Tag Archives: investment advice

The Tolling Bells of Complacency

house and pigMy Comments: Not too many years ago, the idea of stability in the markets was divine. Now, not so much. That’s partly because with new technology and tactical opportunities from Guggenheim Partners, volatility increases your chance to outperform and watch your accounts grow. Of course, it also increases your chance to lose money if you don’t know what you are doing.

All the same, since so many of us don’t really have enough money to secure our long term retirement, I’ll be glad when volatility returns. We are way below average right now, as you can see from the chart which you will have to find by clicking on the right link.

A few years ago, facing a world in crisis, central banks aggressively employed monetary policy to avoid catastrophe in financial markets. Now, they must be equally aggressive in fighting complacency.

Commentary by Scott Minerd, Chairman of Investments and Global Chief Investment Officer – July 17, 2014

Last week, after writing my most recent commentary about market complacency, I was surprised that the latest Federal Reserve minutes revealed that the Federal Open Market Committee is also concerned investors are growing too complacent, raising the prospect of excessive risk taking. That followed remarks from Federal Reserve Bank of New York President William Dudley that low market volatility has made him nervous. Fed Chair Janet Yellen reinforced that view in her latest testimony to Congress, saying investors reaching for yield could increase the risk of market problems, and that some valuations, particularly lower-rated corporate debt, are stretched.

It is commendable that the Fed is acknowledging complacency and trying to remind investors of the uncertain path ahead; but perhaps the largest contributor to the rise in risk taking has been the Federal Reserve itself. The Fed is far from alone in fueling complacency, as central bankers around the world have continued to provide easy money to prop up overleveraged economies with large structural imbalances. The Bank for International Settlements has summed the situation up saying that global central bank policies have reduced price swings and market volatility, encouraging greater risk taking.

The Fed and other central banks are to be commended for having avoided a global financial meltdown by pumping up economic activity through cheap money and inflated asset prices, but this approach is not without risks. Now, with unemployment falling to 6.1 percent, the U.S. economy is building a strong head of steam. Despite that, Dr. Yellen has dismissed as “noise” the possible signs of building U.S. inflation, notably evident in Consumer Price Index data showing inflation running at 2.1 percent. That “noise” may well be an alarm bell that the complacency created, and even promoted, by central bankers could eventually result in unintended adverse consequences in the coming years. As policymakers globally contemplate the source of today’s market complacency, I am reminded of the words of 17th century English poet and cleric John Donne: “Never send to know for whom the bell tolls; It tolls for thee.”

Chart of the Week

ANNUALIZED VOLATILITY BY ASSET CLASS (click HERE to see the chart.)

The past few years of central bank-induced liquidity have calmed markets to a degree that is nearly unprecedented in the last 25 years. From equities to fixed income to currency markets, volatility is near historically low levels. The last time such complacency was seen was the summer of 2007, suggesting investors should not be lulled by the current market calm, and instead prepare for choppier days ahead.

Source: Bloomberg, Guggenheim Investments. Data as of 7/16/2014. Volatility refers to annualized 30-day standard deviation. Volatility of the 10-Year U.S. Treasury is yield volatility. The MSCI Emerging Markets Index captures large and mid-cap representation across 23 Emerging Markets countries. The S&P 500 is a market-weighted stock market index comprised of the stocks of 500 U.S. corporations; the index is owned and maintained by Standard & Poor’s. The S&P GSCI® is recognized as a leading measure of general price movements and inflation in the world economy. The DXY is measured against major foreign currencies. The Barclays U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated and covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities.

Economic Data Releases

U.S. Retail Sales and Industrial Production Confirm 2Q Rebound
• U.S. retail sales were below expectations in June, rising 0.2 percent as May’s gain was revised up to 0.5 percent. However, sales were stronger, excluding the volatile categories of autos, gas, and building materials, up 0.6 percent.
• Industrial production increased 0.2 percent in June, putting the quarterly growth rate at the fastest pace since 2010.
• Initial jobless claims declined to 304,000 for the week ended July 5.
• The Empire Manufacturing survey reached 25.6 in July, the highest in over four years.
• The NAHB Housing Market Index increased more than expected in July, rising to 53 from 49, the best since January.
• University of Michigan consumer confidence was weaker than expected in June, falling to 81.2 from 81.9.
• Producer prices ticked down again in June to 1.9 percent year over year. Energy costs rose 2.0 percent month over month.

Euro Zone Production Weak, Chinese GDP above Estimates
• Euro zone industrial production fell 1.1 percent in May, the largest drop since September 2012.
• The ZEW investor survey of the current situation in Germany fell for the first time in eight months in July, while the expectations index fell for the seventh consecutive month.
• Industrial production in France dropped 1.7 percent in May, the largest decline in a year and a half.
• French consumer prices fell to 0.6 percent year over year in June, the lowest since 2009.
• U.K. consumer prices rose more than expected in June, rising to 1.9 percent from 1.5 percent.
• China’s second-quarter GDP growth increased to 7.5 percent from a year ago, the first uptick in growth in three quarters.
• Chinese exports expanded less than expected in June, showing a slightly faster pace of growth at 7.2 percent year over year.
• Chinese retail sales growth ticked down to 12.4 percent year over year in June from 12.5 percent.
• Industrial production in China accelerated to 9.2 percent year over year in June, the best growth since November.

‘Trust me, I am a financial adviser’ is Not Good Enough

My Comments: There are those in the financial services industry that do not have to be accountable for what they say and do with respect to clients and their best interest. They claim to, but if push comes to shove, it’s buyer beware.

Of course, with today’s instant media, if you are on the wrong side of this, you might be able to create a firestorm that puts it right but there is no court of law to help you. Yes, there are some regulations that help, but no certainty.

Attorneys, CPAs, architechts, physicians, are all bound by what is called a fiduciary standard. This standard, codified in law, says they are bound legally to do what is in your best interest. Add to that the moral and ethical requirement to do all you can to make sure you provide legitimate advice.

