Selling Your Business: The Right Price at the Right Time

Neil and I wrote this two part blog series for Crain's.  They are different from the typical investment themes on here; however, they are still worth checking out!  Please go to Crain's to read:

1. http://www.crainscleveland.com/article/20140528/BLOGS05/140529902/selling-your-business-the-right-price-at-the-right-time-part-1-of-2
2. http://www.crainscleveland.com/article/20140604/BLOGS05/140529901/selling-your-business-the-right-price-at-the-right-time-part-2-of-2

Bonds Holding Strong?

Bonds are moving against what logic would dictate this year and investor portfolios should be prepared for a multitude of outcomes.

As of last Friday bonds, as measured by ETF AGG, are up 2.88%. (per Yahoo! Finance)  This is a slap in the face to the consensus, which expected yields up and bond prices down.

Here are some facts/consensus:

1. Stocks are also up a little over 2%.  (per Yahoo! Finance)
2. While economic growth stunk it up in Q1, consensus is still positive for the year.
3. The Fed is tapering, which means they are buying less long dated bonds.

The above, at least in theory, should equate to higher bonds yields and lower prices because:

1. Stocks and bonds are thought to move in opposite directions as the former is considered risk-on and the latter is risk off.
2. Positive economic growth should increase risk appetite (see above) and inflation, which hurts bonds.
3. Less buying = less demand with same supply = lower prices = higher yields.

So it all makes sense for higher yields, but maybe this is the reality:

1. Stocks and bonds aren’t really negatively correlated.  Sometimes they move together, other times they don’t, sometimes they move in opposite directions.  It really depends on the period.
2. Maybe bonds are telling us the economy isn’t going to pick up?  Inflation is still in a downtrend too. 
3. Some other buyers are picking up the slack.  Think about it, a 10 year at 2.60% is a lot more appealing than at 1.40%.
4. BONUS!  The bond market is wrong.

I am not sure which one it is, but one thing is certain - bonds are moving against what logic would dictate this year and investor portfolios should be prepared for a multitude of outcomes.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

Inflation is the rise in the prices of goods and services, as happens when spending increases relative to the supply of goods on the market.  Moderate inflation is a common result of economic growth.  Hyperinflation, with prices rising at 100% a year or more, causes people to lose confidence in the currency and put their assets in hard assets like real estate or gold, which usually retain their value in inflationary times

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A Plan When Good Things (Rising Equity Market) Come to End

Tailoring downside portfolio risk to an investor’s risk tolerance, goals/objectives, and future cash flows can help reduce the probability the investor will experience a catastrophic loss. 

I last wrote (way too long ago) that hope isn’t an investment strategy when the markets start moving against you, but I failed to give a solution.  A client then wisely asked me to elaborate on the plan we have in place for him, so I walked him through it.

Below is an abridged version of my response.  It outlines his, as well as other clients, portfolio risk management strategy.  Nothing is full-proof, but what this strategy does attempt to do is prevent losses from becoming catastrophic.  This is where panic selling often takes place, compounding the losses. 

By focusing on the client, their risk tolerance, goals/objectives, and future cash flow we can put together a plan that helps reduce the probability of a loss that would have drastic implications for the client moving forward: 

1. Diversification.  By utilizing bonds we can help reduce the downside if equity markets fall.  This smooths returns over the long-run and helps balance the account when stock returns get ugly.  Still, even with diversification returns can be much lower than would be expected given historic returns and volatility…
2. Quality.  We keep the bulk of our assets in Large Cap equities and also allocate more to blue chips in that space.  This minimizes exposure to some of the riskier equity asset classes out there.  So while we may have a muted upside, we believe the downside should also be muted.  Still, the baby can get thrown out with the bath water when the market tanks, so we aren’t done…
3. De-Risk.  We are still bullish on equities now, but what if that changes or we are wrong?  We look for market signals to tell us when we should de-risk the portfolio (e.g. sell equities).  These signals tell us if the market is at a greater risk of a large loss and happen as the market moves down, so we aren’t trying to pick the top, but rather avoid much of the bottom(ing).  These signals have been very good in the past, we have custom models that illustrate this, but there is a chance they could not work…
4. Custom Waterline.  We put together a bespoke cash flow model for our clients, which maps their inflows and outflows moving forward.  From this we can develop a “waterline” – the minimum portfolio value a client can have and may still reach their long-term financial goals.  What this means is that if all the above risk metrics fail we can move to cash on the equity side when this value is met.  Using the waterline allows us to manage specifically to THE CLIENT’S needs and helps increase the probability we keep them financially stable over the long-run.

