make a case now for why investors could now consider an outsized allocation to internationals as a longer-term core holding.  Please note that any commentary hear is market based only focusing on opportunities and risk.  Individual investors have different objectives, risk tolerance and situations so please take this for what it is.

Non-US Valuations are Far More Attractive

There are a lot of messy charts and tables out there regarding this subject but the common summaries of all tell the same story.  International valuations, especially developing and emerging markets are below their 10- year averages but the 10-year average itself is far below the current valuation of the US stock market.  You might know that the last 10 years has been a blow-out for US securities.  However, in decades past, international investments have produced very attractive returns relative to the US.   See below from RBC Wealth Management.

Buffet and Shiller both offer their own studies surrounding these valuation differences using a similar methodology of market capitalization to current GDP (or GNP).  They go further to project forward returns on these data which have historically been pretty accurate with an 8-10 year view.  Again, the story is the same; Internationals are very inexpensive, absolutely and relatively speaking.  Buffett’s analysis below is broken down by country.  If we look at the projected returns below, we see a few important things.  First, the US markets are not projected to earn more than 2% possibly for the rest of the decade using 1/2022 as the start date.  So far, we’re down -14% from that date through yesterday.  Meanwhile, outside the US, we see projected returns at the top of the list closer to 10% and well above in select cases.  Am I going to rush into Russia, Pakistan or Egypt with client money?  Of course not.

But Brazil, Indonesia, Mexico and China are certainly in the hunt.  In the developed markets, we also see consistency of high projected returns in most of Europe as well as Australia, Singapore and Canada.   Note- You’re going to see many of the same countries mentioned below as we move through the analysis.

With a Little Help from My Friends at Chat GPT

Wow, let me say quickly how powerful, awesome and terrifying it is to use Chat GPT.  This is not a search tool; it is an analytical tool that is going to make research infinitely faster for those who are looking for more than just information.  I used my tiny brain to ask Chat these questions in hopes of identifying which countries in the world are best positioned to benefit and sustain from obvious secular challenges.  You’ll see a common thread in the line of questions.

Q:  Which countries have the highest adoption rates of renewable energy?

I am only listing those with over 95% renewables or likely reaching 95% in the next 3-5 years.  Hydro power is considered a renewable energy source here.  Countries that have already shifted to non-fossil fuel-based energy sources are far in the lead.  They are less prone to price swings in oil and gas, less prone to social impacts of petro dictators (Russia, Iraq, Saudi Arabia), and will have better control over their primary input costs from this day forward.

Iceland

Norway, Sweden and Denmark

Uruguay

Germany

Costa Rica

1. Which countries have the highest output of agricultural products?

Food sourcing is increasingly becoming a thing in the global stage.  Those who can produce food for themselves, and the world will continue to have the most influence in geopolitics, costs to consumers and the allocation of favorable trade terms.  The top 6 listed in order.

Russia (sadly)

Brazil

Canada

Australia

Argentina

USA

1. Which countries have the highest known deposits of rare earth metals?

Rare earth metals are critically important in almost all technology, especially energy storage, batteries and electrification of the transportation.  If we are to continue on our current path, rare earth metals will again be one of those important differentiators between countries and who holds the power to the future.  The worlds largest deposits of rare earth metals are found here.

China

Brazil

Australia

1. Which countries are positioned to be least impacted by a protracted period of inflation and why?

This was a tough one for Chat because there are so many variables going into the comparisons.  Preference was given to countries with:

• High levels of diversified exports
• High levels of domestic production of goods and services
• High consumption levels and growing middle class
• Strong monetary and fiscal controls through central banks
• High levels of commodity resources

…and the winners are:

Brazil

Canada

Australia

China

Germany

My line of questioning started with some assumptions about the future.  These are that climate change, resource scarcity, a new and protracted period of nationalism (anti-globalization) and inflation are all going to have profound impacts on the welfare of different countries depending on what each brings to the table.  We see from the output that a certain group of countries are all positioned well while many countries didn’t make the list and could be at greater risk.

Here’s the short list:

Brazil and Latin America, Australia, Canada, parts of Europe and Asia (including China).  

What About Timing?

I’m glad you asked.  The time is now.  Internationals started outperforming the US markets last fall in November.  We saw a bit of a pause in February but now the outperformance continues again and will likely for the foreseeable future.   These changes in leadership between internationals and domestic markets tend to be notable, protracted and consistent once established.  Take a look at this relative strength chart and note the change in trend in the bottom right corner.  This is that time!

What does this mean for investment allocations?

          Well for one, we need to catch this train because it is leaving the station and the longer we wait to get on board the greater the risk of an accident.  Most asset allocation models with a 60% stock/ 40% bond mandate, might have 20% of equity exposure committed to internationals.  Our own Wealth Beacon Conservative model has almost 30% as a slight overweighting.  But our dynamic asset allocation strategies are more at liberty to take a bigger stake, as they have with over 50% of current equities invested, in internationals.   I’m wondering out loud if this is enough considering the very wide differences in valuations, projected returns and the Chat factors listed above?

For our clients, rest assured that we are following the opportunities and trends as they present themselves.  For those in the DIY camp, this is a great time and place to make some long-term investments (not trades) by increasing your international exposure now.

Timely updates and little education – requested and delivered in this Red Sky Report.

Best to all

Sam Jones

 

 

 

 

The markets in March were like watching Russell Crow in Gladiator sarcastically asking the bloodthirsty crowd if they wanted MORE death and despair.  It seems the entire world loves a good financial train wreck and just can’t get enough.  March was quite a month.  It shook the foundation of financial stability and investor confidence.  It was a month of capitulation for investors who finally threw in the towel and gave up on stocks, fearing a repeat of 2008 … or worse.  It was entertaining but not in a good way.

For this update, I’m going to comment on my own commentary from last month.  For the record, it’s bad form to quote yourself but I’m going to do it anyway because the format fits what needs to be said now about markets and economy. I’ll also dive into some anecdotal observations about remote work and implications for rural America.  If you care to wade through it all, you’ll find solid context for some actionable reminders and ideas for personal financial decision making.

Quotes and follow up commentary from Feb 27^th Red Sky Report:

The Federal Reserve chatter box and a few marginally inflationary economic reports, forced the financial markets on a detour from our path toward recession. 

We are now back on the road and possibly in Recession already.  Bonds are up, stocks and commodities are down.  This is what happens to financial markets when the economy is going into recession.  Don’t make this harder than it is.

“They (The Federal Reserve) will raise rates until they break something and that something is the US economy.”

Well, I guess it has started.   The Federal Reserve is largely responsible for two of the largest bank failures in history representing assets over $300 Billion.  Silicon Valley Bank failed on March 10^th and Signature Bank followed on March 12^th.  Credit Suisse also failed blaming weakness in the US banking system and was sold to competitor UBS.  There are likely more to come if we use history as our guide.  I was amazed to see how many small regional banks have failed in the last 23 years. This is not an uncommon event if you look at the 48 PAGES of listed bank failures since 2000 on the FDIC site (https://www.fdic.gov/resources/resolutions/bank-failures/failed-bank-list/ ).   But again, it seems that every failure now invokes bigger and louder crowd reactions than the past.  Glass is breaking.  Heads have turned, eyes are wide.  As sick as it sounds, bank failures are actually helping the Fed bring the US economy to a complete standstill.  Banks failures have the effect of quickly tightening financial conditions both in lending and capital reserve trends.  All of this will put continued downward pressure on real estate, increase unemployment and eventually drive rents lower.  This is what the Fed wants/ needs to happen.

Recessionary evidence is almost overwhelming now.  Nationwide real estate prices are now down for the 7^th consecutive month in a row and threatening to turn negative year over year even as a lagging data set.  Leading economic indicators are down 6% in aggregate year over year.  According to Bespoke, since 1960, this has never happened without the US economy being in recession or within 6 months of recession.  Every broad measure of inflation, yes, every one of them including CPI, Core CPI, PPI, Import prices and so forth are now sharply lower and approaching the same levels as the spring of 2021.  Wages remain high but have flattened and layoffs are accelerating to a point where we should start to see higher unemployment numbers, especially among high paying private sector jobs.  We are very likely in recession already, but the headline is still forthcoming.

“Bonds can do OK but won’t really get much traction until recession realities become more dominant.”

