On President Trump and the Pundits

Recently a client asked about a NY Times article about the near-term future of the stock market.

I am very confident that a long-term strategy is essential for investing in the stock and bond markets.

Lately (December 2016 - January 2017), markets have gone up and that feels good but since March 9, 2009 we have had several market drops (2010, 2011, 2012, 2013...then 2015 and 2016). 

Some market downturns were -8%, some -11% and last February 2016 -14%.

That was interesting and disturbing yet the markets did rebound so the long-term strategy is a reasonable approach. 

Someday we will have another more serious market drop (20-30% or more), but we learned from the 1971, 1973, 1984-5, 1991, 2001-2, 2007-9 major market downturns that the recovery occurs for those who wait - it could be 4 years or more. There never is a guarantee though.

The key: if you need cash from your investments within 5 years, then that portion should not be invested in stock funds.

The other key is to have enough "years of safety" to not worry about market pundits and commentaries. 

For every nay-sayer I can find an opposing viewpoint. My advice: ignore it.

Markets many times do go down about 6 months (a leading indicator) before a recession but no recession is expected by economists in the next year (2017) or two (2018). We will see.

Specifically, about this article, the author wrote:

"...“The big picture for investors is this: Trump is high volatility, and investors generally abhor volatility and shun uncertainty,” he wrote. “Not only is Trump shockingly unpredictable, he’s apparently deliberately so..."

And he said: "...it is simply unthinkable that Donald Trump could become our president..."

Well, he got that prediction wrong so why believe any others of his?

For those Christians among us, our trusted Bible says that if a prophet has one false prediction then do not listen to him. Forecasting the future is inherently difficult. 

Of-course the NY Times and the Washington Post are no friends of President Trump.

So another point is always consider the source of the article.

Wait a minute, this article then goes on to say:

"...From the letter, it is hard to divine exactly how Mr. Klarman is investing his fund’s money..."

And...

"...Mr. Buffett campaigned publicly against Mr. Trump, but he has nevertheless invested in the market since his election..."

Yes, indeed, the truth of the matter is that some of these well-known investors may hold 30% in cash but the rest of the money is invested.

It has to be. Earning 1 or 2% on your money is likely not going to meet all of your goals.

On ETFs and INDEX investments which also were mentioned in the article:

It is absolutely true that holding an indexed ETF means that as certain companies become over-valued we own them. We are owning the market as currently valued. 

That is the point, own the market rather than try to beat it which is, for many, a loser's game.

It is also true that value companies (rather than growth companies) and small companies may have a long-term edge, though in reality, the gap in expected returns appears to often narrow over time.

Yes they move up and down at different rates at different times, but not always.

That is why ETFs are separated into these value, growth, large, small, US and international categories as well as bonds and cash within a portfolio.

Diversification is no guarantee and a market downward trajectory will affect anyone invested in the markets short-term. 

There are other investments that stray from "market- cap" (where the size of companies are in proportion within the funds) but all that really is to many advisor's thinking is market timing of some sort or another.

The strategy I subscribe to is to mix small company funds and value company funds in the portfolio to make those kind of adjustments. So, the lesson:

1) maintain a balanced portfolio

2) keep enough years of safety in cash to meet needs (there are other strategies to research too)

3) ignore the market swings and ride out the inevitable downsides (they do occur and will again)

4) read articles and listen to pundits and prognosticators with much skepticism

Talk of a Bear Market?

Many times investors feel that they know what is going to happen next in the markets or the economy and believe that the advisor just does not understand the seriousness of the current situation.

When the markets dived in February 2016 many were sure that was the beginning of a bear market but then the markets recovered rather quickly from that downturn.

A bear market can be defined as a decline of 20% or more.

How long do they last? How often do they occur? One symptom is that it is a time when more investors are pessimistic about the markets.

Advisors (most) do understand the seriousness of the current situation and realize that it has occurred many times over the history of the stock market. They also realize that it is unpredictable.

The key I believe is to have enough in safer investments (cash and cash equivalents) so that you can hang on for the inevitable down market and eventual recovery.

"Years of safety" has been a term used by many planners to prepare for those down periods and one that I subscribe to also. Especially, when in or near retirement this period can be calculated as years - not months. 

How many? Depending on your situation it could be 3, 5, 7 or more years.