The major push by some to bring the fiduciary standard to the Securities and Exchange Commission, which encompasses so many of us in the financial services industry, is dying a slow death. Wall Street firms have enough influence to deny this push, because they don’t want to be held accountable if an employee at one of their firms is determined to have not worked in their clients best interest.

Some of us, and I’m one of them, are classified as an Investment Advisor Representative. That means our presence on the scene is associated with a Registered Investment Advisor firm, which by law, is a fiduciary. Which means that those of us with this registration to offer investment advice are bound by a fiduciary standard. And that’s a good thing. (The following article appeared in The Financial Times, so the venue is Great Britain, but it needs to be a universal standard.)

By John Kay / July 8, 2014

The management of conflict of interest is a slippery slope, and one that Madoff would slide off.

Last week the Law Commission produced a report on fiduciary duty in financial services. It was a recommendation of my 2012 review on equity markets that they be asked to do so. The obligations a financial intermediary owes to its clients are, as the commission explained, a complex mixture of common law, regulation, contract, and custom and practice.

The world was once simpler. A century ago, after one Mr Jackson, a stockbroker, sold dubious shares from his own portfolio to a Mr Armstrong, his client, he was taken to court. He faced the stern wrath of Sir Henry McCardie, the judge: “The prohibition of the law is absolute. It will not allow an agent to place himself in a situation which, under ordinary circumstances, would tempt a man to do what is not the best for his principal.” Jackson was ordered to make good all Armstrong’s losses.

McCardie would have regarded the concept of a broker-dealer as a contradiction in terms. But from the perspective of Bernard Madoff – who, before he turned to Ponzi schemes, was a pioneer of the new breed of broker-dealers that emerged in the 1960s – paying for order flow was as innocuous as financing a rack of tights at the supermarket till. In due course, market-makers would accept payment to allow high-frequency traders to access their dark pools . That was as innocuous as licensing pickpockets to roam the supermarket aisles.

The management of conflict of interest is a slippery slope, and one that Madoff eventually slid off. Even Goldman Sachs sometimes finds it uncomfortable. Daniel Sparks, the former head of the bank’s mortgage department, struggled to explain the Abacus transaction, in which Goldman was accused of constructing and selling to its clients collateralised debt obligations based on mortgage pools that Paulson & Co, the hedge fund, had selected as likely to fail. After a series of equivocal responses at a Senate hearing, the exasperated Susan Collins, a US senator, asked: “Could you give me a yes or no to whether or not you considered yourself to have a duty to act in the best interests of your clients?” After a long pause, Mr Sparks finally replied: “I believe that we have a duty to serve our clients well.”

In the older, simpler world of McCardie, handling other people’s money involved an onerous responsibility.

The money in the global financial system has always been other people’s money. The Abacus transaction was a link in a chain. At one end were the depositors and policyholders of the banks and insurance companies that held the Abacus bonds. At the other were the beneficiaries of the institutions that had invested in Paulson’s funds. Quite possibly, some people were on both sides of the deal.

The regulatory requirement to “treat customers fairly” is a good deal weaker than a duty to act in the best interests of a client, and even that obligation is weakened as one moves along the chain to the professional investor and the regulatory concept of the “eligible counterparty”. But why should savers lose protection against abuse because they trust intermediaries with their money? Savers – most of them – have not chosen to enter a game in which they choose the players that represent them in the hope that they will outwit the players others have chosen. They have not decided to bet on team BlackRock to beat team Fidelity or vice versa.

They are looking for a safe home for their cash and savings.

When you talk to people in the financial world, you encounter many – notably in retail banking and asset management – who have a strong sense of responsibility to their customers and clients. You also encounter others who appear to recognise no obligation other than to make as much money as possible for their employer and – particularly – themselves. The only way to restore trust in the finance industry is to emphasise the former more and the latter less.

Both brokers and dealers have a role to play in making markets. But what is unacceptable is to spout rhetoric that proclaims the primacy of the interests of the client while the reality is quite different. McCardie saw that you could be an agent or a trader; but you could not be both at the same time, and you had to make entirely clear to the customer which role you were playing. That is surely as wise today as it was a century ago.

US Economy: Misaligned Policies to Blame, Not Structural Flaws

retirement_roadMy Comments: More than once a week, I have conversations with a client, or prospect or someone I run into, who are gloomy to the point of absurd. There is a pervasive expectation that life will be miserable going forward. I suppose it’s a natural phenomenon, but I don’t share it.

That it will be different is a given; every generation for millenia has lived in a world different from their parents, though granted, these days the changes happen faster. But look around you. In the world you live in today, do you see abject poverty in this country? I’m talking about the kind I experienced as a child when I travelled with my parents to India. From the train station to the hotel, surrounded by beggars, some not more than 4 or 5 missing an arm, removed by a parent to improve their chances of a handout.

How many of us have no bed to sleep in, miss a meal every day, have one set of rags to call clothes? Yes, there are some, probably suffering from a mental disorder, but this has mostly vanished from the civilized world. And that includes India.

So get over it, figure out what you can do to help your children and grandchildren live in a different but OK world, and focus on the positive. You may be surprised how good life can be these days.

Michael Ivanovitch / Sunday, 4 May 2014

Investors need not worry about naysayers’ myriad structural flaws of American economy. Some of these problems do exist, most are fanciful, but none are currently responsible for America’s Mediterranean style output gap.

The U.S. economy is held back by a misaligned policy mix: Excessive fiscal restraint and an ineffective monetary policy at a time when aggregate demand remains well below its noninflationary potential.

Jobs, incomes and credit costs are the key variables driving America’s economic activity. All of them are in a dire need of more supportive demand management policies.

It is wonderful to see that 288,000 new jobs were created last month in a broad range of nonfarm business sectors. But that still left 9.8 million people out of work, 7.5 million people stuck in part-time jobs because they could not get full-time employment and 2.2 million people who dropped out of the labor force because they were unable to find a job.