And just like that, bonds are back- now that recession realities are “more dominant”.  They say that the bond market represents the smart money, and the smart money is suggesting that the Fed is going to cut rates to 3.6% by this time next year!  Seems ambitious but they do tend to get it right historically speaking.  The good news is that we now have our old friend, the bond market, behaving as it normally does and acting as a much-needed safety net to stock volatility.  Since the 9th of March, we have reinvested in short term Treasury bonds and investment grade corporate bonds in our diversified strategies, and it does feel very good to know that bonds are finally offering investors some true diversification to owning stocks.  Captain, engine number one is fixed and ready for duty!

“Commodities are going to chop lower as the economy gets weaker and weaker in the months ahead.”

Indeed, commodities in aggregate, led by the energy sector, really gave up in the second half of March.  This is all very consistent with economic cycles and trends as the US economy gets weaker and moves into recession.  Gold is often described as a hedge against inflation.  That’s not actually true.  Gold and gold miners are a hedge against a falling US dollar which typically occurs in the early stages of a recession, like right now.  In other words, we want to own gold when the US dollar is falling.  You can see how the two are almost perfect mirrors of each other below.  We have reinvested in gold and gold miners across several strategies this month as the US dollar continues to fall from its highs in September of 2022.

 

As a related side note, the crypto currency crowd would have you believe that digital currencies are also a hedge against a falling dollar and inflation.  Again, this is also not true.  Crypto has no correlation to the US dollar at all. Crypto is simply a hedge against chaos, anarchy and serves as a badge of honor for libertarians.  Witness the fact that crypto and bitcoin were up over 40% during the few days of bank failure headlines.  Banks were up 3% on Monday, Bitcoin was down 5%.  Chaos and financial instability are good business for crypto it seems.  I would not bet against the US financial system, nor our central banks’ willingness to spray unlimited cash to support it for better or for worse.  Ironically, as we know now, 30% of the bank deposits of Signature Bank came from…. The crypto industry!  Shady bank with shady customers.  Signature Bank was closed by regulators and taken under control of the FDIC on March 13^th.   Chicken or the egg; we reap what we sow, etc.

Ok, let’s move on to other non-market trends

Current Trends in Remote Work

This is a fascinating evolutionary topic.  Remote work certainly has it’s benefits in terms of efficiency, costs savings for office space, reducing traffic and commuter times, improved work life balance.  But perhaps the most profound impact of the new remote work option is the fact that small, rural towns across the country have blown up in growth of new residents who have made permanent changes in their home environments given their new-found freedom to work outside of a company office.  If you can work anywhere, why not work in a desirable location outside the city!  Steamboat Springs, CO where I live is a classic example.  Our town has been smashed with new residents, young families, folks from all over the country who have pretty healthy compensation and are allowed to work remotely – for now.  I can barely afford to live here anymore as the prices for everything has shot up 30-50% in just the last couple years as our new residents seem willing to pay any price.  I suspect we are not alone.  Affordability of living in these small towns has dropped to a place and time where long time locals are being forced to leave.

Meanwhile, I’m now hearing stories of layoffs, especially among those remote workers who had high paying technology jobs in Texas, Chicago, and California.  $250,000 salaries for remote workers are disappearing quickly and these folks are suddenly looking for local jobs paying $17-$20/hr. in service jobs or labor work.  There is a substantial gap between their new life expenses and their new incomes.  They won’t make it.  This is starting to feel a bit like the gold rush era or the oil drilling towns of Virginia.  When the work leaves, the town dries up.

At the same time, I also see a loud and serious call for workers to return to an office, eliminating the remote work option all together.  Most companies are watching the productivity of their remote work force in serious decline.  I have read commentary speaking to the value of in person meetings as related to creativity, work culture, and accountability.  Young unmarried employees generally want to be in an office to meet other people and have some form of social life.  Fun fact, 1 in 3 marriages originated with a workplace introduction.  Now, nearly 40% of all fortune 500 companies have eliminated 100% remote work options and that number is growing.

As we head into recession, reducing head count is a natural event.  Companies are literally using the back to work mandate as an easy way to have employees voluntarily leave.  Subjectively speaking, it’s going to be rough for a lot of people who have really built a new life around remote working.

As such, I will make three forecasts:

1. Many laid off remote workers will try to start new businesses in order to stay remote.
2. We’re going to see unemployment rise somewhat dramatically as many choose to remain unemployed rather than be called back to the office. Now that the huge pile of COVID household savings has been largely depleted, I wonder how long they can hold their breath.
3. Employers will develop different pay scales for office workers and remote workers. Remote workers will make less than office workers for the same job.  The gap will be substantial.

Action Items and Insights

Ok let’s get down to some actionable ideas and insights considering all of the above.  First let’s talk about your psychology at this important moment in economic history because behavioral economics is really all that matters in the end.

This is how you feel today:

We feel exhausted.  Bear markets are exhausting.

We feel financially vulnerable and risk averse especially if one has experienced a job loss, or some severe pain in the financial markets in recent history.

We feel like the pain will never end and we are just beginning a long period of deteriorating financial conditions – yes, I can see you nodding your head.

We wonder what on earth will make things better again.  What could possibly go right enough to fix (fill in the blank).

We want to quit, to get off the ride because the ride causes pain.  Humans want to avoid pain, always.

This is how we feel as we observe the state of the financial markets as they forecast what seems like an inevitable recession ahead.

Successful investors are able to feel these emotions and yet recognize these emotions for what they represent, which is developing opportunity.  We need to remember that very strong feelings of fear are a necessary part of every bear market low (as are bank failures for that matter).

The greatest return opportunities come when prices are low (check), pessimism and fear are high (check), the economy is in recession (check) and the Fed reverses monetary policy (pending).  This is THAT time to get your head in the right place and think opportunistically.

Be the MVP in your company

Recessions and unemployment go hand in hand.  If you are a young person, working for any company, wake up every day and say to yourself “I am going to be the most valuable employee in our firm”.  This is a game of survival, and you want to stay employed with your income intact through a recession.  Income gives you options to invest at lows.  Income gives your freedom to maintain your standard of living regardless of the value of your investment portfolio.  If your company says you need to return to work, pack your bags.

Retirees pay attention to your cash

Please reread last month’s update “All you wanted to know about cash” for ideas.  I still see way too much cash sitting in non-interest-bearing checking and savings accounts.  On Thursday, I am meeting with a US Bank representative to discuss their high yielding savings account options for our personal savings accounts.  I expect to get at least 4% or I will gladly move to a bank that offers that rate on cash.

Another opportunity to reduce your exposure to mega cap tech as needed

As I look through investor portfolios outside of our management, I continue to see shocking exposure to a few mega cap tech names – Microsoft, Apple, Amazon, Google, Nvidia.  Facebook (Meta) has disappeared as most apparently sold after the stock fell 75%.  In the last 2 months, these stocks and many brand names in technology, have seen some enormous moves higher.   But the trends are still down, earnings are still weak relative to price and growth and is not the place to be as we head into recession.  If you have an outsized position in the FAANG names or any other tech company for that matter, you now have another opportunity to consider reducing some of your position size.  This should be done with consideration of taxes, your objective and your total portfolio asset allocation in mind.  Please feel free to reach out to us if you need some consult.

Be Less Flashy

I just reread Morgan Housal’s book “The Psychology of Investing”.  It’s good and I don’t say that lightly because I have read everything and most of it is junk. One of his points that is worth mentioning here and now is that no one is as impressed with your consumption as you are.  I don’t care what kind of car you drive.  I am not impressed with flashy shows of wealth.  I am inspired by people who have built lives of financial freedom, who have time and the means to do whatever they want, whenever they want.  Morgan says that the purpose of wealth is to provide options and freedom of choice.  As the world becomes more and more expensive with persistently higher inflation over the next decade, it’s going to be harder and harder to maintain that veneer of wealth.  Someone will always push your spending up to them, to compete with their consumption, to join the club (literally).  I have no issues spending money on things that are important but do have a hard talk with yourself about what is actually important in your life.  You will not remember your “stuff” on your death bed.  Meaningful relationships and lifetime experiences are all that really matter in the end.   Spend accordingly.

I hope to see signs of Spring soon because I am climbing the walls (6-foot walls of snow).

My best to all.

Sam Jones

 

February 27, 2023

It’s that time again.  Time to discuss cash and how it fits into your financial life.  Cash is becoming the new sheriff on Wall Street as it hovers at that magical 5% level now available in money market funds and short-term T-Bills.  How should we think about cash, right here and right now, in light of other opportunities and our trajectory towards recession.  Everything you’ve been asking yourself right here and right now, right?