If the markets perform like they did in 2007-2009, will share prices go down and never recover their losses? Never? That period lasted about two years and the recovery took another three to four years but, indeed, did recover.

Inverted Yield Curves

In early 2014 (as is the case much of the time), the Treasury's short-term interest rates are less than the long-term interest rates. This is, indeed, normal.

Sometimes the resulting yield curve that is created when you plot short-term to long-term rates is very steep.

In advance of every recession, however, since the 1970's, the Treasury yield curve inverts. Inversion is when the short-term interest rate is actually higher than the longer-term rates. This is not required to occur before a recession but it is one aspect of the economic landscape.

Of-course, this may not change your asset allocation but it might help you prepare for the slow down in the economy to come.

Your personal allocation strategy should be based on your personal situation. Remember that an inverted yield curve is not the norm and usually does not last very long.

China's Economy

The media occasionally writes about China becoming the largest economy in the world surpassing the United States. The Washington Post in an article (Sunday, January 19, 2014) entitled America's slipping to No. 2. Don't freak out. by Charles Kenny (a senior fellow at the Center for Global Development) is one example. The author states that "...the link between the absolute size of your economy and pretty much any measure that truly matters is incredibly weak..."

Here is one of many interesting research papers on just this subject:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1544655

(1) Whether China makes the United States No. 2 in global GDP by 2017, 2020 or 2030 remains unknown, but it is very likely to happen sooner than later

(2) Many people in the U.S., according to surveys, think that this will have a negative impact on the U.S.

This is likely untrue.

Charles Kenny writes that the dollar as a percentage of global reserves has already fallen from 80% to around 40% but that this has not "...spooked global markets...". But the growth of China means that the U.S. and others should benefit from China becoming larger, healthier and more educated. This may also provide more opportunities in travel, in exporting to them and importing from them, and in the potential for increased innovation that will benefit the whole world.

From the www.ssrn.com article referenced above, I would like to highlight that:

(1) Though China's GDP will exceed the U.S. sometime between 2017 - 2030, per capita (because of its large rural population), China is only 1/4th the size of Japan and 1/6th the size of the United States

(2) China represents about 12% of the share of global trade (both imports and exports) of goods and only 4% of the share of global trade in services - the U.S. remains an important player

(3) China's exports will increase toward India and so other developing countries that export similar goods to India will have increased competition to slug through

Some of the good news from these points are that:

(1) China's domestic markets will continue to grow and attract the products that other countries provide (like the U.S.) providing revenue growth worldwide to countries and companies that are globally situated

(2) China, therefore, will continue to attract FDI (Foreign Direct Investment) - it is around $1 trillion today

(3) FDI will, in part, increase domestic consumption in China helping to increase the demand for imports from other countries

As China (and India) continue to grow their middle classes, even though China becomes the world's largest economy measured by GDP with India next in line someday, it will likely mean good things - not bad - for the United States and other countries. A chart in the SSRN article shows that the:

"...Complementary effects of China's trade are increased exports to them and improvement in the trade conditions of exporting countries due to the rising world prices of primary goods driven by demand from China and India..."

"...Competitive effects of China's trade are the substitution of import from China (and India) for local producers..."

"...Openness and integration of China's economy into the world economy...measured as the proportion of imports and exports in GDP..." can help portray China's impact. 

The Fiscal Cliff - A Different Perspective

Dr. Ben Bernanke coined the term "Fiscal Cliff". Here is what he said about it in a November 20th speech (the entire speech can be read at: www.FederalReserve.gov )

"...Of course, we should all understand that long-term projections of ever-increasing deficits will never actually come to pass, because the willingness of lenders to continue to fund the government can only be sustained by responsible fiscal plans and actions. A credible framework to set federal fiscal policy on a stable path--for example, one on which the ratio of federal debt to GDP eventually stabilizes or declines--is thus urgently needed to ensure longer-term economic growth and stability...."

And he included the following quote:

 

As Dr. King is widely quoted to have said, "We may have all come on different ships, but we're in the same boat now."

 It is easy to forget that deficits must be funded and that this willingness to buy Treasury Bonds (at very low interest rates right now) is not without limits forced upon it by others outside of Congress. Not pretty, but a reality.

History in 2 Minutes - wow!