Adding all that up, we get an actual unemployment rate of 12.6 percent — double the officially reported rate of 6.3 percent.

And there is nothing structural about this, even though there are sectoral and regional mismatches between the labor skills demanded and those on offer. A meaningful decline in this huge number of unemployed can only be obtained with a steady and sustained increase of labor demand as businesses expand their output to meet rising sales. That is what we have don’t have enough of.

Weak incomes are a direct corollary to such a large labor market slack. The real disposable household income bounced back in the first quarter of this year, but over the last four quarters incomes grew at an average annual rate of only 1.3 percent.

Ask the Fed why the banks are not lending
How can one expect a buoyant household consumption (70 percent of U.S. economy) from these employment and income numbers?

A puny 2.2 percent average annual growth of consumer outlays during the last four quarters is partly a result of households drawing down their savings to maintain their customary consumption patterns. Indeed, the savings rate, now down to 4 percent of disposable income, has been on a steady decline since the middle of last year.

And neither are we getting much help from a near-zero effective federal funds rate and massive monthly asset purchases that have expanded the balance sheet of the Federal Reserve (Fed) to a mind-boggling $3.9 trillion and the banks’ loanable funds (excess reserves) to an equally extraordinary $2.6 trillion – an increase of 32 percent and 49 percent, respectively, from the year earlier.

All we got from that is a 4 percent increase in bank lending to households. People are increasingly turning to nonbanks, whose consumer loans are soaring at annual rates of 7-9 percent and represent 60-70 percent of total consumer lending.

Somebody should perhaps find out why it is that U.S. banks prefer to keep $2.6 trillion at the Fed at an interest rate of 0.25 percent instead of financing car purchases at 4.2 percent or extending two-year personal loans at 10.1 percent.

Residential investments — the other interest-sensitive component of aggregate demand that is directly influenced by jobs and incomes – have also drastically weakened since the middle of last year. They increased in the first quarter at an annual rate of 2.3 percent, practically collapsing after a hefty 15 percent annual gain in the second quarter of 2013.

The most frequently heard explanations that rising real estate prices and higher mortgage costs are the main reasons for the weakening housing demand are largely peripheral to the core issues of high unemployment and virtually stagnant real disposable personal incomes.

I am not dismissing the negative impact of a 12.9 percent increase in real estate prices over the last twelve months, and a 100 basis points gain in mortgage rates. But, as important as these things might be, they literally pale into insignificance compared with the depressive force of high jobless rates and nearly flat incomes.

A low labor participation rate offset April’s better-than-expected jobs report, says David Dietze, President & Chief Investment Strategist at Point View Wealth Management.

Tell the Congress to ease up on the purse
Faced with weak private sector demand, one might expect that the economy would get some help from stronger public spending. Unfortunately, the opposite is happening. While criticizing Germany for palming fiscal austerity on its recession-ridden euro partners, Washington is in fact following the German policy line.

According to recent estimates by the nonpartisan Congressional Budget Office, a severe fiscal retrenchment is expected to cut this year’s federal budget deficit to 2.8 percent of the gross domestic product (GDP), marking the fifth consecutive year of a sharply narrowing budget gap.

That is a laudable effort, but such haste in slashing public spending is the last thing we need when the economy is growing below potential and struggling with high unemployment.

The U.S. Congress should allow the government to, as the White House says, “spend money on infrastructure to fill up the potholes” and attend to other worthy public services. More generally, a reasonable increase in public spending would go some way toward supporting demand, output and employment.

This discussion shows that there is nothing structurally wrong with the American economy that would degrade it permanently – as some observers seem to believe – to the position of a global growth laggard.

Yes, income inequalities have to be watched carefully, but the U.S. needs no lessons on this because its progressive income tax was introduced in 1862. The progressivity has been sharpened many times since, and the public debate of income inequality will probably heat up during the forthcoming election cycle.

Education, healthcare and a more enlightened approach to immigration are also issues of continuing concern for every administration.

U.S. trade imbalances are another ongoing question of public policy. Clearly, the economy could benefit from a more aggressive enforcement of sound trade practices to even out the playing field for American companies and to protect their intellectual property.

But more than anything else, the American economy needs effective fiscal and monetary policies to narrow its large output gap and to stimulate employment creation.

Don’t sell the U.S. short; its world-beating companies offer some of the best and safest investment assets you can find – anywhere.

Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.

Short Selling Drops to Lowest Level Since Lehman

roulette wheelMy Comments: Last Tuesday, I referenced an article with a compelling reason to think the current stock market move upward would soon go the other way. The author asserted the collapse was already under way. Here is an equally compelling article that suggests it’s not going to collapse, instead is going to continue going up.  (at least for a while!)

All this is to tell you no one has a clue. After the fact, everyone on the right side of history can claim they were right. But that’s like a broken watch which is right twice every 24 hours.

In my opinion, as a fincial advisor, the solution is to employ the skills of talented money managers, people with a laser like focus on one particular component of the overall market. Then make sure they have the ability to be in the market positively or negatively, or in cash. That way you really don’t care what happens, since your chances of increasing the size of your account are higher regardless of the history.

By Miles Johnson, Hedge Fund Correspondent / July 8, 2014
Hedge funds still unwilling to bet against the rally

Hedge funds have sharply scaled back their bearish bets that the value of stocks is about to fall, with the proportion of shares earmarked for short selling at its lowest level since before the financial crisis despite warnings of renewed market exuberance.

The percentage of stocks that have been borrowed by short sellers – who try to profit from a company’s share price falling – has dropped to the lowest level in the US, UK and the rest of Europe since the years before the collapse of Lehman Brothers, according to data compiled for the Financial Times by Markit.

The fall in short selling comes as Wall Street and markets in Europe trade at near record and multiyear highs, indicating that while some high profile hedge fund managers have warned of excessive market euphoria the industry is still unwilling to bet against the rally.

