Posts Tagged 'risk'

What’s Wrong, What We’re Doing About It, and When Will it All End? Part I

I’ve been suffering some serious writer’s block lately. Just can’t seem to come up with the right words to express the current condition we find our condition to be in.

Now usually in the movies, when the main character is a writer suffering from the blank page syndrome, something dramatic happens. Either he goes off to the woods to find inspiration and instead finds a gang of crazy zombies trying to break into his house and kill him. Or, typically after a bottle of bourbon, he makes a deal with the devil – inspiration for his soul. Or even worse (that is if you’re the movie watcher looking for a good action flick on a Saturday night) he finds the “love interest,” and the whole thing just turns into another weepy chick flick.

But as luck would have it, I didn’t need to recluse myself to the woods, or make a deal with the devil. Instead I had the good old European Community to snap me out of my doldrums. You see this past weekend, the G-8 world leaders met, and emerged with what had to be, one of the single most bizarre statements ever made in political/economic history. Since this incident received minimal coverage, let me set the stage and explain.

So picture the G-8 leaders (the leaders of 8 of the largest 12 world economies – they still won’t let the non-white guys in, or Russia which are basically white guys that don’t count), sitting around a table agonizing over unemployment across the EU, lack of economic growth, trillions in deficits, the Greeks are dumpster diving for food, the Spanish are turning back the clock 200 years as young men are flocking to be sheep herders – one of the few jobs available in their new “austerity” economy. Then in the midst of gloom, up pops Eddie Haskell aka French President Hollande, and he says. “Hey Beav, let’s just change our policies to “growth” and our economies will grow again!” The Beaver, played by ECB Chief Mario Drahgi, replies, “That’s a great idea Eddie, why didn’t we do that before!” Then in unison, the rest of the G-8 leaders have their V-8 moment, slap their foreheads with the palm of their hands and, in unison, exclaim, “Yes, we’ll just grow our economies!” They proudly emerge from the conference and announce to the press that they will implement a balanced approach to austerity by adding in growth measures for their economies. The world applauds, and global stock markets rally…for a day.

The immediate reaction to this “Eddie Haskell” moment, was relief. (For both of you readers that are too young to appreciate the Leave it to Beaver references, you can go to youtube.com to see what you missed). The ECB would just give growth a chance, before giving Greece, Italy, and Spain the boot. But seriously, if growth was just a matter of politicians sitting around and agreeing to implement growth strategies, what the heck have we been doing for the past decade(s)?!? You mean we needn’t go through business cycles? Booms and busts? All we have to do, to have consistent sustainable growth, is to say “Make it so”?

The reality is that growth strategy is synonymous with government spending in politician speak. The entire European Union has been implementing “growth strategies” since the formation of the EU. If deficit spending truly resulted in sustainable economic growth then Greece would have the fastest growing economy on the planet, followed by big brother and big sis, Spain and Italy. They have cumulatively spent their way into deficits that are 200% or so of their GDP, saddled their banks with bad debt, and killed off their private sectors in return for the Euro, and more cheap borrowing. You simply do not keep feeding a drunk alcohol to cure alcoholism.

The reality is, the entire G-8 has financed a global boom with massive government borrowing. The end result is that private sector growth has been stunted as capital has been siphoned off to the public sector. Now, when the accounting numbers no longer add up, debt needs to be repaid, there is just not a large and vibrant enough private sector (translation: not enough jobs and the jobs we have don’t pay enough), to generate enough tax revenue to maintain our bloated public sectors AND maintain payments on our accumulated debt. The only difference between us and Europe is that they are further down the road then we are. When the dust settles in Europe, it will be our turn. Pay attention. This is a rare opportunity to watch your future unfold before your eyes.

Why is my adrenaline flowing? Why am I worked up? Here is a quick story: A couple weekends ago I was asked to speak at a conference in Atlanta. It was hosted by one of the largest clearing firms in the US. One of the other speakers was a chief equity analyst for a very big domestic investment company that we all know and love. In addressing the European situation, he said “We see about a 5% chance that the Euro will break up”. I challenged that assessment, asking for his data that would suggest the anyone has enough money to actually get all of Europe solvent again. His reply, and I paraphrase was, “ We really don’t have any data, we just believe that a breakup of the Euro would be so catastrophic, that it just won’t happen.” Really. As he spoke visions of Wall Street bankers flashed through my head, circa 2007, and I wondered how many had said those exact same words referring to mortgages and the mortgage backed securities market?

