We seem to live in a world with absolutes. We’re either in a world of inflation or deflation. It’s more complex than that, though, and I would like to start the May newsletter with a discussion of our view on this subject. And I’ll try not to bore you to sleep.
I am a member of the World Future Society and used to speak quite regularly at their meetings about economic and financial topics. The attendees at the conference like delving into the complex; they tend to embrace chaos and don’t mind stretching their brains to get to understanding. When I look at all the economic forces pulling at the way people and money work in our global economy, I see a world where deflationary forces, or those that limit price increases or even push them lower, will remain quite strong in many parts of the economy. Excess global manufacturing capacity (built to serve leveraged consumers prior to the global financial crisis and sustained by dramatic policy intervention since then), technology-driven productivity gains (domo arigato Mr. Roboto), Baby Boomers moving beyond their peak spending years, and the growing impact of “collaborative consumption” or the “sharing economy” (featuring poster child of the month Airbnb, which recently raised private equity at a $10 BILLION valuation!) are just a few of the factors driving these deflationary forces.
As companies respond to these conditions by keeping a tight lid on labor costs, they add further fuel to the deflationary fire. Stagnant wages force consumers to pull back, and demand for “stuff,” especially discretionary stuff, continues to wane. This is tough on consumer-driven economies like ours in the U.S., where 70% of our GDP comes from consumer spending. And while we have lots of consumers, many of these consumers are becoming increasingly tapped out. Easy access to credit during the ’90s and early ’00s helped paper over the fact that wages were not keeping up with lifestyles. Now with credit hard to find, the only means to cope with wage deflation is tightening the household spending belt or finding new ways to add value to an employer. The pattern is not that different in Europe and Japan, where the deflationary mix of a postcredit- boom bust, aging demographics, sluggish wages and new models of consumption are conspiring to create a spiral of sorts where sluggish price growth drives sluggish wages, which diminishes demand for goods and services, begetting a new round of pricing pressure. Lather. Rinse. Repeat.
Yet, there are certainly areas of inflation as well. The world’s wealthiest continue to do just fine for now. Prices for fine wine, rare art, diamonds and Tesla Model S’s (now on sale in China at an entry price of $118,000) continue to climb. Inflation also seems entrenched in the prices of things found in the most subsidized and regulated areas of the economy, where free market forces have less influence (health care and higher ed are two of the most visible). Then there’s categories of goods where supply and demand can be impacted by forces like severe weather and climate change (think agricultural commodities likecoffee, +72% year-to-date after drought in major growing regions) and geopolitics (like crude oil, more than $100/barrel in part thanks to Obama/ Putin power games).
So, in a nutshell, we see a global economy where deflationary forces continue to have their way in many sectors, especially those sectors offering non-discretionary products and services to all but the wealthiest consumers. Yet, in areas where supply is constrained (many commodities), price discovery is limited (many government-subsidized programs) or demand is driven by bidding wars among the wealthiest segments of society flush with cash from thriving financial markets, we expect to see inflation. Let’s just call this environment “mixflation”, in which protecting and growing wealth requires us to manage with a keen eye to quality and price.
Income investments, for example, which we own throughout our various strategies, even our growth-oriented ones, tend to do well when deflationary forces are strong. Closed-end fixed-income funds trading at high discounts to net asset value are our most obvious beneficiaries in such an environment. Well-managed and appropriately priced infrastructure and real estate investment trusts can also thrive amid a sluggish economy while giving us income growth upside, should the global economy normalize away from these deflationary pressures sooner than we think. We highlight a Central and Eastern European-focused, incomegenerating real estate investment in this month’s Investment Team Spotlight. Niche dominators, like European fruit distributor Total Produce, or Taiwan cable TV operator Asian Pay Television, should also be resilient through deflationary conditions like these and continue paying us solid dividends well-managed primary commodity producers or recyclers of supply-constrained agricultural and industrial commodities, like Dundee Corporation and Umicore, also seem well-positioned to manage through this mixflation environment.
Speaking of positioning, my 12-monthold, William, seems to believe that turning his head away from his bed or changing table when we head that way will change his fate of the naps and diaper pit stops that he is not such a big fan of. He seems to think that if he looks away, the nap won’t happen or he can enjoy another hour of wet britches. The child development books say he only knows what he sees. Today, it seems that the world is full of people who are looking the other way to avoid the reality of the situation. While William has a loving family to take care of him regardless of the “reality” he wishes to see, the person that does not wish to admit “reality exists” is destined to fail at worst or muddle through at best.
