Category: Finding Benjamin

October 24, 2022

Last Friday’s market action offered investors a clue as to how the market will react when the Federal Reserve begins walking back their uber aggressive policy of raising interest rates.  We would be wise to let history be our guide as we are indeed still playing this game right from the 70’s playbook.  In the short term, there is a reasonable chance that a very strong relief rally, in stocks and bonds, has just begun.

What just happened?

Well, it was inevitable that the Fed would begin its choreographed chatter about how they might consider, maybe, sort of, potentially begin talking about reducing the size of their rate hikes after the November meeting.  As we have said for the last several years, this Fed and specifically Jerome Powell is driven by the path of least embarrassment.  They will pursue a relentless policy until it is almost absurd for them to continue and then they will change 180 degrees on a dime.  Today, we have overwhelming current and forward-looking evidence that the US and global economies are either in recession or heading swiftly in that direction.  It would be very embarrassing for them to continue raising rates much beyond 2022 if the data continues as such.    On Friday, Mary Daly of the SF Fed, casually slipped a comment to the WSJ that they “should start planning for smaller rate hikes”.  Following her comments, in a hot second, the US stock market moved from -0.80% on the day to +2.3%.

What a “relief”!

This is the same Mary Daly who said earlier in the week that rates will push higher for the foreseeable future and Fed Feds will reach at least 4.65%.  The Daly show indeed.  Enough Fed shaming for this update… but they do deserve it.

Just The Data Please

Robert Berone contributed a terrific article to Forbes on Saturday entitled, “Did the Fed Just Blink? The Markets Think So”.  Google that and read it if you can (Forbes articles are tough to read without subscriptions).  Berone compiled behind the scenes evidence showing just how quickly our economy, housing, and employment are all slipping into the red.  His point was that the Fed needs to stop now given the evidence.   I’ll give you a few highlights in case you cannot read the article.

• The Housing market is already in decline. Home sales are down for the last 8 consecutive months by -23.8%.  Regardless of what you might hear today, prices tend to track sales.  65% of the population owns a home and price declines will have a negative wealth effect on spending.  Mortgage applications are down -38% year over year (record declines).  This chart was also offered in a separate Fortune article supporting Berone’s comments.  Albeit slight, home prices have started falling predictably.

• On the employment front, there is a discrepancy of more than one million jobs between the Seasonally Adjusted and Non-Seasonally Adjusted data as reported by the BLS. This will be reconciled by the end of the year and the November 4^th report is very likely to show a much weaker labor mark t than what was previously reported.  Does the Fed have eyes on this report?

Big employers have already announced either smaller holiday hires or outright layoffs between now and the end of the year including Walmart, Macys, Fed Ex, Microsoft, Meta , Twitter! And Netflix.  Berone also highlights reporting issues in the BLS related to part time versus full time measures as well as the exclusion of small business labor in their data, all having the impact of overstating employment figures in the last 6 months.

• Inflation measures are mostly showing disinflation now. The Fed is choosing to only look at things going up in price while the majority of “things” are actually falling in price.  Retail sales are down 3% in the last month. Other things falling in price since the spring:  Furniture, appliances, moving expenses, used car prices, gas at the pump, natural gas, prescriptions, theater tickets, hotels, sports events, apparel, and IT services.  Even rents are starting to fall in several major metro areas.  Food is flat year over year.  Tesla just announced a 9% drop in prices for their vehicles sold in China in order to compete with BYD.  We are past peak inflation for sure and CPI is very likely to begin falling from here, perhaps dramatically.

The Fed has been working to fix and correct their last error (not raising rates in 2020 and 2021).  Now they are at risk of making another policy error.  Given the public shaming and overwhelming recessionary evidence pressing on them every day, it shouldn’t be a surprise to hear them start to back pedal on their stance.

The 70’s Playbook

Regular readers and those attending our annual meeting know that we have been expecting a relief rally in both stocks and bonds to begin in October.  At present the marginal lows of the year appear to be October 14^th for stocks.  Bonds may be bottoming now.  Relief rallies can be the start of new multiyear bull markets which is still possible if we somehow avoid a deep recession in 2023.  For now, any rally is simply a response to a change in the central bank policy as we discussed above, and is literally just a relief that the worst of the tightening cycle may be behind us.  Relief rallies can take prices of both stocks and bonds all the way back up to the old highs in a very short time period.  Wouldn’t that be nice!  It happened in the 70’s.  The 70’s play book lasted for the better part of 10 years and stocks (and bonds) moved within a 30-40% trading range during that entire period.

It would seem quite possible that we are just now carving out the lower end of the playbook trading range if history is repeating.

As inflation peaks and the Fed becomes more accommodative, stocks and bonds tend to bottom.  Here’s what that looked like in the 70’s at least for the first round of peak inflation!  In the 24 months following the 1974 low, prices recovered almost back up to the previous highs.

Of course, that was not the end of inflation in the 70s, and the cycle of stocks, bonds and employment and moving inversely with inflation continued until 1982.   The next chart shows the pattern of inflation and unemployment during the 70’s.

Investor Action Items

We like to offer some relevant advice in our updates so here it is.  Investors might use this time and place to consider the following:

1. Make your IRA contributions for 2022 now if you haven’t already – check on your eligibility and limits for deductible contributions here.
2. Consider conversions from IRA to Roth IRA – please consult with us first!
3. Deploy sideline cash to taxable investment accounts – This is likely to be the last good window to get this done in 2022.
4. Add to 529 plans for children’s education accounts for 2022.
5. Help your kids open a Roth IRA if they had summer income.
6. Fund your Health Savings Accounts for 2022 if needed. Details and limits here.
7. There are plenty of investment opportunities here including tax loss harvesting, rebalancing asset allocations, shifting from short term to long term and high yield bonds, etc. We do all of this for our clients in their managed accounts as needed.

As always, we’re here to help our clients with all the messiness.  Please reach out to us if you have questions or need assistance.

We are excited with the technical bottoming pattern that has been developing since the lows in June.  The timing of a relief rally starting now is very good.  As we said in our annual meeting this is a time to banish that fight or flight impulse.  Stay opportunistic, stay in the game, life is long!

Cheers

Sam Jones

October 7, 2022

This market is a lot like waiting in a traffic jam.  It’s never fun and some of us handle it better than others, but we know that eventually the road will open, and we’ll hit the accelerator again.  This will be a quick update and follow up to our annual meeting presentation (recording now available here for those who missed it).  The intent is to give you some mental peace as you head into the weekend knowing that we are still waiting, very defensively positioned, for the developing bottom in both stocks and bonds.

Jammed Up

I think most drivers are aware of the amazing WAZE app that shows traffic patterns and best ways to get from A to B during rush hour.  I won’t go into any city without it personally.  As I look at the sea of red on my quote box today, I can’t help but think this is a lot like a traffic jam where we just have to sit, breathe and know that it will end soon.

The Employment Report released today was the cause of the market’s dive as the monthly number of new hires came in slightly above expectations.  The market was hoping for a more recessionary number. But let’s unpack that for a moment.  First of the all the economy ONLY added 208,000 jobs last month, a mere 8,000 more than expected.  Not exactly a blow out number and 200,000 new jobs is actually pretty soft historically.  A big number is almost twice that amount in an economy that is actually growing.  Second, there is context to any unemployment figures.  Since 2002, our Labor Force Participation rate has been falling steadily and is still well below the last peak set in 2019.

This is a function of early retirements, or others who are still eligible to work by age, but have dropped out of the work force either by choice or involuntarily. Looking at the chart above, only 62% of eligible workers are actually working in our country.  That deserves some more research but not today.   When we have a shrinking labor force (read aging population), any small uptick in employment numbers is going to make us look far more fully employed than we really are.  That’s simply not representative of what’s happening across the working population at large.

Finally, we have to also keep a close eye on the claims for unemployment at this stage which is also telling a different story than what you heard on the news today.  Take a look at the right edge of the chart below.  Do you see the sharp curl UP as claims for unemployment just jumped?  So today, we’re all jammed up looking only at the taillights in front of us and wondering how long we’ll have to sit in this traffic.  But if you could see the “jam” from the perspective of WAZE, you would know that employment is not nearly as strong as suggested today, and we’re on the very cusp of a change where the Fed is going to recognize we’re heading fast toward recession.  I’m guessing November will mark the end of the current rate hike cycle.

While We Wait

Just like any traffic jam, we ultimately settle into resolution that this is going to take a while.   We can do some lane hopping but we really know it won’t matter much as all lanes are all jammed up.  Stocks and bonds are the lanes, and they are both jammed up. Today, our risk managed strategies remain defensive, heavy in cash and hedged with short positions.  It’s been bloody since August.   Consequently, we have cut exposure to the markets since it became obvious that interest rates were not done rising in sync with our menacing Federal Reserve (argggg) despite the very obvious recessionary pressures globally. These are our cash positions in our various risk managed strategies and we literally don’t get more defensive than this in almost any market conditions.

STRATEGY                             Current Cash Position

Freeway High Income                    56%

Retirement Income                         64%

All Season                                          20%  (+10% short position)

Worldwide Sectors                          23%

New Power                                        37%

Gain Keeper Annuity                      40%

Our biggest risk today is that we are grossly underinvested considering the upside potential of this market, but we have to stick to our discipline and trend following rules. When there is nothing to buy, we wait and hold only positions that are generating income or significantly outperforming the broad markets.  That’s where we are today, waiting, fuming, but ultimately knowing that we have some open road not too far ahead.

Have a great weekend and know that your capital is largely out of harm’s way, and we are looking forward to the next BIG thing in the markets – rising prices!

Have a great weekend,

Sam Jones

 

September 6, 2022

August turned into a bit of dumpster fire following the meeting of the Jackson Hole Economic Symposium of Federal Reserve governors.  For this Red Sky Report (print version only this month), we’re going to do a current state of the markets overview and then reach into our advice bag to offer some perspectives on how smart investors might view these conditions.  Spoiler alert- we are approaching another “half full” market buying opportunity.

The Current Dashboard

Bespoke always does an excellent job putting numbers to the market in a clear and easy to understand way.  Here’s a snapshot of their world stock market dashboard through the end of August. There are four columns of information here, all provide a unique perspective.

Let’s dive into the numbers and look for some insights

YTD% – This one is obvious.  Bespoke has packaged and averaged all countries into two groups; developed markets (DM) and emerging markets (EM).  DMs are down -19.48% on average while EMs are down only -11.80%, thanks to Latin America, Brazil and Taiwan in particular.  I find the fact that EMs are down so much less than developed markets very interesting and compelling.  Long time readers know that Emerging markets now present one of the most attractive valuation opportunities of the last two decades and relative performance may have already begun.  In fact, Jared Dillian of the Daily Dirtnap reposted this chart a few weeks ago showing that Emerging Markets, as a group have sold off to the same level as the year 2000, expressed as a ratio to the S&P 500.  In other words, Emerging markets are just as attractive today as they were in the year 2000 relative to the US stock market.  Students of history know that Emerging markets earned over 18% PER YEAR for over 10 years while the S&P 500 generated less than 1.5% PER YEAR in total returns (2000- 2010).  I will say this as boldly as I can.  Emerging market stocks and associated country indices may be approaching one of the best buying opportunities I have seen in the last 12 years.  We have begun methodically and slowly accumulating emerging market stock index ETFS across all strategies now with the intention of riding a new multi-year bull market (in EM) as long-term core holdings.

MTD% – Not a lot of additional information or insights here.  However, nearly 100% of the monthly losses in August across the world have happened since Jerome Powell lit the dumpster on Friday, August 26^th.  Europe is following the US central bank policy now with a pedal to the metal driving developed market economies faster and faster toward recession.  Amazing work by those folks.  I’m being sarcastic if you couldn’t tell.  Central banks are literally creating more volatility (higher highs and lower and lows) in the financial markets.  They kept rates at zero while inflation was raging and now, they are raising rates as inflation is factually falling.  Crazy stuff.  Can’t explain it other than some blend of incompetence and political pressure?  I am not smarter than the Federal Reserve, but I do recognize a pattern of poor timing and resulting outcomes.

COVID Crash 52 -week High – This column shows the gain or loss from the highs BEFORE the COVID crash in 2020.  The “high” points vary a bit from country to country, some occurred in 2019, others at the beginning of 2020.  What you’ll notice is that four countries are still trading above the pre-covid highs.  They are the US, Canada, Taiwan and India.  The war in Ukraine and resulting pressure on energy costs are certainly having an effect on Europe and that side of the world.  It is not a coincidence that the US and Canada, both energy independent countries, have been the two of the world’s best performing stock markets in the last two years.

Current 52-Week Highs  – This column is measuring the percentage losses since the last 52 week high, again packaged by Developed economies and Emerging economies.  From this perspective we see high consistency.  World stocks are down -24% from the highs across the board.  Not shown on the chart are other asset classes so I’ll provide them for reference here.

10-Year US Treasury Bonds -16.29%

High Yield US corporate bonds – 11.20%

Commodities – 16.05%

US Oil – 20.40%

REITS (IYR) – 18.21%

What is a Smart Investor to Do?

Ok, so it’s pretty easy to look at the list above and get depressed.  Where is an investor to go when every single asset class, country, sector and style of investing is trending down?  This is the half empty view.  If we flip that reality on its head, we could logically argue that EVERYTHING is now trading at a discount!  As always, I find comfort in being a contrarian because no investor ever makes money by following the crowd at extremes.  I will be bearish when stocks are overbought and popular – like most of 2021 and I will be bullish when stocks are cheap, trading at discounts and investors are sour.    In mid-June, Investor Sentiment was as negative and bearish as I have ever seen in my career.  We talked at length about that extreme condition in the June 23^rd blog update “Beyond the Obvious”.    Historically speaking the June lows are likely to mark an important turning point of some sort.  They may even be THE lows of this bear market. We are going to find out soon.

Since the June 14^th lows, stocks are still up +5-6%, bonds are still up +2-3% and commodities are now down -13% through the end of August even with the near waterfall type selling of the last two weeks.  This tells me that stocks and bonds are still trying to carve out a long-term low.  This also tells me that inflation has peaked along with commodities for this cycle.  Anything can happen and those conditions may change but that’s the way it looks from here.

In our last blog post, we stated the following

“We are looking for a window to start gradually buying into the bottom of a devastating bear market!  This window is not a small window but could take weeks or months.  No need to rush as the economy is just now slipping into formal recession.” – Red Sky Report June 23^rd, 2022

Nothing has changed from that view.  Longer term investors should stay focused on the objective of adding money to investment accounts as this bear market creates more attractive valuations and opportunities over time.  We will also reiterate that investing in a diversified portfolio across multiple asset classes and styles (stocks and bonds, domestic and international, small caps and large caps, developed and emerging markets) is smart and important.  Remember, nearly everything is trading at a discount from recent highs.  What a wonderful time to pay attention to the internal balance of your investment portfolio! New money even might be used to get rebalanced by adding to positions that have experienced larger losses in the last two years.

We have also advised our clients of opportunities to add cash to investment accounts twice in 2022.  The first was in mid-March with a conditional warning to only add 1/3 of your annual savings goal.  We stated then that stocks are likely to make new lows and conservative investors could wait for a better time and place.  The second opportunity to add to investments was the 23^rd of June in our Blog post where we recommended adding another 1/3 of your annual savings’ goals.  We are now approaching another obvious time and place to consider adding to any investment accounts.  I will hedge again and say that stock selling pressure can easily drive prices still lower, but the technical condition of the markets is extremely oversold as of today September 1^st.  I choose Half Full!

I hope everyone had the greatest summer ever.  Personally, I’m looking forward to the fall and seeing many of our clients in person (finally) at our annual meeting in October!

Regards

Sam Jones

 

June 23, 2022

The second quarter of 2022 was one for the record books.  There are a lot of obvious things happening today creating fear and anxiety among investors as the markets “price in” the reality that the US economy is heading into recession (perhaps already there).  What lies beneath the surface is what interests me now as we look ahead to a market environment with a new set of opportunities.

The Obvious

Let’s get this out of the way.  We are in a global bear market.  Stock markets across the world put in long term price peaks between November of 2021 and Jan of 2022.  Since then, the only things going up are commodities, energy and anxiety.  Bear markets tend to create a lot of wealth destruction.  Here in the US, estimates suggest that $2Trillion in market capitalization value (aka investor wealth) has been destroyed thus far in 2022.  You might remember my warnings back in 2020 that stimulus in the $Trillions would eventually find its way into the stock market and be destroyed by the next bear market.  Well, here we are!  Not all of the $4.5 Trillion in stimulus was destroyed but let’s say half for easy math.

To illustrate the point, look at this chart of small options traders, specifically after 2020 when stimulus money was delivered during COVID.  Yes, some of it went to covering lost incomes, paying for much needed food, etc.  But, make no mistake, billions of dollars went into the stock market via investors who were day trading options at home.  Obviously, they had no idea what they were doing and are now sitting on massive losses.

 

As of last Thursday, the S&P 500 was down 23%, and other indexes are worse, down 30% or more.  The average bear market in the S&P 500 shows a standard loss of 28%.  Remembering how we calculate averages; it would be wise for us to assume that the final low may not be in, but we could certainly be two-thirds of the way there.