Detour!

Let me take a few minutes to talk about the market action in the last month before we dive into the cash discussion.  I should have seen it coming.  No trend occurs in a straight line.  Nearly to the day following my last update, the Federal Reserve chatter box and a few marginally inflationary economic reports forced the financial markets on a detour from our path toward recession.  The February detour has been a little painful frankly, more so than indicated by the major averages.  The US dollar moved almost vertically higher for the month beating up our international exposure and anything in the currency hedge world including our gold positions.  Meanwhile, bonds of all sorts, fell out of bed and are now crying on the floor as the notion of “no recession/ no landing” seems to have entered the psychology (I am laughing out loud right now… and crying on the floor).  Speculative stocks with no earnings, super high valuations, disastrous balance sheets and no worthwhile business models, also took the beatings they deserved.  The broad US stock market indices also gave back a chunk of what was made in January BUT, the uptrend that began in October of 2022 is still intact.  In fact, from a technical perspective, most indices broke into new uptrends in January and have simply pulled back to a nearly perfect, textbook new entry point if this level holds.  This appears to be a healthy short-term pullback within an uptrend – my favorite!  Obviously, the next two weeks will be very important for the state of our “relief rally”.

So, February has been a detour.  The road ahead seems pretty clear to me.  The US is still headed toward recession but as we’ve just seen, it’s never a straight path.   Let me explain the situation using a highway analogy.

We (the economy, GDP, spending) were on the highway travelling at 100 miles an hour from 2020-2021.  Then our engine got a little hot (inflation) and we needed to slow down a bit.  In 2022, we slowed from 100 to 60/mph.  Now, in 2023, we look out the window and relative to 100 MPH, it feels like we could get out and walk, but we’re still going 60 miles an hour!  Smoke is still coming from the hood; our check engine light is still on.  We need to slow down more but we’re still movin’ pretty fast right (says the Fed)?  The Fed is committed to having our vehicle stop in a complete parked position.  They have said as much many times.  They will raise rates until they break something and that something is the US economy.  You see, they know, and we know that inflation will remain a problem until demand falls dramatically and the only way to crush demand is to put our economy into a recession.  Failure to put the economy into recession quickly will lead to a more entrenched and longer war with inflation and eventually lead to catchy 2024 campaign slogans like that of Dwight D. Eisenhower in the early 50’s.

The Fed simply cannot engineer a soft landing because inflation will just flare again.

Remember, we are following the 70’s playbook again.  Inflation AND recession will dominate the environment. 12 months ago, I wrote about Stagflation (stagnant economy with inflation).  That’s where we are, I have no doubt.  So, the road to recession, with persistent inflation should mean SELECTIVELY higher stock prices until the Fed finally buckles and considers dropping rates which might not be until 2024 at this point.  More on this in a minute.  Bonds can do OK but won’t really get much traction until recession realities become more dominant.  Commodities are going to chop lower as the economy gets weaker and weaker in the months ahead but could do ok in light of inflation.   That’s just how it happens, once we get back on the road and off this detour 😊.  My advice don’t take the detour.  Stick to the road with your portfolio allocations.

Cash and an Investment Choice

Ok here we go.  Today we find ourselves in that always intriguing moment for those who like the idea of stable, risk free 5% returns on their money.  I will say with confidence that the vast majority of investors, especially those on fixed incomes, retired, or highly risk averse investors might find cash (money markets and T-Bills specifically) very attractive now.  After all, if we’re heading toward recession and stocks are all over the place, why not just sit back, collect interest and wait it out?  Let’s talk through that emotion.

First, I hear you.  There is a case to be made for carrying higher cash for a portion of your portfolio now that’s it’s earning a higher yield.  The best bonds out there in terms of yield are bonds with maturities inside 1 year.  Longer term bonds have higher price risk and lower yields making them relatively unattractive.   Meanwhile, money market funds are paying 4.12% annually!  I can certainly make a case that assets sitting in cash earning at least 4% are just as good or better than your best Treasury bond paying the same rate but with price and maturity risk.  In other words, I’d rather sit in fully liquid cash than Treasury bonds or even T-bills of any sort and our portfolios reflect that choice.  Clients might recognize that we have exited our few remaining Treasury bond positions bought last October and have a higher “cash” position where we are now earning reasonable interest every day.

Cash in the Bank

You can also do a little searching and find banks paying slightly north of 4% in “high yield savings” with no fees and no minimums.  We haven’t seen this since 2007.  But here’s the problem.  Bank money is not ready to invest.  It must be moved into a brokerage environment where you can make a different investment if and when you choose to do so.  In my experience, money that lands in a bank, tends to stay in a bank even while stocks might be ripping higher for months and years on end.  There is a certain amount of energy, conviction and definitive action that is required for one to move money between institutions.  That conviction is rare and money in savings tends to sit there for a long, long time.  Again, sitting and earning 4% is not terrible but let’s consider some comparative realities.

Cash Does Not Earn More Than Inflation

If you think about how interest rates on cash are derived, it comes from the Federal Funds rate, controlled by the Federal Reserve.  And the Fed Funds rate is dictated by perceived inflation.  Their job is to match the Fed Funds rate with their perceptions of the real rate of inflation.  Ergo, yields on cash will naturally tend to match changes on the real cost of living.  To some, that’s a great hedge against inflation.  To me, I look at that prospect as a game that can’t be won.  If you had 100% of your liquid wealth in cash, you would never have an opportunity to increase your wealth in real terms, or net of inflation.  Now, if you have all the money you need to cover your living expenses to your last day of life and die with 0.0 dollars, then you’re all set!  But some people want to leave some of their wealth to family or charities.  Some don’t want to risk running out of money before they die.  Some might not feel so confident in their assumptions about anticipated costs of living down the road.  Some might live a lot longer than they think.  Some might know after many years on this planet that inflation is grossly understated in our country and cash will only track stated inflation rates (which excludes “volatile” housing, energy, food and nearly anything you actually need to spend money on).  You get the point.  It’s not quite that simple and there are a lot of unknowns and risks associated with a 100% cash position.

Cash Versus Stocks

As I said in the prolog, we have moved to an intriguing moment in time.  Take a look at this chart from Bespoke (www.Bespokepremium.com).

What you see is that the yield (or interest) on a T-bill (or cash) has approached the estimated earnings yield on the S&P 500.  The earnings yield is the inverse of the Price to Earnings ratio.  Said another way, Cash is just about as attractive as the prospects of owning the S&P 500 considering estimated future earnings of the underlying stocks. Hmmmm, why would we want to own stocks?  Well, here’s where we need to be very careful with our investments and allocations outside of cash.  First let me state a few realities.

1. There are many many stocks that are trading at historically low valuations where this comparison wouldn’t be the same.  These are the deep value names and themes we’ve discussed, and I can’t say enough or with enough conviction that investors should stick with value and avoid any type of security that is overvalued or has an “earnings yield” below 5%.    We have populated our stock portfolios with value plays, first and last.
2. In a stagflationary environment, we can still own stocks of companies who offer “must have” products or services and therefore have pricing power. Companies like Microsoft and Apple will do fine because they can charge whatever they want, and we’ll still use them.  Grocery and restaurant?  Yes, we’ll pay for both.  Energy? Yes, at any price, Healthcare and Utilities of course.  Consumer discretionary is…. Discretionary and has almost no pricing power (avoid).  Financials, banks and brokerage can all do well as higher interest rates can be good for business.  What you see is a lot of sectors that will continue to push higher in this environment, but we must be selective about what we own with each.  Stock pickers have a great chance of making solid returns here.
3. The market in aggregate is trading at a significant discount to the highs of late 2021. I personally don’t believe the discount is enough to call this a screaming buy, but a discount is a discount.
4. The markets do tend to rise and have a positive return bias over time. That is simply fact when looking at any time period beyond 3-4 years.  Owning a low-cost S&P 500 index ETF for the last 10 years would have generated almost 10% annualized returns including three bear market losses since 2018!  If we are highly risk tolerant and can get ourselves to buy the big dips, the returns are there.
5. There are also a lot of options beyond owning common stocks found in the S&P 500. We can own REITS, high yield corporate bonds, preferred securities, convertible securities, dividend paying stocks, and internationals, all of which are generating returns or have yields higher than inflation and cash.