As our readers know, I love political economy and find the way the mind works fascinating. Just get mad, and go into a rage every time someone disagrees with you and soon you’ll be hanging out with people that agree with you. Many politicians worldwide seem especially prone to this behavior.
When I was in high school, I played football. I was 5'8" tall, 140 pounds and I stunk, as did our team. But the cheerleaders dutifully yelled, “We are #1!” ... “We are #1!” ... “Hit ‘em again harder!” and arguments would break out in the bleachers over who was best even when we were getting slaughtered. Just because you say it is so doesn’t make it so. Positive thinking and all that is great. But reality is where we need to live, at least to be successful investors. While ignoring the reality of being down by three touchdowns with 10 minutes left in the game and saying, “We are # 1!” our 3-5 win/loss record shows that, in reality, we are far from #1.
Americans, too, like to think that we are #1. We don’t tend to read the articles or research that shows us the reality. We are happy in our little delusion. I find that if I mention we can learn something about education from the Norwegians, and there are 14 countries that outperform the U.S. in the opportunity category, or quote that “while the U.S. outperformed France’s economy from 1975 to 2006, 99% of the French population enjoyed more gains while in the U.S. it was only 1% who shared those gains,” I actually make people mad. When I’m reminded that we saved France from Hitler, I’ll mention that our country would not exist if the French hadn’t helped us kick the crap out of England. But that is just to argue – my point is that if I have spinach in my teeth please tell me. If I can learn from the French about “quality of life,” Singapore about Rapid Economic Progress, or Switzerland who ranked #2 on the social progress index compared to U.S.’s 19th, well I want to learn from them. One important issue to understand, especially when listening to politicians, lobbyists and PAC gibberish is that, “WE ARE WIRED TO BE SLOW TO GIVE UP A ‘BELIEF’ EVEN IF IT IS NOT TRUE, IF GIVING UP THE TRUTH WOULD NOT BE BENEFICIAL TO US.”
Recently, we have been interviewing a candidate to add to our Portfolio Management team, and it seems that all the candidate and I end up talking about is INVESTING. I come up with an investment story to make a point and off we go discussing our successes and “learning experiences,” never getting down to the details of salary, benefits and such. As the recent candidate was driving home, he called me and said something I thought was quite telling about our industry. He said, “You know Paul, the reason I am interested in working at FIM Group is that you’re the only firm I have interviewed where all we chat about is investing, how it could look, values, how you serve the client, and how everything centers around the client’s needs and goals.” He went on and said, “I have interviewed at other investment firms and all they talk about is their business and how much they have, and they never chat about their clients.” After a pause he said, “What I like is that you are all about your clients’ needs and goals.” I want the next 30 years of FIM Group’s history to be as beneficial for our clients as the past 30 years. I do not want us to get stagnant or rest on our good 30-year track record, so in the spirit of staying “fresh” we would like to ask some questions …
We have posted a feedback form on our website that we would love you to fill out. The process is painless. We want to know how we can serve you better … what we are doing well and where we could improve. To make it easy, on this form we only have two questions: 1) What is FIM Group doing right, and 2) What does FIM Group need to improve on? A famous philosopher once said that we should ask those we love, “How can we love you better?” So we are asking that, although without the romantic intention. While we would love to see a flurry of responses right after this article is sent out, our intention is to leave this as a permanent part of our website, so at your convenience, please take a minute to let us know how we are doing.
I have written client newsletters for 30 years – think about that! I used to write them out on a legal pad and have my secretary type them up. Now they’re composed in “Word,” with me doing the typing. I started FIM Group because I wanted to be a money manager. We do the newsletters because they are important for communication purposes. Realistically, I just like managing money – writing newsletters can be a chore. Like Zsa Zsa Gabor’s fifth husband said, “I know what to do – I can do it – but I just don’t know if I can make it interesting.” I know how to write, but I do wonder if anyone reads our newsletter except my mom, who still calls me each month to tell me how she enjoyed my latest newsletter. She liked my high school poem, titled “Why Is This,” that my English teacher read sarcastically out loud in class and then laughed, thankfully not naming the author of the “silly dribble poem.” We, too, would like to know what you’d like us to write about in the newsletters. Please give us your opinions and help us have another good 30 years.
