Is Monetary Manipulation the Only Defense Against Economic Malaise?
Is the Fed going to raise rates this year?
I suspect not, but they are going to at some point, and you may as well be prepared for it whether it happens this year or next year. The several takeaways I would offer you about this subject are as follows: (1) Expect it later than sooner (2) The style and severity matters – in other words, not all tightening cycles are created equal (3) There is going to be a sell-off – it could be anticipatory, it could be after the fact, but no tightening in monetary history has not created SOME sell-off. The question is – how do we want to be positioned when it does happen?
What is your posture right now with fixed income and what is your plan into the next year or so?
We have been and will remain overall very low in duration. This is defensive around rate increases but also risk/reward optimization. We will not take out all bond risk and duration exposure even though we expect it to decline in value when rates rise. This is because we cannot time this, as clearly no one else can either, and we believe in the merits of strategic allocation and asset class diversification. We do overweight low duration, floating rate, and other less-rate sensitive bond strategies, but will all of our bond exposures be up when rates do rise? No, they will not …
Sometimes you seem critical of monetary policy and the Fed, but other times you seem to be sympathetic to what they are doing. What gives?
I have written for nearly seven years now of the dangers of using manipulation of the price of money (interest rates) and the supply of money to effect economic stimulus. As an investor and investment advisor, I prefer to not have the added complexity of deciphering what move the Fed may make next, et cetera. Ultimately, even though short term benefits, I believe the testimony of history is clear that excessive monetary manipulation is distortive and creates “malinvestment.” I am in the school of thought that favors a rules-based approach to monetary policy (in other words, I want there to be a Fed but I want it constricted to SOME standard and formula – the details of which are the subject of MASS debate in economic circles). With that said, I am indeed sympathetic to the plight monetary authorities find themselves in, because I believe the majority of our economic challenges are structural and completely fixable, and yet policymakers have refused to address the issues, leaving these poor lads at the Fed as the only line of defense against economic malaise. It is not my prescription for defense, but I do believe the Fed thinks the only bullet in the gun is their ability to manipulate monetary policy. The great Guggenheim economist, Scott Minerd, calls it the “new orthodoxy”, where central bankers now admit their job is to use their balance sheets to implement policy.
What is the policy they are implementing?
In a nutshell, they are creating a form of “tax” on savers (unnatural low interest rates) and providing a subsidy to borrowers (the same).
Are REIT’s attractive to you at present levels?
Not especially. Yields are much lower than historical levels but of course that is true up and down all asset classes. They are particularly vulnerable to “chatter” about rising rates. I am maintaining a small, passive exposure (via ETF), with an eye towards increasing the weighting in the future if and when rate increases provide a better entry point.
Are you encouraged by elevated levels of stock buybacks we now see?
No, I really am not. They create some degree of increased earnings per share, obviously, but valuations are higher in the stock market now and obviously you prefer to see stock bought at lower valuations. The phenomenal cash reserves companies have built up combined with phenomenal free cash flow is, to me, in a place where dividend growth is exceedingly efficient. I permanently favor return of cash to shareholders when appropriate, but I have a heightened preference for such a thing in the present environment.
The below questions and answers are largely derived from my annual dinner presentation which took place this week and which provide a more philosophical overview of who we are, what we do, and how you might want to think about all of it …
What do you see as ONE particular value proposition The Bahnsen Group offers its clients (amongst many others)?
To be totally honest, the weekly commentary started as a highly defensive and reactive communication in September 2008. Morgan Stanley was in the news every day as a firm caught in the depths of the financial crisis, Lehman had gone down, Merrill had been swallowed up, and people wondered if Morgan was next. A large infusion for 22% of the company from Mitsubishi bank, and later an infusion from TARP, saved Morgan Stanley – but the turmoil in the markets continued. I wrote the commentary to tell clients what was happening with Morgan, with the turmoil in financial markets, and to provide real-time info as the world stood on the brink of a credit crisis the severity of which I still believe society has never fully contemplated … Through time the financial crisis did end, though the markets did not bottom for months later. By then the weekly commentary was a fixed staple in my relationship to clients. Six and a half years later I have missed just one week. But the mere existence of the weekly commentary is not the value proposition of which I speak … My whole mentality has changed. EDUCATION, COMMUNICATION, CONTENT, AND THOUGHT LEADERSHIP should be an integral part of your relationship with The Bahnsen Group. We do not merely want you to think we are smart, though we hope you will. We want YOU to be smart. There will be a certain range of investment IQ that various clients will aspire to, but this desire for our clients to expand their financial intellect is not just self-serving: We believe the more you know, the greater your faith will be in us, and in the plan we are executing on your behalf. And that faith is paramount.