I believe in my heart that a well-constructed and selective portfolio of securities with a value and income bias, will outperform both inflation and cash from here.  Cash might feel good now as a safe haven and a means to avoid potential risk of loss in stocks.  But as Keith Fitz-Gerald of KFG Research said in an interview I heard this week,

Missing opportunities is always more expensive than trying to avoid risks you can’t control.

Cash Versus Real Estate

Here’s the situation with real estate that everyone knows.  Most homeowners today purchased their properties when rates and affordability were far more attractive (pre – 2020).  The last great moment to buy real estate was in 2010 with the option to refi your mortgage rate to below 3% somewhere around 2019.  Cheap real estate prices in 2010 and historically low borrowing rates have both been a huge boon to household wealth at least on paper.   Gains since 2010 have been ridiculous and unsustainable, especially since 2020. Here’s a picture of current pricing again from our friends at Bespoke.

Affordability by any metric is really just the inverse of this chart if you can imagine that.  Now, the market is frozen as buyers and sellers are at a standoff.  Sellers won’t sell and give up their sweet mortgage rate and buyers can’t afford to buy at todays prices, unless they are paying cash or are economically insensitive.   So, sales are falling off a cliff.  This also from Bespoke.

The ONLY way for this situation to reconcile is for prices to fall to a point where affordability becomes more reasonable.  Rates can even fall from here, but it is unlikely to affect sales really until prices come back to earth.  Today it takes 80 hours of monthly earnings on average to cover the mortgage on a house for today’s median prices.  That’s a level not seen since the late 70’s.

Back to the Discussion on Cash

Should you use cash to buy real estate?  Well, now that cash is earning 4-5%, we must have remarkably high conviction that real estate prices are going to go up at least 5%/ year for the foreseeable future.  I don’t see that happening any time before 2026.  We also have to consider carrying costs with real estate.  In May, property owners will be shocked to see their new tax bills associated with the newly assessed values in their properties.  Expect to see 25-30% increases in your property taxes conservatively.  Utilities are up 11% year over year and maintenance costs are up about 10% year over year.  Homeowners insurance is up 7% year over year.  It’s getting expensive to carry a home to be quite frank.  So, all told, using cash earning 5% to buy an expensive piece of property that is likely to depreciate in value and is already seeing strongly rising carrying costs makes zero sense to me.  Every situation is different and real estate is one of those emotional things so I’m sure I’ll get blasted for saying this, but these are the facts today as I see them.  What a wonderful time to rent!

I’ll leave it at that.  Please feel free to reach out to us to discuss your individual situation or any decisions you might be considering.  We want to be your first call when you need help!

Spring is coming!

Sincerely,

Sam Jones

 

 

January 23, 2023

As we said in our Year Ahead update in early January, “We might stay open to some dramatic reversals in 2023”.  Indeed, investors are witnessing a start to the year that doesn’t fit the consensus view of what should be happening.  In short, the markets have been trending up so far in 2023 despite extreme investor pessimism, negative consumer sentiment, dramatic calls for a deep recession, and disastrous earnings warnings.  This update will focus on what’s working so far in 2023, separating lasting opportunities from those that could be more fleeting.

Solution Series – Tax Strategy for 2023 and Beyond 

First a big thanks to Will Brennan, our Lead Advisor and Certified Financial Planner, for conducting our first Solution Series of the year.  It was a well-attended Webcast.  Who knew we could be captivated by all the changes in the tax code for a full hour?  Will did an excellent job highlighting planning opportunities within the new Secure Act 2.0 tax law, many of which go into effect immediately and many more in 2024.  Paying attention to tax saving opportunities can offer you an extremely high return on your time investment.  You can find the video of the whole session here .

YTD Scorecard – Bespoke

Let’s start with this big easy score card provided by Bespoke.  This is something that I look at every week just to get a feel for what’s happening across sectors, style box investing, global markets, and different asset classes. It’s a good exercise that I would recommend to any who care to know what’s happening in the world of finance.

Let’s dive in to see What’s Working!

Internationals > Domestic

Looking at the top right-hand corner of the score card, we see internationals absolutely crushing our domestic markets YTD with special emphasis on China (+12%), Emerging Markets (+10%), Europe (+8-10%), Australia (+9%) and Mexico (+15%) leading the charge.  As regular readers know, we began accumulating positions in internationals in late October of 2022 and brought them to overweight in early December.  In October at our annual meeting, we called out the special opportunity here on the basis of historically cheap valuations, a top in interest and lending rates and a top in the US dollar.  This is the perfect trifecta environment for internationals.  I would add that the clock is ticking on Russia’s invasion of the Ukraine as allied NATO forces add more military and economic pressure to end Putin’s war.  European equities are already beginning to price in the end of the war.  Oil and Gas prices are now BELOW the prewar levels.  This trend has legs for the foreseeable future, but buyers should patiently wait for pullbacks to buy the dips among these new bull markets.  We have special preference for high dividend paying internationals, many of which are paying 4-6% annual yields.  Leadership among internationals has also been one of our Big Three Investment themes since 2020.  However, this trend didn’t really establish itself until late 2022 so we were admittedly early.  Now it is game on.

Note on International Bonds – I would have to extend my enthusiasm for internationals to their bond markets as well, especially emerging market bonds which have a current yield of 6.52%, almost twice that of a 10-year US treasury Bond.  Yes, these bonds have stated lower credit quality around BBB compared to the US AA+ but, but, but… you have to understand that the rating agencies have a strong US home bias.  In the US, our Debt is 135% of our GDP!  If we didn’t have a very active printing press, our credit rating would probably be closer to any 3^rd world country.  For as long as EM bonds are trending up at twice the rate of the S&P 500 and kicking out 6.5% in yield, paid monthly, we’re going to own them.   We own these ETFs and funds in our investment strategies:  EMB, EMLC, PCY, and PEBIX.

Value > Growth

Also in our Big Three themes is the dominance of the Value over Growth.  Thus far in 2023, the theme continues and has not reversed.  Looking at the score card above again, we see the following results YTD through 1/20/23:

Size	Value	Growth
Small Caps	+7.25%	+4.40%
Mid-Caps	+6.98%	+3.78%
Large Caps	+4.10%	+2.94%

 

As discussed last year, these style themes tend to last 3-4 years.  From the chart below from Fama and French, we see that we’re about two years into the trend favoring Value with potentially another 2-3 years to go if history repeats.

With that said, the most pronounced period of outperformance for value is probably behind us and we would expect to see periods like 2023 where there are only slight differences between the two style groups.  If we look under the hood of Value on a YTD performance basis, we see that companies described as “shallow value” are actually underperforming the market, while “deep value” is far outperforming everything.  Shallow value represents companies that are only slightly cheaper than the market but still have positive cash flows, healthy balance sheets, steady revenues, and above average dividend payments.  2022 was a good year for these but 2023, not so much.  We are actively reducing our exposure to “shallow value” ETFs.  “Deep Value” are the bottom 20% of all stocks based on current valuations.  These might seem like value traps to many, but this is where the opportunity lies.  To own these, we really need to get into stock picking and sift through the value universe for the most discounted and oversold names out there, trading in single digit forward P/Es.  Sadly, there are not many index type products outside of specialty “Value” mutual funds that focus on Deep or Pure Value – I’m still looking but haven’t found much.  Note – Our Worldwide Sectors strategy is in a magical place as it can be heavily invested in Internationals and own deep value individual stocks through sector exposure.   I expect good things from this strategy in 2023 as the performance YTD confirms.

While the Growth style is still out of favor and should be held at minimum exposure, there are some opportunities developing in 2023.  This is the first reversal of 2022 patterns.  Again, we really need to sift through the wreckage here to find growth names with longer term potential.  I won’t name names here to protect our work, but I will offer this advice; Investors should focus on 1-year operating cash flow and Price to Earnings Growth ratio (PEG) as good variables to watch for opportunities in the growth world.  Negative operating cash flow?  No thanks!  PEG ratio over 1, no thanks!  As the fire sale in growth is extinguished, we are finding some diamonds among the ashes.  Stayed tuned for more on this.  Current clients are welcome to look at their Worldwide Sectors’ account holdings where you see a few growth names recently purchased at very deep discounts.

Sectors and Cycles

Let’s shift to sector winners (and losers).  This again from Bespoke this am.