A promotional media blitz erupted the first week of April to pique interest in Michael Lewis’ new book about High- Frequency Trading (HFT) called Flash Boys: A Wall Street Revolt. It was summarized, reviewed, critiqued and masterfully hyper-promoted across virtually every possible media outlet, culminating with a very entertaining staged debate on the financial equivalent of the Home Shopping Network, CNBC, where every investment sales organization promotes and sells its wares.
While the substance of the book is nowhere near as significant to the general investing public as the author purports, much of the subsequent analysis in serious financial circles has been quite insightful. The issue at hand is whether investment markets are “rigged.” To cut to the chase here, markets of all kinds are definitely rigged. The world is rigged! While it is up to industry professionals, journalists and regulators to address fraud, regulatory violations and unfairness, the important question for investors is how to best function within the existing environment.
To simplify the issue of HFT, it has to do with the ability of one trading firm to execute a transaction before others. In Flash Boys, Lewis describes a system in which firms have located their computer systems in physically superior geographical locations so that their trades can execute fractions of a second before their competitors’. Being able to do so allows traders to have a slight edge and the ability to “scalp” or “skim” a penny or even a fraction of a penny off of a trade, or to execute complicated trades where they take advantage of arbitrages, or price differences between one exchange and another. Lewis theorizes that this price difference should be eliminated, so that all investors have equal opportunity and those pennies or fractions of pennies are not there for the taking of the firms who employ “tricks” to scoop them. He calls this advantage of one firm over another “rigging,” and says it shows markets are rigged.
In an insightful analysis of the subject, Grant Williams, author of a newsletter called Things That Make You Go Hmmm…, discusses the notion that all markets are rigged. He concludes that this HFT issue is quite insignificant to individual investors, especially relative to other forms of rigging in the markets that most certainly affect investors in a material way. To paraphrase some of what he writes, he describes several forms of rigged markets, including insider trading, access to information and data releases before they are public, fixing of prices, and Wall Street firms continuously committing fraud and paying their way out via fines, to name a few. The most significant of all is the rigging of interest rates.
By artificially and rigidly holding short-term interest rates at zero percent for the past five years (as opposed to letting rates fluctuate freely as a true un-rigged free market would allow), and manipulating longer-term rates with its series of “quantitative easing” bondbuying programs, the central bank has run the Federal Reserve balance sheet up fourfold and has destroyed the means for savers to earn anything from “riskfree” savings vehicles. The interest an average retired saver who heretofore had $500,000 of their savings in “risk-free” savings has fallen from $27,500 per year to effectively zero. Williams calls that not only a rigged market but theft.
I would add that our central bank has also been instrumental in raising the risk profile of most unaware investors in two important ways. First, the Fed has effectively pushed savers to invest their “safe” money in riskier assets such as longer-term bonds and dividend-paying “blue chip” stocks in order to generate some kind of income from their savings. This has pushed the prices of these investments to levels that now make them especially vulnerable to price drops ahead. Second, the Fed has perpetuated a belief among many in financial markets that it will always be there to “put a floor under the market” should downside volatility raise its ugly (but ultimately necessary for healthy markets) head again. The resulting complacency toward risk adds an additional layer of fragility to certain areas of the market.
So in light of the reality that at some level most markets are rigged, let’s think about what it means and what investors can and should do about it. First, it is instructive to look at the two definitions of “rig” Williams pulls from Dictionary.com:
My family recently took a “vacation” on a sailboat with a couple other families for a week. We were the captain, crew and passengers. I learned a bit about the first definition of rigging on this vacation as I was one of the boat’s crew. (My wife for her part learned a lot about living on a boat. She describes our vacation to those who have asked as “a camping trip on the water … and I DON’T LIKE CAMPING!”) We both learned that you must be prepared (adequately rigged) for a multitude of possible conditions, and when the conditions are rough, you better have already been properly positioned. In rough conditions especially, you must resist emotions and remain disciplined, diligent and nimble.
