July 31, 2018

The Investment View from Prescott, Arizona

Why Annuities Are a Bad Deal

I am not a big fan of annuities. The value they deliver is based upon prevailing interest rates at the time the annuity is bought, and locking in today’s very low interest rates is simply a bad idea.

I always knew the hidden fees in annuities were very expensive, but had never found a simple explanation as to why, until last week in a Forbes article by JanTheActuary.com that was reprinted in The Wealth Advisor with these excerpts that follow:

“The key benefits that traditional pensions provided, protecting workers against investment risk and against longevity risk, are available for the asking in the form of immediate or deferred annuities. It’s just they’re so danged expensive that they’re (nearly) uniformly considered to be a terrible means of investing one’s money.

But I think it’s useful to step back and ask, why are annuities so expensive?

. . . anti-selection. It’s the reverse of what happens with life insurance, where insurers will require you to take a medical exam because they know that people with a diagnosed medical condition will be more eager to purchase life insurance, and lots of it.

Quite the opposite happens with annuities — because people in poor health are not nearly so worried about outliving their savings and much less likely to buy annuities, actuaries have to price annuity rates based on very high life expectancy assumptions, which discourages anyone of poor or even average health from considering them.”

My take on this [Will’s comments now] is that since insurance companies assume annuity buyers will have longer than average life expectancies, benefits that can be paid are proportionately smaller since they are being spread out over much longer periods.

Now I know what the real problems with annuities are, and so do you.

What the Markets Are Doing

The US stock markets continued to shrug off trade war worries and creep higher as of this writing on July 29th. The Dow Jones Industrial Average** became positive for the Year to Date but still remains 4.38% below its January 26th, 2018 high. The S&P 500**, which represents about 80% of all dollars in the US stock markets, also had a good July but still remains 1.88% below its January highs. Until these two major indexes move above their January highs the health of the stock market remains in question.

The tech heavy Nasdaq index** led the way in July with small company stocks providing some concern as they have repeatedly failed to break above their June 20th highs, a sign of possible liquidity problems in the market.

Money (liquidity) is the lifeblood of financial markets. As my friend and newsletter writer, Tom McClellan, likes to say, “there are only two things that matter in the markets, how much money there is to invest and how willing are investors to spend it?” Small caps are like the canaries that miners took into coal mines to warn them of danger, in that the small caps failure to keep up with larger companies often provide early warnings about falling liquidity in the stock markets.

The Fed is slowly draining off the “Quantitative Easing” financial stimulus of years passed by selling bonds, an action that pulls cash from the economy. The Fed is increasing their target rate of bond sales to $40 billion per month in July, straining liquidity levels in the market.

We are currently in a high-risk period for stocks, with the weakest months of the year coming up, and the weakest months of the 4-year presidential cycle also coming up, so stock investors would be wise to be careful now.

International stocks recovered a bit in July but still have had a dismal 6 months. Chinese stocks recovered over the past 2 weeks but remain 18% below their January highs.

Gold continues its slide that began in April. Inflation, at 2.9% is at its highest level in several years, so one would think that gold would be rising along with inflation, but it’s not. However, gold is dropping in sync with its 13-month cycle which suggests a bottom about now, so perhaps gold will bottom soon and get in sync with rising inflation. Stay tuned.

High yield or junk bonds are often a leading indicator for the stock market and a high yield index ETF, (symbol: JNK) has leveled off, creating a small net gain for the year to date through July 29th and removing worries that come with deteriorating junk bond markets.

Treasury bond yields have bumped up again but remain below the 3% level for 10-Year Treasury Notes. Treasury Inflation Protected bonds (Symbol: TIP) are dropping as rates rise which, like gold and inflation, are giving us another mixed signal.

This is an interesting market, reminding me of the old Chinese curse, “May you live in interesting times.”

What’s Happening in Your Portfolio

Due to higher than normal stock market risk right now, the strategies employed in Shock Absorber* growth portfolios have been in a conservative growth model for a few months and are currently holding about 20% in cash. In a nod to the market strength in July we are more fully invested than we have been in a couple of months, with further risk reduction tactics ready to kick in on short notice.