The amount of so-called short interest in the benchmark US S&P 500 index is hovering around 2 per cent of total shares in the index, close to the lowest level since Markit began collecting the data in 2006. In the European Stoxx 600 index, the level is similar at just over 2 per cent, while short interest in the UK FTSE All-Share index stands at less than 1 per cent.

This compares with sharply elevated levels in the years preceding the credit crisis, with the data showing short interest in the US in 2007 hitting a high of 5.5 per cent. The Markit data does not take into account all changes in stock indices over the period.

Buoyed in part by injections of cheap money from central banks, including the Federal Reserve’s asset-purchase programme, leading stock markets have continued to rise this year after enjoying strong gains in 2013, forcing some hedge funds to cut their short bets to avoid being squeezed.

As the FTSE All-World and S&P 500 have set records, volatility has faded away, with one measure, the Vix index or “Wall Street fear gauge” dropping to a near seven-year low.

“Historically, periods of low volatility usually lead to further periods of volatility, they are not precursors to a crisis.” – Antonin Jullier, global head of equity trading strategy, Citi

This has prompted a string of recent warnings from a number of leading hedge fund managers such as Baupost’s Seth Klarman, CQS’s Michael Hintze and David Einhorn of Greenlight Capital about the distortions being caused by ultra-low interest rates and bubbles in some asset classes.

Closely-followed short sellers such as Mr Einhorn have argued that US technology shares have reached “bubble” valuations, but have bemoaned the difficulty of making bets against them given the level of hype surrounding the sector.

“It is dangerous to short stocks that have disconnected from traditional valuation methods,” Mr Einhorn told his clients earlier this year. “After all, twice a silly price is not twice as silly; it’s still just silly”.

However, despite a jittery period for some technology stocks in the first half, investors have been undeterred by the warnings, with some analysts arguing that shares are still cheap compared with other assets.

“Historically, periods of low volatility usually lead to further periods of volatility, they are not precursors to a crisis,” said Antonin Jullier, global head of equity trading strategy at Citi.

Mr Jullier said that some hedge funds had become discouraged from short selling as a result of being repeatedly wrongfooted by rising markets.

“Hedge funds have underperformed in the first half and this means their appetite for risk has fallen over the year,” he said.

Rising stock markets have coincided with sharp price increases for other asset classes, ranging from Jeff Koons’s sculptures to junk bonds and London house prices, prompting concerns among some investors that markets have lapsed back into complacency.

Buckle Up! The New Bear Market Has Begun!

1-5-2000-to-6_30-2014My Comments: The writer has a powerful message to send. He was right about this back in 2008 but that doesn’t mean he’s right this time. I have clients and prospective clients asking when the next downturn is going to begin. And yet there are many articles that suggest it’s still a long way off.

This week I received my copy of Investment Advisor. In it five famous advisors share their preferred asset allocation of the month. The most conservative of them has 30% in stocks, 50% in bonds with 20% in cash. The previous month he had 30% in stocks, 40% in bonds and 30% in cash. Clearly, he doesn’t think interest rates are going up soon. The other four had about 65% of their holdings in the stock market.

Another example is an investment manager whose results in 2013 were a plus 17.51%. Rather than moving away from the stocks, he is now fully invested in the stock market to the tune of 120%. (To understand how that works, you need to call or email me.)

PS – I’ve left out the charts since they do not add much to the message other than the one at the top.

Craig Brockle / May. 8, 2014

• This article reveals the convincing evidence that a new bear market has already started.
• Those who failed to sell near all-time highs in 2000 and 2007 have a chance to do it here in 2014.
• Learn the two proven, reliable assets that go up when everything else is going down.

Did you or a loved one lose money in the 2008 Financial Crisis? How about the real estate bubble bursting two years earlier? And if we go back to the turn of the millennium, there was the Dot-com Crash. Remember that one?

This article is intended to help as many people as possible avoid another devastating loss. I will explain where we appear to be in the current economic cycle, what appears to be coming next and how you can protect and grow your money like the top 1% of successful investors.

I’ve done my best to make this article understandable by everyone who reads it, whether you have previous investment knowledge or not. Investment terms, when first introduced have a link to their definition to help aid comprehension. If you see something you don’t understand, a Google search of the word + definition can help.

Before we go any further, observe what the above-mentioned financial events look like on a graph. First, we’ll look at the 2006 real estate bubble. Shown below is the past 20 years of home price data based on 10 US cities.

Up until 2006, the consensus was that real estate only goes up in value and that one’s home was a great investment. By 2009, this belief was proven to be utterly false as foreclosures and short sales became widespread.

There is a great deal of evidence that suggests the real estate market is again poised for a significant drop, but explaining that would be an article of its own. Perhaps after reading this article, you’ll agree that the next financial bear market has indeed begun. If so, you will likely conclude that owning real estate through this period will be hazardous.

Now let’s look at the overall US stock market over the past 20 years as represented by the S&P 500 index in the chart below. This shows the S&P 500 from 1994-2014. (at the top is the S&P from 2000-2014)

If a picture is worth a thousand words, I believe the above chart could be worth 30-60% of your current investment portfolio. That is if you fail to recognize the pattern that’s developed and act accordingly, you could stand to lose that much money.

It’s been over five years since the last bear market bottomed and many investors have forgotten what it was like. The following short clip from CBS 60-Minutes titled “The 401k Fallout” will remind you what average investors were experiencing at the time. Those who cannot learn from history are doomed to repeat it.

Now, let me give at least one reason why you might want to listen to me. After all, there are so many conflicting opinions and obviously not everyone can be right. I’m the first to admit that the market has a mind of its own, which no one, including myself can accurately predict at all times. That said, I went on the record in late 2007 with this YouTube video warning viewers to prepare for the upcoming market crash. That video was released the exact month the S&P 500 index peaked, after which it dropped 57%.

After the real estate bubble collapsed in 2006, it became obvious to my contrarian colleagues and me that it would have a spillover effect into the rest of the financial world. There were other telltale warning signs at that time that I’ll explain below as these signs are giving the same message today.

