Tuesday, July 27, 2010

Did Investors Learn Anything From 2008's Crash?

Lou Harvey of DALBAR takes on the Gods of Modern Portfolio Theory in a recent Barron's article and lays waste to them:

"Nothing's wrong with MPT. It's how people use it. What is needed is a back-up plan to protect investors when the theory fails. And it will most likely happen again. Just look at the current situation. One could argue that the risks are even greater now than in 2008 because of other potential failures out there. We have changed so little from the 2008 failure. Risks have, if anything, increased because of our unwillingness to face up to our problems. We keep talking about a huge increase in federal debt and how, if this trajectory continues, we could even face a downgrade on Treasuries—something many people still believe to be unthinkable

The pushback to our latest report has been strong. Who are we to criticize MPT, devised by a Nobel Prize winner? But this is our research and we stand by what we've found. I have lots of scars on my back to prove it. And I'm sure that after talking to you I'm going to get more. Investment results in 2008 showed clearly that correlation of asset classes varied unpredictably and with no warning. This brings into question the very basis for MPT and its ability to forecast an efficient frontier. MPT simply cannot be used in isolation. Instead it should be thought of as only one reference point for modeling the behavior of a potential portfolio. It is only one dimension of a more comprehensive investment-management process."

As a recovering MPT and EMH'er myself I understand the backlash Harvey may generate, his bold stance is refreshing in this industry that has kept a closed mind for a long time.

Scott Dauenhauer, CFP, MSFP, AIF

New Feature: What I'm Reading

Recently I bought an iPad and it has completely changed the way I consume research. Instead of reading articles as they appear or as I find them I use my iPad along with a great little app call InstapaperPro. Instapaper allows me to save the articles to read later, as I please.

One cool feature is that Instapaper logs all the articles that I've read and allows me to categorize them and it then provides an RSS feed. What I've done is added two new "blog feeds" to the left in My Blog List - one is called What Scott Has Read and the other Meridian Must Reads. Since I consume an inordinate amount of information and can't post all of it, this will give you a glimpse into what I've been reading (What Scott Has Read) and the articles that I think would benefit you the most (Meridian Must Reads). I will continue to post important articles to this blog, but the feeds to the left in My Blog List give you even more insight as to what I've been up to.

Scott Dauenhauer CFP, MSFP, AIF

Then There Is This Route To Retirement......

One day you are at a garage sale and negotiate to buy some negatives for $45 - ten years later you discover they are negatives shot by Ansel Adams that were thought to be lost in a fire.......and they are worth $200 million. That's one way to plan for retirement!

Scott Dauenhauer, CFP, MSFP, AIF

Friday, July 23, 2010

Pissing Match: Is the World Ready for the Waterless Urinal?

I love this story. This may not seem like the typical Meridian blog post, but bear with me.

For my regular readers (both of you!) you know that my belief is that we are in a depression (not a Great Depression....yet), but I also am an eternal optimist and this story is one of those reasons. I believe that the human race is on the verge of technical and biological breakthroughs that will forever change the way we live and approach life. This little invention is just one item of innovation that will save our precious resources. Its a great story and one of many innovations I've posted over the past few years. Times are tough (with 20%+ unemployment there is no other term than depression), but our children and grandchildren will live in a world unlike anything we ever dreamed of.

Scott Dauenhauer CFP, MSFP, AIF

Friday, July 16, 2010

Q2 Meridian Quarterly Commentary (Written July 2, 2010)

Please note - this commentary is on the way in paper form to clients this weekend.

A Will Rogers Market

Volatility Returns to the Market

About a year ago as the Standard and Poors 500 (commonly referred to as “The Market”) crossed the 900 and 950 threshold after hitting a low in March 2009 of 666 I began to call my clients and urge them to prepare for rougher times ahead. Generally, I advised that we reduce “Risky” allocations and change the Risky allocation to become less risky (in my last quarterly commentary I explained each strategy). My reasoning for this was I did not believe the recovery was real and that the probabilities of another crash or prolonged decline were high. As it turned out, the markets and most prognosticators disagreed with me, and stocks continued to soar, hitting a high of 1,186 in late April 2010. While we did capture some of this move we didn’t capture all of it, but capturing the upside of the stock market while limiting the downside is not possible and it isn’t our goal (but don’t get me wrong, if I could do it I would!). Will Rogers once said “I am more concerned with the return OF my money, than the return ON my money” (actually Mark Twain was the first to say this), this is a Will Rogers market.

My analysis led me and leads me to believe that stocks are still overvalued significantly, which of course did not stop them from hitting higher and higher levels. My belief was that if housing wasn’t dealt with in a meaningful fashion and when the stimulus ran out that the party would be over - essentially that thesis is playing out right now. The S & P has since slipped below 1,030 and may be headed back below 1,000 and the market has been very volatile - losing 10% in the 2nd quarter of 2010. The goal of the portfolios I’ve been building has been to reduce the day-to-day fluctuation without missing out entirely on higher returns. This has meant missing out on some market gains in the short-term, but I believe the downside protection has been more valuable. Having said that, one of the funds that I utilized to replace “market exposure” actually beat the market over the past twelve months with considerably less fluctuation.