History in 2:

http://marcbrecy.perso.neuf.fr/history.html

Do the "Right" Thing

I am writing this on August 1st and the deadline for raising the debt ceiling is August 2nd.

"Tea Party" Republicans and a "few" others are trying to do the "right" thing (i.e. reduce government spending in phases and that includes everywhere, especially, entitlements like Medicare and Social Security) and yet some pundits are claiming that they are the "problem" for not compromising their values.

I personally do not think they are the problem, they are the solution. If other Democrats and Republicans would do the "right thing" then no compromise would be needed. For example, here are some "right" things:

(1) Social security age must be raised (that is, in effect, a reduction in benefits) but it is the "right" thing to do. Sorry.

(2) Medicare must be even more aggressively "means-tested" than it is now so high income retirees pay more. Sorry.

(3) Tax system must be reformed (taxes will go up for some) but it is the "right" thing to do. Sorry.

(4) Spending on discretionary, defense and other non-discretionary items must be reduced, too, possibly based on a running average percentage of GDP. Period.

As it is now, it appears that some evenly-divided committee (6 Republicans and 6 Democrats) will make the tough choices as a result of this "grand compromise".

This committee most likely won't agree and then reductions in spending will set in by default with no one voting "for" them. Cute. That way no one is "blamed" for allowing tax cuts to end in 2013 or "blamed" for cuts to Social Security or Medicare. Yet, those are the "right" things to do and phased in over time so we can get through the current malaise in this economy.

Sorry. Everyone except those committed to doing the "right" things should be voted out of office when their time comes - or sooner. It is not the "compromisers" that are right. They all should have agreed to do these things so no compromise (and, by default a "watered-down" non-solution) would be needed.

Some Perspective on Japan's Disasters

From the Murray Financial Group blog entry entitled: "Who’s telling the truth – Japanese officials or the U.S. media?" on March 19th, 2011, Chris Murray states:

"...I was fortunate enough this week to be invited to join in on a conference call that included four Japanese economists who live and work in Japan and are employees of JP Morgan...The bottom line is that even though there is concern and obviously uncertainty, the northern part of Japan where the earthquake and tsunami struck accounts for 4% of the country’s GDP. That means that 96% of the other goods and services produced by the world’s 3rd largest economy is business as usual. Also 10% of the country’s total electric supply comes from the damaged nulear power plant, so 90% of Japan’s energy sources are ship-shape..."

Uncertainty remains and there are many difficulties ahead for the people of Japan but, keeping perspective, this article helps.

China and the U.S. Economies

Subject: Marketwatch Article about China and US economies by Brett Arends
http://finance.yahoo.com/banking-budgeting/article/112616/imf-bombshell-age-america-end-marketwatch

Our son, Nate, sent me the above link. Thanks for sending the article. My comments:

Brett Arends is a reasoned and good financial writer. I liked the article. I don’t think it matters though what measure is used to evaluate the size of the U.S. and China (or any other country for that matter) because within 5-10 years China’s economy will, indeed, be near the same size as the U.S. and that is OK. It does not mean the “end” of the U.S. and so that part is not realistic (dare I write: nonsense?).


What does it mean to have two economies nearly the same size? It means more and more people to buy goods and services. Not just from the U.S. or China but other countries also. It is quite a good thing. Just like the past “era” of having the U.S. four times the size of the once second largest economy of Japan and China in 10th place. Not that long ago actually.

It is truly wonderful to have more and more people entering the middle-class and buying products and services. There is plenty of room for the U.S.’s Treasury bonds in the market just as there is room for Japan’s and any other country's debt. And with more people no longer on farms living on dollars a day but instead participating in the world economy we have everything to be optimistic about.

Why Tax Increases are Never The Answer

Grover Norquist, president of Americans for Tax Reform, is quoted in the Washington Post on Sunday March 13, 2011 stating:

"...every dollar of tax increase is a dollar you didn't get in spending restraint..."

Bingo! The goal to help the economy is, indeed, to reduce the size of government spending as a percentage of GDP. Although the U.S. government's spending is much less than many other countries as a percentage of GDP (over the past nearly 100 years - almost - we have never reached a level of 50%+ as many other countries have), it is higher today than in the recent past and headed in the wrong direction. (See my other blog entries by searching on GDP)

Many pundits claim that tax increases are inevitable but voters need to continue to make their voices heard that Mr. Norquist is correct.

