​The May 2012 Cover Story of Financial Planning Magazine

While we at Silver Oak do not hold ourselves to be real estate experts, our ongoing quest to uncover low volatility investments with healthy income and potentially healthy returns has led us back to real estate.

Our successful “finds” of real estate investments with low correlation to the financial markets plus high and steady income to our clients has led Financial Planning Magazine to find us.  Eric was recently interviewed regarding our return to real estate by the magazine for the cover story in this month’s issue.

Click here to read “Real Estate’s Rehabilitation”

(Eric’s quote begins under the heading “Buy American”)

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Goldman Sachs - Personal Thoughts on An (Im)Morality Tale of Broken Trust and Reputation 

In a New York Times Op-Ed piece by a now former Executive Vice President of Goldman Sachs, Greg Smith tells why he concluded that the only thing he could do was to resign from the firm where he had spent his career of 12 years.  In the process, he shed light on a dark place – the culture of profit over propriety that evolved at Goldman Sachs for over a decade… click here to read the full article.

Executive Summary

As we look back over 2011 from an investor’s perspective, our perception can be framed by one word: volatility. As we began to contemplate how to position our portfolios in 2012, we first needed to gain clarity regarding the factors contributing to last year’s market results. Our letter that follows will build on these main observations and ideas:

- The S&P 500 price performance was literally flat for 2011, after weathering a staggering 1% per day average fluctuation in the index and setting records for one day volatility.

- The factors that caused the volatility in 2011 have not faded away, and may have been exacerbated due to the continuing worldwide sovereign debt crisis.

- Austerity measures forced on Greece have already negatively impacted its GDP, which desperately needs growth, not austerity, to become viable again.

- There is fear that Greece’s debt crisis may spread with Italy and Spain perhaps being next.

- In the US, political rhetoric is calling for austerity in the form of federal spending cuts. What is good for a family is not necessarily good for the country. (see Paradox of Thrift, below)

- We do not expect 2012 to be any less volatile than 2011, with the prospect of either only modest stock market returns, or a strong possibility of negative returns.

- Our “Risk Controlled Asset Allocation” approach continues to minimize portfolio volatility and support stable performance.

- In this unstable world, we prefer to utilize a portfolio–building technique borrowed from Architectural Digest – find solid, stable building blocks to build the portfolio foundation which in 2012 will focus on income-oriented investments that may also produce appreciation… click here to read the pdf article

Since our most recent letter that we distributed shortly after the third quarter ended, we have observed continued volatility in the equity markets and in most risk assets.  This will be a much shorter letter and is intended to bring our clients up to date and to accompany our third quarter performance reports… click here to view the pdf article.

We at Silver Oak have been using every metaphor that we could think of since October 2008 to draw attention to the economic factors that have been affecting the investment world.  We have used the Emperor’s New Clothes to illustrate the fact that it was illusory to believe that the economy was in a strong recovery and could support strong stock market performance going forward.  We tried the history of the construction of the Great Wall of China to talk about the need for both political parties to agree on a viable jobs program based on infrastructure development.  And we even threw in The Search for Red October with an “up periscope” metaphor for the need to safely look around at the global economic landscape to “see” if it is safe to surface and buy stocks again.

There is a very effective television ad for a credit card that asked, “What’s In Your Wallet?”  We will turn that around by asking, “What’s In Your Portfolio?”  Do you know how much risk you have loaded into your portfolio?  You can answer that question yourself fairly simply by comparing your portfolio return for the third quarter with the broad market index, the S&P 500, and identifying how much of the portfolio has been exposed to stock market risk.

I eagerly brought in my L.A. Times and Wall Street Journal to see what the headlines were going to be on this Saturday morning.  There were no headlines in the Times proclaiming the disastrous quarter we just experienced, not even in the business section.  Tom Petruno, Senior Markets Analyst for the Times, penned an article entitled, “A Quarter to Forget, If Only We Could.”

