Market Musings Blog

After Good Friday’s not-so-good jobs report, we expect a continuation of the rocky road stocks are traveling this year. Like last year, a rough winter has sideswiped the economy. But new factors are in place – the fall in oil prices and the big rise in the dollar. Last year, when the economy shrank in Q1, corporate earnings still looked pretty good. Now, low oil prices are not giving the boost to spending that everyone expected, while hitting certain segments of the construction industry, many states’ oil producing industries, and other niches of the economy. The rising dollar has hurt exports across the board.

Stocks are not wildly expensive, but if we have a poor earnings season this quarter or next, that will be new and negative. So far in this bull market, earnings have come through well, quarter after quarter, year after year, pretty much since late 2009. Worse performance on that score will lead to a rough patch for stocks.

Buckle up, but keep an eye out for bargains, too.

No, not me, in fact I don’t really know what this means. But a friend who wanted advice about retiring lately said this to me and it made me wonder, because actually I hear this fairly often. So this is a muse about what it means to ‘not trust’ the market.

Bill, my friend, likes real estate, and plenty of RE investors don’t ‘trust’ the market. They like assets they can touch, and they feel like they can control physical assets. This, of course, is an illusion. Many also think they’ve made money in real estate, but they tend to recall purchase prices, and not the myriad other expenses such as property taxes, interest on the mortgage, refi fees, transaction fees, yard care, repairs, expansions, remodels, etc. Most non-professionals don’t make money on real estate; they only think they do. But real estate has a special relationship with its owner, who is always doing something on its behalf, and thus … feels in control.

Other folks don’t ‘trust’ the market because its price can crater, for seemingly unfathomable reasons. Because they don’t understand the reasons for price movements, they don’t trust it. These folks actually don’t trust themselves, because the market defies their logic. Usually they haven’t followed markets for decades, don’t know a thing about market history, can’t understand the math around internal returns and compounding, and let emotions rule their decision making. Further, real estate prices DO change, but RE is not transparent about price changes. It’s hard to figure out how much your property is worth. Even if you sell it, you are not sure you got the best price.

Weirdly, while stock quotes are far more granular (down to the hundredth), and far more frequent, this constitutes a reason not to ‘trust’ them. It’s as though better information is not desirable.

There’s also a suspicion around price manipulation, and a sense that the market is only for high rollers, or gamblers. We can concede on price manipulation. We see it happen. But, why not take advantage of it, instead of mistrusting it? One of our stocks, Digital Realty, was the target of short sellers who relentlessly hammered the stock. We kept buying it, since the shorts only made it cheaper. Once the shorts went off to play somewhere else, the stock recovered dramatically.

But we can’t understand the ‘high rollers/gambling’ bit. Plenty of ordinary folks have made lots of money in stocks by holding them forever. Stocks represent bits of businesses; okay, some businesses do gamble, and many stocks represent a gamble, but you don’t have to buy those businesses.

The other public relations problem that stocks have is that understanding returns, and what might give you a good return, requires more than a vague facility with math. Many people don’t understand compounding, or internal returns such as return on capital or equity and what those mean over the long haul. They don’t understand the difference between principal and dividends.

All this said, we haven’t seen many folks who don’t trust the market flip, and begin trusting the market. Or if they do, it happens at the top of the market, and getting in then is a great way to reinforce your lack of trust!

Giving to charity can be – like many things in life – fraught with pitfalls. It should be simple, and most folks think of it in that way – write a check or hit the ‘paypal’ button and off goes your money, supposedly to do good. How would you feel if you discovered that a high percentage of your gift went not to the end user who really needs the funds, but to administration or marketing? Or that the endowment that you are flowing cash to has a terrible long term return? Or that your favorite charity is competing with other charities to save the Tiger, in a way that actually deters the desired result?

We think of giving to charity as an investment, similar to picking the next well-performing stock or bond. Steps you can take to begin viewing giving in this light are:

1. Check your charity at charitynavigator.org for how much of every dollar you give actually makes its way to the end user. Keep in mind that new charities, and even some older ones may not show up or may show poorly on charitynavigator for various reasons. When you see a poor result, pick up the phone and call the charity to ask for an explanation.
2. Try to resist giving tiny amounts to lots of charities. Instead, put them in competition for your money by choosing the best amongst them, and plying those few with more cash.
3. Apropos of #2, ask the charity how they know they have been effective, and how they’ve used money more efficiently over the years. Did $100 feed 10 people 10 years ago and now they’ve figured out a way to feed 12 for the same money? If you are making contributions to an endowment, ask for the endowment’s return history and investment policy. If it’s not at least as good as your own investment program, you are better off skipping endowment contributions to that particular organization; instead, given to their general fund.
4. When you apply #2, you may be given a phone number for a contact person at your charity of choice. Having that person’s ear can help you track what’s really going on with your favorite causes.
5. Inspect the premises if you can. We visited World Wildlife Fund in D.C. and interviewed the scientist in charge of endangered species – a great experience that only made us more likely to contribute.