The Economic Slump

In the July 2010 issue of Money magazine, the question was asked: "Has the economy really pulled out of its slump?"

Although 65% of those polled say it is either the same or getting worse, the statistics show a different story:

92% of companies plan on hiring this year

1.9% was the average raise for workers in 2009 (higher than the inflation rate)

9.9% (in April but now 9.5%) unemployment rate, when in October of 2009 it was over 10% - that is the right direction

19.8% increase in auto sales year over year (now comparing August of last year to this August showed a decrease but remember that "Cash for Clunkers" distorted last August's numbers)

9.6% increase in retail sales year over year

2.8% increase in restaturant sales year over year

It may not feel like it, but things are economically better than the doldrums of 2008-2009.

Size of Global Wealth

How much wealth is there in this world anyway? We hear of trillions of dollars of debt but not much about the assets that back them up. We also have heard of the trillions of dollars of wealth lost during the economic crisis of 2007-2009 but not of any recovery.

$111.5 trillion is the total amount of global wealth as of the end of 2009. And guess what? This is, as reported in August 2010 Journal of Financial Planning, "...nearly back to its peak level at year-end 2007 of $111.6 trillion..."

There appears to be a recovery going on after all.

Government Debt

The government debt will exceed $12 trillion and yet balance is necessary. About half of the debt is held by the public (through Treasury Bonds), while the rest is borrowed from within the government itself. Social security may soon be paying out more than it takes in but over the last 75 years (since its inception in 1935) the system has collected more than it has paid out so far. That amount is expected to peak at near $6 trillion. Yes, $6 trillion.

The real issue, just like your personal finances, is not how much the mortgage is (I am sure if you have one the balance exceeds your annual income, too, just like the government), but how much that mortgage is as a percentage of your spending plan.

The government, in effect, is paying "interest only" on its debt. Here are some numbers:

In 2000, the government's annual interest on its debt was $220 billion.
In 2003, that had fallen to $150 billion.
From 2004 to 2008, the annual interest slowly was rising to $250 billion by 2008.

In 2009, the interest cost was under $200 billion again and in 2010 is expected to be slightly higher than $200 billion. The is between 5-6% of the 2010 government budget of $3.8 trillion.

Not much. The average household spends almost 15% on interest costs as a percentage of income per year (mortgage, cars, credit cards, etc.).

Another interesting point is that 20 and 30 years Treasury bonds issed by the government in 1980 and 1990 are reaching maturity and being replaced by bonds with today's much lower interest rates. This is like re-financing your own debt and helps the government be able to withstand more debt because of the lower interest costs.

I am NOT condoning the over-spending but, again, keep things in perspective.

The PIGS - What?

Portugal, Italy, Greece and Spain - the PIGS. Their economies are faultering and many pundits want us to believe that international investing is more dangerous now because of it.



Again, I ask for perspective.



Greece is the most often cited these days for its out-of-control government debt that threatens the EURO. As reported in the WSJ opinion page (Monday March 8, 2010), "...the Euro Zone would never miss Greece, which accounts for only 2% of its total GDP..."



Now there is perspective. Some of these smaller countries have needed austerity measures to put in place but they are small relative to the overall world and/or just the Euro economy.

M2 - The Money Supply

The money supply (M2) includes physical currency, bank deposits and money market funds. As reported in the WSJ (March 4, 2010 by Kelly Evans), the growth of money supply is about 5% and with overall GDP growth of about 3%, we can kind-of see why inflation targets are around 2% - the difference.



During the economic crisis, the money supply spiked to over 20% (2008-9) and yet we had negative GDP. The pundit's and some respectable economist's conclusion: inflation is on the horizon.



However, since mid to late 2009 and certainly in these first couple of months of 2010, the money supply growth came back down to its historical average of 5% and in 2010 has hovered near zero. Why? We are still in a credit crisis and the money being poured into the system has been used to pay down debt not create demand for more goods and services - yet.



Yes, there is much "unwinding" to be done (the Federal Reserve increased its balance sheet from $.8 trillion to over $2 trillion in the past two years) - a brilliant move, in my opinion, to avoid depression. But not one without ramifications as they eventually sell the debt (mainly $1.25 trillion in mortgages they bought) back into the market. But that can be done in a way that mitigates the inflation risk. Only time will tell if the Fed is successful.

