Money Matters Newsletter:
March 1, 2016
No Help from Lazy Legislatures
The Investment View from Prescott, Arizona
espite weak economic growth throughout the world, it seems that the only institutions trying to fix things are central banks, like our Federal Reserve. While they can do a great deal, central banks cannot permanently boost economic growth via increased infrastructure spending or by passing tax, labor, education or immigration reforms. That is a job for legislatures, and they all seem painfully missing in this economic cycle. Worse, the more the central banks stimulate economies, the lazier legislators seem to get.
The Fed was able to bail the banks out of the 2008 financial crisis by printing a flood of new money. But banks respond more readily to an infusion of cash than the production sectors of our economy. Will Fed magic work on the ailing oil industry? It does not appear to be doing so.
Despite trillions of new dollars being created by our Fed, and more trillions being created by the European and Japanese central banks, real economic growth is hard to find anywhere in the world. Demand for goods, notably oil at the moment, is very weak, suggesting deflation is at work.
During inflation, demand for goods is high and prices get pushed up. Deflation is the opposite of inflation. When deflation occurs, demand for goods is low, and prices drop and drop and drop until bargain hunters are attracted. Falling prices are great for consumers, but terrible for people that like to have jobs, since businesses shut down when they can’t sell their goods.
If the current business decline does turn into a deflationary spiral it won’t happen overnight. It will be more like watching a train wreck in super slow-mo. The Japanese economy has been mired in deflation for 25 years. During that time the Nikkei 225 Stock Index** has done little but go down, and is still 60% below its 1989 levels. Twenty-seven years is a long time to wait and still not break even.
Deflation can cause a domino effect of defaulting loans when collateral becomes less and less valuable and does not adequately cover the debt.
We got a whiff of this in 2008 when virtually all asset classes were declining in value at the same time. Real estate, stocks and even bond prices collapsed, threatening the entire banking system which is built on loans.
What is important now for investors to know is that owning debt or becoming a lender in a deflationary era is a dangerous position to put one’s self into. Debts are likely to see much higher rates of defaults as cash available to pay off debts declines as spending declines. The double whammy that may occur will be if collateral values will be declining, too. In that case both lenders and borrowers lose.
Debt investments – bonds, mortgages and annuities – will become hard to cash out without significant losses during debt deflation.
At Hepburn Capital the only debt based investments we buy are stable or rising in price such as bond funds that can be sold for full value at any time. If you aren’t nimble like I am, debt based investments, even mutual funds, may not treat you well over the next few years.
Slice of Life
The Senior Connection in Prescott is sponsoring the Senior & Caregivers Conference & Expo, March 11th at Liberty Traditional School, 3300 N. Lake Valley Rd, in Prescott Valley.
Speaker presentations begin every hour between 10:00 and 3:00 pm. And include topics ranging from Stem Cell Therapy & Regenerative Medicine to Preventing Caregiver Burnout.
Admission is free, and details can be seen at www.SeniorConnection.us
How Are The Markets Doing?
2015, was the year that stocks went nowhere, but last year is starting to look like the good old days compared to this year. Although February saw a dead-cat bounce in the stock markets, the bounce was weak, and as of this writing on February 29th, stock prices are back where they were in the summer of 2014!
Investment grade bond prices are up a little this year as investors fleeing the stock market bought bonds. Junk bonds have a higher yield, but lower credit quality, and are now reflecting why they have that name as junk prices fall due to the rising numbers of defaults in that category.
I have been writing about bear market behavior happening beneath the surface since March of last year. Recession friendly investments like utilities, Treasury bonds, and consumer stocks have outperformed the average stock, while segments that do well in strong markets such as small company stocks, commodities, and emerging markets were in sharp decline.
Investors should know that weakness in the energy sector is a big deal with the potential to ripple through the economy for years. Because of this and the uncertainty about the presidential elections, I think we will see stock prices continue to lower this year before a recovery can begin.
The good news for you as a HCM client is that market behavior is finally respecting history which provides great opportunities for my active management style.
Sadly, Investors who rely on buy-and-hold investing will probably take more losses before they recover. If you know someone like this, please have them call me to discuss how I can help them avoid further losses.
HCM in The News
What’s Going On In Your Portfolio?
Both of my primary strategic models, Shock Absorber Growth* and Flexible Income*, continue to thrive in this rocky investment environment.
As of the close of business on Friday, February 26th, Shock Absorber Growth* continues to hold about 1/3 of its assets in cash because I expect further stock market declines and want to be prepared for them.
Our shock absorbing hedges (inverse funds that go up when the market goes down) have been reduced as the market has risen the past few weeks. While hedges help performance in down markets, they hold us back in rising markets. I will be redeploying the hedges when I think the downtrend is resuming, possibly soon.
