In October, I wrote about capitulation. In November, I capitulated. My customers were out of the market for a week, and some more than a week. Why? Investing is both art and science. The art comes from education and observation. The science is mostly math. The metrics of investing, including beta, standard deviation, scatter plots, and even the Morningstar risk and return percentages, where the number 1 represents the lowest risk or the highest return, seem to be from outer space.
The metrics clearly are not working. While it is true that the market and the economy are not correlated, there is a connection currently. I have a theory (you knew I would, right?) having to do with revolution. I’ll get to that later; first, more about the metrics. When I discovered that the numbers I follow had little or no meaning in the current environment, I suffered the tortures of the damned. What is going on, I wondered. But I should never allow my torture to result in major customer losses, and so I capitulated.
Having said that, I was not out of the market long, and basically shifted emphasis, moving many customers to a bond allocation strategy with a third-party manager, BTS of Lexington, Mass. Many of my customers are in or near retirement; some have technically retired and are consulting. My customers who are in their 20s and 30s are still invested. And all of those who own investment annuities with living benefits are still fully invested.
In previous bear markets in the past, my portfolios — which rely heavily on fixed income (bonds, including inflation-protected ones, and income plays) — might go down 10% in a bad month, but they rarely declined much on a yearly basis. For example, in the debacle of March 2000 to March 2003, I actually had average annual gains in some portfolios, and others were down maybe 2% yearly. In the current market, though, when the S&P was down 40% for 12 months, some of my portfolios were down 20% to 25%. That never happened to me before, and it set off a battle within me. I decided that staying fully invested despite such losses was my ego at work, and making changes to keep people from losing their shirts was the right way to go.
It wasn’t just the metrics, everything seemed to be going down — bonds, income funds, you name it — all bundled into an economics-driven elevator to the sub-basement. If the metrics were wrong, the investments went along for the ride, doing impossible and daring circus see-saws and flip-flops. How can this be? Modern Portfolio Theory is upside-down.
On Nov. 20-21, I moved many investments to BTS, and began some separate equity buying at prices amazingly lower than the previous week’s sell prices. Did we catch the bottom? I’m sure not. I will keep a great deal of customer money at BTS while this debacle, worse by several magnitudes than expected, continues. I plan to keep significant sums there and do my own investment work on the margins, maybe taking 20% to 30% and filling in. In other words, BTS has become the fixed-income part of my portfolio. So, nothing has changed, and yet everything has changed.
Suze Orman Was Right!Many people in our business aren’t wild about Suze. Back in late September or early October, someone in my office made this outrageous statement: “Sarah Palin said to get out of equities.” I said, “What!? No way!” I could not imagine why the then-vice presidential candidate would go out on that particular limb.
At lunch with Jeff Ellson, my buddy from Raymond James, the mystery was solved. Jeff told me that Suze’s advice was to get out of equities, and my office mate had confused Orman and Palin, who knows why? At any rate, in hindsight, she (Ms. Orman) was right.
The RevolutionAs promised, I return to the theory expressed in the second paragraph. Here goes:
1. The people of this great country now understand that the fat cats on Wall Street did ‘em in with crazy creative financing. And Congress — the lair of another species of fat cat, the government variety — more than helped, even acting as a cheering section, with Fed chairman Ben Bernanke as the head cheerleader. And while Congress still doesn’t get it, the folks on Main Street may simply and finally be fed up with special interests running the government.
2. Derivatives seemingly have brought us to our knees financially. I go to the Berkshire Hathaway meetings each year, and I think it was in 2001 or 2002 that Charlie Munger, BH’s vice-chairman, when asked about using derivatives, basically said, “I would rather put a viper down my shirtfront.” Nonetheless, Berkshire, like most large companies, carries some derivatives. In fact, Warren Buffett recently made a large derivative bet with customers that, long-term, the S&P would not be below a certain point at such-and-such a date — a possible obligation that Berkshire now has to “mark-to-market,” since the S&P has declined, and the company stands an increased chance of losing its bet.
Since I like Messrs. Buffett and Munger and invest in Berkshire, I will not call either Warren or Charlie fat cats, especially since they are poster boys for reasonable compensation and foster such among execs at their subsidiary companies. Even so, I am not happy about the hedge bet, even though I expect BH to come out ahead. According to Niall Ferguson, in his excellent new book, The Ascent of Money, the total worldwide derivative handle is $473 trillion, while the combined market value of all global investments is $51 trillion, and the world’s gross domestic product is $47 trillion. Chilling, isn’t it? Just think: $473 trillion in scraps of paper, a lot of it unreserved and uninsured, floating out there at sea, waiting to hit land and cause more trouble.
