Don’t Panic

As of the close of business yesterday, the Dow Jones Industrial Average was down 1,136 points, or 6.8%, since the end of 2013. The venerable average was down 5.3% in January, which lead many seers to warn that the market would therefore be down for the full year. I’m here to disagree with that sentiment. I believe that this is simply a long overdue correction in a bull market that began in March 2009 and remains in place today.

Quite simply, the fundamentals underpinning this bull market remain in place. Corporate balance sheets remain pristine and profits continue to grow. The Federal Reserve remains committed to keeping interest rates artificially low and will inject liquidity into the system at the first sign of danger. Congress has already passed a budget deal and is likely to approve an amendment to the debt ceiling without a protracted fight. And finally, the economy continues to grow, albeit at a somewhat modest pace. All of this suggests that the stock market should again move higher.

Keep in mind that there are relatively few alternatives to an intelligently constructed stock portfolio when it comes to saving for your future. Interest rates at the bank are actually negative when viewed after taxes and inflation. Government debt is not much better. Corporate debt generally has positive yields, but you’d have to extend the maturities too far into the future to reap any reasonable yields, and in doing so you would incur significant interest rate risk. On the other hand, there are many solid, blue-chip stocks that pay annual dividends of 3% or better and are increasing those payments at rates far better than inflation. Good examples include Pfizer (PFE), Verizon (VZ), Proctor and Gamble (PG) and Chevron (CVX). [Disclosure: All four stocks are among the Top 25 positions held by Werlinich Asset Management] And while you enjoy those dividends, you also have the possibility of long-term capital growth.

For example, defense giant Lockheed Martin (LMT) pays a dividend that yields 3.5% at the current price. And the stock has tripled over the past ten years, which represents an average annual growth of about 12% per year for the past decade. While there is no guarantee the stock will continue that rate of growth for the next ten years, if it only grows at half that rate, the stock could double over the next decade, not including the dividend payments. What bond can give you the same growth potential? [Disclosure: LMT is the 3rd largest position held by Werlinich Asset Management.]

When looked at through a longer term prism, an intelligently managed stock market portfolio remains the best option available in order to save and invest for long-term growth and future financial security. 

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The Market Still Doesn’t Care That The Government Is Closed

We are now in the third week of the government shutdown and we’re careening towards the first “deadline” of October 17 with no deal in sight. By that day the Treasury will reportedly have about $30 billion with which to pay its bills. That will leave less than two weeks to scrimp and scrounge before the next big deadline of November 1, at which time the government will no longer be able to make social security, Medicare, pension and other benefit payments. Then, on November 15, the government could default on about $30 billion worth of interest payments due to bondholders. Most rational market observers, meaning those not affiliated with the Tea Party, believe that defaulting on these obligations would be catastrophic to the market.

So why is the stock market within shouting distance of its all time high? Why is the VIX (volatility index) displaying nothing but complacency? To me, the answer is clear. Stock (and bond) market participants believe strongly that a deal of some kind will be reached sometime this month After that the government re-open for business, the debt ceiling will be raised and the Treasury will pays all its bills as promised. In all likelihood, this will be simply a short-term fix, meaning that in a few short months we could very well be right back in this perilous situation all over again. But that will be a story for another day. All traders care about is that the current crisis will very likely be averted.

So what does that mean to investors? It means you should remain invested. Now is not the time to bail on the market. In fact, you should use temporary market dips to add to your holdings. The Federal Reserve remains highly accommodative; and that means the party in the stock market is likely to continue for at least the rest of the year.

Personally, I put some money to work first thing Thursday morning, as the huge two day rally began. As word leaked that an accord could be forthcoming, the market soared. As it turned out, the rumors were just that, and there was no deal. Yet the rally demonstrated how much buying power is waiting on the sidelines, ready to jump in when an agreement is finally reached. Interestingly, the market opened down 100 points today as investors expressed their disappointment in the lack of progress over the weekend. Yet as trading closed ten minutes ago, the Dow Jones Industrial Average was up 64 points. This is simply a market that does not want to go down.

So if the market doesn’t care that the government is closed, you shouldn’t either. Surf’s up; time to ride the wave.

