Thirty years ago

Thirty years ago this week I was beginning what was then a very novel business model: fee-only, no commissions. I was working at Christopher Weil, Inc, after a few years at E.F. Hutton. The consensus among the veterans was that fee-only could never work. Now it’s the industry standard, and I was present at the beginning.

Much to the chagrin of some of my managers, I had moved my clients’ accounts to safer positions because I thought the stock market was overvalued. As the Quotron…a primitive computer…kept posting lower and lower numbers, I looked over at the office manager. His face registered horror. We turned on a speaker from the floor of the New York Stock Exchange, where the trading was done with paper and voice, and we could hear a roar from the crowd. Everyone was trying to sell.

After that, I bought stock mutual funds for my clients and for myself at bargain prices. The market fully recovered within months. Our portfolios benefitted much more than any losses hurt us. Black Monday 1987 was the first time that awareness of overvaluation produced a big win for us.

Since then, calling out overvaluation has been much harder. In the 1990’s we were right but it took YEARS before the 2000 Tech wreck, and many clients became discouraged before it happened. The 2007/2008/2009 Financial Panic was different because recovery took a long, long time. Many clients were discouraged by that as well.

Now the financial markets are overvalued again, but the central banks have changed the game by stimulating. We don’t really know what will happen. Eventually I expect that a correction must occur, but it may or may not replicate the sheer terror of Black Monday 1987. Meanwhile, all we can do is pay attention and stay diversified. As my life illustrates, patience pays.

 

Gone and mostly forgotten.

Ten years ago today, the S&P 500 U.S. stock market index hit its record high before falling about 57% in the Financial Panic of 2008. It recovered in March, 2013.

Before the meltdown, there were already major issues in the financial system which were larger and more dramatic than what we are facing today. So is such a meltdown imminent now? If so, I can’t see it. But valuations and debt levels are again high.

How soon we forget. Read more here. 

60% of a bag full of slow

The stock markets of the world appear to be impervious to every current geopolitical event, including the threat of nuclear terrorism and serial hurricanes, while a growing number of writers are shrieking that the end of the financial world is nigh. (Read the latest apocalyptic broadcast here.) Hmmm. I have my doubts, but there’s a lot of smoke in the air. Conditions being what they are, last week I moved 5% in many clients’ accounts from stocks to short term bonds. That’s very unusual for me. I’ve learned the hard way that even the best-calculated predictive indicators are easily undone by Fed easing. So usually nowadays we simply stay invested. The long-term force is with equities.

However, bonds aren’t deeply attractive right now either, except as a place of relative safety. Some bonds, especially longer-term issues, are overvalued like stocks. And the perception that the Fed Will Make All Things Good is strongly at work in bond-world as well. Here’s an interesting article which details the almost nonexistent difference in three year performance between top-end bond funds. Some of our conservative clients have portfolios which are 60% bonds. Those bonds aren’t producing much. Granted, bonds are traditionally holistically safer than equities, but in terms of gains, they historically don’t do much.

Right now, because of valuations, we temporarily have clients with 60% invested in boring. My hope is to eventually get them into equity bargains, and make some real long term gains. Patience pays.

I think I’ve figured this out.

The more missiles North Korea shoots over Japan without blowing anything up, the more investors think the Federal Reserve is likely to be cautious about raising rates, and thus the more they invest in stock markets.

Absurd but there’s a logic to it.

As someone said earlier this morning as a joke, perhaps the North Korean dictator has a brokerage account or a hedge fund, and he’s doing his part to boost profits. We are only ten or twenty missiles away from Dow 30,000.

We should also consider the consequences if he’s not joking, merely insane. Read some reality here.

Risk Happens Fast

As last night’s 8.2 magnitude earthquake in Mexico illustrates, risk happens fast. We are now conditioned to three beliefs: things will continue as they are today indefinitely, the Federal Reserve will always save us, and we’ll be able to dodge out of the way.

Nine years ago today, that wasn’t the case. One of the largest investment banks, Lehman Brothers, was allowed to go bankrupt and default on its bonds. The stock market fell 25% in one month. The decision to let Lehman Brothers sink beneath the waves was a political choice, based on traditional attitudes towards free capital markets, and one lesson we all learned was that some corporations are “too big to fail.” The global political aftermath of the Lehman Brothers debacle was so painful that it’s doubtful it would happen again.

But the choice to rescue any and all carries risks as well, doesn’t it? We risk rescuing businesses which OUGHT TO FAIL and we reduce the efficiency and effectiveness of the global economy as a result.