Ultimately these strategies are in place to protect the downside for the client, and subsequently help give them some clarity.  If we can do that by minimizing the downside risks, the returns should take care of themselves.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

While there is no assurance that a diversified portfolio will produce better returns than an undiversified portfolio, and it does not assure against market loss, a diversified portfolio can reduce a portfolio’s volatility and potential loss.

Large cap stocks typically have at least $5 billion in outstanding market value. 

Good Things Come to End, Have a Plan

Hoping and wishing your portfolio will hold up when the market turns negative, and turn it will, isn’t a strategy.  Being prepared is the only prudent way to invest.

The last few commentaries have had a bullish bent, and rightfully so, but it’s important for me to scratch my “always concerned about the markets” itch.

Here is a snippet from legendary investor Seth Klarman’s letter.  The whole thing is great, but below are my favorite parts:

• On the current state of the economy/markets: monetary policy is distorting markets, Fed can change how things look, but not what they are, Europe isn’t any better, not many bears left, unsustainable tech business models. 
• “Someday, financial markets will again decline.”
• “Someday, professional investors will come to work and fear will have come to the markets and that fear will spread like wildfire. The news flow will be bad, and the markets will be tumbling.”
• “Can we say when it will end? No. Can we say that it will end? Yes. And when it ends and the trend reverses, here is what we can say for sure. Few will be ready. Few will be prepared.”

Currently, in light of all this, Klarman returned $4b to investors and is 40% in cash.  He can’t find much to buy as everything has been bid up.  Does that mean the market is destined to collapse at any moment?  No, and Klarman noted that in his letter. 

But what he does say is that markets will decline again.  I wouldn’t bet against that assumption.  Further, he noted that most will be unprepared for such a drop and thus will be very vulnerable when this happens.

Don’t wish, don’t hope.  Have a plan to protect your capital.  That is the foundation of how I approach investing.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

Recessions Matter

Despite the lack of correlation between equity markets and economic growth, de-risking before a recession can help investors avoid large losses. 

Sorry for the delay, but have been out of the country only to return and have a presentation to put together.  Luckily the presentation yielded much commentary level material.  The first of which I want to cover is why recessions matter.

Most probably view this as common sense, but the reality is often times the market and the economy don’t run in sync.  For example, the market bottomed in Q1 of 2009, but the economy was still very weak.  Recently, GDP growth for much of 2013 was lower than that of 2012, but the market basically doubled its return in 2013 from 2012. 

Anyway, by and large is that economic forecasting shouldn’t be a huge factor in determining how you allocate your portfolio.  Aside from being terribly unreliable, even when they are spot on the market may behave in an unexpected way.  I agree with that for the most part, except when it comes to recession forecasting.  Here I walk through why:

1. A reduction in corporate profits often leads or coincides with recessions.
2. As one would expect, profit growth is highly correlated with the S&P 500.  Also, that larger market declines happen when earnings fall at or around recessions:
3. Thus, it follows that if economic growth is positive, as it is projected to be, earnings should grow and subsequently the market.
4. But more importantly, if you have a beat on when the economy will slow (and that is very hard to do) you can get out in front of a fall in corporate profits and the subsequent fall in the market.

The takeaway is to use economic forecasts as part of your risk control strategy to move out of stocks before they have a large move down.  But don’t have it be your only piece and certainly don’t go risk heavy because the economic growth is expected to rip as there are other factors at work.  This is a drawn out way of saying “win by not losing big” and seeing storm clouds on the horizon can help with that.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss. S&P 500 Index is an index of 500 of the largest exchange-traded stocks in the US from a broad range of industries whose collective performance mirrors the overall stock market The Dow Jones Industrial Average is a widely watched index of 30 American stocks thought to represent the pulse of the American economy and markets.