May 14, 2013
Kicking the Can Down the Road
The Investment View from Prescott, Arizona
I attended an interesting meeting recently with Chris Krueger, the Senior Policy Analyst with Guggenheim Partners, during the National Association of Active Investment Managers conference, two weeks ago in Denver. Chris is an astute political analyst and Guggenheim has him in Washington, DC for the keen insights he can provide.
The question was posed “If the government keeps kicking the fiscal can down the road, at what point does the can begin to kick back?” Chris outlined three potential scenarios to solve the ongoing fiscal crisis:
1. The bond vigilantes could refuse to buy Treasuries at today’s below-inflation rates, forcing the government to pay higher rates to attract buyers.
According to TreasuryDirect.gov the federal government paid $191 billion in interest during the first six months of Fiscal 2013. We should expect twice that for a full year. Let’s call it $380 billion. And that is with interest rates at today’s record lows. What will happen if rates go back to the historic average of around 6%? It is so disturbing that I don’t want to think about it, but the amount of interest owed will begin with the letter “T”. And that is each and every year. Forget food stamps or fighter jets. All we will be able to afford is interest payments for many, many years. It’s called austerity.
2. One party control of government could also solve the problem, albeit in different ways. Democratic control would give us something similar to the Senate version of the proposed budget where increasing government expenditures are covered with more taxes, fees and penalties. Republican control will lead to lower government spending so taxes can be lowered. At least that is the theory.
3. Or, Congress could undertake the difficult work of weaning everyone from government subsidies, which, believe it or not, may be starting.
The government loves to denigrate the credit rating agencies for their colossal 2007-08 failure to foresee the end-game of the mortgage backed securities bubble, but oddly Congress is heeding what the rating agencies are saying these days.
The credit rating agencies warned the Congress to not lower the $85 billion amount of the recent sequester – which was simply forced budget cuts agreed to in an earlier compromise. Congress didn’t reduce the amount despite pressures to do so.
The rating services also said do not politicize the debt ceiling debate like they did a couple of years back. And Congress didn’t.
So this is the hard work that Congress and the administration need to undertake to avoid items 1 and 2, above. Sure, these are tiny steps in relation to our huge budget imbalance, but at least they are steps in the right direction.
A Slice of Life
One of the more memorable characters in my life goes by the name of Biker Jim. I know Jim from my Alaska days, 30 years ago, and he is one of the most creative people you will ever meet.
Jim used to “steal cars for a living”, a euphemism for driving a repo tow truck. A few years ago, after honing his craft with a hot dog cart on Denver’s 16th Street Mall, he opened a restaurant named Biker Jim’s Gourmet Dogs, two blocks from Coors Field in downtown Denver. And I have to tell you, this is not your father’s hot dog stand.
The menu includes Cilantro Duck dogs, Jackalope (a rabbit and antelope combo), Elk, and my favorite, the Rattlesnake/Pheasant combo topped with cream cheese and caramelized onions. It tastes like chicken. Really, it does!
If you are ever in Denver and want a good, casual meal, check out Biker Jim’s. He’s gonna be Big! And remember, you heard it here first.
Q: Name four days of the week that start with the letter “t”?
A: Tuesday, Thursday, today, tomorrow
How’s the Market Doing?
Are We Out of The Woods Yet?
The headlines are telling about the US stock markets hitting highs not seen since 2000. That sounds good – better than the alternatives anyway. Are we out of the woods? It depends on how you look at things.
The S&P 500** hit 1,515 on Sept 1, 2000. Using the calculator at inflationdata.com, we see that the S&P 500** would have to rise to 2,047 to equal 2000’s high, after adjusting for inflation. So although the current postings are certainly good news, don’t break out the champagne just yet.
The US has been one of the few bright spots in the world stock markets. The S&P World Ex-US ETF (GWL) peaked in Nov. 2007 and has struggled to make only small gains since then, nothing like the US markets. How long can the US continue to carry the world on its shoulders? We only have about ¼ of the world’s economic output so to carry struggling economies in Europe, Japan and emerging markets is a lot for one country to do, even the US.
This is still a fragile economy propped up by Fed stimulus money. I don’t remember hearing the phrase, “the Fed took away the punchbowl” since 1994 when there was a sharp stock market correction when the Fed stopped that particular stimulus program, but we need to get ready for that to happen again.
Ironically, the better the economy begins to look the more likely the Federal Reserve is to reduce its stimulus and end the party. Since almost all professional traders are looking for this to happen before long, when it does happen, the reaction in the financial markets could be spectacular, and not in a good way.
