Buy and Hold Works, But May Not Be For Everyone

I believe the above stampede was engineered by a few hyenas at the behest of Scar in an attempt to kill the king, Mufasa, and his son, Simba.  While the Lion King certainly is not a film about investing, I do think the stampede scene illustrates what I believe to be a fundamental truth about investing – fear leads many to run for the exits all at once.  This undoubtedly is a horrible strategy, and the herd is guilty of buying at the top and selling at the bottom.

The way to avoid this is to build a diversified portfolio, dollar cost average into riskier assets (i.e. spread your purchases over time), and only look at it on occasion.  Almost everyone can do one and two, but the problem lies with #3.  Almost nobody can put their money aside and not look at it.  And if you can’t, chances are you will worry about it from time to time.

Certainly there is nothing wrong with worrying about your money.  In fact I believe worrying, if properly directed, leads to prudent asset management causing the investor to focus on risk as the primary driver of asset allocation.  However, when worry turns to fear and panic, it leads to catastrophe.

We recently met with a very large investment management company, who wanted to pitch us on their investment process.  It had a lot of merit: essentially they skew their investments to assets that have historically outperformed the market.  The issue is that they expected (really almost require) us to hold their investments through up markets and down markets, regardless whether we felt it was prudent for our client to liquidate given their risk level. 

They use a lot of data and numbers to tell their story and wanted us to “teach” our clients how to invest – buy and hold these asset classes until the end of time.  My issue isn’t with their style or their numbers, but they fail to realize an essential fact: when markets are in their darkest hours many investors aren’t built to handle that pain and need to abandon ship, which typically happens to be at the worst possible time.

So how can we as wealth managers prevent our clients from doing this?  The best way is to know your client. This approach will lead to suitable, diverse, portfolio construction, which should minimize portfolio draw downs.  This strategy and discipline should prevent a wholesale sell off for the very risk averse clients. While we aren’t selling at the bottom, we are certainly paring back the risk as markets decline, which by the way is another method to avoid the herd mentality and the risks associated with it.

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.

So What, Who Cares

I have been willfully ignorant of whatever is going on in Washington. When I do hear snippets here and there on Bloomberg I want to do this:

If I listen at this point it will only be a detriment to prudent wealth management:

• T = 0: Self-inflicted issue (e.g. the debt ceiling) that could have a “catastrophic” impact on the markets and the economy starts being chatted about in investment circles

• T = 1: Self-inflicted issue begins to pick up steam as a “legitimate” threat; markets largely ignore

• T = 2: Politicians dig in and hope for a comprise is lost; markets pick up volatility

• T = 3: Now the only thing that will save us is a last minute deal; market moves down a few percent, not enough for me to put cash to work and buy (annoying), but also not triggering any sell signals for existing holdings

• T = 4: At the last minute whichever party is losing the popularity poll caves; market back to where it was before

• T = 5: Self-congratulating politicians save the world from a problem they created; everyone vomits

• T = 6: For real?  Those insufferable mutants only kicked the can down the road, again not solving their own problem

• T = 7: Wait until we get to do this same charade all over again

I am fairly sure the above blueprint can be written in stone.  Thus, if you care to tune out Washington like I do then take a nap for a month and that’s where we will be.

Note: The Debt Ceiling talks of August 2011 coincided with a near collapse in Europe, thus the almost 20% decline in the markets doesn’t count.

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.

Nothing New, Except my ACL

I apologize for the recent lack of posts.  I had knee surgery last week, and my absence is the result of prepping and recovery. I had really expected to be able to blog during the first week of recovery since I am a seasoned veteran of ACL surgery: this is my third; however, this time included more extensive work, and that didn't turn out to be the case. In fact as I write this I am still out of the office with limited mobility, with five more weeks on crutches.  In short, I hate my knees.

The markets must have detected my absence, as my hiatus hasn't yielded any real news of note.  This isn’t surprising, of course.  Here are 10 things that appear to be roughly the same as a few weeks ago.