Last week rattled every investor’s cage.  Statistically, according to the fine work of Sentiment Trader.com, the seven market days leading to the final low on June 16^th marked the worst selling pressure since…. 1928.  Extreme selling pressure is measured when more than 90% of stocks decline on any given day.  The particularly good news is that these type of capitulation events where investors sell everything indiscriminately, tend to be exhaustive events that occur at, or very near, significant market lows.  More on this in a minute.

Also, on the list of the obvious is losses in Treasury bonds.   From the highs in the year 2020, long term Treasury bonds are down almost 40%.  Wow!  The Lehman Aggregate Bond index is down 12% in the last year and losing over 7% per year since 2020.  We have not seen bonds and stocks lose together like this since our last bout with inflation in the 70’s.  For the last 4 decades, bonds have moved inversely with stocks and buffered total portfolio losses to something tolerable. Investors who have no other form of risk management (outside of holding bonds) are feeling this bear market in full.

The Fed is inducing a recession.  As we heard from Chairman Powell in his congressional testimony yesterday, this is the only way to contain the sharp rise in the rate of inflation. They are probably right about needing to induce recession as inflation becomes a greater worry, but they are OBVIOUSLY very late to the fight.

Inflation is still rising on many fronts including core inputs, COVID related industries and especially rents. The idea of too much money chasing too few goods (definition of inflation) is just now starting to revert to a healthier equation; Less money is now finding some or enough supply. And yet, there is still an obvious imbalance that needs to be resolved. Don’t expect the Feds to be your friend anytime soon.

Inflation is very tough to contain once it has been let out of the bottle.  As I said in the last update, demand is obviously drying up daily for everything from housing and mortgages to consumer goods and services.  Inflation numbers from here are not going to be as strong as what we have seen in the last few months and quarters.  In fact, the rate of inflation may be peaking right now.

The obvious state of the financial markets and economy is pretty terrible today.  Now let’s turn to what is not so obvious and see some of the new opportunities that are developing quickly.

Beyond the Obvious

Looking across the spectrum of technical market research that we follow, I see between 3 and 5 other instances of oversold extremes in history that match the current environment.    In all cases, the markets were higher by a minimum of 24% and as much as 48% over the course of the next 12 months.  Those are high odds.  Most investors who don’t understand cycles and markets might see a headline about pending recession and think, “OMG, I’ve got to get defensive or run to cash”.  Counterintuitively, markets tend to carve out long term BOTTOMS within 2-3 months of the first headlines recognizing the arrival of a Recession.  Remember, the markets are an excellent discounting mechanism and have been selling off dramatically for over 12 months in anticipation of today’s condition.  Aggressive and opportunistic investors are now allowed to start looking for new leadership and bottoming patterns in their favorite stocks, sectors and indices with an eye toward long-term buying opportunities.  To be clear, we are not buying the dip, we are looking for a window to start gradually buying into the bottom of a devastating bear market!  This window is not a small window but could take weeks or months.  No need to rush as the economy is just now slipping into formal recession.

Thoughts on Bonds

This is the time and place for the Treasury bond market to find a lasting bottom.  Here we have some urgency as bonds are already outperforming stocks by almost 8% in the last 30 days.  As I said in the last update, bonds are now behaving well and offering investors some much needed diversification juice in our portfolios.  Bonds tend to be the best performing asset class during recession.  Now that Treasury bonds have sold off by double digits and are paying reasonable interest rates again, we can and should consider allocations here.  Again, this might not seem intuitive or obvious as the Fed is headlining with the big fight against inflation as we speak.  This Federal Reserve board is so late in their habits that I won’t be surprised to hear them plan to cut interest rates just as the economy is emerging from recession.

Top in Energy and Commodities

We have heard for the last year that oil is going to the moon.  We have heard that the war in Ukraine will never end and that investors should be overweight in energy for the foreseeable future.  This week we sold the last of our commodities and energy positions across all strategies and we’re happy to be taking profits in something!  Russia has largely accomplished what they set out to do – destroy Ukraine.  Russia has also earned it’s spot as global bad guys for the next several decades.  They will suffer for it just as Germany did post WWII.  Given that the war could end quickly and quietly any day now, we think it’s a grand time and place to take profits in energy.  Gas prices will also find a top in the next 30 days if the patterns follow, just as President Biden comes to the rescue with a national holiday on gas taxes which are projected to save good Americans a total of $13 over the course of the holiday.

It has been an incredible run in energy and commodities but enough is enough and the set up for future gains from here are pretty poor as the cycle moves very quickly toward contraction and favors non-cyclical sectors and asset classes.

New Opportunities

From a cycle standpoint, the market is beginning to look across the chasm of recession and toward recovery.  The first sectors to find traction and lead the charge out of any bear market are financials, consumer groups and technology.  All three have been beaten to dust in the last year.  Nevertheless, our focus should be on these not so obvious sectors looking for strength and leadership in the months to come.

Yesterday, I did my own study on different investment themes that have been outperforming the S&P 500 over the last 30 days.    Several of these groups did not even make a new low last while the broad market plunged to new lows by 5-6%.

These are the results:

Select technology- cloud computing, software, internet, fintech, clean energy, and telecom

Select consumer – consumer staples, consumer discretionary, and retail groups

Healthcare – Pharma, biotech and healthcare services

China – all

Emerging markets – all

Bonds – corporate bonds, municipal bonds, treasury bonds, investment grade bonds

Dividend growth funds

Large cap and mid cap growth funds

Preferred stock funds

With the exception of financials, looking at this list, I see the market quietly starting to accumulate new investment in sectors and asset classes that should perform well during recession and early recovery.

As we close out this quarter, try to remember that the markets are just one very large cycle.  There are up cycles and down cycles.  This is not the end of days nor time to hide.  These are the times to look for discounts and long-term entry points for your hard-earned investment dollars.  Honestly, I don’t expect to convince anyone of the pending opportunity now any more than I could convince someone to sell their Tesla stock above $1200 in 2021 (You know I tried).  Investing is anything but obvious which makes it so difficult.  As always, we are here to help and guide you.  Please reach out if you would like to talk through any anxiety, concerns or need help with your outside investments.

Happy Summer Solstice and Go Colorado Avs!

Regards,

Sam Jones

“Compound interest is the eighth wonder of the world. He who understands  it, earns it … he who doesn’t … pays it.”
― Albert Einstein

Investors would do themselves a huge favor by spending a little time on the basic math behind compound returns.  We tend to forget why this is important until we start to recognize risk and volatility in our investments.  It is never too late to revisit the 8^th Wonder of the World and apply the concept to concrete investment ideas like dividends, risk management and real wealth accumulation over time.

The Math – Average Returns versus Compound Annual Growth Rates (CAGR)

Let’s give a quick example and then explain the results.

Please excuse the crude spreadsheet but the numbers are accurate.

Above we have three investors (A, B and C).  Each investor has a different portfolio of holdings.  Investor A earns a fixed return of 5% during each of the three years.  Investor B has a portfolio that earns the SAME average return mathematically, over the three years but does so with a more volatile series of returns.  And investor C has a Robinhood account, owns crypto currency and is swinging for the fences with unproven growth stocks.  Still investor C, generates the same average return of 5% on paper despite the increased volatility.  But each of these investors do not actually experience the same real returns as in returns that they can spend each year.  The Compound Annual Growth Rates (CAGR) for each investor are shown above.  Investor C clearly earns a lower real compound return compared to Investor A or B.  Think of CAGR as the real returns that an investor earns on their investments and might be able to spend to offset living expenses.  Average returns are mathematically deceptive because they do not reflect an investors’ real experience, wealth or purchasing power.  Why does higher annual volatility in a portfolio reduce compound annual returns?  I’m glad you asked.

The Merciless Math of Losses. 

Quiz – If I lose 50% of my investment during a bear market, how much of a RETURN is necessary to break even?

Answers:

1. 50%
2. 100%

If you chose Answer B, then you understand it takes a greater return than the amount lost to break even due to the fact that you have less capital working for you at the lows of any decline.  If I had $1 and lost .50 cents, I would need to make back .50 cents just to break even, right? (100% return on .50 cents)

The greater the loss, the greater the return needed to just break even.  Think of all those stocks like Peloton that lost 97% recently.  It would take a return of over 900% just to break even if you lost that entire amount (not in your lifetime, that company will be bought shortly).  Many stocks these days are down well over 60% including some giants like Netflix.  Indeed, these are lessons to be learned the hard way for some.

Implications for All Investors

The point of this critical lesson in financial literacy is this.  If we want to improve our Compound Average Growth Rate (CAGR), which is the only true measure of wealth accumulation over time, we should constantly focus on building portfolios that earn consistent returns over time and find ways to mitigate or reduce annual volatility.  Ok, so how do we do that?  What tools do we have in our process, our selection or portfolio design that will help generate consistent returns (aka high CAGR)?

CAGR Seeking Investment Solutions

1. Own dividend and income generating securities.

I can’t say enough about the value of earning dividends and income in any investors’ portfolio.  Consider this.  In the last two calendar decades (12/31/1999 – 12/31/19), the S&P 500 index with dividends earned a Compound Annual Growth Rate of 5.98%.  Without dividends that number was only 4.03%.  Dividends accounted for exactly 33% of the total returns over time.  I would not personally consider the S&P 500 to be a high dividend index, but it does have a history of paying between 1.5 and 2% annual dividends as an index.  Now imagine over a long period of time what we might generate in CAGR if we invested the bulk of our capital in an actual high dividend ETF or index.  We own many of these in our All Season strategy so I’ll list a few holdings and their current annual dividend rates.

• Ishares Core High Dividend ETF (HDV) 3.47% annual dividend yield
• SPDR S&P High Dividend ETF (SPYD) 3.72% annual dividend yield
• I Shares Select Dividend ETF (DVY) 3.24% annual dividend yield

*All three ETFS above are positive YTD by 7-9% in a market that is down double digits.

Chart of DVY (shown in Red) versus the S&P 500 (shown in Green) YTD.

Already we are seeing high dividend paying securities outperforming the markets in absolute terms but importantly they are also generating their returns with far less daily and weekly volatility than the market.  This is an example of consistency and the benefits of real CAGR results at its best!

For what it’s worth, our MASS income strategy which focuses 100% on high Dividends and Income generated from stocks, alternatives and bonds, continues to generate an annualized yield of over 6%.  I’ve said this before but this is just gold in an inflation driven environment like today.

2. Diversify!

It is sort of sad to me to see how many investors are sitting with undiversified portfolios these days.  I only see portfolios of stocks when new investors come to our firm.  Never bonds, never gold, never alternatives, or non-correlated holdings.  Always Technology, always concentrated positions and always a pile of identical stock index securities.  Admittedly, bonds have not served their historical role as a good diversifier in the last two years as bonds have lost as much or more than stocks since early 2021.  But, But, But!  Bonds are now returning to their place in line.  Bonds are beginning to behave themselves and actually move differently than stocks (non-correlation).  That is a tremendous breath of fresh air.  Gold is still moving in sync with stocks but historically has also been a great diversifier. Commodities are the real diversification winner in the last 24 months, as we know, but I never see commodities in anyone’s portfolios except for our clients.  Some think Crypto currencies offer diversification.  However, the evidence would suggest that Crypto is just negatively correlated to anything that goes up (wink).

Regardless, this is a great moment in time to revisit your asset allocation mix and make sure to truly, really, and honestly diversify your portfolio.  If you need help as a DIY investor, please call us asap.  The direction of the markets and economy from here is not going to be pleasant to investors who don’t get this right

3. Risk Management

The final method of seeking consistency and a higher CAGR, is to trade away volatility and this is not something I would recommend unless you know what you’re doing.  Very publicly, I reject the notion that this is impossible.  We have 27 years of data and historical performance to prove it.   People like Warren Buffet and George Soros have done so successfully for decades.  Markets are inefficient enough and run to obvious extremes often enough that there are clear opportunities to “manage” volatility.  Sometimes we want to reach for volatility, like at market lows.  Other times we want to reduce our exposure to volatility at market highs.  Of course, it can be done successfully and repeatedly, but it’s a ton of work and involves a lot of skill and experience.  If you feel capable, have at it.  If you want us to do it, call us.  Otherwise, seek consistent CAGR returns with #1 and #2 above.

On the Main Stage

               I’ll finish with a brief update on current conditions and trends as well as a few predictions which I am always reluctant to make.  The economy is slipping toward recession.  There is little doubt this is happening and the possibility of the Federal Reserve somehow avoiding a recession is nearly zero in my book.  We are already beginning to see the labor market cool off with lower payroll numbers and slightly higher unemployment this month.  More layoffs are coming in bulk, especially from the tech sector.  Those who remain employed however will still be able to collect higher wages and salaries especially in higher skilled industries with high demand. I suspect the work from home thing might also be coming to an end for a lot of companies.  It was fun while it lasted right?   This is not the end of the world but rather a cyclical event that occurs every 5-7 years.  We haven’t had a lasting recession in over 12 years so we’re way overdue.

Real estate is doing what it always does.  Trends in pricing and sales tend to follow behind the stock market by 9-12 months so we would expect to see some weakness starting about now.  You will likely hear about rising inventories of unsold homes, a shift from a seller’s market to a buyer’s market and some price declines in high flying areas of the country.  Income properties, like fully occupied commercial or residential rentals, are really in the sweet spot against high and steady inflation, so those types of assets might continue to appreciate.  This should not come as a surprise to anyone.

Meanwhile, the Fed is going to raise rates again by .50% next week on the 15^th.  They are driving the economy into recession, make no mistake.  It’s the only way out of the inflation bubble we’re in.

Inflation is also starting to peak in terms of the rate.  But remember, that inflation is only reported as a rate of change, year over year.  If inflation goes flat from here and for the next 12 months, we will still be operating in an environment of very high costs of living.  It is not until the inflation rate drops dramatically over a period longer than one year that we will really start to feel some easing in pricing pressures.  In the end, as I indicated several months ago, we will probably have to wade through a tough cycle of “Stagflation” (stagnant economy with inflation), something like the 70’s.

The thing to remember as we move into this next stage of the economic cycle, is that it is just another season or cycle.  There are opportunities and risks in every cycle.  Our job is to be awake and alert to changes in the environment and simply allocate our assets and resources appropriately.  Easier said than done but that why we are here to help.

That’s it for now.  Summer is coming fast!  Enjoy it.

Cheers,

Sam Jones

May 20, 2022

We have returned to an era that is going to be quite different from anything we have seen in the last four decades.  For the last forty years, the US markets and economy have increasingly focused on one primary theme: Growth.  When I say growth, I’m really talking about technology and innovation aimed at consumers.  Looking backward, our economic and market cycles were either growth, or not growth (aka recession) all measured by consumption and GDP.   Clearly now, we are embarking on a different game of winners and losers with a different set of rules, and it seems investors are still struggling to adapt their attention and capital allocations.  I am hopeful that this update might help to reframe investor focus and for our clients, provide a better understanding of why we are allocating your investment assets as we are.

The Big Three Revisited

Regular readers know that we have been focusing our clients’ investment capital across three themes for almost exactly two years (since April of 2020).  In short, these are:

Value over Growth

Commodities Bull Market

International Outperformance

I’ve a talked about these in several ways including Reflation, Reversion and Recovery themes which you can find HERE.  Another way we might answer the question “Why These Three?” can be seen through the lens of scarcity.  Scarcity is something we are all becoming familiar with when we think about all the things we want to buy, but cannot get (That special car, bike, building materials, windows, employees or even more fundamentally certain foods).  Supply shortages are a common topic of conversation usually beginning with the phrase, “I can’t believe I can’t get……”.  And the affect of supply shortages and scarcity are also becoming engrained in our day to day lives in the form of higher prices for everything (aka inflation).  Scarcity is by definition, a decrease of supply and good econ students know that when supply falls, prices rise.  Eventually, rising prices lead to a fall in demand (aka recession) as the market is always working to find “equilibrium”.

Please forgive the econ lesson but there is an important principal here for all to understand.  Eventually at some point in time, demand will fall.  You have heard that the Federal Reserve is raising interest rates.  They are doing so to increase the costs of borrowing, thereby increasing pricing even further, hoping that demand will respond lower.  The Federal Reserve wants to SLOW DOWN demand without putting the US economy into recession (two consecutive quarters of negative GDP).  Personally, I don’t think the Feds need to raise rates as much as projected.  Consumers are already feeling the squeeze of near hyper inflation and at the tipping point of cutting back on their spending habits as much as they can.  Demand will fall all on its own from here forward with or without the Fed.

Ok enough Econ and back to the point.

Looking at the investment environment through the lens of scarcity provides us with some clear guidelines and preferences when considering where we should park our capital.  I’ll present the framework of Scarcity from different perspectives with investment implications.  Of course, any advice given should be considered within your personal situation, portfolio, tolerance for risk and so forth.

Scarcity of Natural Resources/ Commodities

I think some of the absolute best work done in this space has been produced by Crescat Capital, here in Denver through the research of Tavi Costa and Kevin Smith – www.crescat.net .  We know that commodity prices entered a new bull market almost exactly two years ago in May of 2020.  The COVID decline in prices at that time set the stage for commodities in aggregate to put in a final low after declining 75% in value over the previous 12 years. 24 months later, commodity funds are up 160% in the aggregate.  This new bull market in commodities is in the early stages contrary to what you might hear.  Inflation as stated by CPI will go through cyclical ups and downs but the fundamentals and backdrop for commodity prices to run higher for years is likely to persist.  The backdrop is again about scarcity.  There are a couple charts available at Crescat Capital showing that the commodity cycle relative to equities expressed a ratio is just now turning up from a multi-year low and has a long way to go.  Commodities are highly likely to outperform equities for years to come.