Cash is King

I also believe that Deflation is a big risk, though longer term as the government prints more and more money to deal with deflation the risks will turn instead to Inflation. So far the data has proven this out. Money Supply has been falling and as of late, interest rates have fallen below key levels. My approach of holding cash or cash-like securities has caused some pain and generated not a few protests, but I believe this is the best route for right now. Holding cash and equivalents in a low interest-rate environment hurts and the government does this (keeps rates low) purposely to make you feel pain and to move your money out of lower-risk securities into higher-risk securities, essentially in order to bail out the more risky securities (find buyers for them). The more the government can get you to move up the risk spectrum, the more support risky assets will find and the less support the government has to provide and the less likelihood of risky assets collapsing. While the government believes this is good, it isn’t necessarily good for you - you should not be bearing the risk of over-indulged entities.

What Have I Been Up To?

As you know I take my job managing your money very seriously. I also am responsible for helping you with your financial planning needs. The last two years I have spent more time on economic and financial analysis than ever before and it consumes much more of my time than it ever has. This is due to several reasons, but primarily because I no longer believe that simply buying and holding the market is appropriate for most individuals. My point being is that I recognize we haven’t met as often as I or perhaps you would prefer. This isn’t lost on me and I want to assure you that I will make myself available for meetings and conference calls whenever you want to meet in addition to our regular meetings. I don’t want you to think I’ve forgotten about you if you don’t get a call from me for a few months. This is why I write my blog (please follow it at http://themeridian.blogspot.com) and this quarterly commentary - to keep you updated on my latest thinking. The amount of research I consume on a daily basis is truly extraordinary and I couldn’t do it without my new iPad (yes, I had to put a plug in for it!). My hope is that this additional work and research will allow me to make better decisions with your money. I believe it has paid off so far, but only time will tell.

What Can We Expect Going Forward In The World Economy

I am still not convinced that what we experienced (or are experiencing) is not a Depression. The term that has stuck with most news organizations and pundits is Great Recession, but I think they are using that term in order to avoid what has actually occurred, a Depression.

The problem with this thinking is that if we deal with the current economic environment as if it’s a garden variety Recession we end up not dealing with the fundamental issues that face our economy- we spend money we don’t have and bail out everybody except those on Main Street. This thinking makes the situation worse and prolongs it. Instead of intense pain that ends in a short-time period, we have opted for a less, but constant pain over a long time period.

I don’t know what the future holds for stocks, bonds or commodities. I have ideas and I try to build your portfolio around those ideas, but I am not convinced we have dealt with our economic problems sufficiently. If stocks were priced much lower and we had the same issues I could justify adding more risk to the portfolio, but not at these prices. Please understand as much as I WANT to be right, I might not be. Our economy could pick right back up and begin cruising along again with stocks hitting new highs, but I believe it would be artificial. The question remains for your retirement money - do you want to take extra risk to squeeze out a little extra return or would you be more comfortable taking less risk and ensuring that you retain most of your capital? My job is to attempt to align risk and returns, it is not easy and I won’t be right all the time, but my hope is that I am not so wrong as to cause unnecessary losses.

Interest Rates

So where are interest rates heading? Your guess is as good as mine, but here are my thoughts.

I believe interest rates are headed down and may stat there - unless we get an oil shock. If you have been reading my blog you will have noticed that I’ve tilted more toward the Deflation camp and have been warning that interest rates may fall further. In fact, that is what has happened. Could they fall even further? It is possible. Just look at Japan. For this reason, I don’t expect the Federal Reserve to raise interest rates until 2011 (or longer), meaning more pain for investors looking for income. Income investors are paying the price for the bailouts. Having said all that, I cannot rule out an Oil price shock. War and more fallout from oil leaks could put a crimp on supply or expected supply which could lead to high oil prices (right now prices are falling due to unexpected lower demand globally) and those higher oil prices could have inflationary effects on the economy (please note that this is not true inflation).

Longer term I believe there is a high probability the Federal Reserve will resort to another round of Quantative Easing or money printing. While many believe this will lead to inflation or a hyper-inflation (hence the Gold-bugs) I am not yet convinced. If all the printing simply ends up back on bank balance sheets and thus not in the economy it may have no affect (other than to take bad assets off the balance sheets of Too Big Too Fail banks). For money printing to work the money must circulate in the economy (referred to as the Multiplier), as of now it is not. While this does present an opportunity to be in high-grade intermediate bonds, I’m not convinced there are not risks there as well, but you can be assured I will continue my quest for appropriately priced income-risk assets (note, “income-risk assets” is a term I just made up).