Market Achieves Record Levels

About an hour into trading today, the S&P 500 and the Dow Jones Industrial Average have both surpassed previous all time highs and achieved significant milestones. As I write this around 10:30am, the DJIA is at 15,003, marking the first time in history the venerable index has reached that level. Similarly, the S&P 500 is at 1,616, the first time that index has ever been over 1,600. And the Dow Jones Transportation Average is only 7 points below its high. Should the DJTA move to record levels concurrent with the DJIA then we’ll have a bullish confirmation according to Dow Theory. This is all great news.

Yet surprisingly, given these lofty levels, the overall enthusiasm seems relatively muted. There are no fireworks, no parties on the floor of the stock exchange and relatively muted commentary on CNBC. I think that’s a good thing. It suggests that this in not a period of “irrational exuberance”, like 1999. Corporate balance sheets and earnings are in much better shape than in 1999 or 2008 and the global economy continues to be propped up by central bankers. So as long as the money continues to flow unabated, the good times should continue.

That being said, it appears to me that market sentiment remains relatively bearish, or at best very overly cautious, despite the record levels. I think too many individual investors have remained on the sidelines since the crash in ’08, missing out on this stupendous rally. Also, the plethora of contradictory economic news, both in the US and around the world, has left market participants confused and scared. It seems as though every day one economic statistic reveals a slowing economy while another suggests that everything is more robust than expected. Earlier this week the PMI data indicated that the manufacturing sector was slowing. Comments by the Federal Reserve seemed to confirm that thesis. Yet today it’s all wine and roses after the BLS released a stronger than expected employment report. More jobs were added than expected in April, and February and March were revised higher. Additionally the unemployment rate dropped to 7.5%, the lowest level since the crisis began.

It’s possible that since the DJIA and S&P have now breached important psychological barriers that the rally will really take hold as cash begins to move from the sidelines and investors and money managers who have under-performed the market rush to add equity positions. If that is the case, the broad market could move markedly higher from here, dispelling the old adage to “sell in May and go away”.

Conversely, these lofty levels could spur some investors to take some profits and wait for the inevitable correction. We’ve already had a great year after only four months. I certainly would have signed up for a 12% return for the year. If this momentum continues, we could be looking at 20%+ returns for the year. Only time will tell as there is still a long way to go before the story of the market for the year is fully written. Personally, my clients and  I remain almost fully invested, but we’re selling weaker holdings into the rally to raise some cash for the next buying opportunity.

Fiduciary Duty From Your Advisor

This week, I’d like to talk about fiduciary duty. I will be borrowing liberally from an article written by Knut Rostad in the February 11, 2013 edition of Investment News. Mr. Rostad is the president of the Institute for the Fiduciary Standard, a nonprofit formed to advance fiduciary principles through research, advocacy and education.

By way of background, fiduciary law was established to mitigate the knowledge gap between expert providers of socially important services, such as law, finance and medicine, and consumers of those services. Mitigation is accomplished by legally requiring those experts to put the interests of the consumer first, ahead of their own interests.

According to the article written my Mr. Rostad, the following are the six core duties of a fiduciary:

  1. Serve in the client’s best interests – no divided loyalties
  2. Act in the utmost good faith – be honest, truthful and accurate
  3. Avoid conflicts of interest – maintain objectivity
  4. Disclose all material facts and conflicts – make clear, complete and timely disclosures of all material facts and disclosures
  5. Act prudently, with the care, skill and judgment of a professional – use best practices and update knowledge and expertise regularly
  6. Control investment expenses – ensure that all fees, costs and expenses passed to the investor are fair and reasonable

As an SEC-registered investment advisor, I’ve maintained a fiduciary standard in my practice since I formed my business almost 16 years ago. I spend a lot of time with each new client explaining what my being a fiduciary means to them, how that differs from a “sales” perspective, and how that impacts our relationship. I believe strongly that all investors should demand a fiduciary standard from their advisors as it helps to minimize potential conflicts and more closely align the interests of both parties. The next time you speak with your financial advisor, ask him if and how he holds himself to a fiduciary standard.

