December 4, 2018

The Investment View from Prescott, Arizona

The Trade War is Not the Boogeyman

The trade war is really not much of a war, but I had a good insight into the issue when I was in Europe in October. I was marveling at all of the cars I had never heard of like Skoda, Vauxhall, and ones that we rarely see in the US, like various Peugeots and Renaults.

Then I realized that I was seeing no Fords or Chevys. On my 3rd day in Paris I did see one Ford. During my 3 weeks in Europe, I counted 4 Fords and 1 Chevy among the many thousands of cars I saw. That’s it! Because European tariffs make US made cars cost up to 50% more there, Ford and Chevy prices are not competitive with European cars.

The US, led by President Trump, is trying to renegotiate trade agreements that largely went into effect in the years following World War II in an effort to help economies around the world rebuild. Those efforts were successful, so successful that they can now be revisited.

Economically, everyone is better off if we all do the jobs we do best. If China can produce something at a lower cost than we can produce it ourselves, then people in both countries win if we let them do it. But tariffs like Europe has on US cars protect inefficient manufacturers and we all end up paying more as a result.

From a social aspect, the bigger the economy the more money there is for the Federal budget. Whatever your preferences may be – military spending, infrastructure, health care, trade, or maybe even paying down the deficit – you can have more of it in a growing economy. The more revenue generated through economic growth, the more we can accomplish as a nation.

Economic growth is stronger now than it has been in decades, and despite media warnings to the contrary, it shows signs of continued growth. Bull markets can end for a number of reasons, but growth is not one of them. Because of this growth the potential for a recession in the near future is remote.

Wherever your politics lie, as an investor I hope you have come to realize that following the media and their “bold” predictions is a poor way to invest. Usually headlines point in the opposite direction of what an investor should be doing.

There is much talk about trade wars but, with the exception of China, trade issues with Canada, Mexico and Europe are getting settled. China has a lot more to lose than us in a trade war because they export four times more to us than we export to them so they have four times the targets for tariffs. China’s stock market is down 28% since January, and they are feeling the heat, so I expect that issue will wind down, too.

What The Markets Are Doing

After a good start to the year, October’s stock market correction and the trend of rising interest rates hitting the bond markets have caused many investments to lose value.

The iShares Core US Aggregate Bond Index (Symbol: AGG) is considered representative of the US bond market, and it is down 4.53% YTD on a closing basis as of October 31st. Rising interest rates are beginning to make bond yields competitive with stock dividends for the first time in many years. It is my opinion that the risk of losing money owning bonds has risen and will stay high for many years, while the risk of owning stocks has stayed the same. If you are one of those investors considering moving money into bonds chasing higher yields, do so cautiously as these are treacherous times in the bond markets.

The stock market had a rough October with the S&P 500** Index losing 9.88% between September 20 and October 29, and giving up all of its 2018 gains in the process. October was the market’s worst month in 7 years and its worst October loss since the financial crisis in 2008. Both the Nasdaq** and small company indexes were down double digits during this same period.

Emerging markets and developed markets indexes (think foreign stocks) continue their slides that began in January and are also down over 10% since late September with emerging markets hit hardest. China’s large company index leads the retreat with a 28% loss since January.

Oil was up in September and back down in October, ending right about where it began this summer.

Gold finally jumped upward out of its multi-month doldrums, but gains have been small, so the long bear market in gold that began in 2011 looks to be intact.

What’s Happening in Your Portfolio

After a good start to the year, both the stock markets and the bond markets took pretty hard hits. As a result, most of our accounts are down a little for the year-to-date through October 31st.

Our Flexible Income* portfolios followed the bond indexes down but are bouncing back strongly after what appears to be a bottoming process. Still, Flexible Income* portfolios are being held back by the rising tide of interest rates that hurt bond prices and this is the reason that I am recommending some portfolio changes (below).

The stock market had a rough October with the S&P 500** Index losing 9.88% between September 20 and October 29, and giving up all of its 2018 gains in the process.

HCM Shock Absorber Growth* entered October with about 30% cash and as of this writing on November 4th holds about 50% cash in the stock side of our accounts. My hedging activity (buying funds that go up as a market goes down) also provided a cushion for the stronger stocks that I wanted to continue to hold. These two tactics kept our stock losses to one third of the stock index for Adaptive Balance* accounts and about 60% of the index’ loss in our Shock Absorber Growth* (100% growth) portfolios during the October slide.