By October 2007, the S&P 500 index (500 largest US companies) was the focus of attention as it set a new all-time high that month. Meanwhile, the Russell 2000 index (2,000 of the smallest publicly-traded US companies) had already been in a bear market for three months, after peaking in July of that year. This is a sign of stock market exhaustion where only a smaller group of stocks continue to push higher while the overall pack falls off. You could picture this as a huge pack of companies climbing a wall. By the end of it, the overwhelming majority were already in their descent while only the biggest companies inched higher.

Today we’re seeing the exact same thing as the Russell 2000 has again been showing obvious signs of weakness, even though the S&P 500 has been revisiting its all-time highs. The Russell 2000 Index Peaked at 1,213 on March 4, 2014.

Another warning sign that a new bear market has begun is courtesy of the volatility index (VIX). In finance, volatility is a measure of the variation of stock prices over time.

Volatility, investor emotions and stock prices are all very closely related. In periods when volatility is low and investors are feeling complacent or even euphoric, we experience high stock prices. Conversely, when stock prices collapse and fear becomes widespread, we see volatility spike much higher.

Volatility measures can be a very early warning signal. For instance, in the last financial crisis, volatility began to rise seven months before the bear market in the Russell 2000 began and 10 months before the S&P 500 started its decline.

Taking a look at volatility in the current cycle, we see that it reached its lowest point on March 14, 2013. Since then volatility has been in an uptrend, setting a consistent pattern of higher lows. This time around, it has taken the Russell 2000 almost 12 months to peak, hitting its high on March 4th of this year. I suspect the S&P 500 will make at least one last push higher, at least above 1900. This would also help fool more people into believing that there’s nothing to worry about when they should actually be most concerned.

Other warning signals are currently blaring today as they did in 2007. These include stocks being extremely overpriced, selling by the most experienced investors and heavy buying by the least informed, the general public. Let’s look at each of these factors briefly.

Adam Hamilton, a contrarian colleague of mine, recently published an excellent article. In it he points out that as of this year, stocks are more overpriced than they were prior the 2008 financial crisis. In case you’re unfamiliar, the value of a stock is determined by comparing a company’s current stock price to how much profit it earns. This is referred to as a price to earnings ratio. For instance if a stock is currently priced at $10 and has earned a profit of $1 over the past year, the stock would be said to have a price to earnings ratio of 10.

Over the past 125 years, the average price to earnings ratio has been 14 for the largest 500 companies in the United States. Prior to the 2008 financial crisis, these same stocks reached peak price to earnings ratios of 23.1. As of the end of March of this year, the average price to earnings ratio for these same 500 stocks was 25.7. This indicates that even if corporate profits were to remain constant, that stock prices would need to drop 45% just to reach their historical average of 14.

Furthermore, we’ve recently seen a significant increase in insider selling of stocks combined with heaving buying by the general public. Insiders include directors and senior officers of publicly traded companies, as well as anyone that owns more than 10% of a company’s voting shares. Insiders are among the most knowledgeable and successful investors as they have such strong understanding of what’s really going on in their company and industry. When insiders are selling, it’s usually wise to take notice. Insiders are among the top 1% of successful investors and act more on logic rather than emotion.

Lastly, we have the average investor. We could refer to them as the other 99%, based on their sheer numbers. These are the least informed investors and have the worst track record. This group tends to react emotionally rather than rationally at major turning points in the market. This is evidenced by the fact that the heaviest selling of stocks by the general public occurred in the first few weeks of 2009. This was right before the last bear market transitioned into one of the strongest bull markets in history.

Recently there hasn’t just been strong buying by the general public, but they have been borrowing more money to buy stocks than they ever have. As always, knowledgeable insiders, commercial traders and contrarian investors are unloading their positions near the current all-time highs to an unsuspecting public that really should know better by now-especially after what happened in 2000 and 2007. Here we are in 2014, another seven years later and it is again time to prepare for another bear market.

While no one, including me, likes to live through difficult economic times, at least we all have a choice as to how we are affected. There are truckloads of lemons coming our way, so I think we’d best get started making lemonade. And while we’re at it, help as many other people as possible do the same.

In crisis, we find both danger and opportunity. Reportedly, there were more millionaires created during the Great Depression than any other time in American history. And that’s back when a million dollars was worth many times what it is today. A million dollars in the Great Depression would be worth over $35 million today.

So, what is one to do? How can you avoid becoming road kill and instead conquer the crash? Fortunately there are proven, reliable ways to protect and grow your money in a bear market. Below are the two best assets I know for doing so.

The first chart shows the US Treasury fund (TLT) rise as the US stock market fell. The period shown is the 2008 financial crisis. When investors panic, they sell everything they can and put their money in something they consider reliable. This is called a “flight to safety” and US Treasury bonds are considered one of the safest assets during times of trouble.

Based on the information in this article, I hope you too realize that a new bear market has begun. Volatility bottoming last year was the first warning signal. More recently we’ve seen the Russell 2000 run out of steam, corporate insiders selling and the general public buying in droves. On top of this, stocks are more overvalued today than they were at the peak in 2007.

My goal in writing this article is to help you and as many other people as possible avoid another devastating financial loss. My 2007 YouTube warning reached over one hundred thousand viewers. This time I’m hoping that millions of people are able to get this message in time. I appreciate you following me here on Seeking Alpha, leaving your comments and sharing this article with others.

Bear markets are not to be feared. In fact, they can be very profitable for those who are well prepared. Buckle up. This is going to be one heck of a ride!

Source: http://seekingalpha.com/article/2202043-buckle-up-the-new-bear-market-has-begun?ifp=0

A Few Other Examples of Murphy’s Law

My Comments: According to WordPress, whose templates I use for this website, this is my 900th blog post since I started this in April, 2011.

Now that the hurricane has gone off to harass someone else, please accept my wishes to you and your family for a fun July 4th.