Unlike all other areas of the market like finance, technology, healthcare, etc., we have also witnessed a dramatic drop in capital expenditure (Capex) in commodity producers in the last 10 years (see below).  In simple terms, this means, globally, we have not invested in capacity (potential supply) among commodity producers, and it will take years to rebuild that capacity to meet current demand.  Even if we see a drop in demand via a recession, commodity producers are still unlikely to be able to produce enough raw materials (metals, basic materials, oil and gas, wheat, corn, soybeans, etc.). This does not even account for disruptions from wars, climate change, nationalism, etc.  Scarcity among commodities will drive prices higher.

Investment implications should be pretty clear; For those with capacity and willingness to invest in a truly diversified portfolio, you would want to keep a healthy allocation in your portfolio to:

• Broad based commodities funds and ETFs
• Metals and Mining stocks or funds including gold, lithium, rare earth metals, aluminum, steel
• Agriculture producers and soft commodities funds
• Energy distribution companies

Thankfully, there are many to choose from that do not issue annual k-1’s to shareholders!  We are maintaining an overweight allocation to commodities and commodity producers for our clients in all investment strategies outside of our pure income models.

Scarcity of Good Income-Bearing Investments

This is a sore subject for any retiree who is feeling the pain of rising costs of living (8-9%) while secure Treasury bonds are paying at best 3%.  What are they to do?  A heavy stock allocation is not particularly appealing considering the risks and volatility involved but Treasury bonds are also down 10% and only paying 3% annual interest.

This situation has evolved from 40 years of an accommodative Federal Reserve who remains committed to dropping rates to near zero every time we get a hiccup in economic growth.  The chart below is of the interest rate on a 10-year US Treasury bond.

Now, with real rates (interest rate minus inflation) solidly negative, we have come to a hard place and time.   Again, we want to reframe the discussion and invest in scarcity.  In this situation, we need to call on a diversified portfolio of dividend, preferred, fixed and variable income producers in order to push up our annual income without taking on full stock market risks.

Our investment solution to this form of scarcity is our Multi-Asset Income (MASS Income) strategy designed exactly to solve this challenge.   To date, the strategy has generated a little over 3% in dividends and income paid monthly to our clients’ accounts.  This is an annualized rate of over 6%, not quite the current rate of inflation but very attractive!  We have set the default for income and dividends to be paid to cash rather than reinvested in additional shares.  Cash dividends and income in hand give you a lot of options.  The strategy attempts to remain fully invested and as such there is price volatility in the underlying holdings (39).   Investors in MASS Income need to be prepared for their balances to fall in environments like these.  BUT, we are ultimately focused on these securities continuing ability to pay their monthly dividends and interest to shareholders.  Think of it like a rental property we intend to own for a long time.  We do not really care about the market price of our rental property from month to month, but we do, and should, care about keeping our properties occupied and paying regular rent.  So far, so good. All “tenants” are paying full and rising rents in our portfolio!

Scarcity of Value

Just as it sounds, the current investment environment is short on real value (valuable) investment options.  What is value?  Value is something that appreciates over time or has current utility for us today.  Back in 2010, there was a surplus of value to be found as prices of mega cap growth names were trading at very attractive levels.  After 11 years of massive price appreciation, these same stocks became value(less) despite the fact that the companies themselves continue to provide great value to their users (Tesla, Amazon, Apple, Meta, Netflix, etc.).  In fact, the vast majority of stocks on the growth side of the market moved higher in sync to outrageous valuation levels.  Now, 18 months after the peak, we see what happens to overpriced securities when the tide turns against them with prices down 30-90%.  But here’s the important thing to understand.  Real value is still scarce.  Growth names are still unattractive, do not pay dividends or interest and are in the wrong type of business for the new era.  If you think about it, do we have scarcity of mobile phones (Apple)?  Is there a scarcity of streaming content to watch (Netflix)?  How about Electric Vehicles (Telsa)?  Or Cloud based service providers (Microsoft, Google, Amazon)?  Is there a scarcity of social media outlets (Meta)?  Meanwhile, there are companies out there who are directly in the business of providing scarce resources that everyone needs (not wants) and offering investors great values with stocks at attractive prices, paying regular income and dividends today.  The current environment offers discriminating stock pickers an opportunity to remain invested in “Value” as we do inside our Worldwide Sectors strategy.

I cannot provide individual names here but generally speaking, our Worldwide Sectors individual stock holdings (18) have valuations that are 40% less than the S&P 500 in aggregate, are outperforming the markets over the last 3-6 months in price action and paying 2-5% annual dividend income.

I have to throw in the potential of Internationals and Emerging markets here as well.  Admittedly, outperformance by international investments has been hard to spot.  The war in Ukraine might have created a delayed game here.  Rising interest rates are also tough on emerging markets and less developed countries who rely heavier on debt spending.  And above all, a very stiff rise in the value of the US dollar by 13% in less than 12 months has made it even tougher on performance.  And yet, despite all the headwinds, global indices are actually performing better than the US markets YTD and especially since the last FOMC meeting on May 6^th.  In fact, Brazil (keeper of global raw materials and natural commodity resources!) is up almost 18% YTD.  Mexico is also slightly positive YTD, and others like Australia, Canada, Spain and the UK are not far behind.  There is something brewing here.  By all signs, it seems likely the headwinds facing internationals are on the tipping point of reversing.  But the most important thing to remember is that internationals are trading at nearly 50% of the valuation of the broad US stock market.  Invest in scarcity and real value is scarce!

Looking the Wrong Way

I love this image.  I feel like investors these days are like the whale watchers on this boat, peeling their eyes for a return of the WHALEs (like Amazon, Meta, Netflix, Apple and TESLA).  Meanwhile, new whales are breaching regularly on the other side of the boat.  It’s time to turn our heads and recognize the new leadership.  Scarcity is driving opportunity for those willing and able.

We’re here to help as always.

Have a great weekend and know that you are in good hands.

Sam Jones

May 12, 2022

I keep this on a sticky note on my desk.

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Lizard Brain noun:

The part of the brain to which primitive, nonrational, or self-interested behavior is attributed.

“Your lizard brain thinks the world is ending while your more rational side can see that you’re in no real danger”

____________________________________________

What a great moment and time for a mental check up as recent market declines are setting up another one of those very special buying opportunities.  Will you be emotionally ready to be an investor when you need to be?  It is officially time to banish the Lizard Brain!

Empathy for All Investors

Trust me when I say I feel your pain.  Every professional money manager is also a human.  Those who do not learn how to manage their emotions that go along with market volatility usually don’t last long in our business.  I have learned to read and observe my emotions but work every day not to act on them.  Instead, I rely on evidence, systems and a set of rules that has served us well over many years.  Regardless, I want to acknowledge how hard it is to be an investor of any sort in times like these.  It feels dark, hopeless and everything we read and hear speaks of more evil to come.  We are almost relieved when we see that stocks are ONLY down 1% on the day.  We stop looking at our accounts because we don’t want to see the new lower balances.  We think about all the mistakes we have made or the money we spent frivolously in the last few years.  Why didn’t we save more for this rainy day?  There is also a bit of anger in the mix.  Someone did this to me!  Big guys are screwing the little guys again!  In the end, we want out of this emotional state, we want to eliminate the pain and thus we find ourselves ultimately bowing to the Lizard Brain in some act of capitulation.  Investing successfully over a full cycle of bull and bear market conditions is a challenge.  Anyone who thinks otherwise, hasn’t been doing it for long enough yet.

Data

I am an evidence-based investor, or at least I like to tell myself that.  Evidence can help us through tough emotional situations because it gives us better odds of success, if we are strong enough and have enough conviction to simply follow current trends as they unfold.  I am going to give you a few important data points to consider surrounding the current condition of the US stock market.  My hope is that you can push the Lizard Brain away to some degree.

% of Stocks Trading Above a 200 day Moving Average

This is one of the indicators we monitor to identify intermediate and long-term oversold conditions.  Without boring you with the technical details or God forbid a chart, know that this indicator has fallen to 15 or below only 9 times in the last 35 years.  Today the indicator hit 18 and it’s likely we are going to make history again when it tags 15 or less – this month, this quarter, this year?  Literally, this means that only 15% of all stocks are NOT in bear markets and it takes a lot of price damage and a lot of time for the markets to get to this oversold level.  Needless to say, all 9 times in the past have been the bottom of terrible bear markets, crashes and other Lizard Brain events.  Now if we had an evidence based, high probability opportunity to invest at the bottom of every bear market, wouldn’t that be great!  While there is still some work to go, we are getting to that place and time quickly and you should know that empirically speaking, much of the price damage for this bear market is already behind us!  There will likely be lower lows and a period of base building before prices get up and start a new bull market.  I won’t venture a guess on timing at this point, but we need to be ready when we see that very special headline – “Recession is Here”.

Bullish Sentiment Hit a Multi-Year Low Yesterday

Again, the evidence is piling up that even in the short term, the probabilities favor at least a healthy and shockingly strong rebound rally over the next two months.  Investor sentiment is one of the Lizard Brain indicators that seems to stand the test of time, according to the venerable Jason Goepfert of Sentiment Trader.com.  Jason does outstanding work measuring the spread between “Smart” money and “Dumb” Lizard Brain money.  Smart money gets bullish and aggressive at lows (good) while Dumb money sells at lows (bad).  When the spread gets very wide as it is today, we typically see stocks bounce strongly within a few days.  For what it’s worth, Jason notes that this is the 11^th lowest reading in the Dumb money index since 1998.  Of course, these are the same times and dates as our % of stocks trading above a 200-day moving average, indicator above.

Capitulation Panic Selling This Week

One more big one, perhaps the biggest one, to add to the pile.  When the Lizards start panic selling in volume, we know that fear has turned to action.  When all sellers are done selling, there is a vacuum of sellers, with deep price discounts and only buyers left.  Today, sellers are still selling but they are almost exhausted in their efforts (nothing left to sell, 100% in cash? not worth selling something that is down 92% like Peloton?).  This week, and last, we saw panic selling in volume.  The crypto crowd that talks about HODLing (Holding On for Dear Life) is panic selling.  Those who owned all the high-flying crazy valuation technology stocks, panic sold.  And now we are finally seeing real selling in those safe technology names like Microsoft, Google and Apple as they race to catch up to Netflix, Tesla, Facebook and others already in bear markets.   Bear markets take no prisoners.  For the very aggressive investors who can sift through the wreckage and find good companies with strong revenues that are now trading at book values, there are some diamonds out there.  We bought seven new positions in the New Power strategy today and added to several others that we purchased last week.

Don’t Forget Bonds

Bonds also appear to have found an intermediate term low in the last week which is contrary to what you might expect given all the inflation headlines and the Fed raising interest rates on May 6^th.  Treasury Bonds are now beginning to price in the realities of recession in 2023 as they always do 6-9 months before recession actually arrives.  As you know, we have been (re) building our Treasury Bond position for the last couple of weeks and they are finally responding nicely (up 2-4% this week alone).  Investors have been especially beat up this year since stocks and bonds have both moved in sync (down) as they will until inflation calms down.  But for now, bonds are giving us the green light and offer investors a nice place to be outside of stocks.  Commodities are still behaving well, up again today and yesterday while stocks are down down down.  Diversification is another weapon to help fight the Lizard brain.

So, it is raining Lizards right now, they are crawling on the walls, in your car, on the radio, behind your pillow keeping you up at night.  Banish them, get in the drivers’ seat of your own mind and try to recognize opportunities as they unfold.

I hope you are getting outside, it’s nice out finally!

Cheers

Sam Jones

 

 

 

 

 

 

May 9, 2022

As promised, we will be talking about housing and real estate trends in this update. That discussion will segue towards the one investment approach that continues to shine in this “no where to hide” market environment.

Highlights of the Last Two Updates

I would like to take a second to review, in bullet form, the highlights of the last two posts because I’m hearing some bad interpretations of what I clearly said. I will simply cut and paste select exact words for your review.

Calling All Cars #1 – Red Sky Report May 2nd

• Investors have the opportunity to add to stock or bond allocations, preferably at once. 
• It is our expectation that the stock market will remain under pressure and choppy until midterm elections in November.
• If you are more on the conservative side, there should be other opportunities to add to passive accounts throughout the summer and into the fall of this year. 
• I plan to allocate any new money across all assets held in these investment accounts in order to maintain a desired diversified mix of securities. (The current mix in my kids’ 529 education accounts are 36% stocks and 64% bonds which represents the “conservative growth” strategy suggested by College Invest for students of their age -18 and 20).

This is the confirmation of me adding to my kids’ 529 plan accounts today – 5/9/2022

The Gravity of the Situation – Red Sky Report April 29^th

• Gravity is real and valuations ultimately do matter.
• The condition of the economy is also clearly moving from full recovery to early recession.
• Stage 6 is also the time when we see the most wealth destruction as stocks (all stocks including value) can enter the realm of real bear market losses. (We are entering Stage 6 quickly)
• #1 Start reducing your stock exposure all together
• #2 Consider reducing, but not eliminating, inflation hedges, commodities, and hard assets
• #3 Use the proceeds from #1 and #2 to rebuild your bond position                                                                                                                                                                                                                                           

Hopefully, that is pretty clear advice and might help our clients understand our perspective on the markets and the changes we are making now to accommodate current conditions in our active risk managed strategies. Ok, now on to Housing and Real Estate trends.  

Real Estate Trends 

I’ve changed my mind on real estate. Historically, real estate has done well or at least stayed stable during periods of high inflation. Real estate is after all, a hard asset and hard assets tend to retain their value during inflation. In recent weeks and months, we are starting to see the primary drivers of price gains in real estate reverse course. At this point, I think real estate will follow the path of the US stock market with a 6–9-month lag. Let’s go back in time and review the perfect confluence of four variables that drove real estate prices exponentially higher in the last 36 months.  

Free money – Stimulus from the Federal government following the Covid shut down, put $Trillions into the hands of consumers and artificially increased the US savings rate to over 12% in a very short period.  Let’s go shopping for a new house now that we have a larger down payment! 

Work from Home – Covid also drove workers and students to spend more time in their homes. We need more room! In addition, Covid offered some a chance to relocate to more desirable locations especially as remote work became more permanent in certain industries. YOLO! (You Only Live Once). 

Interest Rates Held at 0.25% for way too long – The Federal Reserve dropped interest rates to near zero on March 16^th of 2020. Mortgages followed and remained artificially low for almost two full years. This was happening even while inflation was ripping higher at 6-8%. Logically, home buyers jumped at the opportunity to bid up homes that were rising at 15-20%/ year in price using borrowed money that was still stuck at 2-3%.  

Supply of Homes for Sale Stuck at Historic Lows – This is a tired story but true, nonetheless. The available stock of homes for sale, compared to the demand for homes in the US, was historically imbalanced for the last two years for a variety of reasons. Mostly, there was a shortage of new construction that dated back to 2018 when rates were actually much higher. COVID shut down building and the availability of building materials for about 18 months even while demand was exploding.  

Now fast forward to today. All four variables have almost completely reversed, and yet home prices are still suspiciously hovering at the highs. As a reminder, I do believe in gravity. Good consumers in the US have done what they always do when provided with cash stimulus payments from the government; They spend it all. The year over year, US saving rate shown below, is now back down to 6% which was the pre-pandemic low from a high of 12%. We smart investors should not expect demand for housing (or anything else) to continue at the current pace now that the savings rate in the US is back to “normal.”   

Interest rates are obviously on the rise now as well putting affordability into reverse. Look at the chart below and understand that even before rates went vertically higher this year, affordability based on mortgage payments has been falling since 2020 as prices for homes rose commensurately. A 30-year fixed mortgage was 3.11% in January of 2022. Now that rate is 5.2%.  

Finally, the supply of homes for sale is likely to rise dramatically between now and next fall.  If all the real estate (single family, multi-unit, commercial) currently under construction are completed over the summer, we will have more supply than any time in modern history.  

Without trying to forecast, and just observing current trends, we can make a logical assumption that real estate prices should fall to reflect a reversal in all of the drivers of recent price gains over the last several years. I’m not smart enough to know how the remote worker thing is going to resolve but that by itself is probably the least influential variable to current housing prices.   

What To Do About Your Real Estate Holdings? 

For most, the answer is do nothing. Your primary residence is your home and not some commodity to be traded. You need to live somewhere, and rents are quickly rising to reflect current housing prices paid. This commentary should not inspire you to sell your primary residence by any stretch. However, from a financial planning perspective, we can and should admit a few things looking forward: 

1. You will be in your current home for a while. The music has stopped, prices will fall, and you should get comfortable where you are – maybe a suitable time to do some DIY home upgrades.
2. If you are overstretched and own more real estate than you want, need, or can afford, you might consider reducing your real estate inventory. Get this done quickly.
3. Rental properties should be held! As I said rents are rising and these properties generate much needed additional income while inflation is chewing away at your earned income or assets. Rentals are GOLD in these environments as long as you do not look at or care about the values of these properties. Keep your long-term goggles firmly in place and work to keep your rentals occupied.
4. Falling real estate prices can have a negative wealth effect. Be aware that if we all feel less wealthy because our homes have seen some price decay, this can impact our other spending behavior and general optimism toward the economy and investing just as it did in 2007-2009. Real estate has become another investment for most, often quoted regularly in net worth conversations. Be aware of your psychology here; best to emotionally unhook from the value of your home if you can.