Optimism: The Case For It (and a teeny bit of cynicism)

I don’t believe we will have a double-dip recession for two reasons:

1. I don’t believe we ever got out of the first recession, this is just a continuation
2. I don’t believe we are in a recession, I believe it is a depression

There is your cynicism! Like I’ve said in the past, I believe we are in a depression. When one fifth of the work force is unemployed or underemployed it is a depression. It just is.

You need to realize a few things about a depression, first, they are not new to Americans (but they are new to most current Americans) and two, they are not all “Great”. The Great Depression was considered “Great” because it was so bad in comparison to previous depressions. Unemployment was double what it is today. We are NOT in a Great Depression or a Second Great Depression or a Greater Depression. Great is a modifier of the word “depression” and Americans experienced many Depressions in our 234 years of existence. You must also understand that not everyone experiences a depression. Some thrive or simply don’t get hurt as much – hence Gershwin’s famous line “Nice work if you can get it”. Finally, this depression is, so far, very different from the Great Depression in turns of living standards and government safety nets. It should not be lost on us, however, that it is these safety nets that form part of the reason for our current economic malaise.

Now. for some good news. I know many of you have expressed your concerns to me that my commentaries can be a bit....depressing. I understand, but my obligation is to tell you what I see and not sugar coat it. In my heart I am an eternal optimist and I do see things that make me believe there is still.....pardon the overused expression....Hope.

First, as with the Great Depression, American’s attitudes toward spending, savings and family changed. Americans turned more inward and focused on taking care of one another. Americans also rediscovered the lost virtue of savings. My hope is that these lost virtues are found again (though the evidence on savings is not good right now). It is hard to save when you don’t have a job and you are over-leveraged and over-taxed. Further optimism is based on the continued technological and biological developments that are being made daily and the continued spread of the internet (and hopefully with it - knowledge), which unites people and ideas. If you think about the changes our world was on the verge of during the Great Depression that were positive, we are positioned in an even better manner now.

I’m convinced we can avoid another Great Depression (though not convinced we won’t avoid another World War), but not convinced we won’t. Regardless of how the next ten years play out, the next fifty will likely witness the greatest leaps forward ever witnessed by the human race. Things we never thought possible today will be commonplace for our children, grandchildren and great-grand children. Lessons learned today will hopefully not be forgotten easily (even though it feels like we learned nothing from 2008).

We continue to face major headwinds and currently face a lack of leadership to effectively deal with the structural issues our nation and much of the world face (please don’t think I am only referring to Democratic leadership, there is a leadership vacuum in general). My goal is to navigate you through these treacherous waters, knowing full well that we will float off course sometimes and will not always be correct, but with perseverance we will make it through.

Warm regards,

Scott Dauenhauer CFP, MSFP, AIF

ECRI Growth Rate falls to -9.8% - Bad Sign

In the 42 years of data we have for the ECRI (Economic Cycle Research Institute) which tracks leading economic indicators there have been ZERO times where the US did not fall into recession when the index growth rate hit -10%, a point that we are .2% away from. As my readers know, I don't believe this signals another recession - I believe it signals the strengthening of the current recession/depression the United States (and much of the globe) is mired in.

Scott Dauenhauer CFP, MSFP, AIF

Friday, July 09, 2010

Quick Thoughts on Double Dip

I'll be posting my 2nd quarter commentary shortly, but wanted to say something about all the Double Dip recession talk.

Many economists are forecasting another recession in the very near future, they are nuts. This whole concept of a double dip recession right now is almost a slap in the face. There can be no Double Dip as we never left the first Dip - we are still in recession.

Unemployment has not recovered and we are not adding enough jobs just to cover new entrants, nearly one in five Americans who can work - are not (or are not doing it full time) - that is not a recovery.

So, my quick thoughts are: We are not going to Double Dip because we never left the first recession - the first recession will continue to drag on (and, oh yes, its a depression, not a recession).

Scott Dauenhauer CFP, MSFP, AIF

Friday, July 02, 2010

Russian Spy Was (is?) A Certified Financial Planner!!

You can't make this stuff up...or can you? 35 year old accused Russian spy Cynthia Murphy was a financial advisor. Not only that, she was a Certified Financial Planner to boot. Now, in addition to being worried about whether your advisor is running a Ponzi scheme you have to be worried they might be a spy!!

What is funny is that a few years ago I was talking to a television producer (okay, wannabe television producer) and I was explaining my idea for a show centered around a financial planner (I figured I could play the part) who also doubled as a CIA agent. Not exactly the same thing, but close. For the record, I am not a CIA agent...of course if I was I wouldn't tell you and I'd probably write a blog saying something like "For the record, I am not a CIA agent."!

I just couldn't resist posting this story.

Scott Dauenhauer CFP, MSFP, AIF