1. Domestic equity markets are at roughly the same place.
2. Yields are still much higher than they were earlier in the year, though have seen a noticeable change since I've been gone.  
3. The Fed is still contemplating to taper or not to taper its bond purchases. 
4. Economic data has been expansionary.  
5. Syria, still in a Civil War.  No action taken.  But maybe.
6. The Government may did shutdown. This may be resolved postponed, etc. by the time of the post.  My guess is there will be kicking and screaming and right before it’s about to matter whichever party is losing the PR battle will cave.
7. There is also the debt ceiling too.  (See resolution to shutdown).
8. Emerging Market stocks are still attractively valued.
9. Europe is still Europe. 
10. One Big Change: Cleveland sports in the aggregate are no longer the national punching bag.  If Jacksonville counts, I think they win that distinction.

Frankly, most two week spans are strikingly similar:

1. Dominant trends tend to play out over longer periods of time.Thus, items that are worthy of attention tend not to change overnight and stories that are mostly noise self-reinforce to produce more noise.  
2. Seldom does any of this news require immediate reaction, in fact responding to new data without quality analysis often backfires.
3. While this lack of movement is boring, it bodes well for those of us who are off the grid for a while, either by choice or for ACL replacement.

I need to get caught up and back up to speed this week, but you can expect regular, roughly bi-weekly posting to resume later this week or next week.

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.

Interest Rates Rise, Other Assets Moves

The 10-Year bond is almost at 3%, which pretty incredible as in early May it stood at 1.63%.  Depending on your time frame, this is one of the larger moves of all-time:

Since interest rates affect every other asset class and the economy, let’s see how this rise has filtered through and the possible reasons why:

• Emerging market assets have gotten crushed - See India.  Reason:  Investors move out of higher yielding emerging market assets as they now have a higher rate of interest here.  As assets move out, their central bank has to sell Treasury Bonds to accommodate currency flows, reinforcing the problem.

• Mortgage rates are up big - Reason:  Fed tapering includes Fannie and Freddie bonds, which are pooled mortgages.  Less demand via Fed and the market (given the Fed’s move) means higher interest rates on those bonds and the subsequent mortgages tied to them.

Note:  Interest rates rise and bond prices fall.  If there is less demand then the price will fall, thus equating to higher interest rates.

• Real Estate in general hasn’t fared too well - See Homebuilders and REIT ETFs.  Reason:  Higher interest rates = higher mortgage rates (see #2) = higher cost of purchasing a home = less demand.

• Stocks are up - See SPY.  Reason:  Fed’s taper and economic data indicates improving (slightly) economy > higher revenues > higher earnings.  This is a positive change, as in the recent past there have been times where weak data has meant more easing, lower rates, and higher equities. 

Of course other markets are moving, this is just a snapshot. Yet, the following presents the most interesting questions moving forward:

At what point do rising interest rates, or the pace of that rise, compress earnings given higher borrowing costs and lower consumption?  Alternatively, will the economy improve enough to cancel out the earnings hit?  If not, will the Fed un-taper?

While the debt ceiling, government shutdown, Syria, etc. will take all the headlines, to me rising rates and how they filter through the economy are the biggest risks moving forward.  

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.

Stocks out of Retail’s “Circle of Trust”

I remain unconvinced retail investors have let equities back into their circle of trust.  An easy way to see this is through mutual fund flow, because mutual funds are predominantly owned by retail investors.  This chart from JP Morgan (through May 2013) illustrates this:

I should note, other charts from Goldman Sachs show a similar trend through mid-August.  Point being, retail investors have been selling throughout most of the rally, and appear to be adding those funds and some cash to bonds. 

But what we haven’t seen yet, even this year where bonds have been under pressure, are retail investors selling those bonds and moving them into equities.  It appears most of fund flows are coming from the money markets.

Glass half full: this rally, which started in 2009 can have more steam if retail rotates into equities from money markets or bonds.  Glass half empty: retail is permanently scarred from the financial crisis, and stays on the sidelines.  I tend to think it’s more the former, but this chart gives me pause:

Even with the equity markets up nicely for the year, at the first sign of a minor pause, retail heads for the exit.  So, while the trend is positive…

Scars of ’08 and ’09 still haven’t healed to the point where we can say convincingly that it is sustainable.  But if that happens, this bull market could have some legs.

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.