We at Silver Oak know Tom pretty well.  We have been fortunate to have been quoted by Tom numerous times over the years.  We’ve been suggesting to Tom to write more about the need for investors to protect their portfolios and take less risk since 2008.  Yet being the balanced reporter that he is, Tom continues to prefer to lay out the competing cases for either buying or selling stocks.

We have not vacillated because, unlike Tom who apparently must focus on writing impartial stories, we must focus first and foremost on protecting the wealth of real people.  If that sounds a bit harsh, we are sorry but this is no time for pulling punches.  We would prefer that Tom use his bully pulpit by standing up and shouting to Angelinos, THE WORLD IS A SCARY and UNCERTAIN PLACE – CONTROL THE RISK IN YOUR PORTFOLIOS!

Tom’s article contained the stock market results for the quarter, which we don’t mind quoting.  The 30-stock Dow Jones industrial average lost 12.1% in the quarter and the broader S&P 500 lost 14.3%.  Tom pointed out that this was the biggest decline since the fourth quarter of 2008.  Even worse, the average European blue-chip stock tumbled 17.4% in the quarter.  Tom also correctly mentioned that the asset many people (including us) had viewed as a haven – gold – was pummeled in the final few weeks of the quarter amid a steep decline in commodities.

But here’s the rub.  Tom quoted a nationwide August survey by Russell Investments of “big money managers” that found 79% did not believe the U.S. economy was entering a recession.  My guess is that these same money managers are continuing to promote buying stocks.  Have you ever seen headlines from Smith Barney, Bernstein, RBC Capital, Wells Fargo Private Wealth division, or any of the other major money managers advising their clients to exit the stock market?  I suspect that such an occurrence would be difficult for them to do since, on aggregate, they represent the stock market.  They can’t exit the stock market; there would not be much of a stock market without them.

The good news for our clients is that Silver Oak is not a “big money manager.”  We are an independent and objective money manager and as such, we have the independence to call a spade a spade.  We observed many market anomalies in 2008 that lead us to conclude that the markets were dysfunctional and the global financial system was broken.  We proceeded to adopt a more conservative, risk-oriented approach to asset allocation.  That approach has caused us to focus on controlling risk as the key factor in designing portfolios that can withstand this “new normal” environment, as PIMCO calls it.  With the expectation of continuing global geo-political financial fissures disrupting the investment world for years to come, risk-based asset allocation as a methodology is an approach that we will continue to implement and refine.

Last month, I stood up at a meeting of professionals called Provisors and offered to do what I call a stress test of their portfolios – an analysis of how much risk was in their portfolios.  I don’t know if no one believed the market could go down further, but no one asked me to look at his or her portfolio.  I plan on revisiting that offer this month because I still think we could go down further and that our economic malaise could last many more years.  We will gladly make the same offer to any of your friends who would like to better understand their portfolio risk level.

As we look around the world, we at Silver Oak are focusing on a number of factors that lead us to our conclusions.  At the top of our list are the following items:

1. Equity prices over a reasonable period of time should be driven by the fundamental health of corporate America.  In other words, if companies increase their profitability, their earnings will grow.  The price/earnings ratio should then increase, driving the prices of stock higher.  It is quite apparent today that such fundamental factors are not driving stock performance as we have witnessed the market declining even as companies meet their earnings expectations.
2. Technical factors and global macro-economic events have been in the driver’s seat with respect to equity prices.  Wild market volatility, up and down, occurs every time a European central banker gets quoted about whether Greece will default.  And, we are greatly concerned about what may follow after an imminent Greek default.
3. The problems emanating from the Great Recession of 2008 are a result of what is being called a balance sheet recession in contrast to routine business cycle recessions.  Until there has been sufficient worldwide deleveraging (and this will not be complete until we have experienced much more financial pain, we will have a difficult time pulling out of the tailspin we have been experiencing.
4. Our own domestic political climate has been contributing to the climate of apprehension being felt by our business community.  There is too much uncertainty in issues relating to taxes and regulations, to name just two, for corporate America to be willing to take the risks associated with hiring more people and building more plants.  So, they have been content to sit on the cash in their coffers.  We would love to be wrong, but we don’t see this political climate becoming more conducive to business growth in the near future.
5. A number of key commodities have been driven down to bear market territory.  This is an indication of a worldwide slowdown in growth.  The Thomson Reuters/Jefferies CRB index of 19 major commodities tumbled almost 12% in the third quarter according to Petruno’s article.  Copper is another leading indicator of such a slowdown.  Often referred to as Dr. Copper for its ability to diagnose the health of the world economy, its current value is indicating a prognosis that puts economic growth on life support.