Wow, what a reversal of trends from 2022!  Communication Services was the worst performer of 2022, now it’s the best with over 80% of underlying stocks trading above the moving average trend.  On the flip side, consumer staples, utilities, and healthcare are all some of the worst performers YTD.  All three “recession” sectors are down YTD.   Broadly speaking, what we are seeing in sector moves does NOT tell a story of deep recession or a recession that isn’t already priced into the market!  Sector strength is a leading indicator, and the story so far is about a strong consumer that is fully employed and an economic cycle that is almost emerging from recession!  On Thursday, we’ll get a look at GDP, it will be positive.  On Friday, we’ll get a look at Core CPI, it will be tame and falling month over month.  In February, the Fed will raise interest rates reluctantly by .25% but it is likely to be their last.    Frankly, I’ve seen economic environments that are far worse than what I see today. Again, the hardest thing about investing is eliminating assumptions about the future and allowing pure data to show you the true path.  Too many are emotionally locked into an outcome that simply may not happen and they will miss tremendous opportunities (as always). I have zero opinions about the future, just watching the data and responding accordingly.

Bonds/ Stocks/ Commodities

Looking through the asset allocation lens we see all three food groups trending up thus far in 2023.  What a refreshing change from 2022!  Bonds are discounting a future recession and easing inflation.  Stocks continue to rise from the lows in October.  Commodities are not doing much but still slightly positive suggesting that inflation is not gone yet.  Today is a great day to hold a diversified portfolio across different asset classes and a clear opportunity for investors to rebalance their unbalanced positions.  If I had to pick an asset class with the most potential in 2023, it would have to be bonds, especially hybrid types like preferred securities, investment grade corporates, high yield corporates and emerging market bonds.  It’s not wrong to own your basic Treasury bond as well but there is just a lot more bang for your buck in the lower quality areas now.   After a rather bloody 2022, both of our bond income strategies are already having the best starts YTD since 2009; a year in which both strategies generated returns over 20% (not a forecast!).

Commodities have the least opportunity from our view with the exception of precious metals.  I do not expect energy to repeat 2022 performance in any way and it would be very surprising to see inflation beneficiaries excel in an economic environment that is somewhat recessionary. Why precious metals?  That’s a long discussion but generally Gold and Silver tend to do very well in a falling US dollar world especially as the Federal reserve ends a tightening cycle.  We bought gold and silver mining ETFs (RING and GDX) back in September and added to them in October.   Precious metal mining companies have outperformed the S&P 500 by 3:1 since October.

There are a lot of opportunities and new bull markets in development now.  What a change from 2022 when nearly everything lost double digits or worse.  We’ll take it as it comes.

Cheers!

Sam Jones

 

 

January 4, 2023

As is tradition, today’s update will look ahead to significant opportunities and new risks in the financial markets for 2023.  Happy New Year to all and thank you again for another year with our firm.  We genuinely appreciate your continued trust and confidence.

Opportunities – Dare to Imagine

Fear has become the dominant sentiment regarding public securities, markets and the economy.  It has become so pronounced that analysts’ estimates for future earnings are being adjusted down for companies that are already off their highs by 60-80%.  I cannot find a headline that doesn’t speak to recession in 2023 these days and indeed the evidence in support on that outcome is considerable.   It’s truly amazing to me how much recency bias develops when markets move in one direction for even a period of several months.  Today, there are widespread assumptions that technology stocks will continue to fall, that energy stocks will continue to rise to infinity, that the US dollar will march upward as the Federal Reserve will continue to raise interest rates.  Oh my, where do I begin?  The only crisis I see today is a failure of imagination.  Imagine if these dominant trends will either not continue, not happen or even reverse direction 180 degrees in 2023.  Imagine that!  The market has a way of punishing the greatest majority of investors possible so we might stay open to some dramatic reversals in 2023.  In fact, given the extreme consensus view of a pending mild recession, we should all remain alert to two alternative outcomes.  The first is that the widely anticipated mild recession is not mild at all but rather severe as suggested by the current bond market yield curve.  The second is that we have no recession at all.  Personally, I can make a compelling case for either.  Regardless, 2023 will offer investors significant opportunities especially for those willing and able to buy low and/or sell high and more importantly think unconventionally about how their money is allocated inside the new investing landscape.  My blanket advice to all investors for 2023; free your mind of assumptions about what will happen and imagine consensus opinion failing to produce expected outcomes.

The New Investment Landscape

Let’s set the stage a bit.  What exactly is the new landscape.  As I’ve said many times in the last two years, we have crossed into an environment where debt, inflation and tightening monetary policy by way of central banks, have and will continue to be, obstacles for many public companies and asset classes.  This didn’t just suddenly happen.  We find ourselves in this environment having travelled here for over 20 years of easy money, artificially low interest rates, financially engineered earnings and debt-based form of capitalism.  In short, money (capital) has been too plentiful and too cheap for more than two decades.  Consequently, public companies have done what we would expect them to do. They have borrowed money to buy back their own shares and issue dividends in lieu of focusing on growing earnings and revenues (aka financial engineering).  They have committed no crimes but they have artificially pumped earnings higher on a magnificent scale.  This is probably the best chart I could find from Standard & Poors illustrating the point. Aggregate Buybacks and Dividends (yellow line), have been hovering between 75% and 140% of annual operating earnings (Green line) for most of the 2000’s! In basic terms, the vast majority of operating earnings have come on the back of accounting strategies and share count manipulation.   And as you can imagine, when borrowing costs rise, share buybacks using borrowed money, ends quickly.

Cheap and plentiful money ALWAYS leads to inflation as we see today, just as we saw in the 70’s and early 80’s.  Eventually, we reap what we sow. The new environment will force companies to actually show real profits, actually have solid balance sheets, and actually pay attention to their expenses and debt levels.  Likewise, companies with negative earnings can only survive in the old environment of nearly free capital and unlimited investors’ appetites.  It’s a little disturbing to see an all-time new high in the share of US public companies with negative net earnings.  Over the next decade, this line should work its way back toward the zero line as companies (re)focus on generating real positive net earnings.

The new investor environment is therefore more selective and less rewarding for those who don’t understand how the tide has turned.  For those who get it, there are still plenty of new opportunities by simply reinvesting in companies that have the right stuff.  We have already made these changes across all managed investment strategies, starting in 2021.

Opportunities

#1 Adopt a Macro Strategy

What the heck does that mean?  In short, a “macro” approach to investments bases its holding on big picture type issues like the direction of interest rates, debt levels, central bank policies, currencies, politics and overall economic health on a global scale.  It also has the capacity to own many more types of assets outside of US bonds and stocks including things like commodities, Gold and Silver, alternatives and other non-correlated securities, real estate and even long/short hedging securities if possible.  Generally speaking, these are active strategies run by managers who have a lot of experience and understand the drivers of returns.  “All Season Financial” was founded as a macro strategy investment firm all the way back to the 70’s; The last time we had real inflation.

Looking backwards to 2022, we know with 100% clarity that nearly every investment style outside of macro strategies suffered one of the worst single years in modern history.  Energy and commodities, hedges and the US dollar, were the only investment “things” that finished positive on the year.   2023 is likely to see a broadening number of winning sectors and asset classes as we climb down the inflation ladder.  However, investors still shouldn’t expect an easy environment by any means.  Transition years like 2023 are always frustrating because investors find themselves watching the very thing they just sold, take off the upside.  We should also be aware that significant bear market BOTTOMs occur smack in the middle of labelled and acknowledged economic recessions.  Today, we have not acknowledged that we are in recession and are therefore not in the middle of anything.   At its worst, the broad US stock market was down -25% in mid-October.  Is that enough of a decline to say that the market has “priced” in a recession?  Probably not.  Historic averages tell us the AVERAGE bear market decline with a recession is 34%.  If there is no recession, then indeed the work of this bear might be done.

A final bottom in US stocks and the end to this bear market, still looms but could easily occur anytime in 2023.  Buyer beware but buyer be ready!

…back to the point

For the first time in nearly 30 years investors are learning the hard way, what true diversification actually means and why it’s important.  We are in a bear market for both bonds and stocks.  Diversifying across only these two asset classes did nothing to prevent significant losses in 2022.  Investors will need to embrace strategies that reach beyond these two icons if they hope to have a more positive outcome for the foreseeable future.  The last cycle of serious inflation in the US lasted for 14 years (1968-1982).  All Season Financial has a strong commitment to this space as 6 of our 10 in house strategies are driven by Macro factors with true, multi-asset diversification of securities.