Investors are well-advised to take those same precautions and actions by rigging (putting in proper order) their financial plans and investment processes to be as resilient as possible to the knowns and the unknowns ahead in light of the rigged financial world we live in. Chief among this rigging:
FIM Group remains focused and disciplined in those areas above that we control. That is our job. We don’t listen to CNBC. We strictly use limit orders on buys and sells. Whether one firm scalps a penny from another is of no interest to us and has no effect on what we do. We are not worried about the din of fear/greed/sales-driven noise in the financial media. We are focused on the expected future return of the businesses we invest in and whether their current market prices have built-in margins of safety and offer sufficient expected returns. We remain diligent and nimble. It is presumably why you have hired us to manage your portfolios. Now if I could just figure out how to optimally rig my sails …
Re-tire-ment (noun): the act of ending your working or professional career (Merriam-Webster)
Each of us has a unique vision and meaning for retirement. For some, it’s the ability to travel across the country in their transformed 1971 solar-powered VW Westfalia, while for others it’s the ability to be more present with their family and community. Regardless of your unique vision, our financial behavior tells us to work, save and retire, and the opportunity to choose our retirement will present itself – the one caveat is our savings behavior and its influence on our future ability to choose our retirement lifestyle.
In our financial planning meetings, retirement holds an emotional, philosophical and intellectual significance in our clients’ lives. I feel blessed to be invited to clients’ detailed retirement visions and the sense of what that would mean for them, even including the inevitable shift when the discussion turns to “how.” I have learned that the utilization of money is the transfer of value – review your next credit card statement and determine if your spending aligns with your values. The value of saving for retirement can be difficult to quantify based on a myriad of factors: not knowing where to save, how much to save or even the knowledge to save. The non-profit RAND Corporation concluded that individuals who saved for retirement had a positive correlation to their confidence in their overall knowledge and ability. Our role is to empower clients to have the confidence to know how much to save, where to save and why they need to save, so they can achieve the opportunity to retire and to stay retired.
According to a study presented by economist Shlomo Benartzi, less than half a percent of Americans feel they are saving enough for retirement (Benartzi, 2011). “Enough” in itself is a loaded word and carries significance related to your unique vision of retirement. So, where is the disconnect?
Cognitive behavior tells us that even though our intention is to save today, tomorrow will be easier (i.e., if I save more today, I would have to reduce my spending, which correlates to less for me today, therefore I will save tomorrow). This concept of risk aversion, or fear of scarcity, permeates much of our daily lives, from our health and wellness programs to our investments. For many of us, we understand that a disciplined approach to saving will alleviate the pain experienced by today’s “loss” because it is tailored to our goals. We ask that clients provide a detailed budget during the planning process in order to determine the appropriate savings approach. This seemingly simple task is intended to bring awareness to personal spending behaviors, or transfer of values, and to shift erroneous spending to areas that lead to financial success while eliminating concerns of not saving “enough.”
The Center for Retirement Research found that half of U.S. workers in the private sector participate in retirement savings plans, even though 78% of private companies offered plans. In 2013, HelloWallet published research stating that more than 60% of workers who participate in a Defined Contribution Plan, 401(k) for example, accrued more debt than they saved. This study underscored the need for “holistic, independent financial guidance” as a means of providing support to increase retirement account balances and offset accumulating debts (HelloWallet, 2013) – holistic meaning overall financial planning, not just retirement planning. This astounding research shows that many Americans lack or underestimate the fundamental value of retirement planning and financial planning.
As a fee-only adviser, FIM Group practices as a fiduciary and seeks to build relationships where we can visit our client’s retirement vision and create a successful plan of getting them there. By being disciplined and saving with balance, the decision to retire and live off the income generated from your investment portfolio should be easy. Our role is to give you confidence leading up to and during retirement, and to assist in understanding the value in saving today for tomorrow. I encourage you to honor your retirement savings plan, speak with our financial planners to strategically monitor your successes, and speak with those you care for about formulating a savings plan with a fee-only adviser. Unlike Merriam-Webster’s definition of utilizing the word “end” as part of retirement, I inspire the thought of beginning a new journey with time to reflect, experience, give and break routine – I wish this opportunity for you and for all those important to you.
Benartzi, S. (2011, November). “Saving for Tomorrow, Tomorrow.” TEDSalon NY2011. New York City, New York, USA: TED Conferences, LLC.
HelloWallet. (2013, October 24). New Research Reveals Majority of 401(k) Plan Participants Accumulate More Debt Than Retirement Savings. Retrieved April 17, 2014, from PR Newswire: http://www.prnewswire.com/news-releases/new-research-reveals-majority-of-401k-planparticipants-accumulate-more-debt-thanretirement- savings-229037131.html
Merriam-Webster. (n.d.). retirement. Retrieved April 17, 2014, from Merriam-Webster: http://www.merriam-webster.com/ dictionary/retirement
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