Investing in High Dividends/ Income  

You have heard me beat the drum on this for a while now. Dividend paying stocks, funds, closed end funds, ETFs, preferred securities, and master limited partnerships are a lot like rental properties. They are currently and historically the inflation fighter of choice, outside of pure inflation hedges. My benchmark for security selection is a minimum of 3-5% in annual dividends. Yes, there are many securities out there paying those annual rates as regular monthly or quarterly dividends. Our job is to identify them and research their continued ability to maintain or grow their dividend payouts to shareholders.  

Our Multi-Asset Income strategy (MASS Income), established near the lows in April of 2020, does exactly that and boasts a 6.2% annual dividend stream across all securities held in the strategy including our current 10% cash position. Comparatively, the rate of inflation is still running above 8% but that number should drop in the months to come as year over year comparisons will become more reasonable. There is compelling evidence to suggest that inflation will stabilize between 4-5% as we get closer to the end of the year which is still more than twice the historic rate of inflation for the last couple decades! 

Dividend payers are naturally those companies with high free cash flow, very little debt on their balance sheets, and are STILL trading at much more attractive valuations than the growth side of the market.  Dividend payers are a big part of the “Value” trade we have spoken of for the last year or two. I’ve heard some recent chatter about valuations becoming more attractive in technology and growth type investments now that prices are down 70-90% from the highs.  Sadly, there is still a long way to go before growth actually becomes attractive relative to Value. Technology for instance still represents over 27% of the S&P 500 as of last Friday where a normal weighting is closer to 16%. Meanwhile dividend payers found in the Energy, Utilities and Consumer staples sectors are still well below their historic weights in the broad market indices. There is a long way to go on the Dividend/ Value trade, perhaps years.  

Performance in the High Dividend ETF space has been excellent YTD in both relative and absolute terms.  

Please fee free to contact us if you are looking for high dividend payers for your own portfolio. We’d be happy to help you with some suggestions after reviewing your situation.  

That’s it for this week, enjoy the spring.  

Sam Jones 

 

 

 

 

 

 

 

 

This is a special update for those who are looking for guidance as to when to add to investment accounts.  Details to follow. 

Calling All Cars! 

We send this notice to our clients and interested parties when we see an opportunity to add to investment accounts when the markets are trading at a discount or have reached a notable oversold extreme.  The strategy in play here is most appropriately applied to accounts where investments are held passively (aka Constant Exposure) with a long-term time horizon.  These accounts might be taxable accounts held by high-income households where trading might generate unwanted short term capital gains.  Other accounts might not allow much trading, like 401k plans, active retirement accounts, 529 education saving accounts, or Health Saving Accounts.  As we mentioned in our last update, the best strategy for any and all passive accounts is to stay diversified and simply to look for lower risk entry points or discounts in the markets and use these opportunities to add to your investment portfolio.  This is not a buy the dip strategy, it is a buy the deep discount, oversold condition strategy.  Now on to the specifics. 

How and when to add to your passive portfolio 

Let me be clear that BOTH stock and bond markets are in deep corrections and selling pressure remains present in both asset classes.  We are faced with a rare environment, due to very high inflation, when stocks and bonds have both sold off substantially in unison.  Therefore, investors have the opportunity to add to stock or bond allocations, preferrably at once.   

This is a time to identify cash or available funds, put them into your investment accounts and begin adding to your passive investments.  There is not a single day or a time to do so but rather a zone and we are in that zone!  It is our expectation that the stock market will remain under pressure and choppy until midterm elections in November.  All things considered, there is certainly an above average risk that the entire global equity markets will be lower in the months to come.   If you are more on the conservative side, there should be other opportunities to add to passive accounts throughout the summer and into the fall of this year.  However, today we know two things.  1.  There is growing evidence that stock and bond prices are trying to find a solid level of support at this level.  And 2.  A discount is a discount.  This is our first zone in the year 2022 when we can logically add to our accounts based on a market that is now trading at a discount (12-20% off the highs for both bonds and stocks).   

I will also offer my personal strategy for adding to my own investment accounts now.  I plan to add approximately 1/3 of my intended annual investment additions within the next week.   I will be adding to my kids 529 plans in the next week, and I will be adding to my constant exposure taxable accounts in the next 72 hours with SOME available cash.   Finally, I plan to allocate any new money across all assets held in these investment accounts in order to maintain a desired diversified mix of securities.  For our clients, you can simply add to any accounts, and we will be responsible for the timing of all investment additions.   I also assume that there will be other opportunities to continue adding to accounts as we move closer to the end of the year so be on the lookout for future Calling All Cars! 

As Will Brennan, our capable CFP, likes to say, “control the things you can control”.    Adding money tactically to your investments when they are down and discounted is highly beneficial to your wealth accumulation and the compounding of your returns.  Don’t let a good crisis go to waste! 

Thanks for reading. 

Sam Jones 

April 29, 2022

April is historically one of the strongest and most dependable months of the year for market returns. Obviously, we are making history in the year 2022. Behind the losses for the month, we also witnessed something that I find very gratifying. We are finally seeing the markets return to a more rational, logical condition in a world where gravity proves to be a real force. Please excuse the victory laps in my commentary below. Clearly now, the economic and market cycle is shifting forward toward recession or Stage 6 (of 6). Asset allocations need to be changed to stay with the trends and follow new leadership avoiding new risks and engaging with new opportunities. For risk managed money, this is a time for action, not complacency. Conversely, passive investors or allocations to constant exposure strategies, should do exactly nothing beyond rebalancing, as prescribed.

The All Season Economic and Market Cycle

I describe this cycle as one for All Seasons because we need to remember that every “season” in the economy and the markets presents new risk AND new opportunities. It is true that there is always a bull market somewhere. Investors unfortunately tend to think that US stocks are the only investment out there. The season for global stocks and bonds is in Winter to stick with the analogy, while commodities have been in a well establish spring and summer mode. For my first victory lap, I will remind all of our readers that I said in our year end update, “2022 could be a year where commodities are the one and only place to be”. Clients know that we have held a double overweight position in commodities, gold, energy, and materials for almost 18 months. It has been a great ride, but all good things must come to an end. This chart provided by Bespoke Institutional – The Bespoke Report 4/22/2022.

Let’s look again at the market and economic cycle pattern so I can show you where we are now and what SHOULD happen next in terms of asset classes and sector strength and weakness. Chart provided by Stock Charts and S&P guide to Sector Rotation.

As shown above, the market cycle shown in orange shows which sectors lead at different stages. Clearly based on sector performance in the last 5-6 months, we know that energy, materials, and consumer staples are the only sectors that are positive YTD. That fact alone tells us that we are near, at or even slightly past a stock “Market Top.”  Meanwhile, the condition of the economy, shown in blue is also clearly moving from full recovery to early recession. Financial markets look ahead of economic conditions which is why the two bell curves are slightly offset with the markets effectively leading the economy by 6-9 months.

Now here is the critical takeaway.

When we see a top in the energy and materials sectors, then we know that the cycle for the stock market in general is also topping out. This event historically happens when the Federal Reserve is aggressively raising interest rates in an effort to curb inflation and the rise in commodities like energy (read gas prices). On Wednesday of next week, the Fed is going to raise rates again by .50% adding to their .25% increase last month. This is not a secret and stocks are now pricing in the reality that the economy is slipping toward recession. Yesterday, the US Gross Domestic Product (GDP) for the first quarter was reported as -1.4% down from +6% last year. Maybe slipping isn’t the right word here.  Looking at the chart above, smart sector investors should now set stops on their energy and materials positions and stick with consumer staples, utilities, and healthcare. Financials are something to invest in closer to the bottom of a recession, so we will start looking there in 2023. Of course, we still want to stay far, far away from technology, consumer discretionary and communication services. As I write, Amazon is plumbing new lows, down 13% today alone. In fact, Apple is now the only stock among the fabled FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google) that is NOT down between 20-70% from the highs. Remember when they said that valuations do not matter anymore because interest rates are so low. I said that was dilutional. Gravity is real and valuations ultimately do matter.  Now, we are finally seeing massive wealth destruction in technology companies that traded at nosebleed valuations as I suggested in 2021 (victory lap #2).

Now let’s talk about asset class (stocks, bonds, commodities, and cash) rotation in the context of cycles and seasons.

Enter the Pring Turner Six Business Cycle Stages!

In 1994, I read Martin Pring’s book, the All Season Investor. It was profound for me to the extent that I renamed our firm, All Season Financial Advisors a few years later. This construct is pretty basic and simplified but it does correlate with the sector cycle chart above nicely.

With perfect hindsight, we know that the economy was between Stage 3 and Stage 4, back in October of 2020. That was the time to “Buy inflation sensitive” stuff (like energy, commodities, materials, etc.). We did so aggressively for our client accounts. It was also a time to sell bonds aggressively as indicated above. Stocks could be held then as long as one was selective and leaning toward value, dividend payers and high cash flow companies. You’re all probably tired of hearing me harp about Value over Growth trades but it’s been a winner obviously (Victory lap #3).

Most of 2021 fell into a Stage 5 environment (Stocks Ok, Inflation Sensitives Strong, Bonds weak). And 2022 is quickly moving toward Stage 6. Let me spend a bit of ink on this stage.

Stage 6 is short, thankfully. Stage 6 is also the time when we see the most wealth destruction as stocks (all stocks including value) can enter the realm of real bear market losses. Stage 6 also sees a top in commodities and inflation hedges as the economy slips toward recession and inflation recedes. We’re still early here and inflation is not done, nor are we formally in recession yet.  But that is the NEXT thing to happen from a cycle standpoint. Can we skip stage 6? Can the Fed orchestrate a soft landing and avoid a deep or lasting recession?  We will see.  So, dear investors, we are approaching a rather serious time and place where we need to begin making asset allocation changes to our portfolios. Please note, this advice is only appropriate for portfolios that are intentionally dynamic, risk managed and preferably tax deferred (to avoid unwanted taxes associated with trading). These changes are as follows:

1. Start reducing your stock exposure all together if you have not already done so. During stage 6, all stocks washout, the good and the bad.
2. Consider reducing, but not eliminating, inflation hedges, commodities, and hard assets.
3. Use the proceeds from #1 and #2 to rebuild your bond position. These can be intermediate or long-term Treasury bonds, investment grade corporate bonds and municipal bonds (for taxable accounts).

Our flagship All Season strategy has the following asset allocation for reference as of today.

Global Stock Indexes – 60%

47% domestic stock ETFs, mostly dividend payers and value – reduced!

17% international stock ETFs, mostly emerging markets, Canada, and Mexico  – New!

Alternatives/Inflation Hedges – 21%

9% Commodities – reduced!

8% Gold – hold

4% Real estate – reduced!

Bonds/ Income – 19%

5% Long Term Treasuries – New!

5% investment grade corporate bonds – New!

6% Specialty Income – New!

3% cash

Constant Exposure Approach during Stage 6

As you know, we have a growing number of client assets invested in our “Constant Exposure” strategies. These are formally our Wealth Beacon and Custom Direct Index strategies. The obvious concern for any who are invested in more passive models during a stage 6 environment is that your account balance will fall. That is 100% true. But the strategy of investing with constant exposure is not to attempt to sidestep risk and loss but rather to find great moments to add to these strategies. Stage 6 presents constant exposure investors with that opportunity. We are not there yet. Our goal with any passively invested money (529 plans, 401k plans, constant exposure models) is to buy low, that’s it. We do not attempt to sell high or do sector rotation or move a lot of money between asset classes as described above. We build our asset allocation models to include mostly stocks and bonds, we remain disciplined in keeping our portfolio balanced and we patiently work to find that time and place when we can add to our portfolios. This is the simplest, most effective, and most productive way to manage your money assuming you have the tolerance for this approach.

So, for all investors who have money committed to Constant Exposure, I will offer some simple advice. Pile up your cash, be patient and know that your day to deploy at deep discounts is coming. You will make greater after-tax returns than any other approach if you remain disciplined over time. What you cannot do is sell out at the lows in an emotional act of sudden risk aversion. Selling at the lows destroys the entire process of accumulating wealth, adds tax liability, and forces you to buy back often at much higher prices. There is merit in the constant exposure approach if done correctly with discipline. We are here to help guide you through this process and work through the emotions that come along with it.

Next update, we’ll be talking about real estate.  There is much going on here and given the fact that so much wealth in our country is tied up in real estate, it will be worth your time.

Have a great week! Mud season up here in Steamboat Springs (not my favorite).

Cheers

Sam Jones

 

As always, stock markets experience corrections, some even turn into bear markets.  As we say in our Guiding Principles on our website splash page, “Risk Management Is Critical To Your Success”.  For this timely update, I’m going to do a deeper dive into the specifics of how, and to what degree, our various investment strategies do Risk Management, and we’ll finish with an action item for opportunistic investors.

The Purpose of Money

Importantly, all investors must remain focused on the primary goal and purpose of our money and that is to serve us in finding financial independence, covering our living expenses in retirement, and avoiding the risk of outliving our assets.  As I’ve said in recent updates, I’ve seen a lot of bad behavior in market participants in the last 24 months angling toward get rich quick or entertainment and stock market gambling.  We want our money to be boring.  We don’t want drama.  We want to fall asleep watching our investment balances rise consistently over time.  Entertainment is easy to find at Netflix, Vegas, Sports, etc. Let’s all commit to having our money serve its true purpose and leave entertainment out of the equation.

Markets Continue Deep Correction

Certainly, a large swath of the financial market is already in a bear market defined as losses of 20% of more.  Ask Cathy Wood, the know-it-all investor in all things “entertaining”.  The Ark Funds are down over 60% since February of 2021 (not 2022) and falling 2-3% a day.  But her funds are actually a nice representation of what’s been happening to a lot of investor capital in the last year or so.  Fun fact, only 25% of all stocks in the NYSE are trading above a 200-day moving average as of yesterday.  That number will be quite a bit smaller after today.  The “200 day moving average” is a long-term trend indicator that effectively shows whether a stock, index or sector is in a bull market (above a rising 200 day) or in a bear market (below a falling 200 day).  Said another way, even though the mighty S&P 500 is only down 11% YTD, over 75% of the market has already been in a heavy bear market experiencing losses of 20% or more.  To be clear, while painful looking backwards, this creates an enormous opportunity looking forward.  Who wouldn’t want to buy the bottom of a bear market?  Well, there are a lot of things in deep bear markets now!

I don’t know when or where this correction ends.  We do know that risk controls should be firmly in place for investment dollars that are dedicated to managing risk.  In the short term, the markets are marginally oversold and sitting at a place and time where we might expect a bounce in prices.  However, the vast majority of our intermediate and longer-term indicators suggest that there is still significant downside risk, and the burden of proof lies with the bulls.  So, let’s get into how, where and to what degree, we manage market risk in our various strategies.

Risk Controls in Our Strategies

Understand that among our 11 different programs, we have two primary types of investment strategies in our firm’s offering.  We have dynamic, actively traded strategies and we have constant exposure strategies that adopt a more passive approach.  All are “risk managed” in their own rights so let’s dive into those distinctions.

Active Strategies (All Season, both Income models, Gain Keeper Annuity, Worldwide Sectors and New Power)

These strategies are best suited for tax deferred accounts where trading does not generate excessive short term capital gains.  We have been working with our clients in high tax brackets for the last two years to move any taxable accounts into more tax efficient programs.  Active strategies have the capacity to orient your investments incrementally and methodically into leading asset classes and securities while avoiding things that are unattractive for any number of reasons.  As regular readers know, we have carried an absurdly large inflation hedge position in our All Season strategy by owning gold (IAU), silver (SLV), metals and mining (PICK), agriculture (RJA), commodities (PDBC) and energy (AMLP).  All these securities are up strongly this year, several approaching double digit gains in a market that is now down double digits.  In sympathy, we have carried a very small position in bonds for over 18 months.  Bonds tend to do poorly, as they have, during inflationary cycles.  Our stock positions have been relatively underweight and focused on value, select internationals and high dividend payers.  Further, we have a volatility control allocation to securities that have very little correlation to the movements of the broad US stock market.  Some of these are short positions that actually make money on down days.   At the end of the day, our All Season strategy is barely down on the year net of fees.   All Season and our Gain Keeper Annuity strategy have very similar approaches to dynamically shifting investment dollars among assets classes.  Both strategies have very similar results YTD.

Other active strategies that are committed to stocks only like Worldwide Sectors and New Power, manage risk through selection criteria.  Here we are working daily to invest in securities that have attractive valuations, are in the right sectors of the market and trending higher in price.  That’s a tall order given the volatility in the markets.  Naturally with any stock only program, one would expect higher volatility, but the risk adjusted returns here are far higher than the alternative of simply owning the whole market through any stock market index or ETF.  Risk adjusted returns means returns are generated with much lower risk and volatility than our respective strategy benchmarks.  For those who want to own stocks and do so with less risk of permanent downside losses, these strategies are great alternatives.

Finally, our Income strategies are also dynamic and actively managed for downside risk.  Here we work only with bonds and income bearing securities as our universe of investible options.  But we do have a great deal of choice.  We can own Treasury bonds, which have been extremely unattractive for the last 18 months or we can swing all the way out to High yield corporate bonds which tend to act more like stocks.  In the last year, sadly, the entire spectrum of bonds and income investments have been in downtrends.  In these situations, we tend to just patiently wait in cash.  Income strategy investors might have noticed a 40-50% cash position for most of the last year.  Cash is a choice.  Cash is an investment.  Right now, we choose cash and are glad for it.  But soon, possibly very soon, we will begin to deploy our cash as the set up for new buys is becoming more attractive by the day.