#2 – Stick with Value

Hopefully, I made the point clear that the new environment is not fleeting.  It is a long-term structural change in how companies will approach their own survival and growth prospects considering the new cost of capital.  This is a good thing and a healthy change.  We want companies to produce profits by adding value, innovating, investing in R and D and growing organically as opposed to engineering their earnings in an unsustainable form of capitalism.  “Value”, even deep value companies are those that never left this space and thankfully, 38% of all public securities still offer tremendous value.   Our industry has made it quite easy to invest in funds that focus exclusively on value, deep value, high dividends, etc.  Value comes in many flavors as well.  Regular readers know that some of the best values in the world are outside the US markets, especially China and Emerging markets.

*Note on China.  I’ve heard many times in 2022, that China is uninvestable due to the heavy hand of the Chinese government.  Like most free Americans, I have no love for their autocratic/ communist culture or the loss of civil liberties.  However, do be aware that China has added 500 million people to their “middle class” in the last year while the US of A has lost almost as many to poverty.  Likewise, the Hang Seng now trades at 1/3 the value of the S&P 500.  Consensus opinion regarding Chinese investment opportunities could be very wrong.

These, together with most of Europe, appear to have put in long term bottoms in October after devastating bear market declines.  Now, internationals are outperforming the US markets by a wide margin, and most have entered new bull markets.  Again, if you’re stuck in a US centric bubble where stock and bond indexes are your only holdings, these new opportunities will pass you by.

#3 – Special Situations

There are a number of special situations out there in the opportunity camp, but I will highlight four of them.  High Yield corporate bonds have historically never experience two consecutive years of losses.  As I write, the High Yield bond index is closing 2022 down -11.24%.  The risks of owning HY corporate bonds as we enter a recession do not escape us but again, let’s try to use our imagination.  What if there is no recession and default rates don’t spike higher?  What if inflation continues to fall and bond yields fall back to 3%?  Wouldn’t an 8% yielding corporate bond suddenly look pretty attractive?  High yield bonds could have a very good year despite conventional thinking.

Home Builders are also in a potential sweet spot.  Demand for housing is still very high and supply is not coming from the existing homes as homeowners are essentially frozen in place carrying 2-3% mortgages.  Where will supply come from?  New homes!  Homebuilder valuations are also very attractive.  Consensus views might have you think that all forms of real estate are dead in 2023.  Think again!

A third sector with great potential is financial services, especially banks, brokerage, capital markets and asset managers. Again, value is present here and the cycle should begin to favor financials as inflation cools.  Imagine this; Bank profitability reached a 14 year high in 2022 with a return on equity of 12.5%.  Bank stocks are trading at 50% of the valuation of the S&P 500.

Finally, one area of value that looks attractive on pure fundamentals are the gold and silver miners.  Crescat Capital does some of the best research I’ve seen in this space (https://www.crescat.net/mining-industry-renaissance/).  After 7 years of deleveraging their balance sheets, gold and silver miners are sitting on the highest levels of cash in history and are now paying some of the highest dividends in the market.  Furthermore, gold and silver reserves are at historic lows while ore prices continue climbing steadily.  The timing and set up to own gold and silver miners may be one of those rare premium value plays in 2023 for a small piece of your portfolio.  Even Warren Buffet, notorious hater of Gold, would have to take a second look at the mining companies.

New Risks

When we think about potential recessions, investors tend to lean into “safe” things like consumer defensive stocks, utilities and healthcare.  While these sectors have held up better than most in the last 12 months, they are simply no longer attractive from a valuation standpoint.  Many like Walmart, McDonalds, Proctor and Gamble, Costco and Pepsi, now have P/E multiples higher than the technology sector which is still very expensive by any standard.  The same goes for the biggest names in healthcare and utilities.  It seems the market has already priced a future recession into the defensive side of the market which presents a new risk for 2023. If we do escape recession, these sectors could be some of the worst performers in 2023.  Any holdings here should be on your “watch to sell” list.

2023 is going to test your resolve as an investor.  Perhaps the greatest risk of all time for investors in the throws of a deep and lasting bear market is the risk of giving up.  I choose my words carefully.  Giving up is that moment when you can’t stand to lose another single dollar to a market that feels hopeless, literally without hope.  Why would I stay invested or buy any security with price risk when I can “get” 4% year risk free in short term bonds or an 18-month CD?  Why am I investing at all?  I want out!  That is giving up and it happens at or near the very lows of every bear market.  We saw it happen in late May and late September of 2022.  The markets finished 2022 slightly above those levels.    We’ve all been there, when it’s dark and headlines offer no optimism.  Emotionally, we need to protect our egos, so we find an excuse for selling everything.  Managing your emotions and staying engaged with your investment discipline is the most challenging risk we all face.  At the same time, it’s important to keep your money in the right place at the right time, manage your tax impact, manage your asset allocations, keep them in balance, find new opportunities and avoid obvious risks.  Above all, stay in the game and remember that the greatest risk is to have your investment assets sit idle and unproductive after experiencing a loss, while your cost of living goes up over time.  Stay strong and use 2023 as a year to find new opportunities for your investment dollars.

Best of luck to us all,

Sam Jones

 

 

Happy New Year!

This year, the turning of the calendar comes with increases to social security, tax brackets, standard deductions, annual exclusion gifting limits, contribution limits, and RMD ages that we want you to be aware of. Please  review the summary of Key Financial Planning Figures for 2023 below and reach out to us if you have any questions.

We look forward to working together in 2023!

Sam, Will, Kris & John

December 9, 2022

          I am not an expert in Real Estate but have been a macro strategist for the better part of 25 years.  Real estate is no different than any other investment asset class despite the emotional bonds that persuade us to think otherwise.  As promised and as requested, these are my thoughts on trends in real estate, both current and future.  

Flashback to 2006 

          In October of 2006, I stood at our annual meeting at the Lakewood Country Club in front of one of our largest attended events ever.  I began the presentation with this image, snipped from the cover of the Economist entitled, “The Houses That Saved the World”.

 

          I went on to horrify our clients by suggesting that real estate was a disaster waiting to happen and that we could see up to 15% declines in prices nationwide over the course of the next 2-3 years.  I was terribly wrong of course as real estate lost 25% nationwide and nearly 40% in many markets, combined with the bankruptcies of several giant financial institutions and mortgage lenders.  This period was fodder for the famous movie, “The Big Short”.  On that day, no one could image that real estate could fall even 10%.  It simply had not happened in several decades and we heard regularly how inventories were low, demand was high and interest rates were at all-time lows.   Moreover, real estate had become a great source of wealth accumulation for homeowners at large, as well as an absurdly lucrative revenue stream for brokers, homebuilders, developers, house flippers, mortgage lenders, banks, etc.).  No one wanted to believe that real estate would do anything but go up in value.    

This Time is Not Different 

Today, there is a near consensus opinion that real estate prices are in trouble for the next couple years.  It’s hard to argue with that point of view considering all the things we already know.  Affordability, measured as the cost to buy a median home relative to average incomes, is at an all time low.  Mortgage rates have doubled from 3.4% to 6.8% in just 11 months.  No one wants to sell and trade their current 3% mortgage for a 7% mortgage, right?  So, sales have completely dried up and are now down over 40% year over year.  However, if one were to look at price trends, you might be surprised to see the Case Shiller National Average still up 10% year over year ending October!  I want to give a quick shout out to Bill McBride who offers some of the best work I’ve seen on macro trends with a strong focus on real estate, mortgages, and consumer behavior.  You can find him at www.calculatedrisk.com .  Much of what I’m talking about today has been said better by Bill with all the supporting data.  Check him out.  

          If we were to unpack the +10% YTD, number we would see that real estate prices WERE up over 20% YTD and are now down 10% from that high.  Bill likes to watch the month over month price trends which are obviously negative at this point (see below).  Prices peaked in March on the National index and have been falling about 1% per month since.  Industry people will suggest that the national average doesn’t apply to their markets.  Yes, it does and yes it will.  Some markets and regions are just early in the trend, and some are later, but rest assured that all ships rise and fall to varying degrees, with the tide for real estate.  

 

Most of the smart people I follow, including Bill are looking for prices to fall almost 20% which would simply erase just the last 18 months of price appreciation.  Not a big deal!  Especially considering that homeowners are still sitting on a pile of equity, and most aren’t feeling pressured to sell, at least not yet.