Individual investors and mutual fund owners are at greatest risk. Few individuals are prepared to move as quickly in the face of market turmoil as we are here at HCM.
Individuals who primarily invest in mutual funds and variable annuities often expect more management than those funds are structured to deliver. Expectations that the manager will move your money out of the market during significant market declines often go unmet because most funds have policies to stay fully invested no matter what.
In 2001, I spent parts of 3 days interviewing the managers of the Invesco family of mutual funds. I had breakfast one morning with Brian Haywood. Brian was the manager of the Invesco Telecommunications fund, at that time one of the largest telecom funds in the business. He had lost about $500 million (25%) for his investors in 2000, and at breakfast he looked like a wide-eyed deer in the headlights as he said “This is really a bad decline. We see it going on for another year, perhaps two.” Believing in selling high and buying low I asked him why he stayed fully invested if he knew things were going to get worse? He looked at me like I had just fallen off the turnip truck and responded, “When people invest in our fund, we assume they want their money in telecom stocks, and we assume if they want to be in cash they will withdraw from the fund.”
How many times have you ever had a financial adviser tell you that?
Advisers paid on commission are normally prohibited from moving commissioned investments around due to the potential for “churning”, movement of investments that generate extra commissions for the investment representative. So, investors who expect full management of assets are usually disappointed when the market turns down and they see even good investments take stomach-churning losses.
The kind of “fully invested” policy Invesco had is usually written in fund prospectus. It does give investors certainty about how their money is invested, but in bad markets it can also limit fund managers to doing little more than rearranging deck chairs on the Titanic.
Hepburn Capital’s niche in this market is to fill that gap between what clients expect and what mutual funds are structured to deliver. Although we don’t trade all that often (we’ve held some investments since 2011) we are prepared to move entire portfolios to cash or other safe harbors in times of trouble.
What’s Going On In Your Portfolio?
Both our Flexible Income* and Growth models* continue to do well.
I sold the Australian and Bank stock funds two weeks ago after a period where these two holdings were lagging the market. Those proceeds were held in cash. Right after I sold, the stock market moved higher (Murphy’s Law). Better safe than sorry, though.
And last week I sold our mortgage REIT. It had been a good holding, producing double digit gains since we bought it December, plus paying a 5% annual dividend. It was held in both our Flexible Income* and Growth portfolios*.
As of this writing on May 12th, our Growth model* holds real estate, health care, and consumer goods stocks and funds, plus a couple of diversified growth funds and 20% in cash.
Flexible Income* accounts hold high yield municipal, floating rate and high yield funds, plus a high dividend real estate stock, a couple of diversified bond funds and about 6% in cash.
Scottsdale Office Date
Please call the office (928 778-4000) to schedule an appointment if you would prefer to meet with Will in Scottsdale rather than Prescott.
It’s That Time Again
Would you like to see a company Brochure?
The bad news is that each year we are required to offer you the updated version of our company Brochure, formerly called SEC Form ADV Part 2. This is our SEC required disclosure document describing how we do business.
The good news is that we no longer have to kill trees to send printed copies for something that most folks don’t give a hoot about. Now you can see it electronically or print a copy if you wish to. You may see our current Brochure at hepburncapital.com/form-adv.html
Invitation to Hear Will Hepburn Speak
Will Hepburn will be the keynote speaker at the Annual Meeting of FCANA, (formerly The Memorial Society of Prescott) hosted by The Adult Center of Prescott on Rosser Street.
The presentation will be on “The Top 10 Investment Scams Affecting Retirees and How to Avoid Them,” and guests are welcome. So, if you would like to listen in on this fun and interesting presentation, come on down!
The date is June 5th. Coffee begins at 9:00 a.m. with the meeting scheduled for 9:30 a.m. My presentation is slated for around 10 o’clock.
Come on by and say hello. It will be nice to see you there.
Our Spotlight Strategy
With our Flexible Income Strategy we strive to provide high total return consistent with Capital Preservation.
Your money will be invested in bond or currency funds, including precious metals that may be used as currencies and equity-income investments whose price trend is up. If the price cycles down, holdings are replaced with new investments that are going up. Repeat as needed. Growth stocks are not used.
If you would like a current copy of our SEC Form ADV, Part 2, it is on our website at hepburncapital.com/form-adv.html
* The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. 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.
** The S&P 500 and Nasdaq Indexes are unmanaged lists of stocks considered representative of the broad stock market. Investors cannot invest directly in the S&P 500 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.