Money Matters Newsletter:
September 1, 2015
Another One Bites the Dust
The Investment View from Prescott, Arizona
A generation ago we all worried that Japan would take over the world. Their manufacturing prowess was the stuff of legends; they were buying up American Icons from Pebble Beach to Rockefeller Center and no one could see the end of the Japanese run.
Since then, the flaws inherent in Japan’s command economy came to the surface, their economy stagnated in a deflationary spiral and their stock market has been stuck at a level less than half of its 1990 peak.
Deflation is the evil twin of inflation. A tide of too many dollars causes the price of goods to get bid up, inflating prices. Deflation is too many goods chasing too few dollars, causing the prices of goods to deflate downward until bargain hunters are attracted.
While deflating prices might seem good for us as consumers, it destroys businesses as it has done in Japan. If prices fall 20%, like some apparel and electronics goods have, that means that a business must sell 25% more goods to keep their revenue stream up to where it was. When an economy has very little growth, 25% sales increases are very rare. Most businesses can’t do it and revenues used to pay wages begin to wither.
Further hindering businesses, is that the competition for dollars drives prices down while raw materials and wages often stay firm. That means that price cuts usually come out of profits first. Unprofitable businesses don’t hire, build new factories or expand, which is why many jobs are disappearing. Falling prices are a two edged sword.
Most companies will operate at a loss for a while. Entrepreneurs that run companies are not quitters, and will usually choose to bleed to death slowly rather than just shut a business down.
China’s command economy has been running on fumes for years now with construction going full tilt even though Shanghai was becoming full of empty buildings. Banks were pressured to make loans to build more and more, so now the Chinese banks are shaky, too. With the deep recession in Europe, the demand for Chinese good is way down, but Chinese factories keep churning out doodads that flood the market and further deflate prices putting even more pressure on their factories and ours.
The Chinese stock markets are down 30% in 4 months in a decline reminiscent of the beginning of the Japanese decline 25 years ago.
Will the dictator-run economy in China be able to recover? Only time will tell, but they have systemic problems which suggest that their decline is not nearly over and may become like that in Japan.
It may take some luck for the Chinese deflation to avoid spilling over into the US. Actually, we have had deflation for years, but the Federal Reserve Bank has been shoveling money into the economy to create inflation, hopefully offsetting the deflation, so we have some industries that are inflating (banks, education, real estate and health care) and others that are deflating (electronics, energy, raw materials).
When history is written, deflation will be the economic hallmark of these times.
Slice of Life
Your Birth Song
This website’s a keeper. It plays the song that was Number One on the day you were born. And, if there is a video available with the artist, it will play it for you. This is really a fun site. Enjoy!
How Are The Markets Doing?
Stock markets worldwide were rocked last week by sharp drops and sudden jumps. These wild gyrations are called volatility and volatility is not your friend while investing. Just because the stock markets regained half of the losses from the previous couple of weeks does not mean the uptrend is back. These zigs and zags are the nature of stock markets, and when they zigzag in giant steps, caution is called for.
The major stock indexes posted gains in the 4% neighborhood Wednesday, August 26th. However, this isn’t necessarily a good sign. History’s biggest one-day gains have come in bear markets, not bull markets.
The markets were also rattled by more than 1,200 trading stoppages on Tuesday, August 25th when no buyers could be found for some stocks and exchange traded funds. Since a trade requires both a buyer and a seller to agree on a price, if buyers stay home, security prices can have huge drops in minutes, and those kinds of drops triggered “circuit breaker” stoppages last Tuesday.
None of the investments Hepburn Capital had in client accounts were affected, and our system of using hedges to avoid being forced to sell in sharply down markets worked well last week.
Confounding experts and gold bugs alike, the dollar continues to be one of the strongest currencies in the world. The Economist magazine produces their Big Mac Index as a means to gauge the dollar’s strength. Since Big Macs require the same materials and labor wherever they are produced, their cost, when translated back into dollars, is a simple measure of dollar strength. “How many Big Macs can you buy for a buck?” so to speak. The latest Big Mac Index showed the US to have the strongest currency behind Switzerland and Norway, and ahead of all other countries.
There was an interesting survey of financial advisers done by InvestmentNews last week that said 61% of advisers expected the decline in stocks to continue, but only 7% had any intention of reducing client exposure to stocks.
At first, I thought this was just insane for advisers to know an accident lies on the road ahead and they won’t even tap their brakes. Then I realized that the vast majority of financial advisers simply have no method for dealing with imminent market declines. They merely sell mutual funds or ETFs and move on. They are salesmen, not money managers. So rather than it being insane, I have decided that it is just sad that so many financial advisers don’t have a clue about what to do when a market goes through a significant change.
And it is really sad that so many think these advisers are doing something for them when they are not. If you know someone whose investment adviser is doing nothing in the face of this decline, have them call me at 928-778-4000, quickly.
What’s Going On In Your Portfolio?
As you might imagine with the losses in the stock market, our Shock Absorber Growth* portfolios showed some red ink also, but only a small amount compared to the S&P 500 Index** that was down 6.2% for the month of August. Our losses were offset with cash holdings and inverse funds that act as shock absorbers at times like this.