Explain what that means: “faith is paramount” …
We cannot have clients who do not trust us. And you cannot have an advisor you do not trust. Perhaps six years of a rising bull market has hidden this reality, but there will be a time when you will need to trust us in order to do the right thing for your financial objectives. You will be promised a risk-free 15% return by some devil in the high wind, and you will need a relationship with us rooted in trust to walk away from the Bernie Madoffs who are looking to take you down. You will see a quarter or two when energy markets disturb a significant portion of your holdings even when the market is doing reasonably fine, and you will need trust to persevere. (Okay, maybe that has already happened.) We are going to advise you through a lot of seasons in your life, and in both the PORTFOLIO and the PLANNING components of that, we work off of your implicit trust. And in exchange for your trust, we offer you complete and total trustworthiness.
How does one know if they can trust an advisor?
How does one know anything? You use a combination of empirical facts available and your own intuition. An advisor culture that centers around what people want to hear instead of what they ought to hear is the enemy of trust. Trust is not built by being right about each and every stock call or hedge fund selection; trust should be built around a relationship rooted in principles, in integrity, and in the willingness to say something that one doesn’t want to hear. “My friend’s guy says he can get me 10%; what can you get me?” If the answer is anything other than “I haven’t the foggiest idea,” run like the wind.
Maybe I can’t trust an advisor – maybe the only person I trust is MYSELF?
Maybe. And I would grant you that most individual investors will not rip themselves off. But I think trust transcends the need for integrity. Can most “do it yourself” investors trust their own competence, their own diligence, their own access to information, their own process? If the answer is YES, and for many it very well might be, the question that then takes over is, “can a do-it-yourselfer trust his or her own emotions and psychology?” Furthermore, should they? I am happy to make all the arguments about how I would rather pay someone to fix my car or tailor my suits based on the fact that I trust their expertise more than mine and do not want to exert the time, energy, and effort needed to do such things. But even those analogies miss this critical point: Our carburetors and our French cut shirts are not usually DEEPLY emotional to us. We are MORE susceptible to bad decision-making with our money than the other examples I could use because it is at the core of what is most important to us – the vehicle by which we play out our desire for freedom and peace. Very often, we should not trust ourselves with this.
So we need to trust you in your portfolio decisions. What about planning?
Proper planning is the cornerstone of wealth management. We want to prepare for what can go wrong so that we can benefit from what will go right. This is far more rewarding than when a key stock holding has a big quarter. A head-to-toe, soup-to-nuts, A-to-Z analysis of your financial life is our commitment to you. Retirement income pro formas are nice, and frankly worth the price of admission. But so is a Long Term Care insurance analysis. So is a healthy discussion about a big purchase before it is made. So is an introduction to an investment banker that can change your company’s exit plans. So is assistance with a complicated tax reduction strategy. So is an overview of your estate planning top better align your transfer plans to your family’s value system. I would take too much space to cover all the bases of what thorough advanced planning is supposed to entail. It is truly at the core of what we do, and how we can bring greater financial peace to our client’s lives.
What is unique about your approach to portfolio management?