To be clear, risk management is not risk avoidance.  None of our strategies eliminate risk.  To do so would literally eliminate return.  Our job is to actively orient assets into things that show better risk/ reward properties and have favorable price trends.  We do accept some volatility along the way, but our downside losses should remain shallow, manageable, and recoverable within several months as they are today.

Constant Exposure Strategies (MASS Income, Wealth Beacon and Direct Indexing)

Constant Exposure is a nice word for a Passive investing style.  Nothing is really passive as in held forever, so Constant Exposure is really a more accurate way to describe what we do.  The idea here is that for accounts where trading securities might generate unwanted tax liability, we want to own securities for longer periods of time (in excess of 12 months) in order to generate long term capital gains.  Even better, we might hold securities for years and push out any tax bills into future years.  Gains are only taxed when securities are sold for a profit, remember.

Constant exposure strategies are intentionally designed to “Expose” assets to the full benefits of the stock market which does factually tend to rise over time.  Market corrections, even bear markets are opportunities to act for these strategies.  We can sell securities that are held at a loss, capture the loss as a tax credit and replace those securities with new positions – keeping our exposure “constant”.  We can also use market corrections to rebalance our holdings.  For instance, bonds have become a smaller part of our constant exposure strategies in recent months which the stock side has increased substantially.  Now, as stocks are selling off, we can potentially rebalance our portfolios by adding to bond positions and bringing stock allocations back to their prescribed weightings.  Market corrections also provide investors an opportunity to add to their constant exposure strategies just as any of us would take advantage of a desirable item that is suddenly on sale!

Our Multi-Asset Income strategy (MASS Income) is a bit of a hybrid approach that I find very attractive in the world of passive constant exposure approaches.  Here we focus assets on high dividend and income generating securities across multiple types of securities (stocks, stock funds, closed end funds, REITS, preferred securities, mortgage bonds, credit bonds, etc.).  The goal of this strategy is to remain invested (Constant Exposure) and generate a total yield of 6-7% annually.  Price patterns and preservation of principle during market declines is a secondary consideration while we remain focused on the durability of the monthly and quarterly income distributions instead.  Investment capital is the means of generating income and we need to stay invested in order to keep those checks coming!  Think of it like a rental property.  We always want to keep that property occupied with tenants who pay rent.  This is very much the same approach using public securities while avoiding the time and energy of taxes, tenants, and broken toilets.

Of course, constant exposure strategies are going to realize the full upside potential of the market and the full downside potential so it’s critically important to make sure your allocations to these types of strategies is within your personal risk tolerance and capacity.   Risk management is therefore light in these strategies and investors should not expect much principal protection.

Magic is in the Right Mix

One of our primary jobs as your advisors is to create the right mix of strategies for your situation within our offering.  It is absolutely appropriate for most of our clients to have multiple strategies in play with representation from both Active and Constant Exposure camps.  In times like these, active strategies do a great job of preserving capital and limiting losses.  In raging bull markets, the constant exposure side of the mix carries the performance torch.  When executed properly, the whole portfolio yields the desired results in risk control, tax efficiency, income generation and growth.  THAT is when the magic happens, and your assets work to serve their real purpose in your life.

 Short Term Opportunity – Calling All Cars!

There is a developing opportunity to add cash to the financial markets.  The entire stock market is trading down in double digits now and the growth side of the market is down in excess of 40% or more in a lot of cases.  Internally, speaking as the manager of most of our company assets, we are looking to get aggressive with our allocations and remove defensive positions (hedges and other securities) as prices continue to fall.  We are looking for some indication that selling pressure is declining and that buyers are willing to step up.  So far, we see nothing constructive, including today which has seen mushy, selective rebound following news of Russia’s invasion of the Ukraine.  Lower lows and perhaps a few more uncomfortable red days (or weeks) could push this market into a deeply oversold condition that would be attractive.  Regardless, this is A TIME AND PLACE, to consider adding new money to investment accounts.

Regular readers know that we issue a notice called Calling All Cars as an instruction to identify cash, move it in to investment accounts and start a shopping list of potential buys.  This is that time!  I will be doing the same for my personal accounts, planning to add to retirement accounts, kids 529 plans, and potentially starting a new direct indexing strategy on our new Canvas platform (happy to provide more details upon request).

It is time to act if you have sideline cash that you are interested in investing.  Any new buys done on a DIY should be made judiciously and with good empirical evidence.  There is never a day to sell all or buy everything.

That’s it for now, hoping to help you understand a bit more about how and to what degree we manage the risk in our clients’ portfolios.

Sam Jones

 

I was 32 years old in the year 2000, when I was invited to participate in the Denver Post Investment Roundtable talk alongside some industry heavy weights who had a lot more experience than me.  I was nervous.  This was the first time I had been recognized as an expert in anything having started in the business only 5 years earlier.  After a two-hour long passionate and heated debate, I realized I was the only participant in the room voicing grave concerns about the overvalued condition of technology and the pile of new internet stocks. The elevator ride down from the meeting room was a bit like a cage match.  The grey beards turned on me in a unified voice and said,  

“You will not survive in this business if you say bearish things in public!”. 

I think they were trying to provide some constructive career advice.  It was a pivotal moment for me realizing that the old guard and the public really don’t want to believe or hear, that today’s (yesterday’s) big winners could fail or that returns might stop.  I also understood clearly that the financial industry has a vested interest in feeding the machine of bullishness in order to keep investor money flowing, even in the face of damning evidence to the contrary.   

3 months later, the technology heavy Nasdaq peaked and fell 80%+ over the next three years.  I got lucky.  We made a positive return in each of the next three years for our clients by simply investing in other areas of the market that were still very attractive including value, bonds, and small caps.   

On January 6th, 2022, I posted a very clear update regarding “What’s Next”.  I almost felt like that 32-year-old kid again saying the same words about the ridiculous valuations in mega cap technology and the top-heavy nature of the financial markets.   Several readers suggested I am too bearish and negative.  I’m having Déjà vu.  

To be clear for all of my regular readers; I am rarely if ever bullish or bearish on “the market” as a whole.  After all, there is always a bull market somewhere!  It’s a bit like food for me.  I like food, I eat it regularly.  But sometimes I want to eat meat, other times I like to eat vegetables.  Sometimes both!  Putting your entire financial world in one food group or another is just about as silly as that sounds.  My unapologetic promise to all.   

I will always call it like I see it, with honesty and integrity. 

I will point to evidence regarding risk and opportunity before offering my opinion.   

The only thing I will remain bullish about is our value as a steward and manager of our client’s wealth in all market conditions. 

Still Bullish on the Big Three Themes 

For the last two years, we have been guiding toward significant opportunities in three areas of the market.  These are working, unlike a lot of things in the market now.  These are, and will, continue to be the focus of our actively managed strategies for our clients.  But there are some subtle changes taking place in each.  The Big Three are STILL as follows. 

• Value  
• Emerging Markets 
• Commodities/ Inflation

Value Over Growth

Value has been outperforming growth since… November of 2020.  There was a slight pause in this relative relationship last summer, but it wasn’t enough to change leadership.  We remain dedicated to the value trade in all senses.  Value companies are those who have high free cash flows, low debt, pay dividends and tend to occupy the cyclical side of the market like energy, industrials, transportation, materials, banking, and infrastructure.  These tend to do well when GDP is growing (now 7%).  These companies are making new highs regularly even during January’s sell off. 

Nothing really subtle about it.  Own Value and stick with it.  Likewise, we are avoiding growth companies as they remain out of favor, overpriced, over-hyped and trending lower in price in a meaningful way.   

Emerging Markets 

This Big opportunity didn’t work well in 2021.  In fact, the opportunity didn’t happen at all, and emerging markets actually showed a minor loss for the year (-0.61%).   China makes up a large portion of the “emerging” market and China experienced some politically self – imposed destruction of wealth.  Chinese mega cap technology companies like Alibaba, Tencent and Bidu were down almost 50% in 2021 as a group.  However, like so many things this year, last year’s losers are becoming this year’s winners.  I’m not ready to say that Chinese stocks have turned higher but they have stopped falling and that by itself is noteworthy.  If the Chinese market can turn higher, we’ll see an explosive move in any of the broad-based emerging market funds.  Latin America on the other hand is already booming, led by resource intensive countries like Peru (+9.7% YTD), Chile (+11.2% YTD) and Brazil (+9.8% YTD).  We have initiated positions in emerging market stock and bond funds that are heavy in Latin America and intend to add to them in the weeks to come.  Would you believe that Brazilian bonds are paying almost 12% in annual interest?  

“How much is a Brazilian anyway?”  George W. Bush 

 

If you’re looking for a cheap (deeply discounted) side to the financial markets, stay focused on Emerging Markets.   

Commodities/ Inflation 

I’m really struggling to not say “I told you so”.  Commodities continue to move higher in price to all-time new highs in the face of a sharply falling US stock market.  This is the only source of diversification in any asset allocation portfolio and will remain so for the foreseeable future. Bonds have stopped falling but are still positively correlated to stocks.  That means that bonds are no longer serving their purpose in providing ballast or stability to a stock portfolio.  Commodities, however, are doing exactly that.  There are subtle changes emerging in this space that might require some adjusting of your commodity exposure.  Crude Oil may be approaching the upper end of it’s historic price range in the upper $80’s.  Yes, it could go to $100+ easily but this would likely to be an outside and an exhaustive move (good place to lighten up on oil and gas if you own them).  Oil and gas still dominate most broad-based commodity funds and ETFs by weighting, so there will be a time and place to reduce exposure to commodity funds soon.  At the same time, we’re seeing some amazing opportunities in metals and miners both in gold, silver, platinum, palladium, even uranium.  We are likely to shift assets from broad based commodities funds and into more specific metal’s investments in the days and weeks to come.  Agriculture and food commodities are up, up and away. As a firm, we took a stand with commodities in September of 2020, adding to those positions in early 2021. Our allocation to commodities in our dynamic asset allocation strategies like All Season remains firmly at 25-30%. Commodities and hard assets will continue to rise in value for as long as inflation is with us. Now I’ve heard a lot of talk about the end of inflation in 2022. I will leave you with one chart.  Look on the right side and I want you to ask yourself if the recent move in PCE (Personal Consumption Expenditures), the Federal Reserves’ favorite measure of inflation, looks like the beginning or the end of inflation. I know my answer. 

 

There are a lot of things to be excited about in this market.  There are also a lot of new risks. Our job as investors is to allocate our money properly in sync with the current economic and financial environment. As usual we are handling all of this for our clients so you can focus on the things YOU can control. 

Happy February! 

Cheers 

Sam Jones  

 

 

 

As many of you know, my wife and I have a four-month-old son at home. Today was a big day in our house—our little guy rolled over from his stomach to his back for the very first time. Yesterday he couldn’t, today he could, what an incredible development! In the next year we are certain to experience a number of these milestones—eating solid food, crawling, talking, walking. Each one will happen suddenly and, in some cases, without advanced notice. The changes he’s experiencing will be, exciting, happen rapidly, and be easily observable.

Contrast this with the adult world around us. Our environment, our economy, our lives, our careers, our relationships, our viewpoints.  For most, these things grow or develop (sometimes devolve) from day to day, week to week, month to month, year to year with the changes remaining mostly hidden or unnoticed. The instant gratification, what-have-you-done-for-me-lately bent to our lives leads most of us to miss the small, incremental changes that will undoubtedly shape our futures in positive ways. Only when we inject time and look backwards can we realize the profound impact an innovation or new way of thinking has had on our lives. Hello, iPhone.

In the investing world, when you buy one share of Alphabet (Google) stock, you are inherently relying on the company’s almost 140,000 employees (crazy big number right?) to steward its existing business lines and to create new products and services that will ultimately generate revenue and in turn, earnings, in the future.  How successful will Google’s employees be in this endeavor relative to the employees of other companies? Hard to say, but they are sure to try. In the process the company will grow and change at a glacial pace (at least from the outside looking in) while you and I continue to interact with the company’s browser, search engine and ads and track its stock price on a daily basis.

As of this writing, Alphabet’s stock (GOOGL) is down a hair over 10% in the first three weeks of 2022. I guess they should pack it up, call it a day and close up shop, right? What changed in the first 14 trading days of the year? Did someone pull the plug on the Google machine on December 31 as they left the building in a post-resignation blaze of glory? Hardly. Did something happen in the world that instantly made Alphabet a less valuable company? Is inflation or the prospect of interest rate hikes going to diminish the company’s ability to continue to grow its assets, revenue, and earnings in the successful manner they have in the past? Anyone’s guess. In any event, 140,000 employees are going to go to work today to try their hardest to deliver incremental value to you, the shareholder.

And Alphabet is only one company! Think about it this way: there are hundreds of millions of employees across the globe representing thousands of public companies and working for their stakeholders in the exact same way. And that doesn’t even begin to scratch the surface of private companies!

Weeks like the last one are not fun for anyone. Watching stocks (Alphabet included) sell off across the globe leaves most investors with a feeling of hopelessness and the sense that we are not in control of our respective financial destinies. Weeks like last are the reason why we work with you to build financial plans—to help refocus on the pieces of your financial lives that you ultimately control.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

I hate to break it to you, but watching your portfolio decline never gets easier. Market volatility is a feature of our markets, not a flaw, and there will always be reasons to sell. The instant gratification of taking action today might feel good in the short term, but can have a major impact on your retirement as you  give up on the seemingly small, glacial developments that are sure to drive returns in the future.

 

 

 

 

 

 

 

Source: Michael Batnick, The Irrelevant Investor

Having said that, if market movements over the last week have you feeling concerned or nervous or reconsidering the purpose of risk in your portfolio, now is a great time for us to get together to review (or build) your financial plan.

In closing, I want to share a quote Morgan Housel’s Psychology of Money: “Optimism is a belief that the odds of a good outcome are in your favor over time, even when there will be setbacks along the way…The short short sting of pessimism prevails while the powerful pull of optimism goes unnoticed.”

As we move forward in 2022 and beyond I know that there will be successes and setbacks in each and every one of our lives. The magnitude and rate of change in my son’s life will slow over time as he ages. There will be elections, market corrections, wars, inflation, diseases, recessions, deflation, politicians we don’t like and many other maladies. Despite how scary some of these things seem, I am optimistic that we can work together to build a plan that will help you and your family weather any and all storms that come ashore.

Will Brennan

 

 

Every new year, I find some quiet time and space to just think, observe and research the current condition of all things financial.  My intention with these personal sessions is to shed my emotions and assumptions from the recent past and just observe what “IS”.  Often, I find that I’ve gotten caught up in the moment, especially when it comes to making investments or financial decisions.  At the top of my notes page, I write “What’s Next” forcing myself to move beyond the moment and establish some guides for financial decision making in the year ahead.  Please enjoy my notes for this 2022 New Year update.

Notable Quotes 

“Success is 50% luck, 50% timing and the rest is your talent” – Scott Galloway (Pivot Podcast) 

But 

“Luck is the residue of design and hard work” – Branch Rickey 

And 

“Trust is the union of intelligence and integrity” – my Yogi Tea bag 

So 

Please trust my thoughts below and know that I have no specific talent beyond a keen sense of observation and 30 years of experience.  Hopefully we’ll all be lucky enough to make smart decisions when the timing is right in the days ahead. 

 Thoughts on Stocks 

Stocks across the globe should begin adjusting to a reversal, and eventual removal, of central bank monetary support.  In simple terms, here in the US, that means, the Fed is now embarking on their long overdue process of removing liquidity from the markets in hopes of containing very high and persistent inflation.  Given current valuations and the new shift in monetary policies globally, my expectation is that broad market stock indices will generate below average returns for the next 1-3 years with above average volatility.  Earnings per share in the US stock market in aggregate since 2015, are running 209% above actual profits due to share buybacks (companies buying their own stock to boost earnings in the absence of real profits).  And corporate profit margins are just starting to compress now as input costs are moving strongly higher.  Speculation is rampant (SPACs, NFTs, IPO wave of companies with zero income, etc.).  Finally, way too much money is still concentrated in just a few mega cap technology names making this a top-heavy market.  Market indices will go the way of Mega cap tech for the foreseeable future until Mega cap tech no longer carries such a high weighting in the index – specifically the S&P 500. 

I know that doesn’t sound great but at the same time….. 

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Stock pickers and value investors still have an opportunity to perform very well with outsized positive returns in the next few years. 

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Roughly 40% of the current market of US stocks are already very deeply discounted, trading at 12-year lows, spinning off high dividends and just now turning up in price.  Stock pickers and value investors still have an opportunity to perform very well with outsized positive returns in the next few years.   

The market and economic cycle guys that I respect are ALL pointing to the end of 2023 as the next significant low in equity markets and potential best zone to load up on stocks again.  Seems pretty plausible actually.  Between now and then, risk management and selectivity among one’s personal assets, is going to be critical. 

Thoughts on Bonds 

Bonds are unattractive now but could be worth a trade in the second half of 2022, especially long-term bonds.  For as long as the Federal reserve is posturing to fight inflation with the potential to hike rates, bonds won’t provide positive returns.  Allocations to bonds should be kept to a minimum until inflation ultimately drives the economy into recession – later in 2022 or 2023.   