This Time Is Different! 

          Today, unlike the last real estate price decline in 2007-2010, we have a new force called inflation that is still clipping along at 7%/ yr.  Inflation is a bit like wood rot; It’s hard to see the decay that is happening beyond the surface, but it has a way of structurally eating away at your financial foundation.  With inflation running this high, even a small loss in real estate prices can have much greater impact on the “Real” value of your property.  Let me explain.  We can look at real estate prices with or without inflation factored in.  If we consider prices without inflation, then we are simply looking at a linear move up or down in an asset without context.  Here’s what the price trends look like in absolute values.   

          But the context here is your real cost of living including the costs to maintain your home versus the current value of your home.  With inflation on the rise we see higher maintenance costs, higher utilities, higher building costs, higher borrowing costs and even higher taxes (coming soon).  We also have a higher cost of living in general which establishes a higher benchmark for pricing just to stay even.  Therefore, if we care about the state of our wealth and the value of our assets, then we must measure them relative to our variable costs as measured by inflation.  This is what real estate price trends look like when factoring in inflation over time (again hat tip to Bill McBride ) 

 

           Hopefully, when looking at charts above, the important takeaways are obvious.  

1. Real estate prices have peaked and are just now starting down.
2. Real estate prices are peaking from a much higher level than the last peak in 2006.
3. Factoring in inflation (aka affordability), we should expect some relatively severe price impacts in coming months unless mortgages come all the way back to where they were in 2020 (~3%).
4. Note the time gap between price peaks.  I could argue that timing with real estate purchases matters more than location, location, location.

The Big Picture 

          Now I’m going to switch to demographics as related to very long-term real estate trends. Here are a few facts. 

• Households in our country tend to buy real estate from our early 30’s (first homes) and hold properties until we are in our early 80’s.  That’s a long time!  
• Beyond 80 years old, there is a strong tendency to sell property and move to assisted living, move in with family or otherwise. 
• Currently only 13% of our population is age 80+
• By the year 2042, more than 30% of our population will be 80+
• 46% of our population is in prime real estate purchasing age (between 30-39).  But that number only grows by 2% until it peaks in 2030.

          If we mash all these stats together, we see that demand for housing is likely to be strong for another 7-8 years but after that we are sort of facing a Japan style environment with an old and aging population who is not likely to want more real estate and is far more likely to be on the sell side as we move closer to the 2040’s.  For those who know the history of Japanese real estate, you know that prices entered the dark ages in about 1990 when their population had become older with a large portion over the ages of 80.  Here’s a chart of the Japanese Real Estate prices from approximately 70 years ago to now. Note how the percent change by year stayed negative or near zero for almost three decades.  Interestingly, we are just now starting to see prices move consistently higher – need to do some more research on that. 

 … In Conclusion 

          It would seem logical that real estate price trends are going to be highly cyclical and far more sensitive to borrowing costs at least for the next 7-8 years.  We should also expect higher carrying costs associated with owning real estate starting today.  Landlords beware!  Today we’re at the top of the cycle but we would look for a next buying opportunity after the next recession (2024) when prices and rates should be lower.  We will still see some incredible moves higher as those Millennials and Gen Zs continue to buy the American Dream!  However, after 2030 and increasingly until 2042, we will start to see inventories rise consistently as demographic demand starts to wane.  When I am 75 years old, I’m sure I’ll look back at this time and marvel at todays’ price appreciation as a thing of the past.  

          This is some very blunt and non-actionable advice of course.  But seeing as how real estate is arguably one of the largest drivers of economy and wealth in our country, it’s worth spending some time trying to understand the big picture and set some expectations looking forward.  Homes are wonderful places to live, but maybe we should start thinking about them as just that and not as much of a source of wealth or income.  Something to consider. 

Enjoy the weekend, 

Sam Jones 

 

      

December 1, 2022

The Stockings Were Hung By the Chimney With Care… Why Not Fill Them, With “Valuable” Shares?

So clever… This update is directed toward parents of young adults looking for a solid game plan to help their children get started early with investing.  What an incredible gift we have before us; To get the right types of accounts set up, funded and invested while there are still multiyear investment opportunities to be had.

First let me start with a little shaking of my head in disbelief.  Why is it that we all charge out to power shop on Black Friday or Cyber Monday to take advantage of deals on consumable, discounted stuff but show no interest in buying shares of public companies trading at multiyear valuation lows?  Which one of these will be the better investment in 10 years; A pair of Chuck Taylor high tops at $199 (on sale from $249) or putting $199 into any number of stocks paying 5% dividends with 10-15% annual growth in earnings per share?  I’ll bet the shoes are in the landfill by year two.  Seriously, think about this as the gift that keeps on giving this holiday season.  Your kids will not even remember the high tops but they will fondly remember you when they can thankfully afford a down payment on their first home.

Ok, let’s do some smart shopping.

Set Up Two Types of Accounts for your Kids

This is some conditional advice so please reach out to get clarity on your specific situation.  Broadly speaking, a Roth IRA for a Minor (Aka custodial Roth IRA) is a great first account to get set up.  Any major brokerage shop like Fidelity or Schwab has on-line tools to help you set this up in a few minutes.   The condition here is that your child is under 21 and has some form of earned income.  This income can be from a summer job with regular w-2 income or even baby-sitting, mowing lawns etc with some limitations.  Some think you need to file a tax return for your kids to be eligible to set up a Roth IRA.  Not so!.  Unless your child earned $12,550 or more in 2022, there is no need to file a tax return.  My kids generally make between $3-5K in summer jobs so they are no where near the threshold. But, they are still eligible to contribute the lesser of their earned income or $6000/ year to a ROTH IRA.

Details to Remember About Roth IRAs

• There is no tax due on their earned income (if under $12,550), so we are not trying to fund a traditional IRA with deductible contributions right? Thus we are making NON-deductible contributions to a Roth IRA.
• Roth IRA money grows tax FREE. At their age, they might have 40 years of growth in these assets that will never be taxed.
• Roth IRA money cannot be accessed without penalty until age 59.5. They cannot buy a sweet Camaro with this money, it is for their retirement.

The second account to set up is a taxable UGMA/UTMA (custodial) account.  This is an account that they can access and will formally own under their own name at the age of majority in your state.  In Colorado, that age is 21.  Unlike the Roth IRA, realized gains and income are taxable and will add to their “earned income” each year so you need to be careful about staying under that $12,550 number unless you care to file a tax return.  There are again different thresholds for how income and capital gains are taxed in these types of accounts.  Here’s a great cheat sheet from Fidelity on all types of custodial accounts, including rules, limits and taxation.  The point of this second account is to provide them with starter money, out of school, that they can use for a down payment on a home, maybe to cover rent, go to graduate school, etc.  I would spend a little time having open conversations with your children about the purpose of this money.  It will be theirs but is to be used responsibly and for their financial foundation and not for consumable items or entertainment.  If you have concerns along those lines or children with disabilities, talk to us about setting up a trust.

Who is Funding These Accounts?

In either case, the source of the funding doesn’t matter which means you, as the parent, can help them!  Enter the teaching moment.  This is the “deal” we have with our two boys with the clear intention of developing good financial habits with saving and investing.  At the end of every summer, we match 100% of their annual savings toward their investment accounts.  My sons typically save 25-30% of their summer incomes toward investment accounts.  In our example, they might choose to save $1000, we match the $1000 for a total of $2000.  Often, they split the total savings equally between their Roth IRAs and their custodial UTMA accounts – some to long term, some to short term.  Suddenly, they have skin in the game and want to start talking about what types of investments they can buy, what should they buy, how do they build a complete diversified portfolio, what does a bear market feel like, etc…?  Good stuff to learn at an early age.   More importantly, they develop a habit of saving annually for themselves and their futures.  Side note – I have strong opinions about the risks and bad precedent of handing your kids lots of money, open credit cards, and paying for everything without them having to bring anything to the table.  You are digging a very deep hole of dependence let alone stealing your kids’ right to any sense of pride in making it on their own.  Teach them to fish right….

How to Invest These Accounts?