Polish chess grand master, Savielly Tartakover, said that “tactics is knowing what to do when there is something to do, and strategy is knowing what to do when there is nothing to do.” That is how I manage money, too. I use an overlaying strategy and underlying tactics designed to get a satisfactory rate of growth with minimal risk.

Our gold holdings are currently inverse gold ETFs so we can profit from gold’s recent decline.

Flexible Income* portfolios are fully invested in several income funds and performing well lately.

Our Municipal Income* portfolios leveled off over the past month but have YTD gains in line with CDs, but with tax-free income.

• 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 would like to have more growth in your portfolio, call the office to talk about moving to portfolios with more growth and less income exposure.  It is a simple change to make.

Mental Floss

 Work of a very talented street artist.        

Cybersecurity at HCM

Hacking incidents are usually the byproduct of self-inflicted wounds and neglect, such as use of outdated equipment, lack of system updates, reluctance to adopt newer software and lack of security awareness training.

At Hepburn Capital we have always had robust cybersecurity, but with the dizzying pace of change in the nature of cyberattacks, we have enlisted a full-time cybersecurity firm to be our watchdog. With a new high-powered firewall that screens all Internet traffic, and enterprise level anti-virus protection, along with 24/7 system oversight and frequent staff meeting discussions about procedures to protect us, Hepburn Capital’s cybersecurity is about as good as it gets. I thought you would like knowing that.

Retirement Plans

A new client asked me about my retirement plans, and I realized that I had not mentioned that in my newsletter for quite a while, so here it is.

The bottom line is that I am not the retiring type. I don’t know what I would do without something to do each day, and the stock market and golf are just about the only two things that have held my attention for any length of time. So, I have no plans to retire.

About 15 years ago I realized that I would probably never retire, so the office has been structured so that I do only what I enjoy and I can do my work without breaking a sweat. It helps to have 3 staff members who have each been with me for 13 years or longer, too.

Since I travel 10-12 weeks a year, play golf once or twice a week, and can sleep late when I want to, what would I retire to? Life doesn’t get much better than I already have it.

If I were to get run over by a beer truck or something else, a couple in Austin, Texas has already agreed to be here within days to take over the business. She is a CFP, and he is a number crunching active money manager like I am. Together they make a great team, and they use the same custodian as Hepburn Capital, so very little would change for you.

I also have had several members of my family live to be 100, so don’t plan on me checking out anytime soon.

Office Hours Change

To accommodate shifting schedules, our office is now open on Fridays by appointment only. We will monitor phones on Fridays, so if you need assistance just call the office at 928-778-4000 and we can help you or schedule an appointment.

The office will be staffed Monday-Thursday from 9:00 am – 4:30 pm as usual.

Have You Received a Statement This Quarter?

We have arranged for independent custodian to send you quarterly account statements, even if there is no activity in your accounts.

Bernie Madoff made off with billions because he was allowed to produce his own phony statements. Your independently produced statements, sent to you directly from the custodian, are for your protection.

Whether you choose to get paper statements or opt for electronic ones that you can print when you choose to, it is very important that you receive statements one way or the other. If you have not received a statement this quarter, please call the office so we can correct that situation for you. 928-778-4000

Our Spotlight Strategy – Adaptive Balance

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.

Our proprietary indicators are used to determine a stock market exposure that adapts to both strength and weakness in the market, directing exposure to the HCM Shock Absorber Growth strategy from 0% to a maximum of 50% of the account value. The balance, 50% to 100% of the account value, is invested in the 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 Balance.

A Slice of Life… 

One of the best entertainment values in town may be at the Top of the Elks third floor ballroom, the 2nd Monday of each month, when El Gato Azul caters delicious hors d’oeuvres, and a different jazz band plays each time. The best part is that during the first hour, swing dance lessons are given for free.

I had a paper route in 8th grade so I missed the dance lessons being given at my local YMCA. Ever since then I have always felt a little awkward trying to dance, and this is a fun way to get over one of my few regrets in life. And the food is good, too!

You can get tickets at www.elgatoazulprescott.com/shop

I’ll see you on the dance floor. 

* 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.