Investors should NOT depend on bonds to provide much diversification benefit until inflation finally tops out – again, maybe second half of 2022.  This condition has been the case since early 2020, no change for now. 

Thoughts on Commodities  

Commodities and commodity producers are behaving well, as we would expect.  They are rising consistently with the constraints in raw materials and high demand.  They are making new highs regularly and now energy is back on board this train after consolidating prices for the last 6 months.  Commodities, including gold at these levels, are now one of the only true sources of portfolio diversification as bonds are no longer serving this purpose.  However, we all need to accept that commodities have much higher volatility than bonds.  Therefore, investors who want lower portfolio volatility in general are going to have to get more comfortable carrying higher cash or investing in securities (funds) that are explicitly designed to control volatility. 

Commodities, as an asset class, are historically under-owned by institutions and retail investors alike.  Valuations are still very attractive relative to stocks and bonds, and I would expect the commodity bull market that began in the Fall of 2020 to continue for longer than most would consider reasonable.  As a new secular bull market in commodities unfolds, it will take several more years of growth and higher prices to attract a representative amount of investor capital.   If inflation goes away in 2022 (not my expectation), then the commodity bull market will end quickly. 

Thoughts on Real Estate 

It’s hard to have any conversation with anyone about real estate without using the word “crazy”.  Indeed.  It is what it is – crazy.  A reasonable person should expect prices to stop moving higher from here.  A reasonable person could also make the case that prices don’t need to fall much considering demand, supply and affordability based on still rock-bottom mortgage rates.  So, we can make a reasonable assumption that real estate prices are probably going to be flat at best for the next several years.  Timing is everything and you must have some pretty evidence-based arguments to convince me to buy real estate now.    Strangely, I’m still seeing people load up on real estate as if it’s a good deal, as if they had better get in now before prices go even higher.  I think that’s foolish, wishful and backward thinking.  I said the same thing back in 2019 before the Covid induced gold rush in real estate.  Nothing has changed in my mind.  Real estate prices will follow the direction of the stock market just as they did in 2008.  They are now partners in the Wealth Effect game. 

Like stocks, there are still some pockets of opportunity.  Income generating rental and commercial properties could be attractive IF you can buy them at a reasonable price (tough!) and can generate positive free cash flow. Rents are going up and will continue to go up for at least the next 8 months to match prices paid for real estate.  Given that OER (Owners Equivalent Rent) accounts for 39% of Core CPI (consumer price index), it’s pretty safe to say that higher rents are going to push core inflation higher well into 2022. 

On the other hand, office property could easily be the source of a nationwide problem.  Let me explain.  We as a country are not going to return to commuting, paying for transportation and parking, just to sit in a cube farm in an 85 story “office” building.  Apple has lost almost 20% of it’s engineering talent to Meta in the last 6 months following Apple’s back-to-the-office mandate.  They say it costs $28,000 per employee to provide office space.  Companies are more than willing to jettison this expense.  This is a structural, seismic shift in how we work that is never going back to the way it was.  How many millions of square feet of office space are collecting dust right now?  How many owners of office property know that once the current lease expires, there will be no tenant to replace those who have left?  What will our cities look like in the absence of “office workers”?  How will we find a mate outside of the office? (1 in 3 marriages come from office introductions).  Big changes are coming. 

Anecdotally, we are in the permit process to convert the second floor of our Denver Office building into a fun residential loft for personal use or short-term rental.  The downstairs will remain as a conference room for meetings with clients.  Mixed use will become all the rage.  If I ran the zoo, I would consider converting many office buildings into residential apartments and condos asap.  

Thoughts on Labor 

This issue is one for the textbooks.  Talk about unintended consequences.  Our labor shortage problem is not a short-term phenomenon either.  Labor participation rates (meaning among the total number of eligible working population, what percentage are employed?), are still stuck hovering close to the historic lows set in March of 2020.  Quit rates (the number of employed who have recently quit) are also on a parabolic rise consistent with the parabolic rise in job openings.   

 

 

 

 

 

 

 

 

 

What’s going on?  I observe a generation of baby boomers who are choosing to retire earlier than expected.  Make no mistake, monetary and fiscal stimulus always finds its way into the hands of asset owners and the Baby boomers are the current owners of assets in bulk.  With a big thanks to the Fed, they can now retire early!  Gen Xers and Millennials are not ready, willing or able to fill those empty seats.  In addition, burn out, health concerns, needs to cover childcare, and interest in starting a new company are all contributing to The Great Resignation thing.  I don’t know where this trend goes from here honestly.  What I do know is that wages are not going to revert to the sub-standard levels of pre-Covid, in the foreseeable future.   Higher wages and salaries that match the real cost of living are now the new standard.  Why is this relevant?  It comes back to the argument of why inflation is not transitory.  The economy and earnings will adjust to a permanently higher wage base putting a new higher floor on costs of goods and services.  As I like to tell friends; We have moved beyond a system that provides what you want, when you want, at the price you want.  Now, you’re lucky if you get to choose one.  Decisions of when to buy, when to build, whether to buy or repair, will become more important than in the past.   

Thoughts on Control 

I see a lot of bad behavior out there these days.  Too many newer investors chasing things they don’t understand, trying to get rich quick, concentrating assets in just a few of last years’ winning stocks.  For all the market talk and attention, I want to remind everyone that the most impactful thing you can do to Create and Defend Your Wealth is to focus on your own spending and saving patterns.  These are the areas where you have control, rather than the markets where you have little to no control and have a relatively low probability of getting rich quick with some great idea or another.  We hear only the stories of that women who is buying a $200M beach house with her recent winnings in Ethereum.  But we don’t hear about the other 99.9% of crypto investors and Meme stock traders who are sitting on massive losses, reluctant to sell and admit error.  We work hard to help our clients understand the purpose of money and to what degree they need to generate returns to cover their real living expenses net of incomes.  Pay close attention to how your taxable money is invested such that it doesn’t generate a lot of short-term capital gains.  Pay attention to your asset allocation mix making sure that you have an adequate amount of cash to cover any expense shortfalls in your house for the next 1-2 years, so you are not forced to sell stock holdings at a bad time.  Consider using a free spending and budgeting app like Mint.com or YNAB.com (You need a budget) for a few months to discover where you are really spending your money.  You might be surprised!  Are you putting money into a 529 plan for your kids’ education and saving on State income taxes?  How about funding your Health Savings Account for $8300 this year as a deduction against Federal Income tax?  Can you really afford a second home?  Is this the right time for a kitchen remodel?  How can you make sure that your income is stable and growing for the next 5,7 or 10 years?  

These are the things I wish more people would focus on.  Those who do tend to worry less and find true financial independence much earlier than the gamblers out there.  Focus on the things you can control, and your wealth will follow!  Yes, it’s messy, but that’s why we’re in business.   

Best to all in the new year. 

Sam Jones  

 

 

 

 

 

 

There is a sickness in the market that is becoming more evident by the day.  The relentless selling since mid-November has come as a surprise to many.  We all look at our investments with a raised eyebrow and more questions than answers.  For this update, I’m going to try to clarify what we see happening in the context of some very notable and recent changes in leadership in the markets.  This may prove to be one of the most important moments in recent history for those wishing to (re)position themselves appropriately for 2022.    

What is Going On? 

Well to put it bluntly, what’s happening in the markets today is nothing that any veteran of a full market cycle hasn’t seen before.  Personally, I’m a little surprised to see it manifest right now given all the current data but quite often the most persistent and lasting trend changes in the markets happen when no one expects them to occur.  What trend changes am I talking about? 

At a very high level, the market is now adjusting to the fact that the Federal Reserve is beginning their long overdue process of removing liquidity from the markets.  Nothing much has happened yet and is not likely to happen anytime soon in terms of the Fed Raising interest rates, but they are starting the process of becoming less accommodative to the markets.  Why?  Well because they now understand clearly that inflation is not transitory beyond a mild loosening of supply chain restrictions in 2022.  They are feeling pressure to “do something!!” knowing quite well that raising rates won’t do anything to curb this form of inflation.  In fact, any action on their part to remove liquidity is likely to increase inflation as the rising cost of borrowing will be added to the pile of higher input costs.  So, they reach into their box of tricks and begin tapering bond purchases as well as pursuing reverse REPOs with their banking partners to create the perception that they will control inflation.   

As a result, we’re seeing the economic cycle clock turn quickly toward full recovery/ early recession environment.   

Let’s take a minute to review what that means from a leadership standpoint in order to help us understand where we should be cutting exposure and where we might add exposure in our investment portfolios.  The chart and illustration below are provided by Stockcharts.com 

Look to the right side two columns marked as Full Recovery and Early Recession.  Right now, I would peg our current environment as closest to Full Recovery mode.  

Consumer Expectations Declining… check 

Industrial Production Flat…. check 

Interest rates Rising Rapidly…. check (but may be “peaking”) 

Yield Curve Flattening Out…. Check 

Looking above to the chart, in a Full Recovery environment, we should expect the following: 

1. The stock market should be topping out broadly with continued leadership in energy, materials, consumer staples, utilities, healthcare and financials.  This is a time when investors must be very selective about what they own and keep risk management protocols firmly in place.  The worst performers should be technology, consumer discretionary, and communication services sectors from here forward. 
2. During this time commodities can continue to do exceptionally well but investors shouldn’t expect the same high growth rates as the last two years.  In fact, in some economic cycles, especially those dominated by inflation, commodities become the only productive asset class. There is real potential for that outcome now. 
3. Long term bonds should start to perform better as the Fed threatens to push up short term rates.  Today the 30-yearTreasury bond broke out to a new 8 month high.  Still, expectations for bonds to be a highly productive piece of any portfolio should be kept in check.  Bonds at this stage are just a safe haven offering a little volatility control in your portfolio. 

Getting (Re) positioned for 2022 

I’m going to say this again as a final warning as we head into 2022.  The greatest risks I see in today’s market is the very high concentration of wealth among a few mega cap technology names.  You know the names.  Apple, Amazon, Google, Facebook (Meta), Microsoft.  These names have become an enormous piece of our country’s annual GDP in terms of their enterprise value (see below courtesy of Crescat Capital LLC) – 37% to be exact.  Similarly, these same names collectively represent a weighting of over 30% in the entire stock market.  I always like to ask, what could go wrong? 

I’m not going to be the guy that tries to explain why, how, or when any of these behemoths could see their stock prices fall.  I can only say that once a set group of names climbs to this type of dominance in the economy and the financial markets, the results looking forward have not been great.  Crescat also showed the last time we had a concentration of financial wealth in just a few names.  That time was the year 2000 when our markets were dominated by GE, Cisco, Exxon Mobile, Intel and Microsoft.  Of those five, only Microsoft has generated a reasonable return on an average annual basis over the last 21 years.   

Average annual returns (including dividends) since the highs in the year 2000 through yesterday: 

GE                         -4.62% 

Cisco                    -0.08% 

Exxon                   +4.68% 

Intel                      +0.31% 

Microsoft            +10.52% 

Back to the script.   If I were a betting man looking into 2022, I would consider (re) positioning my portfolio to have a more reasonable weighting in these names or any others with clearly ridiculous valuations (TSLA, NFLX, NVDA).   

At the same time, we investors should all acknowledge that if these companies run into trouble for whatever reason, they will take the market with them by the shear fact that of their market capitalization weighting in the stock market index, notably the S&P 500.   

In just the last few days, we have started to see some real unbridled selling in technology names with stock prices that simply don’t reflect current earnings growth in any way.  Today, we heard about Docusign (DOCU) which is down -40% as I write after missing earnings by a mere $26M last quarter on earnings of $574M!  That’s not a big miss but it is a very big reaction to the news!  Pay attention to these things.  Salesforce (CRM) and Adobe (ADBE) lost over 9% in single day reactions as well.  Tesla is down 6% today on no news at all.  (Re) positioning for 2022 and profit taking appears to be happening now among names that are wildly overvalued.  I fear for the future of Cathie Woods and her infamous Ark ETFS (Next gen technology funds) that are moving quickly toward losses in excess of -20% YTD.  

Where Should We Look to Buy? 

Always a great question.  Regular readers know the answer, but I’ll spell it out clearly for any DIY investors out there.  Stock purchases should be in the value side of the market where prices are low relative to earnings growth.  We have been accumulating these names in the last three weeks.  Take a look at this Market map provided by FinViz.  

To understand what you’re looking at you don’t have to do much more than squint your eyes and look for green spots.  This is a market map showing the Price to Earnings Growth (PEG) of the components of the market index.  A number higher than 1 shows a stock that is generally overpriced relative to its current earnings growth.

Note a name like Salesforce (CRM) that is showing a PEG ratio of 9.29.  Salesforce got slammed by investors this week.  Tesla at 4.86 is no deal.  While not as overvalued, the same goes for MSFT, AAPL and AMZN. If the current price action is any indication about where gains will be had in 2022, we would recommend selectively looking for lower PEG ratio stocks aka the value sector.   Note- PEG ratios should not be anyone’s sole evaluation metric.  

As mentioned above, Commodities can also be held or accumulated on pull backs like the one we are seeing now.  There is higher risk in commodities today than 12 months ago, but the trend is still our friend here and the cycle says hold commodities for now. 

It’s also not a bad time to add back some bond exposure just to control volatility as we move into 2022.  Longer term bonds (TLT) are showing the best price action as the market is betting the Fed controls future inflation.  I’m not so sure but I would avoid short term bonds in the coming months as you will be fighting the Fed while they try to manage inflation. 

All in, these are slight but potentially significant changes that investors should consider as we move toward 2022.  We are making these changes to our clients’ portfolios now.   I read somewhere that past performance is no indication of future results.  I would modify that statement to the following. Past performance rarely, if ever, indicates future results. 

What a great time to consider (re) positioning for 2022. 

Stay tuned for more ideas on year-end financial planning and tax strategy coming soon. 

Cheers 

Sam Jones 

   

 

 

Why did I just listen to a nine hour audio book of Warren Buffet’s “Ground Rules”?

Get Your Mind Ready

Living in Steamboat Springs, CO, I have seen my fair share of elite winter athletes mentally preparing for the ski course ahead. They are standing at the top of the course, eyes closed, in the moment of perfect memory, virtually skiing the gates ahead of them. I find myself, doing the same now as I believe the markets are approaching the “start” of a profoundly different market environment that will differ from what many have accepted as permanent leadership.

In preparation, I thought it would be helpful to step into the metaverse of those great money managers of all time who were at their peak in the early 50’s through the 1970’s.  Hint there really aren’t many still alive, beyond Buffet. My takeaway after digesting “Ground Rules” was that Buffet really was (is) an exceptional money manager. His boldness as a 20-year-old was just shocking but in a calculating, educated, disciplined way that is nearly the polar opposite of a lot of the behavior I see today. “Ground Rules” is a long walk through Buffet’s annual investor letters in which he openly talks through his own journey and evolution in identifying unique investment opportunities different strategies within his own skill set, never reaching beyond his own ability nor forgetting his own rules for margin of safety with investor capital. Buffet was the protege of Benjamin Graham, The Godfather of qualitative value investing and a survivor (winner) during the Great Depression. That mentorship certainly forged a lifetime bias in Buffet as a value investor that served he and his investors incredibly well for over 7 decades to date.

The Start

In the last update, I described what I am excited about. This is an extension of that commentary but want to focus more specifically on the developing opportunity to accumulate stock in companies, sectors and asset classes that are selling at historically cheap valuations. I believe this is the start of a secular move where value dramatically outperforms growth as we quickly and not so quietly, graduate from a world dominated by a just a few mega cap growth names. I realize this is now a well-worn story in the financial news, but remarkably, investors are not acting on this opportunity in any scale (yet). Bear with me as I walk through the evidence and set some expectations for our clients heading into 2022.

Why Value Now?