Today is not a day to be thinking about the crisis de jour and all the crap that threatens to make our lives miserable. It’s a day to relax and reflect on good stuff. What follows is my feeble effort to add a little levity to the equation.

1. Ralph’s Observation:   It is a mistake to allow any mechanical object to realize that you are in a hurry.

2. Quantized Revision of Murphy’s Law:   Everything goes wrong all at once.

3. Zymurgy’s First Law of Evolving Systems Dynamics:   Once you open a can of worms, the only way to recan them is to use a bigger can.

4. Glatum’s Law of Materialistic Acquisitiveness:   The perceived usefulness of an article is inversely proportional to its actual usefulness once bought and paid for.

5. Etorre’s Observation:   The other line moves faster.

6. Lowery’s Law:   If it jams – force it.   If it breaks, it needed replacing anyway.

7. Knight’s Law:   Life is what happens to you while you are making other plans.

Powered by the U.S., Global Assets Forecast to Hit $100 Trillion

My Comments: So, just how much is $100 Trillion?

Can you say “A lot!”?  What’s equally mind boggling to me is that in 1967 ( or maybe it was 1966?) I built a house for myself and my wife. In those days I acted as my own general contractor. Back then, I could also dig my own footers. The plans were drawn by an architect friend who charged me something but I have no idea what.

My point is the house cost less than $10 per square foot to build. And today is stands proudly in a quiet Gainesville neighborhood, though it could use a coat of paint. At the time, though the total was less than $17,000, it was a lot of money. Back then, to have been told that in 2014 it would cost at least $250,000 to build a house of similar size would have been equally mind boggling.

So while $100 Trillion is a lot of money, it’s all relative. It’s what you do with the money that counts, not how much there is. And if you can’t use it to spend on stuff you need and want, it has very little value.

By Nick Thornton / July 1, 2014

Worldwide assets under management are poised to hit $100 trillion by 2018, so long as U.S. markets continue to lead the way, according to Cerulli’s latest research.

The U.S. accounts for just under half of global assets under management.

Low interest rates around the globe have pushed cash into equity, boosting financial markets.

Cerulli’s five-year prognosis is optimistic, though the report predicts that managing assets going forward will be trickier than in the past several years.

“The dark days of late 2008 and early 2009 may be well behind us, but there continues to be pressure on net revenues,” said Shiv Taneja, a London-based managing director at Cerulli.

The firm’s annual report, now in its 13th year, is a massive analysis on markets around the world, from emerging markets to the developed economies of Europe, Asia and North America.

“For all the bashing the global emerging markets have taken over the past couple of years, Cerulli’s view is that it will be markets such as Southeast Asia and a handful of others that will top the leader board of mutual fund growth over the next five years,” said Ken F. Yap, Cerulli’s Singapore-based director of quantitative research.

US Health Care System Ranks Dead Last

healthcare reformMy Comments: For the past several days I’ve been involved in a fantastic LinkedIn discussion about why so many foreigners come to this country for medical care when we rank dead last in globally published metrics. The gist of it is that if you can afford it, we are fantastic, but if you can’t, then you might as well plan to die early. It’s not quite that bad but…

The medical people responsible for exceptional procedural success are understandably miffed with WHO numbers saying we are dead last. I’m encouraged to congratulate them for what they do and for their success. But I’m also encouraging them to work as hard to understand that access to health care, be it to reduce infant mortality, to simple quality of life questions, is also important so that ALL OF US can better realize our potential.

I’m asked from time to time why I support the Democrats and the Affordable Care Act. After all, “We have the very best health care system in the world today, so why do you want to change it? How can you deny that you are really a socialist?” I don’t want to change that which works; I want to change that which doesn’t work, as evidenced by the WHO metrics.

Those of us who undestand economics and finance have long known that we have been heading for a socio-economic cliff with staggering consequences for a long time. Unlike our politicians on the right, we’ve been worried about this event and the consequences for our children and grandchildren.

There are now some steps being taken to limit the damage. I encourage you to become more aware of the obstruction and head in the sand approach from those who would eviscerate the PPACA and attempt to turn the clock back by 40 or 50 years. Yes, it needs to be tweaked, but that’s far better than replacing it with nothing which is what some would have us do.

By Kathryn Mayer / June 16, 2014

Despite having the most expensive health care system, the United States ranks dead last in the quality of its health care system when compared with 10 other western, industrialized nations, according to new analysis out Monday.

It’s the fifth consecutive time the United States has ranked last by reports ranking health care by the Commonwealth Fund. While other countries compared in the analysis have improved over the last decade, the U.S. has not, keeping with its lowest performance, while also spending far more on health care costs per person than any other country.

The United States spent $8,508 per person on health care in 2011, compared with $3,406 in the United Kingdom, which ranked first overall. It’s also significantly higher than Norway, who spent the second most on health care, at $5,669.

“It is disappointing, but not surprising, that despite our significant investment in health care, the U.S. has continued to lag behind other countries,” said the report’s lead author Karen Davis, a health researcher at the Johns Hopkins Bloomberg School of Public Health.

Other countries that were ranked in the study include Australia, Canada, France, Germany, the Netherlands, New Zealand, Sweden and Switzerland.

America’s ranking is “dragged down substantially by deficiencies in access to primary care and inequities and inefficiencies in our health care system,” researchers said.

The report found that the U.S. ranked last on measures such as infant mortality, preventable deaths, access to care based on affordability, efficiency and equity.

Specifically, the report found:
• The U.S. ranks last on every measure of cost-related access. More than one-third (37 percent) of U.S. adults reported forgoing a recommended test, treatment or follow-up care because of cost.
• The U.S ranks last in efficiency, due to low marks on the time and dollars spent dealing with insurance administration, lack of communication among health care providers and duplicative medical testing. Forty percent of U.S. adults who had visited an emergency room said they could have been treated by a regular doctor, had one been available; that’s more than double the rate of patients in the U.K. (16 percent).
• About four of 10 adults with below-average incomes in the U.S. reported a medical problem but didn’t visit a doctor in the past year because of costs, compared with less than one of 10 in the U.K., Sweden, Canada, and Norway.