The Cliff, The Deficit and What It Means To You

A few weeks ago (the December 8th entry) I told you that the world wasn’t coming to an end because of the Fiscal Cliff. I said that “it is HIGHLY UNLIKELY that every tax increase and spending cut will, in fact, come to pass. Some compromises will certainly be made by our leaders in Washington, despite the radical bleatings of the far right and far left. Whether the deal is brokered in the next two weeks or the next two months, I’m confident a deal will be made that will leave both sides less than happy but will stave off the worst result, which would be simply doing nothing.

As I predicted, a deal was struck with much fanfare and with thundering applause from Wall Street which rewarded the hack show by staging a huge two-day rally. That’s the good news. The bad news is that the deal accomplished virtually nothing for the long-term health of our economy. It is simply a tiny band aid on a festering wound. It feels better now but it does nothing to stop the internal bleeding.

The bigger problem is looming: the fight over the deficit and increasing the debt ceiling. And this time, the Republicans in Congress hold the power. Mr. Obama is going to have to negotiate legitimate spending cuts in Social Security, Medicare/Medicaid and other sacred cows whether he wants to or not. I don’t think there’s really any way to avoid it much longer. It’s time to take the medicine. It’s past time for America to tighten its collective belt and start living within its means. As anyone who runs a household or a business implicitly understands, you simply cannot spend more than you earn, going deeper and deeper into debt. Eventually, you either go bankrupt or someone breaks your kneecaps. I believe the national debt is now approximately $17 trillion, give or take a trillion. It’s time to start to reducing this of our own volition before our creditors force Greece-like austerity measures down the road.

But before we get to the debt ceiling drama, let’s see what the Fiscal Cliff agreement means to you and your money. First of all, if you make less than $400,000 (or $450,000 as a couple), you should be pretty happy. The only real change for you is your payroll taxes will rise 2%. The dividend and capital gains taxes remain at 15% and your income tax levels remain where they are. For those high income citizens, you will face the same 2% payroll tax increase, plus you’ll be subject to a higher tax bracket and capital gains and dividend taxes of 20%. None of this is end-of-the-world stuff. The estate tax exemption remains at $5 million which is good news for everyone. So, in the end, this really isn’t a horrible agreement; it could have been much worse. But the flip side is that while it isn’t bad for people, it’s bad for the government as it actually reduces its long-term tax receipts. Hence the looming fight over the deficit.

And what does all of this mean for our investments? The agreement on the capital gains and dividend tax rates are a plus for the stock market. The higher estate exemption is also good for the market. Any increase in payroll taxes, or income taxes, is a net negative, but it really isn’t a huge problem. So for now, we’re ok. We just need to listen to the rhetoric about the deficit and pay close attention to what kind of spending cuts are forthcoming because that will directly affect the economy, which will immediately impact the stock market. So stay tuned.

Prepare For Year-End, Not the Fiscal Cliff

There are three weeks left in the year and the world won’t be coming to an end, literally or figuratively, regardless of what the various doomsday prognosticators have to say. It’s impossible to turn on the television or open a newspaper without being assaulted with dire warnings about the impending disaster that is the “Fiscal Cliff”. It’s gotten to the point where I can only watch CNBC is when it’s on mute.

For those of you who’ve been living under a rock, the Cliff is the December 31st deadline after which substantial tax increases and mandatory spending cuts will take effect. The tax increases are largely from legislation passed by President Obama to pay for his health care program along with the end of the Bush tax cuts. The spending cuts were mandated during the last failed deficit negotiations. It’s been estimated that should all of these tax increases and spending cuts come to pass, it will shave 4%-5% from GDP growth, sending the country into a deep recession.

While I’m growing more and more angry and frustrated (if that’s even possible) at the intransigence emanating from both parties in Washington, I honestly don’t think the looming fiscal cliff is really the nightmare everyone is saying it will be. It is HIGHLY UNLIKELY that every tax increase and spending cut will, in fact, come to pass. Some compromises will certainly be made by our leaders in Washington, despite the radical bleatings of the far right and far left.