1. Valuations – I know that’s sort of silly to say. Let’s buy Value because it’s “valuable” ! They say, a stock’s valuation doesn’t matter until it does. Now is the time when valuations matter. Today we have a market that is dominated by growth names selling at absurdly high valuations by any measurement (P/E, Price to Sales, Price to Book, Price to Earnings Growth, Earnings Yield… take your pick). Meanwhile, I am now seeing a small but growing number of companies with expanding earnings, high dividends, low debt to equity selling at prices that are approaching their liquidation values. I presented some of these ideas last week with my commentary about Ford vs Tesla. In full disclosure, we sold the last of our TSLA shares in our New Power strategy above $1200 last week. Apologies for realizing the gain for those with taxable accounts. We will continue to add to Ford on pullbacks. Buffet has got to be excited with the prospects for Berkshire Hathaway which is probably why they just executed an enormous buyback of their own shares this week. There are other “Fords” out there for those brave enough to act with discipline and avoid caving to conventional thinking.
2. Inflation – You know my thoughts on inflation. It is not temporary unless temporary is 3-4 years for you. Please reread any of the posts in the last 12 months as to why inflation is not temporary. We are now approaching the end of year 1 and it is just now becoming something of a headline. Inflation is the enemy of companies that are owned for their growth prospects. Why? Because inflation makes FUTURE earnings less valuable than earnings (or dividends) paid in today’s dollars. Growth companies reward investors for FUTURE earnings while today’s value-oriented companies reward investors with earnings and dividends TODAY. Recognition that inflation is real and persistent should drive investors into the value sector and out of growth. This is a special moment in time, right here, right now for those looking to reposition their portfolios as the relationship between growth and value is stretched to a historic extreme. If the past is our guide, we would not be surprised to see value investments continue much higher even as the growth side of the market experiences bear market type losses.
3. The Fed is Trapped – Powell is going to lose his job because President Biden doesn’t like the sound of “Bidenflation”. There was a lot of chatter leading up to the last Fed meeting about how they were going to taper their purchases of bonds in the coming months. Yes, they are tapering their bond purchases, but this is not tightening in any way, it’s just less accommodation. In fact, statistically, the Fed will be purchasing another $400 Billion in credit and bond securities before they are finished next year according to plan. Raising interest rates is something that will happen later, maybe much later, or maybe never considering the Fed’s new laser focus on employment. They know that raising rates and the cost of borrowing will yield higher unemployment and will do nothing to curb inflation. Remember, raising rates only restricts an economy that is stretched on credit. Today, households and corporations are sitting on more savings and cash, respectively, than any time in modern history. We have too much money chasing too few goods with very low labor participation rates. Raising rates will do nothing to curb these inflationary realities.
4. Gambling Not Investing – I’ve seen this movie before. It happens when not so smart and inexperienced investors chase anything that moves fast. It doesn’t really matter what “it” is, just that it’s going to the moon! Gambling culture has moved from Vegas to DraftKings to Robinhood and now to the general stock market. I am admittedly a terrible gambler. The entire notion of betting big on something that offers a low probability of return is simply against my DNA. Gamblers always think they have an edge of some sort that makes their bets a high probability. Ask any Crypto maniac and they will tell about their insights and skill. Don’t confuse brains with a self-fulfilling crowd inspired price frenzy. Those of us who have been doing this for a while have seen speculative markets like these when whispers turn into 30% single day gains. When companies like Rivian come to market with an IPO valuation larger than Ford or GM without having delivered a vehicle yet. When small lot options trading becomes a hobby for home gamers. When things like SPACs and NFTs go mainstream. These are the days. What a great time to reinvent yourself as an investor in real value, real things, paying real dividends and providing real shareholder yield.

Strategy Orientation for 2022

This section is speaking to our current clients in an effort to tell you where we are going with your money and our general orientation toward the markets going into 2022. We are acting on these ideas now, because the opportunities described above are now.

In short, the environment we see looking forward, is one of contrast. The odds strongly favor a move toward a new environment with big winners and big losers and away from the current phenomenon where all things seem to rise in unison (a very rare condition. Strategies that can judiciously accumulate shares of deeply discounted shares now with the intent of holding them for years will stand apart from the broad market and those portfolios that remain locked into yesterday’s winners.

In our all-stock strategies like Worldwide Sectors and New Power, you should expect to see more individual stock names. Our intention here is to accumulate shares here and now, while value is still present and hold these names for longer than we have traditionally in the past adding some tax efficiency, lower trading frequency and more concentrated positions to these strategies. Our approach shifts a bit in the process, with less of a focus on momentum approach seeking leadership and more attention to fundamentals and valuations. Volatility in these programs will necessarily increase as we carry more individual stock holdings.

In our dynamic models like All Season and Gain Keeper Annuity, we will orient our strategies toward oversold asset classes, styles and sizes where value hides. Today, those are in small caps (esp small cap value), internationals and emerging markets, commodities, dividend payers, and inflation beneficiaries like gold, silver, and agriculture. We expect to continue holding just a minimum allocation to bonds as per our guidelines and avoid large cap growth altogether until we see a more attractive set up to reinvest. Volatility should remain roughly the same here.

MASS Income will remain invested in our current near equal allocations to dividend paying stocks (1), high yielding REITS and inflation beneficiaries (2) and credit bonds (3). If rates begin to move higher, we are likely to skew away from bonds.

Our newer Constant Exposure strategies (Wealth Beacon and Direct Indexing) won’t do anything different. Constant exposure is constant exposure. If there is a larger market decline in 2022, these strategies will take advantage by realizing losses, creating some tax credits against future realized gains, while remaining fully invested. Our “tilt” toward small caps, value and internationals remains going into 2022 across all Constant Exposure strategies.

Both of our Income models (Retirement Income and Freeway High Income) will work hard to preserve capital and clip as much income as we can. Admittedly, this is an uphill battle against the tide of inflation. The good news is that once interest rates finally sync up with real inflation, our income models will ride again, generating very stable high single digit returns as they have done under more normal economic conditions. Until then, Income allocations should be looked at as a ballast to any equity investments to control portfolio volatility or a source of cash to cover living expenses rather than a means of creating wealth. Special note – You will always have something in your portfolio that is less productive than other investments. Anything invested in bonds fits this role now. But it’s important to consider the very purpose of your fixed income investments in your portfolio now. Why do you have any fixed income ever? Growth of capital has never been the answer of course. If the lure of higher returns found in stocks is nagging at you, make sure to let us help you evaluate the importance of this piece of your portfolio first. Maybe you don’t need it and maybe you really need it! Everyone’s situation is unique.

The Point

One of our jobs as your advisor and asset manager is to set expectations as best we can. We are your guide with all things financial including the mix of strategies within your total portfolio. When there are significant changes in outlook, strategy holdings or perspectives, we want you to know what we’re thinking. That’s all 🙂 There is no action needed on your part and we look forward to seeing you on your next review.

Cheers

Sam Jones

 

 

 

 

 

I’m seeing some very exciting developments in the current market.  Things are popping again and there are compelling opportunities in sectors that present current value and significant growth potential.  Today, I hear two types of concern.  The first is that the markets are way too high and overvalued.  The other is a palpable fear of missing out (FOMO).  This update will address these fears by showing you what I’m really excited about, right now (and what I’m not excited about….)

Please note this is not a recommendation to buy any of the following securities or investments.  Investors should make their own decisions or consult with their financial professional.  In full disclosure, clients of All Season Financial, may own some or all the following securities in their managed accounts with our firm.

Let’s get into it.

End of October is the End of Mutual Fund’s Tax Year – preamble

Let me explain a little-known fact about our industry, which we saw play out in perfect form on Friday.  October 31^st strangely marks the end of the fiscal year for most mutual funds in the finance industry.  Managers of mutual funds, of which there are still many managing $21 Trillion dollars, use the end of October as a time to do several things.  They want their “current holdings” to look good to their shareholders in those glossy mutual fund prospectuses delivered later in the year.  Looking good means owning popular things, like Apple and Microsoft and Tesla.  Looking good also means NOT owning small caps, internationals, emerging markets, or other asset classes that have been trending down for the year.  In industry terms, this is called “Window Dressing” and it’s a bigger thing than most are aware.  On Friday, we saw all the old mega cap tech stocks get a nice bid higher by 1%+, while small caps, for example, lost over 1% and emerging markets lost 1.5%.

The end of October also marks the day of reckoning for taxes.  Those same managers would necessarily want to sell things held at a loss to minimize their annual taxable distribution of realized gains to their shareholders.  Consider the fact that over 24% of the S&P 500 stocks are negative on the year and you can imagine that managers had a lot of options to sell holdings and reduce their tax liability.  To the market observer, you might have noticed that stocks trading down on the year, traded down a lot more last week as this tax loss selling process was completed.

The good news is that today is November 1^st, and all of the mutual fund manager operational trading is now done!  And today we are seeing real strength on some of the areas that I’m excited about owning.

I’m Excited About Small Caps!

Wow, today was a breakout day for small caps to be remembered!  This happened while the large cap growth names actually lost money on the day.  Small caps finished the day up between 2 and 3%.  Why should you be excited?  Well, if I had a dime for every investor who said they don’t want to put money into the market now because it’s overvalued, I would be retired now.  Consider these facts:

• Small caps are trading at a 26% discount to large caps, one of the widest valuation margins in recent history.
• Small caps have been consolidating gains since March and are now bouncing right off the long-term Uptrend line!
• Small caps have a history of outperforming the market between now and the end of January.
• Small caps are going to benefit from a lot of domestic spending on infrastructure
• Small caps represent nimble companies that can be wildly profitable and adaptive during very dynamic economic times like these. Much more so than large or mega cap companies.

Here’s a snap of the chart of the Small Cap Growth ETF (IWO) which we own for clients as of today.

I’m Excited About GAARP! (Growth At A Reasonable Price)

In our New Power investment strategy, after a long painful summer of consolidation in prices, we are seeing recent and persistent strength in the renewable energy sector (solar, wind, batteries, green hydrogen, fuel cells, etc.).  This has been our expectation all summer as the new $Trillion Federal spending bill takes shape with renewed investment in climate-oriented infrastructure.  Our New Power strategy remains fully invested and just gained 11% in the last two weeks.  Beyond renewable energy, there is also a new group of companies that fall into the basic materials sector, who are reinventing input materials to be less energy intensive, biodegradable, sustainable or otherwise “green”.  One example which we have owned for almost 6 month is Danimer Scientific (DNMR) which makes biodegradable, compostable, polymer bioplastics WITHOUT petrochemicals.

https://danimerscientific.com/ – read all about it

In short, they are finally bringing us a true biodegradable water bottle to serve a global consumer that just can’t stop buying single use plastic water bottles (shame on us!).  We hope to see an end to this madness.

We have made two purchases of DNMR, one in late May and the other in August.  Both purchases are held at a modest loss (still).  But today was a big day for DNMR (+20.39%) and it looks to be breaking into a new long-awaited uptrend after falling more than 70% from its high of last year.  Like I said, investing is often about patience, and I hope our wait is almost over.  I’m excited!

Also in our New Power strategy, we have another great investment in an old name that is going to be a game changer in the electric vehicle space – Ford Motor company.  Yes, we still own Tesla (TSLA) but I’m not as excited about that name as Ford (F).  Ford just raised its dividend last week for the first time in years and trades at a below market Price to Earnings (trailing 12 months) ratio of 19 versus Tesla at 218! For all the attention paid to Tesla which is up 57% YTD, Ford has been quietly up 97% YTD.  Ford is not just the next electric truck.  The Ford 150 is the best-selling pickup truck in the world; almost 1 million units/ year.   That truck is going all electric with the 2022 Lightening!  This truck alone will create a bridge between two cultures.  That truck driving guy that tends to lean far right, will finally have reason to embrace a clean green, electric transportation future.  There will be no resistance because there will be no other option.  Again, I’m excited about the options I see TODAY for new investments like these, (speaking ever so softly to those who think there is nothing to buy today).

I’m Excited About High Dividends That Beat Inflation!

Inflation is a theme we’ve covered at length.  It’s here, it’s going to be here for a while and it’s going higher from here.  Enough said.  We’ve talked about the importance of not sitting on a pile of cash in the bank earning zero, worrying about inflation and a market that doesn’t appear discounted or to have any opportunity.  So, here’s another great option.  Our MultiAsset Income strategy is currently generating an estimated annual dividend yield of 6.26%.  Inflation is running at 5.3%.  Now, if the prices of all 38 securities held in this portfolio did nothing for an entire year, your portfolio would still beat inflation through the dividends generated. For instance, one of our holdings is AGNC Investment Corp. (AGNC) which pays an annual dividend of 9.39%.  This is a company that effectively leverages Federally backed (agency) mortgage securities into a dividend generating portfolio.  YTD AGNC is up 9.69%, but down from it’s high in June by 14%.  Every month, AGNC pays its shareholders 0.12 per share.  So, for the last 5 months, while the price has been falling, we have received over 4% in dividends.  All good!  AGNC is very likely to continue higher in price, but the point is, you get paid to be patient!

Thus far, the prices of our holdings have been appreciating very nicely as the world is hungry for dividend yield.  MASS Income is up over 23% YTD in total return net of fees adding to the 26% gains generated in the last half of 2020.  The strategy is well diversified in equal thirds to stocks/ stock funds, alternatives, and bond/credit funds.  We’re happy to walk anyone through the holdings and the strategy but suffice it to say that this is exciting stuff.

Other Things I’m Excited About

• Having a great team at All Season – they are the best!
• Being an empty nester – new chapter
• Getting in another day or two of fishing before winter hits
• Tacos and Tequila – Sarah and I last night

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Things I’m Not So Excited About (speed round)

• Investors who think this is a game and love to gamble with their net worth for entertainment
• Metaverse
• SPACS, NFTs, 6500 new crypto currencies in the last two years
• The concentration of market capitalization in 5 names (you know the names)
• Higher taxes
• Treasury bonds
• Crazy politicians doing crazy things (still)
• Worrying about a fight breaking out on my airplane
• The cost to fix my dryer – $481

That’s it for this week, enjoy the last of Fall!

Cheers,

Sam Jones

 

 

 

 

 

 

 

 

 

         It seems that our last update regarding what to do in the event of a correction was pretty timely.  Now, that we’re in a correction, the question on everyone’s mind is whether or not this is “that time” to add cash to investments, rebalance, realize losses and all the stuff we suggested in our update.  Read on for a murky answer to that question. 

A Little Context 

         First let’s back away from the moment and look at the big picture.  The US stock market is now arguably the most overvalued in modern history.  If one is looking for some relativity to that statement, we could say that stocks look relatively more attractive than bonds or real estate.   We can also argue that stocks are relatively not that overvalued considering the very low interest rates.  But let’s not kid ourselves into thinking that stocks are cheap by any stretch.  They are either the most overvalued of all time or the second most overvalued of all time, one of the two.   

         Now think about a good sale or discount.  What makes a good discount?  Is it 10%?  20%?  30%?  What number would compel you to act on a purchase of something you wanted in the retail world?  20% usually piques my interest, 10% not so much.  Well for all the drama in the last couple weeks, the US stock market is barely off its high by 5%.  Does 5% compel you to act?  I am not compelled. 

         Finally, let’s look at what lies immediately ahead from several fronts.  First, we have what has been called a mega mashup of political fights in congress for the next 30 days.  They are fighting about rather large issues that will have a profound impact on the economy, possible default on Us Treasuries, natural disasters and Covid relief, tax policy and the big infrastructure spending bill.  The House narrowly passed a bill yesterday to “suspend the debt limit and delay a government shutdown”.   

https://www.reuters.com/world/us/us-house-vote-tuesday-fund-govt-through-dec-3-raise-debt-limit-2021-09-21/ 

         This bill is unlikely to pass in the senate, but we’ll see. The debt ceiling issue is always an annual dog and pony show and we know how it will end.  They will expand the debt ceiling but the “show” this year is going to a big one with competing powers on both sides of the aisle not wanting to budge. For now,  they are trying to buy themselves time to have a good public fight.

Second, we have seasonality which is negative until the middle or late side of October.  This factor is a blunt instrument for trading but the pattern over the years is pretty well worn with September and October being two of the worst months of the year historically (reasons unknown).   

         Third, we are entering a new earnings reporting cycle starting in mid-October.  Earnings for the 3^rd quarter will look back to earnings from the 3^rd quarter of 2020 which will still compare well on a year over year basis but not nearly as BIG as what we saw in the year over year comparisons from the 2^nd quarter of 2020.  April, May and June of 2020 (the 2^nd quarter) marked the very worst conditions for most companies in their histories.  But the 3^rd quarter showed a significant increase in earnings and activity.  So long story short, it’s going to be tough for earnings to look as good as they did last quarter.  Given how stocks are priced, we might be ready for some earnings disappointments in the weeks ahead. 

         And last, we have a bunch of other junk acting as unknowns and headwinds to stocks.  They are China and their little real estate developer problem, COVID Delta variant, and whether or not this thing is contained, a slowing economy that is now measurable on many fronts, and very high Inflation (more on this in a minute).   

         If I pile up all this context in terms of timing and headwinds and compare it to a market that has corrected ONLY 5%, I have to wonder if we’re looking at a real discount at all?  Is a 5% correction enough to create value, or discount the list of serious issues directly ahead?  Probably not.   

Get Ready…. Get Set 

         Think about our situation now as sitting at a traffic light that is showing red.  Red means stop and wait for the green light.  Red means, if you choose to move forward through the red light, you could get hammered by something moving fast.  Red means wait.  We know that the next light is green however, so this is a good time to “Get Ready and Get Set”.  What does that mean in investment terms? 

         Getting ready to take advantage of any pullback requires action.  Here are a few ideas for everyone out there including our clients and anyone trying to manage their own money: 

1. Add cash to your investment accounts but wait to deploy that cash.  This might be your planned annual IRA contribution, funding a 529 plan, or just adding cash to a taxable account (assuming you have more cash in your bank than desired). Moving cash into your investment accounts is an action item, get er done.  Do it today. 
2. Start making a shopping list of potential investments to buy.  We have a systematic approach to finding our next investments based on relative strength, leadership, oversold, valuations and general asset allocation guidelines.  We have cash ready to deploy but will let the market tell us where to deploy that cash with a special eye toward potential new leadership.  Right now, I see no leadership…. Anywhere…. One more clue that it’s too early to deploy cash.  But it is time to actively shop and explore.  
3. Take a second to look through your portfolio to identify which positions you hold at a loss.  Given that over 30% of the market is now trading below a 200-daymoving average, I’ll bet you have more than a few.  These might be candidates for sale in taxable accounts in an effort to “harvest your tax losses”.  If you feel the need to raise cash, this might be a time and place to get that done.  Selling securities held at a loss creates a capital loss that you can use against future gains in your year-end calculations of net realized gains.  Remember, our goal is not to sell and sit in cash forever but rather to sell, capture the loss, and redeploy the proceeds into something more productive and promising.  Again, this is only a relevant action item for securities held in taxable accounts. 