The key to successful long-term investing is keeping losses to a minimum, and I have done that for you. If the markets were to continue down from here, we would be sitting pretty, but I expect the recent decline ended last week and I have begun to readjust the portfolios for growth.

The stock market will bounce back, and may already be in the process of doing so. My greater concern is the bond markets. The trend of rising interest rates is one that generally is very long, once it gets started. This means that bond market losses will become very common going forward and history suggests that this negative trend may last many years.

If you have an account managed with Flexible Income* (100% income) or Adaptive Balance* (at least 50% in income) I am going to recommend a portfolio change next time we speak to reduce your exposure to the bond markets.

The new portfolio may have a greater allocation to stocks, but my track record in my growth strategies shows that risk in my growth portfolios is only about 40% of the stock market indexes. I am a very low-risk growth manager. Because of the current high risk in the bond market, reducing exposure to that risk pretty much offsets any risk of increasing the stock allocation.

• • 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.

Mental Floss

In George Washington’s days, there were no cameras. One’s image was either sculpted or painted. Some paintings of George Washington showed him standing behind a desk with one arm behind his back while others showed both legs and both arms. Prices charged by painters were not based on how many people were to be painted, but by how many limbs were to be painted. Arms and legs are ‘limbs,’ therefore painting them would cost the buyer more. Hence the expression, ‘Okay,  but it’ll cost you an arm and a leg.’  (Artists know hands and arms are more difficult to paint.) 

Earn a Discount on Our Fees

Would you like to save hundreds of dollars every year? Simply refer family and friends to Hepburn Capital.

We give a volume discount based on the total amount of money we work with for a family or other grouping of clients, including friends. The higher the amount of assets being managed for the group, the lower the fee percentage becomes for everyone in that group.

Besides being one of the nicest things you can do for us (and them), mentioning Hepburn Capital to your friends can save you real money. The easiest way to introduce someone to our work is to ask us to send them a complimentary copy of my new book, Why Bad Things Happen to Good Investments, or forward our newsletter to them.

What We Were Saying Back Then

Bitcoin Blues

I’ve commented several times over the years on Bitcoin, and I notice that as of this writing on November 30th that Bitcoin traded as low as $3,640 on November 23rd after declining from its $17,394 closing price on December 11 of last year. That is a 79% decline rivaling the 80% loss the tech heavy Nasdaq Index suffered between March 15, 2000 and October 7, 2002.

Is Bitcoin done with its crash? I don’t think so for two reasons.

Bubbles, as Bitcoin clearly was in, don’t normally stop crashing until they get back to the price point from which the bubble began. From looking at the chart of Bitcoin, that place is well below $1,000, making a 94% overall loss a possibility (only a 75% loss for bargain hunters who buy at today’s prices.)

Also, the Bitcoin industry infrastructure is crumbling beneath it. Bitcoin relies on massive computer farms all around the world who all check entries in a unique accounting system called blockchain. When a transaction in Bitcoin is done, these data centers are the ones that verify and make the permanent record of the transaction. These vast data centers are very expensive to build and run and they are paid in tiny bits of Bitcoin for each transaction earning them the name “Bitcoin miners”.

The latest problem is that some of these data centers are losing money because they have a break-even point above the current price of Bitcoin. One large Bitcoin pioneer, a company called Giga Watt, filed for bankruptcy on November 21st. I think Giga Watt is just the tip of the iceberg, and miners will continue to drive the price of Bitcoin down as they sell Bitcoins that they have earned to try to save themselves.

It is fascinating watching this financial train wreck unfold in slow motion before me. I’m just glad I never invested in the stuff.

Our Spotlight Strategy – Adaptive Growth

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.

Click here to read more about Adaptive Growth.

A Slice of Life…

Our Prescott office will be closed from December 24th to January 2nd. We will be monitoring email and phones during that time and we will be happy to meet with you during that week to get your year-end business done, but by appointment only.

Our new office hours allowing us to close on Friday seem to be working well. I occasionally meet with a client by appointment on Fridays, and no one seems to have been inconvenienced. If you may have come by on Friday to find the office closed, please let us know.

These changes are part of my “I can manage investments for 20 more years” office design.

* 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.