Roth IRA – This is long-term, tax-free money so let’s invest it that way. In this account they should own mostly stocks and seeking growth or combinations of growth and high income.  We have low cost ETF asset allocation models that we can provide to you if you simply want to own 7-10 total positions and build an aggressive portfolio on a set it and forget it basis.  Please ask!  There are also some developing options for the gamers out there.  I think 2023 will provide us with several generational opportunities to buy individual stocks with a portion of this account.  My kids have about 20% of their Roth IRA accounts in individual company shares with the rest in index ETFs.  They have been doing some buying recently in names like Airbnb (ABNB), Bloom Energy (BE), Zillow Group (Z), Snowflake (SNOW), Block (SQ) and Wayfair (W) with Rivian (RIVN) and Uber (UBER) on the watch list.  These are stocks that we have talked about and are now trading 60-80% off their highs.  Some may do nothing, some may not exist or be purchased in the future.  But some may do Amazon type returns in the next 40 years!   There will be more opportunities like these in 2023.  The rest of their portfolio is fully diversified across equity ETFS and high yielding closed-end funds.  These accounts will be substantially larger by the time they are 59.5 years old.

Custodial UGMA/ UTMA  – For these accounts, we want to be a little more cautious with sensitivity to capital gains and taxable income.  This is shorter term money that needs to be there for them when they are done with schooling.  Here we like to own a fully diversified portfolio of stocks, bonds, commodities, gold, internationals, income and real estate funds.  We want to lean into value and lean away from speculative growth.  These positions are to be bought and held with a focus on adding to positions when they present discounts in order to limit risk and taxable gains.  Are there any discounts in the markets now?  You betcha.

Final Thoughts on Risk and Return

This is a good conversation to have with your young adult children.  There is a notion in the financial media that more risk equals more return over time when it comes to security selection.  This is patently false.  More risk is just more volatility.  Now, if over time, volatility is in the form of higher prices, then good for you and honestly the broad markets do tend to rise over time.  As long as you have at least 20 years of investment time horizon, your odds of success are nearly 100%.  However, as evidenced by the number of popular names that have experienced wipeouts in the neighborhood of 80-90% this year, risk can also mean downside volatility.  How long does it take to break even on an investment that loses 90% of it’s value?  Let’s say, not in your lifetime.  Any company that goes through this type of loss of capitalization and price decay is either on its way to bankruptcy or a buyout.  Timing matters, what you buy matters, profits and balance sheets matter, valuations matter.  Last year, we watched the Superbowl played inside the Crypto.com stadium.  Laughable.  Why is anyone surprised that Crypto turned out to be an enormous dumpster fire of an investment.  Concentration of your wealth in just a few companies is simply leveraging the concept of risk.  Nothing is forever and there is no guarantee of success with any company even over the long term.

When investing with your kids, perhaps the greatest gift is the gift of knowledge.  Use real investment accounts and savings habits as a mechanism to teach them how to be mature investors, including the beneficial principles of diversification, patience, humility, and solid behavioral practices like buying when share prices are down and cheap.

… and to all a good night

Sam Jones

 

 

 

November 9, 2022

Regular readers might recall the rollout of our Big Three investment themes in April of 2020. Two of the three are now well entrenched and we’re about to see the third and final big opportunity unfold as the markets and economy slide deeper into recession. Dynamic asset allocators should be on the move here, reorienting portfolios for the Next Big Thing.

The Big Three
You might want to take a few minutes to brush up on the Big Three by reading our Dec 30th 2020 post HERE. For the reluctant, I’ll summarize the themes and bring you up to date with the state of these trends.

1. Commodities and Inflation Hedges – Entrenched uptrend since April of 2020.
Now in its third year, the commodity/ inflation trade is still one of the only investment themes that has actually made money in 2022. Energy is up over 60%, broad commodity funds are up 24%, inflation beneficiaries like steel, copper and materials are flattish YTD. And just this week, Gold, Silver and associated miners have just bottomed in a clear and decisive way after falling a surprising 30% (blame = super strong US dollar). Gold miners are up 17.5% in the last three days. We bought gold miners in several strategies on October 3rd. From a cycle standpoint, we should expect to see commodities top out around here as the economy slides deeper into recession. We might continue to move pure commodity positions more into gold and gold miners as a safety measure in the weeks ahead.

2. Value Over Growth – Entrenched since December 2021
Wow did we get this right! Even this week, growth investments are still plumbing new lows led lower by mega cap tech names like Tesla, Meta (Facebook), Alphabet (Google), Microsoft and Amazon. Take a look at the losses in both stock prices as well as market cap, courtesy of Bespoke.

I have said many times that the concentration of investor dollars in these six names represents the greatest risk to investor wealth in a generation. This risk extends to the US stock market as well, given their dominant weight in the broad market indices. As these names go, so goes the market. These six alone have collectively lost over $5 Trillion in market cap in the last 12 months. The entire S&P 500 has lost over $9.5 Trillion by comparison. That is a lot of wealth destruction and I feel badly for those who still maintain concentrated positions here. I see no sign of a price bottom in growth at this point. Meanwhile value is trading very well and higher in most cases. “Value” represents those companies that have high free cash flows, pay dividends, are profitable and carry relatively little debt. This environment rewards those types of companies and punishes over-priced growth names, especially those without profits and burn cash to stay warm. Outside of New Power, our investment strategies remain piled high in value, dividend payers and virtually zero growth or technology names. At this point, the benefits of owning value over growth have manifested as (much) smaller losses but losses, nonetheless.

This chart is only updated through mid-August. The only thing different to date is that the orange bar in 2022 is now – 33% while the green bar is down around -8%.

If history repeats, we’ll see these relatively small losses in value turn into absolute gains as the stock market finds its footing and develops more sustained price recoveries. How long can the Value over Growth theme last? Again, with history as our teacher, each dance partner tends to maintain the lead for 5-6 years before handing off to the other. We are in year two of this value leadership so yes there is much further to go especially considering how long growth previously held the lead (from 2004 to 2020!).

3. Internationals over Domestic – The Next BIG Thing!
This theme has been a bugger as the Federal Reserve has been driving up the US dollar for almost two years in conjunction with runaway inflation. A rising US dollar creates headwinds for US dollar denominated international investments.

But this is about to change in a big way. How do I know? Two main reasons.

The first is that we are already in a quiet recession, but that fact is about to become very loud and pronounced in the next 30-60 days (rising inventories and unemployment, falling real estate prices, falling demand, falling PMIs, falling prices, lower CPI, etc.). The US dollar falls when recession is finally recognized. Again, a falling US dollar acts as a tailwind to international investments.

The second reason is this:

This was the cover image of Barrons on October 4th, 2022. The Barrons record of highlighting the very last gasp of any long trend is nearly flawless. If you’re on the cover of Barrons, the trend is over, your days are numbered. The same goes for Time Magazine Person of the Year.

Elon Musk 2021

Now the king of chaos and volatility in 2022.

The US dollar peaked on October 12th and has yet to make a higher high for the record.

Select internationals, especially non-China based emerging market funds and stocks, are already outperforming the US market. Brazil is up 21% YTD (we own it), Latin America in general is up 17% (we own it), Mexico is up 11% (we own it) and I see compelling evidence that Europe is bottoming now (buying now). 27 of 42 foreign country ETFs are now outperforming the US stock market and that number is growing daily. This is happening while the US dollar is still sitting at its highs of the year. Imagine what will happen when the US dollar starts a new downtrend!

Finally, remember that the valuations of the international world are almost 50% of those in the US. We are no longer the best-looking horse in the glue factory. In addition, most international stock and bond funds are paying dividends in the 5-6% range. This is a compelling moment in time to rebuild or initiate a solid international position in your portfolio as we have done for our clients.

Other stuff – Bonus thoughts in brief

• Mid term elections will not make a difference to this market. A very health year end rally into early 2023 is a high probability even as recession headlines hit the press.
• Real estate is in trouble – long term. More on this in future updates.
• Inflation has peaked – this will become more and more obvious. In 6 months, Year over Year CPI measures will be close to zero.
• Feel free to book and PAY FOR your international adventure of choice. After exchange rates, your trip is 20-30% off.
• There are lots of juicy short-term interest-bearing securities out there. I clipped this from Fidelity yesterday AM. Wow! We are beginning to reinvest our Income models now after carrying nearly 60% cash for most of 2022. Look at the 18-month column.

Lots of new opportunities developing for investors who are awake, aware and care to make some money in 2023.

That’s it for today. Big snow coming to Steamboat Springs, CO. We already have over 25”.

Sam Jones