It’s worth remembering also that almost nobody was able to dodge out of the way of the Lehman default. Our asset allocations going into the chaos determined our overall performance. As Mark Hulbert and Doug Kass have written, risk happens fast, too fast to dodge out of the way. Diversification has a price, but it also has a benefit.

Read more here.

We send our prayers to those damaged by the earthquake and by Hurricanes Harvey and Irma. It’s a busy world out there.

The stock markets of the world are apparently missile-proof.

Seriously. The North Koreans just shot missiles over Japan and global stock markets shrugged it off.

Yet again we learn why we should stay at least partially invested. In the past few decades, central banks have changed the way investors perceive risk. Most people think now that central banks can rescue us from ANYTHING!

As Hurricane Harvey (yet another non-event in the stock markets) rips its way through Texas and Louisiana, it’s worth pondering what is happening in Houston. Houston is a mega-city. The mayor has said that it’s simply too big to evacuate in the event of a natural disaster. Thus he has advocated sheltering in place…where thousands are flooding. Let’s consider this a lesson in the inevitable imperfection of governments, and support for the concept of financial diversification.

Stay safe.

Read more here.

I’m just going to put this here.

At the moment I’m not making any changes to our portfolios due to this information. As I’ve mentioned before, by classic standards, I’ve been advocating relatively conservative portfolios of mutual funds. And, as I’ve said before, I’ve been mildly wrong for the past three years: the markets have continued to rise despite all our fears. So the balance of proof is now weighted in favor of a continuing bull market, and staying invested anyway is a decent strategy. Nobody really knows what will happen. Staying diversified is a proven tactic. But but but…there’s this. So I’m going to post it for our later review. Happy weekend.

Are Small Stocks Leaving the Party?

The market for small stocks just turned negative for the year. That’s big news, and you aren’t likely to hear it elsewhere because it disrupts the narrative of a rising stock market.

Why is it happening? This article provides more data to suggest stock market overvaluation. In this case, it’s the small stock markets, exemplified by the Russell 2000 Index. What’s more, this downturn is a divergence: the performance of the Russell 2000 Index is now negative for the year whereas the market for large cap stocks is up. Shades of 2000.

However, this mild decline in the small stock arena, combined with the insecurity created by terrorism in Europe, is likely to trigger a Federal Reserve stall of plans to raise interest rates. So a decline is by no means certain. We simply need to remain aware. Since we are diversified and modestly defensive, if a real downturn DOES occur, we’ll be buyers. When that will actually happen is anyone’s guess.

Good thing we’re diversified.

We haven’t (yet) responded to recent market turbulence by altering our portfolios. We’ve simply been maintaining our current very diversified allocations, which aren’t fully invested in the U.S. stock markets. As I wrote in my last posting, long term holding is a very decent tactic. And right now we’re a little bit allocated towards safety. From this position, it’s OK to ride out short term news.

However, this weekend’s blog on “Wolf Street” is interesting. Read it here.

While we watch financial markets surging today, in an apparent relief rally from not being blown up by North Korea over the weekend, it’s also true that earnings in the S&P 500 are not as good as they seem to be. Quote:

“Aggregate earnings per share (EPS) for the S&P 500 companies on a trailing 12-months basis rose for the second quarter in a row. That’s the foundation of the Wall Street hype. But here’s the thing with these EPS: they’re now back where they had been in… May 2014.”

Thanks to the Fed, the S&P 500 has gone up anyway, and the money we’ve made is real. But good thing we’re diversified.

The Ten Year Anniversary of the day the world changed.

Ten years ago today, French mega-bank BNP Paribas announced it couldn’t place a value on its US-created collateralized debt obligations, complex toxic “derivative” investments, and thus was suspending client withdrawals from the funds which held them.

That was the first indication that the most gigantic financial panic since the Great Depression in 1929 was about to unfold.

The world has changed a lot since then. But many of the same structural flaws remain, patched and propped but not repaired by governments or by central bank intervention. Vastly greater debt loads are even more of a potential problem than they were in 2007.

The greatest lesson of the 2007 Financial Panic was that central banks transformed the investment markets by intervening. Perhaps they helped, perhaps they hurt, perhaps in a variety of ways they did both. But there’s no denying that the central banks are now involved in our financial markets in ways that would have been unthinkable before August 9, 2007.

Another key lesson of the 2007 Financial Panic was that many sophisticated investors did just fine, thank you, while others got hammered.

Yet another lesson was that we all muddle by. If you stayed invested through the carnage of that awful event, you have probably done well, despite it all.

Read more here.