October 9, 2012
Risk Goes Up With Time
The Investment View from Prescott, Arizona
We had a Blue Moon about the time my newsletter came out two weeks ago. A Blue Moon is a second full moon in one month. Normally we think of the lunar cycle taking around a month, but occasionally we do see two full moons in the same month.
Investors tend to think of unlikely events as being distant in time, or they think they are more likely to affect someone else. Back in 1980, we had double-digit inflation – but that couldn’t happen now! Or could it? The Japanese stock market crashed and continued to decline for over a decade before ours finally gave way in 2000. We were still caught off guard, because we didn’t think the same thing could happen here.
A long period of time guarantees nothing. Even the most logical forecast can be interrupted by “an ugly surprise.” When I talk with investors about all this, they nod their heads to infer that they understand. Still, too many fail to protect their nest eggs because they assume that with all the sophisticated research, and with so many of us in the same boat, there is a certain comfort of doing what everyone else keeps doing.
All research is imperfect! While we can assemble lots of information, we can never get all the pieces to fit together well enough to predict the future. The world is just too complicated. Another financial ‘blue moon’ could appear tomorrow without warning, and all that we considered safe could crumble.
Author Nicholas Taleb calls these “black swans”. Europeans assumed all swans were white until explorers reached Australia and discovered black swans there. Because one cannot imagine something until we experience it, does that mean it does not exist?
Paul Samuelson, a professor at MIT and Nobel Prize winner was a leading economist of the 20th century and author of one of my college text books on economics. Samuelson is quoted as saying: “The longer one holds a stock the more certain it becomes that he will encounter a significant market upheaval. Risk does not go down with time, it goes up!”
The only reasonable way for individuals to participate in the stock market is with active strategies that may protect us when blue moons appear in the markets. While it would be nice if a single investment could protect us year in and year out and generate the returns we require, it is just wishful thinking.
In a buy and hold strategy the odds may indicate that you’ll be likely to realize some kind of positive return over the next ten years, but the risk that your investments could suffer unrecoverable losses during that time period is equally real. Financial calamities come along like blue moons, not often, but they do happen.
This is why Hepburn Capital focuses on strategies that Adapt to Changing Markets®.
A Slice of Life
Last summer I had the opportunity to spend a few hours in the new Musical Instrument Museum – MIM to those in the know – down in Phoenix.
What a fascinating place filled with state of the art displays of musical instruments from all around the world, their evolution and construction, from the crude and simple to the fanciful and complex. One could easily spend a half day in there and not see it all.
When you have time, check out the MIM at 4725 E. Mayo Blvd, just off the 101 near Tatum. I’ll bet you will be as wowed as I was. http://www.themim.org/
How’s The Market Doing?
The stock market has not made much progress over the past 3 weeks since the initial burst of enthusiasm when our Federal Reserve and the European Central Banks announced further financial stimuli. Some analysts say we get less economic boost from each bushel of money the Fed prints and the market could be reacting along this line.
The market’s hesitation could also be due to the uncertainty over the Presidential election outcome – the markets do not like the uncertainty that comes with change. Could this be interpreted as President Obama’s reelection being uncertain? Possibly.
However if President Obama is reelected, the huge tax increases scheduled for January 1st will be more likely to stay in effect, and that could make the markets uneasy, also. I have seen reports that big time investors such as Warren Buffett, George Soros and John Paulsen have been selling a lot of stock recently. My guess is that they are selling now to lock in this year’s lower tax rates, and that kind of selling is adding to the market’s headwind.
The messages the markets are sending are not as clear as they were 4 years ago. That is not all bad, though, since 4 years ago was the really ugly 2008.
Corporate earnings will begin to be reported in the next week or so, and we may get a better reading on just how much the economy is being affected by slowdowns in Europe and China. We will be watching all of this for you.
Q: If lawyers are disbarred and clergymen defrocked, doesn’t it follow that electricians can be delighted, musicians denoted, cowboys deranged, models deposed, tree surgeons debarked and dry cleaners depressed?
What’s Going On In Your Portfolio?
Through this writing on October 8th the Flexible Income* side of our portfolios continues to do well since its turnaround from a tough spring, making small but steady gains while collecting regular dividends.
There seems to be a change happening in stock market leadership as some previously strong segments weaken and are replaced by new leaders.
In the past couple of weeks I sold off the home builder and real estate stocks that began to falter in mid-September after the Fed’s announcement of QE3, the latest financial stimulus plan from Washington.
I find it odd that these market segments are weakening since the common interpretation of QE3 is that it will be inflationary, yet real estate, one of the most inflation-sensitive segments of the markets, is saying otherwise.
What I read into this is that deflation, rather than inflation is increasing and both real estate and the Fed are reacting to that. Real estate stocks are heading south and the Fed is shoveling a huge amount of cash into the economy trying to rekindle inflation and pull us out of deflation. Since deflation is much harder on an economy than inflation, this is a disturbing possibility.
Gold had a nice run up in August, but also has leveled off during the past few weeks. Again, if QE3 was going to bring immediate inflation, one would expect gold to be taking off. It looks like the rumor of QE3’s coming brought out gold speculators, but since QE3 was announced little new buying has occurred. Things are getting curiouser and curiouser.
Several times in my career there have been big happenings that did not really make sense at the time. As history is written we can all go “well, of course, now it is obvious”, but right now we don’t have the benefit of historical perspective. My experience says these events are pointing to a significant change. I don’t have to know why it is happening to recognize and react to it. I am ready to shift gears once the direction of the change can be seen.
Those who insist on understanding why something is happening – those who need to read about it in the newspaper before they react – may be too late to avoid financial problems. Even worse off, will be those who think they can buy an investment and just hold onto it, thinking it will serve them well in good times and bad. It’s been ten years since that worked, and may be another ten before it may work again.
Scottsdale Office Date
If you would like to meet with Will and the Scottsdale office is more convenient than the Prescott office, please call the (928) 778-400 to make an appointment to meet in Scottsdale.
What We Were Saying Back Then
I have railed against uncontrolled government spending many times in this newsletter. I believe our current level of spending is unsustainable, and failure to slow it down will lead to big problems down the road.
The chart below illustrates how big the problem is:
I suppose if you work for the government or get grants from the government, this chart may not be disturbing. But as a taxpayer who is not supported by the government, it makes me lapse into pirate talk – “arrgh!!”.
Need A Speaker?
I have had fun this year doing several presentations on “The Top 10 Investment Scams”. It is an entertaining program and educational as well.
If your organization needs a speaker, please have them call the office to schedule a time when I can present this fun program to your group. (928) 778-4000
Our Spotlight Strategy
With our Adaptive Balance Strategy we strive to provide high total return from a combination of investments in both the equity and income markets with an emphasis on the income markets. [Adaptive Balance]
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.