Shock Absorber Growth* accounts, which focus on growth stocks, have gained between 1-2% since the beginning of 2016, while the S&P 500 Index** is down 4.69% during that same period.
Flexible Income* accounts, which avoid growth stocks, had strong performance in February with help from the government bond portion of the portfolios. Flexible Income* has seen values rise about 2.5% since January 1st.
Municipal Income* accounts have also posted modest gains for the year.
Of course our blended portfolios, Adaptive Balance* and Adaptive Growth*, include varying percentages of Growth and Income models and are showing positive growth rates somewhere between those two primary models. In this market they are looking really, really good.
Over the past few months, I have been reducing the growth allocation in our blended portfolios to keep us on the right side of long term market trends, and my calculations show another reduction will happen soon. After that next change in allocations, Adaptive Growth* accounts will be 50/50 growth and income and Adaptive Balance* will be 20% growth and 80% income.
If you have Shock Absorber Growth* (100% growth stocks) as your investment objective and want to reduce the risk in your portfolios, this would be a good time to change to Adaptive Growth* or Adaptive Balance*. Just let me know and I can make that change for you.
Avoid This Sales Gimmick
There is an old story in my industry were the financial planner calls the client and says “I have good news and bad news. The bad news is that your portfolio has dropped 20% this year. The good news is that I saved you 1% in fees.”
Low fees are often a euphemism for a low level of management, and in rapidly changing markets, good management is worth a lot.
A new client came to me recently with a portfolio that was well diversified among stocks and bonds as suggested by Nobel Prize winning Modern Portfolio Theory (MPT). However, MPT has a financially fatal flaw because it uses only one strategy, buy and hold. It is a simple and low cost way to invest, but MPT does not Adapt to Changing Markets® as my portfolios do. Unfortunately, what works in theory, often does not work well in practice.
Before coming to Hepburn Capital, this client experienced double digit losses since the middle of last year. My Adaptive Growth portfolio rose in value during that same period.
I may not have a Nobel Prize, but flexibility makes my system vastly superior when markets change directions.
The mutual fund industry has made MPT into one of the best sales gimmicks they could imagine: “Just put your money in our funds, and never sell.”
They conveniently overlook the fact that the great American investment creed of “Buy Low, Sell High” has two parts. If you are not willing to sell at some point you won’t get it right.
In November, I had dinner with Jamie Green, Editor of Investment Adviser Magazine who said to me “Your (Hepburn Capital’s) job is to protect your clients from the financial services industry.” Protecting clients from this MPT sales gimmick is a good example of what Green meant.
Don’t fall for industry sales pitches. There are times to be invested and times to be out of the market. I know how to get your money out of harm’s way when that is called for. It won’t do you any good to call me after further market declines. Call me today if you have money that I am not already managing. I can help protect your interests.
Resetting TCA Passwords Just Got Easier
Did you know you now have the ability to reset your own online account passwords? On the Liberty login screen there is a link called “Help me recover my password”.
If your account has already been set up, you can reset you own password anytime you want to.
Am I Meeting Your Expectations
My style is to not call you and bug you about things you hired me to take care of. That stereotype is born of commissioned salesmen whose managers tell them to call you frequently so they can sell you on the newest, latest, better-than-the-last-one investment so that they earn another commission.
I just quietly take care of your accounts so you can go about your life and don’t have to worry about where your money is or isn’t. After all, would you rather have me doing market research or making phone calls?
This newsletter works well as my primary means of communication with you. You can see what I think about the market and changes I am making in holdings to manage the current conditions.
But this medium does not tell me what you are thinking, feeling and experiencing in your lives.
If you have changes in your life circumstances or your tolerance for risk, or if something is just bothering you, please let me know so I can make sure that I am using the appropriate investments for your situation.
If I am not meeting your expectations please tell me. If I am meeting your expectations, please tell your friends.
If it is more convenient to meet with Will in Scottsdale, please call the office to schedule your appointment. 928-778-4000
Why We Look so Good
Our offices always look good from the street due to the efforts of Michael Martin, a quiet and gentle man whom I have know for 25 years or so.
Michael comes by and trims our roses and other bushes, keeps leaves from piling up and controls our weeds to keep our corner of the world looking good.
If you have yard work that needs doing, call the office and we can give you Michael’s phone number.
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 mutual funds and exchange traded funds (ETFs), including inverse and leveraged funds, 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, repeating as needed. Growth stocks are not used.
Click here to read more about Flexible Income.
* 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) 2015 William T. Hepburn. All rights reserved.