A final thought for those investors who prefer socially responsible investing and are sometimes frustrated in the search for good performers in that space: one alternative to hewing to socially responsible investing is to compromise to some extent on those criteria, then make up for your transgressions by increasing your charitable giving, focusing on needs that matter to you.

In our last blog we railed about how everyone calls themselves an ‘investment adviser’ – but many are not. Here is our handy guide to all the folks out there and what they really do.

Broker: Sells product. Paid by commission. Has an incentive to make changes in order to get paid, or at least to sell you in-house mutual funds, annuities, insurance policies with long term, ‘trailing’ commissions where he gets paid for several years after you buy. BEWARE: the broker can turn into a ‘financial adviser’ while sitting at the same desk, and ALSO charge you management fees. Sometimes this will happen if the broker asks to split your account. On one, he takes commissions; on the other, he takes fees. Defense: ask exactly how much you will pay per year, in dollars, if you invest a certain amount of money with the broker. Ask for his performance record.

Financial Planner: No offense to these folks, but many are jack of all trades and master of none. They often charge fees AND commissions. They budget or create a plan for you using a software program purchased from a vendor. Review the plan carefully; I have seen errors like inflation escalators on mortgage payments that are fixed, and totally unrealistic investment return patterns that culminate in showing you that you will be worth six million dollars in twenty years when you start with $500,000. Financial planners may also help you with your insurance needs (read: sell you expensive insurance policies), estate planning and taxes. They are eager to manage your money. Defense: Ask how much you will be charged. Ask what is the underlying theory behind the practice: is the firm aggressive, or conservative? Be sure you understand how the fat book you will receive with fields of numbers and charts relates to YOU. Look for credentials and career persistence in the field of specialty. We generally believe it is better to get tax advice from a CPA, estate planning advice from an estate planning attorney, and investment advice from a professional money manager, because you are then tapping into specific expertise for every facet of your requirements.

Registered Investment Adviser (RIA): This refers only to the requirement that the firm register either in the state where it practices or with the Securities & Exchange Commission. It communicates very little information about what kind of firm or person you are dealing with.

Portfolio Manager: Cascade’s professional staff are all portfolio managers. Like other portfolio managers, we spend 100% of our time determining what clients need to earn to meet their goals, and researching solutions in the form of securities purchases and sales to achieve those goals at an appropriate level of risk. Paid by fee only. “Fee only” generally aligns client interest with the manager’s interest, in that if the asset base does what it is supposed to do, you stay with the manager, and he keeps getting paid. Defense: understand the investment philosophy and why it is supposed to work. Ask how it works in good markets and bad.

Aside from these typical adviser types, you will encounter CPAs, lawyers, and all sorts of other practitioners who want to manage your money. Again, find out how much you will pay, research credentials, and ask for past performance in all market cycles for the type of account you have.

I am passionate about what I do, and I am glad that I bent my career away from economics and towards becoming a money manager. But the ‘advice industry’ as it is now called drives me nuts. Perusing the industry magazines that arrive for free in our mailbox is completely depressing. While a few articles focus on investment ideas – usually the latest expensive product that can generate a ton of commissions like hedge funds or ‘liquid alts’ – the preponderance of the literature is geared towards signing new clients, or acquiring other firms, or how to be acquired. In other news, ‘watchdog’ firms like Morningstar name “managers of the year” who then underperform with great regularity. This serves as a kick in the teeth to investors who try to find managers with true skill.

Speaking of performance, managers do a terrible job differentiating their investment portfolios and philosophies to clients. Index funds are swallowing the industry, and that’s at least partially the fault of the managers who practice our craft. Practitioners make the same mistakes over and over, without discovering a way to outperform. No wonder investors turn to index funds – there is hardly any help for the lay person who might want to try to find a good manager, and the ‘help’ that exists – manager of the year, fund of the year awards – often backfire.

Meanwhile, hardly a week goes by but what some adviser or another doesn’t commit some sort of fraud against clients, causing ever tightening nets of regulation to drop on all of us.

Our own bad habits are perpetuated by our nomenclature. Everyone calls themselves an ‘investment adviser’ – financial planners and brokers who charge commissions, money managers, registered investment advisers. No one can tell the difference.

Next blog, we’ll provide a short guide to the adviser types you might encounter, so that at least you can be armed with that knowledge.