Don’t worry, I’m not going to get biblical on you with this update. But, I do have several market and personal finance revelations to share that every investor should know at this stage of the cycle.
The financial services industry always seems obsessed with benchmarks. Where would companies like Morningstar be without them right? Three stars, five stars, whatever, all derived from comparisons to a benchmark of some sort. I love it when I see an index benchmarked to the same index. A perfect 10 every time! The creators of LIBOR (London Inter Bank Offered Rate) benchmark are now in hot water as it seems they have been adjusting LIBOR rates to satisfy the needs of their banking products. Why not make it easier to sell your loan product, which is tied to LIBOR rates, by changing LIBOR itself? Wall Street has so much hatred for current bank regs because they are so restrictive. My take - bank regs can never be too stringent – not from what I've seen in the last two decades. Increased credit regulations do not restrict lending but rather bankers who do not want to lend money for 30 years at 3% interest rates. Trust me, when rates move up to 5,6, 7 and 8%, you will magically see lending restrictions lifted again.
In a recent conversation, it was mentioned that “the market” is up 10% YTD. What is “the market”? Is it the S&P 500, which is up 10.5% YTD and 30% into all time new highs? Is it the Dow Jones Industrial Average of 30 stocks which is up 6.4% YTD and out to new highs by 24%? Or maybe we should consider any number of the broader, global indices for comparison. I have 343 indices in my universe. The NYSE Composite index has not yet made a new high from the one set in July with roughly 2.3% to go. The MSCI Global Stock index is up 2.85% including a heavy weighting in the US, and is still trading below the highs set in…. 2007! So here’s the revelation regarding benchmarking. US only stock indices like the S&P 500 and the Dow are cap-weighted indexes meaning a small company like Apple or GE can wildly skew the total performance of each. But why should you or I care? What happens in the world of benchmarking standards when applied without real knowledge is that we all tend to work harder and harder to beat something that isn't reflective of total “market” conditions. We are effectively driven to chase returns among only those things that are moving faster than the fastest benchmark leading us to own wildly overbought stuff that are experiencing nearly vertical price patterns. Apple is the largest company in the world by market capitalization. It is the biggest stock in the S&P 500. If we want to beat the S&P 500, why not just own Apple? Is beating the benchmark the only objective? For MOST of our industry, the answer is yes which is why everyone must own Apple, whether they really like it or not.
From a personal finance perspective, chasing performance or evaluating an investment manager using something like the S&P 500 as a benchmark is almost a recipe for failure by itself. You will always find yourself buying a stock or fund that has already run higher or looking off a perfectly respectable performance stream just because it doesn't beat the S&P 500 every week or every quarter. At All Season Financial, we are conscious of what “the markets” are doing but really focused on meeting our self imposed strategy return and risk objectives. These objectives are based on our analysis of what is possible in the way of generating the highest risk adjusted returns we can given strategy design, asset class risks and opportunities. For instance, within a given risk profile, our tactical equity models (3) are shooting for average annual returns between 8-12% net of all fees in the current market. Our blended asset strategies (3) are shooting for 6-10% average annual returns and our income models (2) are shooting for 4-6% average annual returns net of all fees. We measure these objectives against real returns on a rolling 5-6 year window and we don’t really care about benchmarking beyond that frankly and our objectives have both return and risk criteria.
Credit Market Revelations
Revelations, as the last book in the Bible’s New Testament, is really about a suggested apocalypse. I am not suggesting anything of the sort for the credit markets. However, I am not alone in my long range assumption that our global credit markets, specifically sovereign debt or government bonds from all countries, are in their final stages of very, very long bull markets. Currency wars between countries have been with us now for nearly eight years, together with massive stimulus and quantitative easing measures by central bankers all having the effect of driving bond prices artifically up and interest rates down to nearly zero. For most sovereign debt issues, I believe we saw a bottom in rates (top in prices) in July of 2012 with the most glaring example coming from Japanese Government bonds (JGBs). In July of 2014, the US dollar index confirmed a meaningful and associated bottom as well and has been heading almost parabolicaly higher since. Bill Gross sees the writing on the wall and left Pimco. Now the table is set for a revelation of sorts in the credit market when the price of government bonds of the US and Europe begin to move lower meaningfully signaling a primary trend change. For the crafty dynamic asset allocators like us, we might yawn and simply rotate more into dividend paying stocks, preferred securities or perhaps bond surrogates like gas, electric and water utilities – happening now. Those in fixed blends of stocks and bonds like the many trillions trapped in 60/40 blends or things called “Balanced” funds will see their returns flat line year over year over year. Those with all of their money in government bonds will not yawn, they will be very sad as they watch their wealth do what’s happening in Japanese bonds, losing -12% annually.
When our credit market revelation occurs or is recognized, stocks will not like it initially, and this will be the catalyst for our next bear market in stocks without a doubt. I will be surprised if we don’t see it happen by next summer. But any decline in stock prices while interest rates are moving gradually and persistently higher will be one of the last great moments to buy equities at a discount. Between now and then, we have our End Game (topic of many updates) to contend with and will be focused on capital preservation as always.
Tax Time Revelations
Yes it’s that time again and 2014 is going to be terrible for mutual fund capital gain distributions. I have seen notices from several fund shops announcing 15, 20 and 25% distributions to shareholders this month and next. Let me explain why this is terrible for you as a shareholder. Distributions are not like dividends or other income. Mutual fund distributions are simply taxable gains passed from the fund to you the shareholder and the share price is adjusted down appropriately on the same day. THERE IS ZERO ADVANTAGE TO YOU AS AN INVESTOR. You own the shares so you are required to pay the tax for the fund’s aggregate gains realized each year. But suppose you bought the fund in January of this year and it’s up only 5% since purchase. The fund is effectively handing you capital gain earned over the course of the entire bull market dating back to 2009 regardless of whether you owned it back then or not. 2014 is proving to be that year in which mutual fund managers took a lot of profits on long-term positions and are planning to “distribute” those long-term gains to current shareholders. The personal finance tip is this. Check your fund and see if you can find out how much they plan to distribute. They are very sneaky these days because they don’t want everyone to sell out ahead of large distributions, which is exactly what you should do if the distribution is beyond 5-7% in our view. Sell it and buy something else – something that is not a mutual fund.
Several years ago, in light of these types of things with mutual funds as well as the egregious abuse in terms of costs, redemption fees, adverse trading policies etc., we made the conscious decision to move away from all mutual funds except those that don’t pay distributions like index funds or select bond funds. Instead, we employ exchange traded funds and individual stock issues which are clean, tradable and pay out real income and dividend streams. Yes, we pay a little periodically in transaction costs ($7.95) but we save an enormous amount in avoiding things like tax distributions.
This is also the time to review your tax strategy in terms of itemized deductions, contributions to retirement plans or education accounts like 529 plans. It is a time to consider charitable giving either as cash or appreciated stock. We have the knowledge and the people to help but every situation is different. Please feel free to call us but don’t wait until the last week of December. We can help you if you give us time to do so.
*Reminder – This Wednesday is our H.I.P. investor Solution Series Webcast – 9:00 am. The notice is posted on this Red Sky Report with link to log in info. H.I.P. stands for High Income Producing as in those making more than $250k in annual income. You won’t want to miss this webcast as you are now the IRS’s favorite punching bag.
Have a great week!