Flexible Income* accounts saw good gains as our Government Bond* strategy had a second straight great month. I have also increased our allocation to Government Bonds and added a small position in gold, as it often bounces as the stock market slides.
Adaptive Balance* accounts (currently 50% Shock Absorber Growth* and 50% Flexible Income*) have shown gains in the 3rd quarter. Adaptive Growth* (80% growth and 20% income) showed small losses for the quarter, but far outperformed the stock market as a whole.
William Arthur Ward is quoted as saying, “The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails.” This is exactly what we are doing at Hepburn Capital. I had been expecting a bounce in the stock market at the end of last week, and now that that has happened I have increased our hedges – the inverse funds that go up when the market goes down – to the point that we should make a profit if the market continues down from here.
College Classes Coming…
Managing an Inheritance: Planning It, Getting It, and Keeping It
October 7th at 3:00-5:00 pm
If you plan to be on the receiving end of an inheritance from a parent or other loved one, planning is crucial if you hope to preserve your windfall, save on taxes and avoid family squabbles. This two-hour discussion will guide you through the heart of complex issues, both emotional and financial, that beneficiaries face during the three phases of inheriting: planning your inheritance, receiving it, and making your life better because of it. Topics include: documents you may need, dealing with disability, the use of trusts, basic estate planning principals, and protecting your new assets. Call Yavapai College at 717-7755 to enroll in course # FA15-142. Tuition is $45.
Begins next week on September 9th at 3:00-5:00 pm, running three (3) consecutive Wednesdays through September 23rd.
This course is designed to help investors become more confident about their financial decisions. In an easy to grasp format this class provides a broad knowledge of investments preferred by investors approaching or already in retirement. Learn the ins and outs of stocks, bonds, mutual funds, annuities and more. Topics include recognizing risk, controlling the tax impact of IRA withdrawals, avoiding common investment mistakes and simple risk reducing strategies that anyone can use.
Call the college at 717-7755 to register for course # FA15-135. Tuition is $65.
If it is more convenient to meet with Will in Scottsdale, please call the office to schedule your appointment. 928-778-4000
Our Spotlight Strategy
With our Adaptive Growth strategy we strive to provide high total return from a combination of investments from both the equity and income markets with the emphasis on equities.
Our proprietary Stock Market Exposure Indicator is used to determine a stock market exposure that adapts to the strength or weakness of the market, directing exposure in the HCM Shock Absorber Growth strategy to range from 20% to a maximum of 80% of account value. The balance, 20% to 80% is invested using the HCM Flexible Income strategy. The HCM Safety Net indicator is designed to warn of sudden potential declines in which case stock market exposure is quickly reduced.
When Insults Had Class….
“I am enclosing two tickets to the first night of my new play; bring a friend, if you have one.”
– George Bernard Shaw to Winston Churchill.
“Cannot possibly attend first night, will attend second …. if there is one.”
– Winston Churchill, in response.
Of Bernie Madoff, Money and Thieves
Economist Elliot Eisenberg reports that over the past 6.5 years, trustee Irving Picard has recovered almost $11 billion of the $17 billion stolen by Bernard Madoff. But this work has been costly. At $413.30/hour after a “public interest” discount of 10%, the 97,115.5 hours Picard’s team billed in just Q1/15 came to $40 million! All totaled, Picard has billed $700 million for his work on the Madoff case. Luckily for investors, the money for Picard’s fees comes from insurance, not recovered proceeds. But still, $700 million is a lot of money.
* The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. Performance and activity in client accounts may be different from that in the model in amount of each investment, specific timing of trades, and actual security used, which may vary from account to account. Not all trades are profitable. It should not be assumed that current or future holdings will be profitable. A list of all trades in these accounts for the past 12 months will be provided upon written request.
** Indexes are unmanaged lists of stocks considered representative of a broad stock market segment. Investors cannot invest directly in an Index.
This newsletter may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Information in this newsletter may be derived from sources deemed to be reliable, however we cannot guarantee its accuracy. Please discuss any legal or tax matters with your advisors in those areas. Neither the information presented nor any opinions expressed herein constitute a solicitation for the purchase or sale of any security.
In all investing, past performance cannot assure future results, and as such, our efforts are not guaranteed. Losses can occur. All strategies offered by Hepburn Capital Management, LLC adapt to changes in the markets by changing the investments they hold, therefore, comparisons to broad stock market indexes such as the unmanaged indexes mentioned may not be appropriate. Sometimes client accounts are invested in stocks or markets not included in these indexes. Past performance does not guarantee future results. Investment return and principal value will vary so that when redeemed, an investor’s account values may be worth more or less than when purchased. Mutual fund shares and other investments used in our managed accounts are not insured by the FDIC or any other agency, are not obligations of or guaranteed by any financial institution and involve investment risk, including possible loss of principal. Advisory services offered through Hepburn Capital Management, LLC, an Arizona Registered Investment Advisor. Adviser will not transact business unless properly registered and licensed in the potential client’s state of residence.
Copyright (C) 2014 William T. Hepburn. All rights reserved.