Whether the deal is brokered in the next two weeks or the next two months, I’m confident a deal will be made that will leave both sides less than happy but will stave off the worst result, which would be simply doing nothing. It is truly in the best interests of everyone, other than perhaps that fiscal terrorist Grover Norquist, to get a deal done. There is simply too much self-interest in Washington, especially in the House of Representatives, where they must stand for re-election every two years, to allow a fiscal calamity to happen on their watch. That’s a great way to get thrown out of office by a pissed off electorate.

So if we’re able to drown out the noise about the cliff, what should you be truly focused on between now and the end of the year? Given all of the current uncertainly, there are no simple answers, but here are a few suggestions for you to ponder:

  1. If you have large unrealized gains, consider realizing some of them this year to take advantage of the low capital gains tax rate, which is likely to rise next year.
  2. If future capital gains taxes aren’t really an issue, don’t forget to match gains with losses where possible to minimize your tax bill this year.
  3. Check your portfolio to see if your holdings need to be re-balanced. Avoid having any one position be too large a percentage of your overall holdings. I generally like using 10% as a maximum position size. Similarly, either add to, or get rid of, positions that are simply too small to make a difference.
  4. If you have a large estate, consider making gifts of up to $5.1 million before year-end to take advantage of the large estate tax credit that expires this year. Unless a compromise is reached, it reverts back to $1 million next year.
  5. Speak with your adviser to make sure your investments are suitable for your financial objectives and risk tolerances. Times and conditions often change, and our investment approaches sometimes must change as well.
  6. If you don’t have a will; write one. If you have a will, but haven’t updated it in more than five years, it’s probably time to look at it again.
  7. If you haven’t already done so, consider giving some of your time and/or money to a worthwhile charity. There are so many organizations out there that desperately need your help, especially during the holidays. So open your heart and your wallet and make a difference for those in need.

Unspoken secrets in the money management business

The past few weeks have been dominated by storms, literal and figurative:  the election, the fiscal cliff, Sandy, the nor-Easter and now infidelities. It was enough to give me a brain cramp and writer’s block. Rather than talk more about that which has been discussed too much already, I thought today I’d share with you some of the unspoken secrets in the investment management business because they have potentially serious implications for your money. And that is, after all, what I’m supposed to be writing about.

Professionals in the investment business, whether they’re called stockbrokers, investment advisors, financial advisors, money managers, or something else entirely, are often described as “playing with other people’s money (OPM)”. That phrase alone should give you pause as it suggests a carefree attitude to investing by the pros because it isn’t their money. The idea is that a client gives you money, and you employ some method to decide how to deploy those funds, then you sit back and collect your commission or your fee. One of the unspoken truths in the industry is that few of these professionals are the ones that actually invest the money that they are paid to manage. Indeed, they usually farm that responsibility out to someone else.

Oftentimes, once the advisor has your money, he will usually either hire someone else entirely to manage the money, or rely on his research department pick the investments for you, or put your cash into pre-determined “model portfolios”, or simply dump the money into a bunch of mutual funds according to the asset allocation tenets of “modern portfolio theory”. More often than not, advisors are simply cash aggregators; accumulating as much money as possible, thereby generating the largest fees possible. How that cash is actually invested, and by who, becomes secondary. And to compound the problem, since it’s just “other people’s money” he has no personal stake in how your money is ultimately invested because it’s your money, not his, that’s at risk. And that’s where I’m different.

I make 100% of the decisions as to how my clients’ money is invested. The buck clearly stops with me. And as importantly, I have 100% of my own money, and that of my children and other family members, invested in exactly the same securities as my clients. Indeed, I personally own 29 of the largest 30 positions owned by my clients. I am clearly talking the talk AND walking the walk. My general rule is that if it’s good enough for my clients, it’s good enough for me and my family. I wouldn’t buy anything for my clients that I wouldn’t buy for my own children.

So what does this mean for my clients? It means I have my skin in the game, right alongside theirs. That I will not take any risks with their money that I wouldn’t take with my own. And it also means I am DIRECTLY accountable for the money that I’m managing on their behalf. Can your advisor say the same thing? Have you ever asked your advisor who is actually managing your money and where his own money is invested? Maybe it’s time you did.