3. Into the financial part of this mess steps one Hank Paulson, treasury secretary and crossover fat cat, having moved from Wall Street to Washington. In the first bailout plan he presented, Paulson didn’t even think to limit executive compensation. If the government bailed out Company A or Company B, the execs at either firm could still take home up to $100 million in bonuses and pay. After all, Hank and these guys play golf together, or at least sup from the same silver spoon.
4. Congressmen and senators are so used to the trough that, like orchard pigs, they root among the lobbyist weeds and grow fat from scraps. They cannot comprehend that they sell their souls to special interests. And what do they get? Campaign contributions and the occasional junket, but, mostly, they get to stay in the Washington wallow, where the sun shines a bit brighter, and the rain falls gently from above. How can they identify with the average American? And they do this even in the face of the most horrible public approval ratings in history. But here’s the thing: people now realize that Congress doesn’t always have constituent interests at heart. And they know the Wall Street fat cats only want to line their own pockets.
5. The car company fat cats (maybe a bit leaner now) have come to Washington, hats in hand, for money. The truth is that Detroit now makes a quality car. I’ve had no trouble with my Chrysler 300 since I bought it, except for once needing a bolt tightened; I think there may have been one recall. The American cars I have owned from the 1990s through now have been very reliable and well made. But employee legacy costs (mostly for retirement and medical benefits) are choking our auto manufacturing sector, and such benefits were not properly pre-funded. Like government, industry is all too happy to push cost responsibilities off for future generations to solve. Government, however, at least is easier to understand than industry. Government does not “save” money; it simply nets income and outgo. But industry and unions should have worked out ways to insure that the money promised to retirees was in the kitty.
6. Falling demand has drastically reduced gas prices, which makes me believe in economics. (I have more trouble believing in some of the too-optimistic mutual fund economic advisors, who often work too hard to find bright spots and ignore danger signals.)
Thanks for allowing me the rant. I needed to get that out of my system. America has completely figured out the greed thing in Washington and Wall Street. I expect 25% or so of registered reps and investment advisors to seek other pastures, probably without a bailout. Pray with me that those in authority truly focus on a fair deal for citizens and not on political gain. If the fix they work out is only temporary, the problems down the road will be beyond imagination.
Broker’s BookcaseReward Systems — Does Yours Measure Up? by Steve Kerr (Harvard Business Press, 2008). The author worked for Jack Welch at General Electric and was chief learning officer at Goldman Sachs, so as you would expect, he knows his stuff. He defines performance and comprehensive ways to measure it, and suggests reward systems that work.
Of the excellent examples Kerr offers, one of my favorites is the reward metric for runs batted-in, or RBIs, in baseball. It really refers more to the person who bats ahead and gets on base. Kerr suggests that this is therefore skewed; the person driving in the run, not the lead batter who makes the run possible, gets the reward. This book is an easy (and valuable) read, and you’ll get insight from a person who walks the walk and talks the talk. In addition to his corporate work, Kerr was a college professor for 23 years at schools such as the University of Michigan and Ohio State University.
Exiting Your Business, Protecting Your Wealth — A Strategic Guide for Owners and Their Advisors by John M. Leonetti (John Wiley & Sons, 2008). Leonetti, a lawyer and CFP, is an expert in the difficult subject of winding-up businesses. I’m currently working on an exit strategy with an investment partner, so I appreciate the fact that this book goes w-a-a-y beyond the rudimentary buy-sell approach.
Leonetti gets inside the hearts and minds of business owners — Bill, the beer distributor, is the model. The book delves into such techniques as employee stock ownership plans and auctions. Did you know that selling a business at auction can be a good strategy?
If you want substantially all the information about leaving a business,
Exiting Your Business is for you. It gets into the nitty-gritty (even estate planning!) and is written for business owners and their advisors alike.
Readers may write to Richard Hoe at Richard Hoe Investments, LLC, 7134 South Yale Avenue, Suite 560, Tulsa, OK 74136, or e-mail him at richardhoe@richardhoe.com. Mr. Hoe has been an investment professional for 40 years, and is a registered representative and investment advisor representative. He has been writing professionally for more than 50 years, and is a member of the adjunct faculty at the California Institute of Finance, a graduate school at California Lutheran University that offers an MBA in financial planning. He holds five designations, including Chartered Financial Consultant, Chartered Life Underwriter, and Accredited Estate Planner. This information is intended for financial professionals only, not the general public. This is not a solicitation to buy or sell any specific security. Mr. Hoe may have positions in the securities or other investments discussed.