Conclusion

I was a Boy Scout.  In fact, I am an Eagle Scout.  What does that have to do with concluding this letter, you might ask.  Well, I have this “thing” about helping little old ladies across the street – an image from some Norman Rockwell painting I suspect.

The point is that our role is to first protect our client’s wealth and secondly to help them grow their portfolios.  We help our clients get “across the street” – a phrase that we can use to mean successfully moving from a working lifestyle to a retired lifestyle.  To cross that street requires having built an amount of wealth that translates into financial security.  We want to make sure that we do everything in our power to keep people on that side of the street, comfortable with the financial security they have achieved and able to sleep well at night with the knowledge that we at Silver Oak are focused on their goals.

For clients who are not yet retired, we want to create a financial plan that continually moves them forward, toward their goal.  We see too many prospective clients who have been taking steps backward because their portfolios have been steadily losing money.  This is completely unnecessary.

If you are still in an asset allocation and an equities-oriented investment strategy that has not been working during the last three years, and possibly for the last ten years, you might ask yourself “why?”  We know that changing investment strategies is difficult.  At some point, however, when you realize that you are not getting to the other side of the street, you had better start watching out for the oncoming traffic!

Since we don’t see any business headlines that are screaming this message, we decided to create this early fourth quarter newsletter to create the headline ourselves.  “OUT OF STOCKS” does not literally signify that we will never own a stock.  It does, however, mean that we do not currently own stocks because the uncertainty around the world has elevated the risk level to the degree that we don’t think an investor can be properly compensated for the risks.

We want to encourage investors, and that includes nonprofit entities and private foundations, to reduce the level of risk in their portfolios.  There are still strategies and methodologies to make money in this environment, but it is not possible by sticking to an outdated methodology of asset allocation that has worked in more stable times.

To our current clients, we again thank you for the confidence that you have expressed in Silver Oak and in our investment approach.  It makes that Boy Scout in us leap for joy when we can help you stay on the good side of the street.

1.      Is the (investment) world coming to an end?

This is a natural question when we see the stock market decline as it did last week.  As you know, if you have read our other communications throughout this year, we have virtually no U.S. equities in our portfolio models at present – haven’t since late May.  We do have allocations to other asset classes that have been negatively affected by various economic factors, and we will discuss a number of those asset classes separately.

While Silver Oak has been very defensive and conservative in our asset allocations, even the most conservative holdings have given back some of the gains we experienced earlier in the year.

However, even with those pullbacks, we are pleased to say that each of our portfolio models is in positive territory for the year.  While not every client portfolio is exactly the same in composition and has performed exactly the same, we can say that as we look at the S&P 500 results (as of Friday September 23^rd they were negative by over 10%), having positive portfolios means that we are substantially ahead of that index.

 2.      Do our portfolios still own gold and silver?

We certainly have looked upon these precious metals as tools to help us protect portfolios against a number of dire economic scenarios, and especially as a “no confidence” vote against  the dollar.  Silver has exhibited quite a bit more volatility than has gold, which has been a bit troubling.  We therefore bought and sold silver twice so far this year.  The following chart reflects where we bought and sold the silver ETF during 2011 for many portfolios, depending on the specific model and allocation to the higher risk bucket.

We continue to hold our allocation to Gold.  There are many factors that will affect the price of gold.  Aside from jewelry demand and large purchases by central banks, gold has tended to rise this year due to a number of crises including the Greek debt crisis and the political stalemate in Washington, D.C. over raising the debt limit.