Without taking away one iota from my prior points regarding the priority of investor behavior in determining long term results, and our mission from God in helping to guide that investor behavior, we do manage things a bit differently than many advisors. Let me share three things with you that I believe put us outside the norm of the cliché, style box, consensus, vanilla portfolio management styles that permeate today’s investing culture:
(1) We love expanding P/E ratios that push our stock prices higher, but we do not believe there is ANY remotely sensible way to forecast P/E expansion. The vast majority of investment approaches today are SOLELY driven on the aspiration for P/E expansion, and what is even worse than that is that most advisors are not aware that this is their strategy. We believe the hard work of analyzing expanding earnings, and more importantly DIVIDEND COVERAGE, is not only infinitely more KNOWABLE than what a P/E ratio will do, but infinitely more IMPORTANT. We know how much money can be made in buying expanding growth, but we know how much can be lost when high multiples become low multiples. Earnings can still be going up for a growing company and yet with a contraction of multiples, the stock price can be slaughtered. The sucker of sucker bets is buying a company AFTER it has achieved a stratospheric P/E ratio, and I don’t care how hot of a company it is.
(2) We are investment people. Today’s investment firm culture are paid to gather new relationships, and outsource the investment management, the estate planning, the cerebral side of the work. Advisors are captive to their firm’s worldview and firm’s strategy set, and have little to offer by way of intellectual autonomy. We are fallible, and we have much to learn, but we are fully engaged in the experience we deliver our clients – we asset allocate, we select securities, and we manage the advanced planning phase of our client relationships. And we do this as fully independent fiduciaries operating with complete intellectual autonomy.
(3) There is a real fundamental logic to our process. First of all, we have a process. I do not believe a popularity contest is the same as an investment process, which is what permeates the Do-it-yourself crowd and frankly many “professional advisors”. Secondly, the process is not rooted in momentum, in passivity, or in blind faith. It is rooted in the basic economic law that the return in risk-free money is essentially through time less than the inflation rate, and that the return we can expect on our capital is a RISK PREMIA – a premium or excess return in exchange for taking a risk. We manage and isolate that risk to the risk of volatility. We do this by diversifying away single stock risk, by asset allocating away broad market anxiety, and focusing on the single thing investors of all ages have ever wanted – CASH FLOW. Once we agree that CASH FLOW is why we invest (whether it be current or future), we have to solve for the best way to get that cash flow. Our empirically discovered conclusion is that the indisputable answer to that question is DIVIDEND GROWTH investing.
(4) We monitor sentiment, but not to chase it; rather, to AVOID it. We are willing to look stupid in the short term for the purpose of achieving a longer term superior result. Going against the crowd is a key hallmark of our philosophy.
(5) We strategically utilize alternative strategies that are maybe more sophisticated than the traditional sleeves of a portfolio, and do so intelligently and deliberately. Whether it is solving for a alpha/offense objective, or providing greater diversification and non-correlation within the portfolio, we believe in Alternatives, and we use them the RIGHT WAY.
Are you optimistic about the future?
In the most broad and big-picture sense possible, I am wildly optimistic about the future. I believe in the undeniable upward trajectory of human progress. I believe in self-interest, I believe in the capitalistic ingenuity that acts on that self-interest, and I believe in the vehicles we use to monetize that – to become participants in the great process of investment capitalism. But I also am very concerned. I believe we have had a six year bull market numb people to the reality of risk. 1-2% moves should be inconsequential to a serious long view investor. 15-20% moves can and will happen. I fear society’s readiness for investment reality. I think we are addicted to booms and busts as a society, and I see no evidence human nature is going to change any time soon. With record levels of people between the ages of 50 and 70, I fear the prospects for the current investor class which has very few viable options for planning, for portfolio excellence, for unvarnished truth-telling, and for behavioral management. With a central bank more involved in investment reality than they ever have been, unprecedented global conditions (debt and otherwise), I fear how investors will react to the turmoil that lies ahead. I want nothing more than for there to be no need to hold hands during the coming investing era – for it to be a 1980’s and 1990’s-like straight line bull market.
But we are going to have to earn our fee for the next 20 years. And earn our fee, we will.
The answer to the question is that I am very optimistic for the financial futures of clients of The Bahnsen Group.
Quote of the Week:
“The optimal advisory model combines the best of both structures: the scale and operational depth of a large firm, with the client access and service that can only came from owner advisors operating their own local offices.” – Elliot Weissbluth, CEO, HighTower Advisors
(The quotes are generally meant to be more inspirational and application-oriented, but you can imagine there is a particular context to this week’s quote.)