Inflation and the Fed 

         I’m going to finish with a little macro-opinion because today is Fed day so I feel compelled.  Jerome Powell had the hawk beaten out of him by Trump and Co. back in 2018 when he was personally and squarely blamed for the 20% market decline by tapering bond purchases and raising rates.  Powell is not willing to be the nations’ punching bag again, probably not again in his career.  Powell is therefore likely to talk down inflation (as temporary!) and come up with any and every reason why the Fed needs to continue to support the economy (weak employment, weak economy, etc.).   

         We also know that practically every public measure of inflation is understated, almost to an absurd level.  The Fed is broadcasting the Personal Consumption Expenditure (PCE) index as their measuring stick which is now less than the Consumer Price Index (CPI) which is WAY less than the Producer Price Index (PPI).  My best guess for real inflation in our country is that the cost of living is currently increasing close to 6%.  I pull that number from the average annual change in wages in the private sector which is just under 6% for the last 12 months.  I suspect employers are trying to keep wages in line with the real cost of living for their employees in order to retain them.  Anyway, the point is that the Fed needs to show a different number than reality in order to avoid embarrassment in not doing their job (Fed mandate is price stability and full employment).  Prices are not stable and we are not at full employment.   

         The problem for the Fed as we move forward in time is that their arguments surrounding the temporary nature of inflation are going to become thin and hard to defend.  I want to highlight one of the biggest contributors to the Consumer Price Index which is housing costs represented in the index as a combination of “Rent of Primary Residence” and “Owners Equivalent Rent”.  Note that neither variable includes the real prices of homes sold but rather the rental equivalencies.   What we’re about to see is that rents in our country are going to go up, straight up.  Rents follow home prices with a lag of about 13 months.  Look at the chart below from the BLS that is circulating everywhere. 

 

         You can see that rents (shown in blue) are experiencing an historical divergence with actual home prices (shown in Red).  We are also approaching the 13-month time and place when we would expect rents to chase prices.  Furthermore, the rent moratorium is now over, not extended by the courts, so landlords are free to raise rents or evict.  It’s a sad moment for many who are renting as they are about to get some harsh notices from the property owner.  This is always what happens when we try to control prices in anything.  Once the price control is lifted, they race hard and fast to get where they want to go.  Rents are about to go as sharply as what we have seen in home prices over the last year.   

         Here’s the critical takeaway.  31% of the CPI index is comprised of these housing rental costs.  If rental costs are going sharply higher, CPI will go sharply higher and the Fed is going to be embarrassed into acting swiftly (tapering bond purchases, raising interest and admitting that inflation is not temporary).  From a timing perspective, we’re looking at early 2022. 

         I wanted to include this macro commentary because Federal policy has a direct impact on the financial markets.  Today they are our friend; they will say nothing today that disturbs the market.  We might even get a brief relief rally in prices.  But the trend of Fed policy is not so benign looking forward as conditions out of their control, impact their stance.  Clearly, we want to be aware of the context of timing and the environment in terms of what we buy, how much and when.  As such, I believe we are quickly entering a new regime in which the typical “buy the dip” strategy becomes more challenging and we might consciously wait to buy bigger dips and deeper discounts.   

Enjoy the Fed Commentary today… or take a nap, you won’t miss anything 

Sam Jones      

 

       This is an important update for any and all investors.  We offer this advice in the vein of financial literacy such that we can make smart, productive, and rational decisions when adverse market conditions compel us to do just the opposite.  

Focus on the Things You Can Control 

       Risk management in the investing world attempts to control a lot of things including portfolio volatility and absolute downside losses when the financial markets experience deep corrections or bear markets.  The practice is both art and science.  But there are limits to what any form of risk management can accomplish.  To be clear, risk management does not eliminate risk, nor does it try to sidestep every down week or negative giggle in the markets.  It is about reducing volatility and reducing downside losses to a tolerable level such that recovery periods are shorter in both time and magnitude.  Risk management cannot control what the market does of course, we can only respond to what the markets present us in both risk and opportunity.  To the point, as investors, we can only control our behavior.    “The market” is never wrong, just our assumptions about what it should do and our reactions to real price action.  

Now with that said…

Will Brennan, CFP Advice- Best Practices for Investors Following a Market Correction 

       I asked Will to write up a specific piece of advice for our clients.  The question I posed to him was this. 

Will, from a financial planning perspective, what should investors do after a deep market correction or even a bear market? 

Here’s what he had to say. 

Will Brennan, CFA, CFP 

       Following-up on our recent piece concerning return expectations, we are publishing a roadmap or checklist of action items to pursue in the event of a market selloff or correction. Market corrections, defined as drops of more than 10% from recent highs, have occurred in 11 of the last 21 years (source: Charles Schwab). Going back even further to 1980, the S&P 500 has seen an average intra-year decline of 14.3% despite annual returns being positive in 31 of those 41 years (Source: JPMorgan Guide to the Markets). That said, corrections are normal market events that, while scary, present good long-term financial planning and buying opportunities. While we cannot predict when a market correction might occur, we want you to understand the ideas and logistics of how to react during a selloff or correction: 

1.) Harvest Tax Losses

• a)A selloff or correction might provide an opportunity to realize (harvest) taxable losses.
• We can simultaneously reposition the portfolio to catch the subsequent market rebound.
• Realized or harvested taxable losses can be used to offset future capital gains OR to reduce ordinary income by $3,000 per year.
• Unused losses may be carried forward in perpetuity.

2.) Stay Invested but Rebalance

• Similar to number 1, a sell-off or correction may afford the opportunity to reposition an individual’s portfolio by asset class as well as by strategy type (active to passive).

3.) Ante Up

• While staying invested during market selloffs or corrections is paramount, it also presents opportunities to buy risk assets at cheaper or distressed prices.

4.) Accelerate or Bunch Retirement Plan and/or College Savings Plan Contributions

• Selloffs or corrections provide great entry points for retirement plan and/or college savings plan contributions.
• If you find yourself in a correction, it may be wise to accelerate or bunch planned contributions into these accounts.

5.) Consider Roth IRA conversions

• Selloffs or corrections may allow for opportunities to convert dollars from pre-tax IRA accounts to after tax Roth IRA accounts.
• This would require taxes to be paid up front.
• Future growth on converted dollars is TAX FREE and not subject to required minimum distributions.
• Before recommending Roth IRA conversions, we encourage a careful examination of your tax situation today and in future years.

6.) Consider withdrawing cost basis from Annuities or Variable Insurance Products

• Selloffs or corrections may allow for tax free opportunities to withdraw the cost basis on Annuities and/or Variable Insurance Products.
• Before recommending withdrawals from Annuities or other Insurance Products, we encourage a careful examination of your tax situation.

Great Advice! 

       Of course, we’re here to help all our clients navigate these decisions when the time comes, and the time will come.  Think about these things and get yourself ready to act when the time comes.  Let’s turn a market discount into the opportunity that it is! 

Changing our Asset Allocation Mix in Response to Market Conditions 

       What a perfect time to provide a quick update on a change in our dynamic asset allocation model made effective last Friday.  Again, we’re not forecasting, nor trying to control the markets, just our response to conditions as they unfold.  These changes are happening in our flagship All Season and Gain Keeper annuity strategies which by design actively overweight and underweight investments into (and out of) various asset classes based on empirical evidence and price trends.  Other equity only strategies like Worldwide Sectors and New Power are making adjustments as well mostly by raising some cash and selection criteria.  Our passive programs like MASS income and Wealth Beacon strategies remain fully invested- as they should. 

The market environment today is beginning to respond to several key factors in terms of strength and weakness in sectors and asset classes.  The key factors are as follows in no particular order: 

1. Increasing recognition that inflation is not temporary – Latest PPI number was shocking, inflation now running at 8.3% year over year. 
2. Likelihood that the Fed is going to be forced to respond to inflation sooner than they suggested.
3. Recognition that we will continue to see BOTH labor shortages and persistently high unemployment (we have spoken of this phenomenon several times in the past few months).
4. The post Covid economic recovery is showing clear signs of weakness now.
5. Treasury bonds and interest are more focused on inflationary pressures than economic weakness (Treasury bonds). 
6. Inflation trades are showing new signs of resurgent strength after a very weak summer.  
7. Housing prices are flattening – lower growth and increasing supply but not price declines.
8. Transportation sector is under fire – this is one of the economically sensitive sectors to watch for early signs of economic weakness.
9. Earnings season has been very strong but year over year comparisons are going to be much tougher in the 4^thquarter as we push past the depth of COVID data in 2020. 

        Jason Goepfert of Sentiment Trader, maintains a Macro Index Model that effectively mashes all this stuff together and plots the aggregate against the stock market.  As a thesis, the markets tend to have a very high correlation to trend in the Macro Model, give or take a few months.  Last week, Jason made note that their Macro model just hit the 2^nd lowest level since the last bear market in 2008.  In other words, the economy is not nearly as strong as the markets would suggest. 

 

At the same time, we are seeing very clear evidence that inflation is still running much higher than expected or desired.  The possibility of 70’s style stagflation is increasing every week … and so, without guessing at the future,  our asset allocation mix will follow the evidence of what is happening with these key economic and market trends.  This is never a one and done thing but rather a slow-moving evolution through ever changing conditions. 

Specifically, we have made the following changes to our Asset Allocation mix as of last Friday. 

1. Reduced our World Stock Index exposure by 10% (from 60% to 50%).
2. Increased our Alternatives and Volatility Controls by 5% (from 15% to 20%).
3. Increased our Inflation/ Commodities allocations by 5% (from 10% to 15%).
4. Bond and Credit allocations remain the same at 15%.

       Thanks for reading and stay tuned as we have a lot of great financial planning opportunities as we angle closer to the end of the year.   

Sincerely, 

Sam Jones – President 

Will Brennan – CFP 

 

 

 

 

 

     

      As August comes to a close, I like to reflect on some observations and perspective gained through casual conversations with friends, family, and strangers on time away from the day-to-day data mining and office grind.  I jot down notes of comments that I hear over the summer.  Honestly, I feel like I learn more just watching life around me and listening to people talk than I do reading through piles of technical financial reports.  These are my observations in no specific order with personal opinions regarding expected resolutions. 

Return Expectations Are Very High

      When conversations turn to “what do you do”, and I reveal that I am in the wealth management business, I often get an earful.  If I had to summarize, the consensus is that stocks will not go down more than 10% (before the Fed steps in to save us) and that returns for next year will easily be double digits.   

“ I think the rest of the year should be pretty easy.”   

“Markets won’t lose more than 10%, the Fed has our back.” 

 “I only invest in things that make 15-20% a year.” – my favorite 

Indeed 

      Jared Dillian of the Daily Dirtnap posted the results of investor surveys showing that investors on average expect a 14% gain in 2022.  It’s so nice when data and conversations tell the same story. 

      My Opinion – Forecasting returns is big business for some, but not our firm.  We are trend followers and accept asset class trends as they come and avoid relying on dependent variables.  However, human nature is one of the few things we can depend on when it comes to investing.  We silly creatures have operated under a nearly perfect inverse relationship between expectations and outcomes regarding market returns for as far back as stock market data exists. When investors are bullish with crazy high expectations as they are now, we know with high probabilities that the market is unlikely to produce those results.  The opposite holds true at major market lows when expectations for future returns are bleak and negative as they were in March of 2020.  So, for this bettin man, I’ll take the odds that the markets are not going to produce 14% until we see prices reset to more attractive levels.  I’ll also take the odds that our first pullback of 10% will not stop at 10%.  2021 should still be a good year, it already is.  But corrections eventually happen and they do create new powerful return and wealth creating opportunities.  I look forward to both… in 2022. 

Real Estate 

Oh my, everyone wants to talk about real estate.   

“I can’t believe how much my house is worth.” or  

“My neighbor sold his house in 1 day for 10% over asking price.” or 

“It’s just crazy what’s happened to real estate.” 

“We are buying a bigger home because rates are so low.” 

      Yes, yes this is what real estate does when borrowing costs are at 3% for 30 years and inflation is running hot at 5-6%. Add the fact that we have a new generation of Millennials who are buying their first homes, sprinkle in some pandemic recognition that you can work remotely from anywhere (why not move to some place great!) and finish it off with a national housing supply shortage.  Voila – prices go up 20-30% year over year!  Nothing crazy, it’s just supply and demand. 

      But there is a new conversation creeping in – carrying costs for housing are also rising sharply. 

      Carrying costs are those pesky expenses that surround home ownership, like mortgage interest, taxes, utilities, landscaping, a new roof, replacing a washer/dryer, snow removal, etc.   

      Anecdotally, a neighbor rents a vacation home for the summer months.  Last week she learned that her leach field would need to be replaced and that her property taxes were going up 35% from the last tax assessed value.  She was very upset.  These additional costs were going to erase nearly 3 years of rental income (net of expenses).  Nothing about owning a home is cheap anymore.  As house prices rise, so too do the costs to maintain and carry them.  Bigger homes have bigger costs 1:1. There is no economy of scale in real estate maintenance costs.  

      We also know that mortgage rates have stopped falling and may be turning up as the Fed talks more often about tapering their stimulus measures, even increasing rates in 2022.  Mortgage interest is not a variable cost for most but a new and potentially higher cost for the next buyer. 

      My Opinion – I see a lot of people buying a lot of real estate and paying some very high prices, carrying mortgages that I can’t imagine.   I don’t like the set up for real estate from here.  If mortgage rates go up beyond 3.40%, real estate prices will fall regardless of the favorable supply and demand stats.   

      This is perhaps one of the most interest sensitive real estate markets I have seen in my career.  Forbes agrees  https://www.forbes.com/sites/billconerly/2021/07/27/the-end-of-the-housing-boom-will-be-when-mortgage-rates-rise-in-2022/?sh=f7cb1e56770b 

      Strange as it might seem, I would also expect rising carrying costs to become a source of selling pressure especially for rental property owners who have been hurt badly by the 18-month rent moratorium which ended today with a vote by the supreme court. 

      Supply of homes for sale should rise from here, while demand for new homes at these prices should fall.  These trends are already happening in certain locations, with price gains tapering or even falling.  With that said, any pullback in prices while rates move higher should present the next great opportunity for buyers.  Be patient now and keep saving for that home.  2024 would be about right if I had to guess. 

      As I have written about before, there is an easy way to own real estate without owning the hard asset and still collect the healthy income.  https://allseasonfunds.com/reits-or-rental-property/ 

Frustration With Summer Chop in the Markets

There is clear frustration with the market performance since last spring.   

“Nothing I have is making money.” 

“I’ve had it with my bonds – I’m going to sell them.” 

“It seems like my portfolio just goes up and down the same amount every month.” 

      Our client portfolios are experiencing much of the same, no big movements up or down for several months now. 

      Bonds or any fixed income investments are now posting losses on a total return basis over the last 12 months.  The 10-year US Treasury bond is down -4.15% including all interest payments since the highs in August of 2020.  Investors are noticing. 

“I feel like I should be doing something different with my bond money.” 

      Of course, losses in the bond market presents a bigger problem.  Retirees, risk averse investors or anyone who uses bonds as a risk control tool are now facing a challenge.  They must either accept the underperformance and stick with their allocations or make a big jump toward risk assets like stocks.   

      My Opinion – Investors need to remember that no asset class goes up in a straight line.  There are times like these when we need to stay patient and wait for a definitive trend.  I can’t say with confidence that the current trend in stocks is either up or down.  It’s just choppy.  Considering the gains off the lows of March of 2020, I think we should all be VERY thankful that we’ve only seen sideways chop so far.  I would have expected a sharp round of profit taking after that run but investors seem willing to ride this bull and give it the benefit of the doubt.  So far, a few months of sideways chop is not a painful experience beyond the wait. 

      On the bond thing – Bonds have traditionally served us well in providing gains and income when stocks are falling.  For as long as inflation is running hot as it is today, bonds are not going to provide that service and function.  They will just gradually lose money as they have been for over a year.  Arguably, there was a time to reduce bond exposure 12 months ago – as we did for our client accounts.  Bond prices were hitting all-time highs while stocks were still deeply discounted from the COVID wipeout.  Asset allocators would use that time and place to rebalance from bonds to stocks and commodities.  Few did but that was the optimal time to do it.  Today, bonds are becoming more attractive as prices are falling and stocks are becoming less attractive.  We could even argue that a prudent asset allocator would begin moving money from stocks TO bonds now.  Again, few will do so.  It’s hard to add to something that is losing and reduce exposure to something that is winning.   

      Our positioning to bonds is very small (15%) by historical standards (~40%) and we have no plans to add to bonds until we see a definitive top in stocks and commodities.  We are still in an inflationary cycle that could become problematic if the Fed doesn’t end their over easy policies very soon.  Inflation is bad for bonds, good for stocks and commodities.  We are in year one of this cycle and have no idea how long we can expect inflation to be with us.   No doubt, investors in any income model are a bit frustrated now at the lack of returns over the last year.  If your financial plan is accepting of a smaller bond position, it’s not wrong to make a change.  If not, stick to your plan, and be patient.  Frustration should never be a reason for making a change to your prescribed asset allocation. 

Let’s leave it there for today. 

      I hope everyone is enjoying the last bits of summer – boys are heading back to school/college this week.  Sad to see them go as always. 

Sam Jones