More on the Great Recession

To extricate us from the Great Depression, President Roosevelt started to spend taxpayer's money like crazy with the New Deal. Deficit spending did finally start to work.

However, 1937 saw another recession due, in part, to the government efforts at the time to balance the budget by slowing spending, the Federal Reserve's efforts to slow money supply growth by raising interest rates in 1935 and early 1936 and, of-course, the new anti-business regulations that pervaded the period. It all happened too soon and the recovery halted.

Yet many are clamoring for these things to be done again - already.

Do you think the government and the Fed will make these same mistakes again?

I do not think so. So far, they have not repeated the mistakes in this Great Recession like in 1929-1932 when they did not provide money supply growth like the have done today, for example.

Yes, it is painful to watch the soaring government debt and soaring money supply but I do believe it is necessary. Inflation and recovery (economic, not necessarily stock markets) may be years away and with unemployment so high still (9.4%; normal is nearer 5%) and productive capacity at 68% (normal is 78-82%). There should be plenty of slack to avoid inflation in the short-term.

By the way, the Fed raising interest rates is not the only way to begin the exit from this Great Recession. Programs like their buying US Treasuries and mortgage-debt are planning to end next month, in March, after reaching $1.25 trillion.

Savings Rates

Savings rates for households are considerably higher outside the United States than those within the U.S.

A long-term investment in international and emerging markets to, as Merrill Lynch states it in their RIC report, "...capitalize on the potential purchasing power of non-US consumers..." has always been a part of a good, diversified portfolio.

Just don't give up on U.S. consumers because, though there is reduction of debt these days, the capacity to leverage is quite high and will resume, in my opinion.

Politics and the Markets

Remember that the economic cycle has a much stronger influence on the financial markets than the political cycle does, according to the Merrill Lynch RIC Report (November 2008 issue), and history that shows that government policy alone can mislead investors.

And regulation can be a good thing for the markets. Sarbanes-Oxley Act of 2002 was enacted prior to a bull market recovery that lasted from October 2002 through October 2007. Coincidence? Maybe.

Market Sizes

I often write about keeping perspective when hearing on the news about large numbers - those "in the trillions" dollars.

Size, stability and efficiency are three key attributes of any equity market and should be considered if you diversify into international companies, small-cap companies, emerging markets, commodities and other areas (like frontier markets).

The average turnover of the top 10 U.S. companies is 16% of the total world market. That means that, to put it simply, nearly 2 out of every 10 trades are in the those top 10 U.S. companies. That is a lot of concentration even still for a global economy. The entire country of Japan (the 2nd largest economy) represents 25% of world trade activity compared to just these 10 companies in the U.S.

The world bond market is around $61 trillion and the world stock market is a little less at around $56 trillion (now these numbers are always changing but the point is to give you an idea of the size of the financial markets). Derivatives were, at one time, around $500 trillion but after this global economic crisis have retreated substantially.

The point is that it is huge.

How many Treasury bonds are currently outstanding by the U.S. Government that are publicly held? About $6 trillion - or only about 10% of the total bond market. The news repeatedly hypes the U.S. deficit (annual numbers) and U.S. debt (accumulated amount of all years) and they are large but perspective is still helpful to keep.

Sites to research: www.wsjmarkets.com; www.bloomberg.com

Reminder from History on Volatility

Market ups and downs have been tremendous during this 2007-2009 crisis (See the VIX - a volatlity index). However, as Harold Evensky CFP(r) writes in the January 2010 issue of the Journal of Financial Planning, "...they also remind us that extreme events, characterized by volatility jumps, increased risk aversion, negative returns for risky assets, and increased correlations across asset classes, are not a a new phenomenon..."

He cites that there are 10 major market events that happened over the last 21 years, including:

1987 Black Monday drop of 22%+ in one day
1994 Mexican Crisis
1997 Asian Crisis
2000 Tech Bubble
2001 9/11

The 2000-2002 period saw a decline of nearly 50% and that was within this first decade of the 21st century jst past. Yet, this 50% decline of 2007-2009 was faster and accompanied by addition risks to the economy (credit freeze, high unemployment) and therefore different, yes, but not unprecedented. Read about the Panic of 1907 as an example but no FDIC insurance existed, no SEC and many other regulations.