Data for the 2014 report was collected before the Patient Protection and Affordable Care Act, so that the effects of the law may help boost America’s ranking in coming years, researchers said.

“The U.S. performance on insurance coverage and access to care should begin to improve, particularly for low-income Americans,” Davis said. “[PPACA is] expanding the availability and quality of primary care, which should help all Americans have better care and better health outcomes at lower cost.”

The Rise of Tactical Asset Allocation

retirement_roadMy Comments: Yesterday I talked about investment risk, and how we, both clients and advisors alike, should understand it. Today, I’m reposting an article that describes, for me, a way to help clients achieve their perceived objectives, and keep the risk element under control.

As before, risk is not to be avoided, but to be managed. It’s only with risk can we hope to realize our financial goals, which for most people is a bigger pile of money than you started with, one that will translate to peace of mind and a greater ability to enjoy life.

It’s somewhat technical, so if that turns you off, then either struggle with it or call me for an explanation. Or both.

Posted by Michael Kitces on Wednesday, June 20th, 2012

The foundation of investment education for Certified Financial Planner (CFP) certificants is modern portfolio theory, which gives us tools to craft portfolios that effectively balance risk and return and reach the efficient frontier. Yet in his original paper, Markowitz himself acknowledged that the modern portfolio theory tool was simply designed to determine how to allocate a portfolio, given the expected returns, volatilities, and correlations of the available investments.

Determining what those inputs should be, however, was left up to the person using the model. As a result, the risk of using modern portfolio theory – like any model – is that if poor inputs go into the model, poor results come out. Yet what happens when the inputs to modern portfolio theory are determined more proactively in response to an ever-changing investment environment? The asset allocation of the portfolio tactically shifts in response to varying inputs!

The evolution of the industry for much of the past 60 years since Markowitz’ seminal paper has been to assume that markets are at least “relatively” efficient and will follow their long-term trends, and as a result have used historical averages of return (mean), volatility (standard deviation), and correlation as inputs to determination an appropriate asset allocation. Yet the striking reality is that this methodology was never intended by the designer of the system itself; indeed, even in his original paper, Markowitz provided his own suggestions about how to apply his model, as follows:

“To use [modern portfolio theory] in the selection of securities we must have procedures for finding reasonable [estimates of expected return and volatility]. These procedures, I believe, should combined statistical techniques and the judgment of practical men. My feeling is that the statistical computations should be used to arrive at a tentative set of [mean and volatility]. Judgment should then be used in increasing or decreasing some of these [mean and volatility inputs] on the basis of factors or nuances not taken into account by the formal computations…
…One suggestion as to tentative [mean and volatility] is to use the observed [mean and volatility] for some period of the past. I believe that better methods, which take into account more information, can be found.”
– Harry Markowitz, “Portfolio Selection”, The Journal of Finance, March 1952.

Thus, for most of the past 6 decades, we have ignored Markowitz’ own advice about how to apply his model to portfolio design and the selection of investments; while Markowitz recommended against using observed means and volatility of the past as inputs, planners have persisted nonetheless in using long-term historical averages as inputs and assumptions for portfolio design. Through the rise of financial planning in the 1980s and 1990s, though, it didn’t much matter; the extended 18-year period with virtually no material adverse risk event – except for the “blip” of the crash of 1987 that recovered within a year – suggested that long-term returns worked just fine, as they led to a stocks-for-the-long-run portfolio that succeeded unimpeded for almost two decades. Until it didn’t.

As discussed in the 2006 Journal of Financial Planning paper “Understanding Secular Bear Markets: Concerns and Strategies for Financial Planners” by Solow and Kitces, the year 2000 marked the onset of a so-called Secular Bear Market – a one or two decade time period where equities deliver significantly below average (and often, also more volatile) returns. The article predicted that the sustained environment of low returns would lead planners and their clients to question the traditional approach of designing portfolios based on a single, static long-term historical average input (which leads to a buy-and-hold portfolio), and instead would turn to different strategies, including more concentrated stock picking, sector rotation, alternative investments, and tactical asset allocation. In other words, stated more simply: planners would find that relying solely on long-term historical averages without applying any further judgment regarding the outlook for investments, as Markowitz himself warned 60 years ago, would become increasingly problematic.

The Growing Trend of Tactical
Although not widely discussed across the profession, the FPA’s latest Trends in Investing study reveals that the rise of tactical asset allocation has quietly but steadily been underway, and in fact now constitutes the majority investing style. Although not all financial planners necessarily characterize themselves in this manner, the study revealed that a shocking 61% of planners stated that they “did recently (within the past 3 months) or are currently re-evaluating the asset allocation strategy [they] typically recommend/implement” which is essentially what it takes to be deemed “tactical” in some manner.

When further asked what factors are being re-evaluated to alter the asset allocation strategy, a whopping 84% of respondents indicated they are continually re-evaluating a variety of factors: 69% indicated following changes in the economic in general, 58% indicated they watch for changes in inflation, and another 58% monitor for changes in specific investments in the portfolio. Notably, only 14% indicated that they expected to make changes based on what historically would have been the most popular reasons to change an investment, such as changes in cost, lead manager, or other administrative aspects of the investment.

Although not directly surveyed in the FPA study, another rising factor being used to alter investment allocations appears to be market valuation, on the backs of recent studies showing the value and effectiveness of the approach, such as “Improving Risk-Adjusted Returns Using Market-Valuation-Based Tactical Asset Allocation Strategies” by Solow, Kitces, and Locatelli in the December 2011 issue of the Journal of Financial Planning, and more recently “Withdrawal Rates, Savings ratings, and Valuation-Based Asset Allocation” by Pfau in the April 2012 issue, along with “Dynamic Asset Allocation and Safe Withdrawal Rates” published in The Kitces Report in April of 2009.