Here is the bottom line. Risk is not about the odds of something happening. It is about the consequences if it does. The question you should be asking yourself is not whether the Euro fails or not. The question is, what happens to my investments, my retirement, my kid’s education, my sanity, if we go through another market crash as seen in 2000-2002, and 2007-2009. And if you are not willing to accept the consequences of another 50% loss or so to the equity portion of your portfolio, you need to take steps now. Either get out, lighten up on risk, or plan an exit strategy. If Greece exits, the global financial markets will be in trouble. If Europe holds it together, we will be knocking on the door of the next secular bull market – you’ll have 15 – 20 years to make some serious money. Being on the sidelines for the first 3 – 6 months or so, would really not be a big deal.

Up next: The indicators we’re watching and how we’ve prepared our portfolio’s.

Now is Not the Time for Risk

Yesterday I received a “query” from a writer for the Wall Street Journal’s online edition for information on a story. A “query” is typically sent out by a writer looking for an expert opinion. For this query the writer was asking for suggestions on ways that a near-retiree could add risk to their portfolio, in an effort to boost returns. The idea is that so many retirees have suffered such poor investment performance for years that soon to be retirees need to play a little “catch up.” My response was basically that that was one of the stupidest ideas I had ever heard! So assuming I won’t be quoted in that piece, and there is no reason to wait for the article to be published, let me share some thoughts on this subject.

Investors (and apparently financial writers at wsj.com) have been misled on what risk is, and how it affects portfolios, for years by the mutual fund industry and the financial planning community. The theory goes that by increasing the risk of a portfolio, the investor also increases their return. As if this is a foregone conclusion. But if that is the case than where is the risk? If by definition you change investments and you, by definition increase return, than there is no “risk.” So everyone would be stupid not to have “high risk” portfolios. Heck the more the better, let’s dial up a little more “risk.” Just turn up the heat on the oven and the bread will be done sooner. Right?

Last night I was watching Extreme Pawn Stars. If you haven’t seen the show, it’s about a pawn shop in Detroit. It offers entertainment on two levels, first it’s interesting to see the stuff that gets brought in, and second the characters that bring in the stuff! Last night, this guy brings in a Cabbage Patch® doll and wants $100 for it. The pawn shop owner asks him simply, “How did you come up with that number?” His answer, now pay attention here, was, “Because I’m being evicted and need $100.” The store owner offered him $10. The moral of the story is that neither the pawn shop owner, nor future buyers for the Cabbage Patch doll, really care that this guy needs $100. The just want to pay what the thing is actually worth. $10.

This made me think about the whole premise behind the query from the WSJ writer. Investors, for whatever reason, think there is a correlation between needing a higher return on their investments and actually getting a higher return on their investments. The fact is the “market” doesn’t really care that you, or any other investor actually needs anything. And just because an investor needs a high return does not mean that there is some dial that can be turned to turn up the returns as well. The sad truth is, neither owner of the pawn shop nor the market, really cares what anyone needs for their Cabbage Patch doll, or from their portfolio. Each is worth exactly what someone else is willing to pay for them. No more, no less. Personal circumstances just don’t matter.

I will go a step further and explain that this is the difference between the professional investor and the amateur. The amateur is always “long” or fully invested, expecting high returns, because they need those high returns. They typically take risks, at the wrong time. The professional understands that just because he or his clients need return, it is not always possible to get them.

I’ll close with a sad but true example. Almost exactly a year ago, my partner and I went out and made a proposal to manage a company’s pension plan. They had lost a lot of money in the plan and had to add $1 million from the company account to the pension plan. I recommended using our dividend value strategy. In a shaky economy dividends would add stability and provide cash flow to pay out benefits down the road. The owners were noticeably upset that they had lost a significant amount of money and had to now fund the losses. I thought this was a prudent strategy. Instead, the owners went another direction. Determined to “make up” their losses they went with a rather high risk/high return strategy (in their minds) choosing a “specialist” in small company stocks for their existing balance, and self-directing $1.4 million equally divided between Wells Fargo, Citi, and Bank of America. In their attempt to catch up, because they needed the return, they have lost probably another million dollars in 12 months. Instead of catching up, they will need to somehow find another $1 million from company coffers, in this economy, to fund their pension plan or risk penalties from the Department of Labor.

Turning up the heat on the oven is more likely to result in burned bread, instead of simply finishing it sooner. Similarly turning up portfolio risk is a good recipe for being burned as well. In baking and investing, patience is truly a virtue.


bill@401advisor.com • 937.434.1790

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Charles H. Dow Award Winner 2008. The papers honored with this award have represented the richness and depth of technical analysis.

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