June 5, 2018

The Investment View from Prescott, Arizona

The Future of Real Estate

Occasionally clients ask me what I think of real estate investments which are a good way to diversify if you don’t mind dealing with rentals, financing and so on. So, I wanted to pass along a valuable insight I gained recently when someone made a comment that “real estate lasts a lot longer than we do.” That got me thinking.

Most real estate analyses I have ever seen focus on the numbers of buyers coming into the market, new home construction and existing home sales.

Only when demand for existing homes begins to outstrip supply will prices rise enough that contractors can build new homes and make a profit. If the supply of existing homes increases beyond the demand, prices will decline and new home construction will dry up. Economics 101.

Right now, the market is healthy. Demand is forcing prices up and bringing new construction into the market. But things appear to be changing.

As the baby boomer generation begins to downsize and die, the useful lives of all of the houses owned by baby boomers will continue, and those houses will come on the market. Considering the vast size of the baby boom generation, this wave of added inventory of existing homes is very likely to create a gentle but persistent headwind which could hold back prices in the real estate market for the next 15-20 years.

As mentioned in my September 2017 newsletter, interest rates appear to have turned the corner on a 60-year cycle, suggesting as many as 30 years of rising interest rates are in our future.

Most home buyers don’t worry too much about the price of the home as long as they can afford the monthly payments. With rising interest rates on mortgages, home buying is becoming more expensive, and pricing an increasing number of buyers out of the market. Fewer buyers at a time when supply is growing could really put a damper on rising prices.

This headwind from rising interest rates will be felt strongly over shorter periods as interest rates zig and zag their way upward putting a volatility into housing markets that has not been present for a decade or so.

And with Trump getting ready to impose 20% lumber tariffs on Canada, the real estate market may take another hit. Since lumber is around 20% of the cost of a house, a 20% increase in lumber prices would raise housing construction cost by 4% almost overnight, making housing that will already be facing supply and demand issues find even fewer buyers.

With rising supply, courtesy of aging baby boomers, a shrinking pool of able buyers due to rising interest rates, and sudden new home cost increases a distinct possibility, I’m concerned that this may be the perfect storm of problems for the real estate industry. The signs that we may be reaching a peak in the real estate market are all there.

I’m a stock picker, and I don’t consider a generalized concern about a peak being at hand the same as an outright sell signal. However, I certainly would not be loading up on investment real estate right now. Chances are that you would be buying high.

College Classes Coming

Tax Tips for Arizona Newcomers – Tell your new friends that they can discover valuable tax savings from details about Arizona taxation that may differ from States in which you have lived in the past. Tax deductions, tax credits, investment and estate planning considerations unique to Arizona will all be discussed. June 14th from 2:00-4:00 pm at Yavapai College. Register online at https://www.yc.edu/ or call the college at 928-717-7755 to register for class #SU18-119. Tuition is $45.

Why Bad Things Happen to Good Investments – This new class is the Cliff’s Notes version of my new book, Why Bad Things Happen to Good Investments, all in 2 hours on June 21st at 2:00. Register at https://www.yc.edu/ or call 928-717-7755 for class #SU18-120. Tuition is $45. 

What the Markets Are Doing

After peaking in late January, the S&P 500 Index** experienced a sharp 10% correction and has been chopping sideways within a trading range ever since. A short term uptrend that began in March has only managed to bring the stock market back into the middle of the trading range. We are still a long way from being back in a bull market for stocks.

Although the short-term trend is favorable, the market appears to be running out of gas as the past few weeks have seen no gain at all. The intermediate term trend is still down, so at this point it is unclear whether the market will break out to the upside or head down.

As mentioned elsewhere in this newsletter, the bond market is in full retreat as all segments of the US bond market, junk (high yield), investment grade, municipal and Treasury bonds all have posted losses for the year through May 31st.

Gold has been going down as the dollar has surged on world markets over the past 7 weeks. These two often move opposite to each other. Both silver and platinum prices are declining with gold.

Oil prices have finally begun to come down as I predicted in my May 1st newsletter. Crude is down about 10% over the past week or so, so look for prices at the pump to begin to drift down, also.

What’s Happening In Your Portfolio

May ended profitably for our Shock Absorber Growth* model portfolio and moved us into the black for the year as well. As always, the results I mention are after deductions of all fees and expenses.