Notwithstanding the magnitude of this emerging trend towards more active management, it doesn’t necessarily mean financial planners are becoming market-timing day traders. The average number of tactical asset allocation changes that planners made over the past 12 months was fewer than 2 adjustments, and approximately 95% of all tactical asset allocators made no more than 6-7 allocation changes over the span of an entire year, many of which may have been fairly modest trades relative to the size of the portfolio. In other words, planners appear to be recognizing that the outlook for investments doesn’t change dramatically overnight; however, it does change over time, and can merit a series of ongoing changes and adjustments to recognize that.

Tactical Asset Allocation: An Extension of MPT

At a more basic level, though, the trend towards tactical asset allocation is simply an acknowledgement of the fact that it feels somewhat “odd” to craft portfolios using long-term historical averages that are clearly not reflective of the current environment, whether it’s using a long-term bond return of 5% when investors today are lucky to get 2% on a 10-year government bond, or using a long-term historical equity risk premium of 7% despite the ongoing stream of research for the past decade suggesting that the equity risk premium of the future may be lower.

Consistent with the idea that financial planners are recognizing tactical asset allocation as an extension of modern portfolio theory and not an alternative to it, a mere 26% of financial planners answered in the Trends in Investing survey that they believe modern portfolio theory failed in 2008. For the rest, the answer was “no”, modern portfolio theory is still intact, or at least “I don’t know” – perhaps an acknowledgement that while MPT may still work, many of us lack the training in new and better ways to apply it. Nonetheless, that hasn’t stopped the majority of planners adopting a process of making ongoing changes to their asset allocation based on the economic outlook and other similar factors.

Unfortunately, though, perhaps the greatest challenge for planners implementing tactical asset allocation is that we simply aren’t trained to do so in our standard educational process. Some financial planning practices are responding to the challenge by investing in training, staff, and/or research to support a more tactical process. Others are responding by outsourcing to firms that can help; the Trends in Investing survey showed nearly 38% of advisors intend to outsource more investment management over the next 12 months, and 42% are already outsourcing more now than they were 3 years ago.

Regardless of how it is implemented, though, the trend towards tactical itself appears to have grown from a broad dissatisfaction amongst planners and their clients that the “lost decade” of equity returns has left many clients lagging their retirement goals. Even if diversified portfolios have eked out a positive return, it is still far behind the projections put forth when clients made their plans in the 1990s, forcing them to adjust by saving more, spending less, or working longer, to make up for the historical returns that never manifested. And as long as the secular bear market continues, the strategy will continue to be appealing. Ultimately, though, the sustainability of the tactical asset allocation trend will depend on it delivering effective results for clients.

So what do you think? Would you characterize yourself as a tactical trader? Is tactical asset allocation a short-term phenomenon, or here to stay? Is tactical asset allocation simply modern portfolio theory done right, or does it represent an entirely new investing approach?

The Paradox of Investment Risk

profit-loss-riskMy Comments: First, let’s both understand we are talking about financial risk. Second, financial risk for me is likely to be defined differently from how you define it. Third, there is always an element of uncertainty about any future outcome, whether it’s getting married, having children, accepting a new job, etc. Uncertainty implies a potentially unfavorable outcome for almost anything we do, but to the extent it is “risky” depends on our frame of reference.

For example, walking along the roofline of my house, at age 73, is much riskier for me that it might be for someone age 22, who is a chamption gymnast. Mind you that’s physical risk and not financial risk, but there are parallels when it comes to money.

I’ve just taken a step that caused me to reflect very carefully because it has caused me to trust someone to do something with my money that I personally cannot replicate. For me, I had to come to terms with the “risk” involved because it’s something I can’t do. The person who I’m trusting has done this successfully for the past 35 years. For him, it is considered safe and conservative. Only I don’t “know” that, so there is an element of risk involved.

by: Franklin J. Parker / Tuesday, June 17, 2014

Like most retail financial advisors, I have thought a lot about how to reduce both actual risk and the perception of risk in my client’s portfolios. Since 2008 we have all thought, rethought, written and rewritten about risk.

I focus on financial planning to help clients understand why they are investing. I have had discussions about why portfolio allocation helps to protect clients; I’ve used all the financial metrics and Monte Carlo simulations. But no matter the conversation, it seems that clients see themselves forever in danger of falling off a 1,000-foot cliff — a fall they feel is one small misstep away.

And this, to me, is the real problem with the current wealth management paradigm. We do hours of financial planning work: calculating different saving scenarios, market returns and retirement dates. But when it comes time to actually construct a portfolio, we give the client a risk-tolerance questionnaire that is entirely unrelated to their financial planning needs.

What if a client scores very conservatively on the questionnaire but actually needs a more aggressive portfolio? Or vice versa? To not use the financial planning process to directly inform the investment management process makes no sense to me. Well, actually it does.

Let’s be honest: As an industry, planners continue to use risk-tolerance questionnaires because they are defensible in court. But these do the client a disservice; they let advisors avoid the real conversations our clients need.

We must ask clients which competing risks they are willing to accept: Are you willing to accept the risk of not retiring on time? If not, are you willing to take on more portfolio risk? That is the proper role of a risk-tolerance questionnaire: to inform the conversation about risk, but not to dictate it.

It is an easy thing to calculate the return requirement of a future goal. It seems sensible to assign a portfolio allocation that has the best likelihood of achieving that goal. And, taking this idea a step further, it is not a hard thing to figure out the maximum loss a portfolio can sustain before a plan gets derailed. You can even dust off the old stop-loss tool to help limit the risk of those catastrophic losses.

Using such a process might help give clients context, and a better sense of the risks they are actually willing to take. By assigning a loss threshold coupled with some hedging strategies (even as simple as stop-losses), we can help clients better understand which losses are tolerable and which are not.

This may be the point. As retail advisors, it is our job to keep clients rational and on track. With some safety nets, we may be able to help clients stay rational and not fear that 1,000-foot cliff so viscerally.

Franklin J. Parker is managing director of CH Wealth Management in Dallas.