I have added quite a few stocks to the growth portfolios over the past few weeks and our growth portfolios have been performing well with them included. We still hold 26% of our growth assets in cash, so we are ready to become more aggressive or more defensive depending on whether the stock market breaks up or down out of its current trading range.

As the income market deteriorated I have been selling weakening holdings and consolidating the Flexible Income* portfolios into the few income funds that are still performing well. We currently hold only three income funds, but each of them has been outperforming the broad bond market. If this keeps up I expect Flexible Income* portfolios to recover and begin posting gains.

Last year gold was one of our star performers, but in today’s choppy gold market a trend has been hard to catch. Our gold allocations are currently invested in inverse gold funds which should make a profit if the price of gold keep going down. We have a little bit of gold in both our Shock Absorber Growth* portfolios and our Flexible Income* portfolios.

• Shock Absorber Growth is our 100% growth portfolio. 
• Flexible Income is our 100% income portfolio.  
• Adaptive Growth Portfolios are currently allocated with 80% Shock Absorber Growth and 20% Flexible Income. 
• Adaptive Balance is 50/50 between growth and income.

If you haven’t had a review of your account for a while, please call the office to arrange a time to talk in person or on the phone. The number is 928-778-4000.

Mental Floss

Richard Lederer is a friend, poker buddy, San Diego Union Tribune columnist and wordsmith extraordinaire having written more than 20 books on language, most of them funny.

Rich teaches as well as entertains with items like his comment on the much-debated use of serial commas. Should the sentence read:
“I want to thank my parents, the Pope and Mother Teresa.”, or
“I want to thank my parents, the Pope, and Mother Teresa.”

You can discover more of Rich’s great work on his verbivore.com website. 

D-Day for Bond Brokers

Many financial advisers have been pushing bonds to their clients despite knowing that prices would tank when interest rates rose. And that appears to be what has happened.

The chart below shows the iShares Investment Grade Corporate Bond ETF (Symbol: LQD) for the year to date through June 1, 2018. The loss shown is -5.46%, -3.92% with dividends reinvested.

So, why would advisers be recommending bonds in the face of such losses? Follow the money, as they say.

With stock trades, commissions are spelled out on trade confirmations. However, until last week most municipal, corporate, and government agency bonds were sold without any disclosure of the cost to the client. Bonds were marked up from wholesale to retail prices, just like the grocery store buying Wheaties by the case and marking each box up a buck when they go on the shelf. The price markup is not disclosed.

However, a new rule has just hit the bond market stating that the full cost to the customer of the trade must be clearly disclosed. The rule modifications require trade confirmation statements to include the price charged to you, the price the firm paid for the bonds and the difference between the two prices.

A Merrill Lynch trade confirmation used for broker training has the example “Markup total is $300.00, which represents 2.54% of prevailing market price” according to an AdvisorHub article.

In the era of $7-$10 stock trades advertised by many discount brokers I’m guessing few clients knew they were often paying 2-3% for bond commissions. No wonder so many advisers were telling clients to own more bonds.

At least we get to score one for the good guys with this new rule change. And I’m guessing bond prices will come down because of it.

Our Spotlight Strategy – Future Technology

With our Future Tech Strategy, we strive to provide a high rate of capital appreciation using primarily equity investments in emerging technologies.

We invest primarily in stocks, mutual funds or ETFs, and a money market fund. The proprietary HCM Safety Net suite of indicators is used to warn of potential stock market declines in which case exposure may be quickly reduced or hedged using inverse funds.

Click here to read more about Future Technology.

A Slice of Life… 

I drove to Phoenix Sunday for a Diamondbacks game (They won, yes!), and was struck with how brown the countryside is. It is so crispy as to be scary with almost no rain for many months. In 32 years here I don’t remember a spring as dry as this one. Friends in the ranching business are having to sell off their cows and apply for federal disaster relief because there is no grass.

I really like it when it rains – the air smells clean and fresh and the plants and critters all go “ahhhhh”, we get to hear water flowing in the creeks, and I just like the sound of falling rain.

There is some rain in the forecast for next week, so everyone do a little rain dance, please. 

* 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) 2018 William T. Hepburn. All rights reserved.