This week, we are experiencing a countervailing factor that has caused the metal to lose some of its luster, specifically the strength of the U.S. Dollar versus the perception of the Euro.  Should the situation in Europe stabilize soon, we expect the dollar to continue to weaken, having a positive influence on the price of gold.  Should stabilization not be in the cards for Europe in the short term, thus keeping the dollar strong, we will be watching gold closely in its relationship to the dollar and in absolute terms to see how it performs.

3.      Why do we see some of the bond investments declining?

Our portfolios contain many different types of bond investments for diversification purposes.  Some of our bond mutual funds are internationally diversified and are denominated in foreign currencies.  The recent strength of our dollar also has a negative impact on these bond funds.  While we continue to like international and emerging market bonds as part of our long-term strategy, we are in the process of trimming some of those positions due to near-term weakness.

Our investment philosophy places most of our bond holdings in the lower risk bucket.  Certain bond funds with more volatility due to wider currency swings are placed in our higher risk bucket.  Our goal is to maintain a target rate of return of 5-6% in the lower risk bucket.  While we have generally been on track with meeting this target, periods in which significant actions are taken by both our Federal Reserve and by central banks in foreign markets certainly make this goal more difficult.  We will continue to monitor the global macro economic factors that impact bond prices and plan to adjust portfolio holdings as needed to maintain our return target.

 4.      What is going to happen next?

That is certainly the $64,000 question.  If our crystal ball was working, answering this question would be a lot easier.  All we can do is to continue to monitor the economic fundamentals and events as they unfold, and translate economic policy into portfolio holdings which offer investment opportunities at a reasonable level of risk.

As our Fed Chairman noted last week in his prepared remarks, there are “significant downside risks” to the economy of the U.S.  At the same time, some say that a recession in Europe is likely and that the demise of the Euro cannot be ruled out.  There are too many structural issues at play for us to feel optimistic relating to many higher risk assets.  However, at some point, with faith in the continuing recovery of our economy and in our free-market system, we will eventually conclude that the prices of equities have reached fair valuations and that expected returns justify their inherent volatility.  At such time, we will add equities again to our higher risk bucket.

As always, we welcome your questions, emails, and telephone calls.  This is a very unsettling period, and we are here to answer any questions you might have regarding our “take” on the current and future investment climate.

But first, let’s talk about the President’s speech to both houses of Congress last week.  We will start by forgiving him for interrupting the opening football game of the season.  At least he didn’t interrupt a debate by the Republican candidates for President.  Of course, to be perfectly honest, it is quite unprecedented for the Speaker of the House to refuse a President’s request to address both houses of Congress.

Those may seem like small issues.  They are, just as the tip of a small iceberg was enough to sink the Titanic.  Perhaps somewhat like the rather small hordes of Genghis Khan.  Old Genghis was a small thorn in the side of a number of Chinese Emperors.  History tells us that the Chinese called a joint session of their feudal lords and decided on a major public works project to put people to work and save the kingdom by building the Great Wall of China.

Even if building a Great Wall here would put millions of Americans to work, it is quite apparent that our leaders would find ideological reasons to dismantle the project.  It may be that we need that Great Wall.  Not to keep out Genghis’ thundering hordes, of course, but as a symbol of action that could lead to at least a partial solution of our protracted unemployment challenge.  Estimates are that the proposals might lower the unemployment rate by 1%.

Let’s be clear: there are no easy cures for the ailments that plague our economy.  At the same time, let us be completely candid and recognize that we are facing systemic modifications to our way of doing business.  By systemic we mean that many of the pillars of our political system and the structure of our economy are being disassembled and retooled based on a structurally different architectural rendering.

This is significant.  Yet we are not hearing this kind of candor from anyone in positions of power.  Think about the fact that it is quite unusual for the President of the United States to ask to address a joint session of Congress.  The Constitution sanctions the joint session to permit the President to discuss the State of the Union, and also during times of crisis.  With the fabric of our economic system fraying and facing entrenched unemployment which will threaten the well-being of the middle class, we should be inferring from the President’s appearance on Capitol Hill this past week that we are indeed facing a crisis.

Investment techniques during periods of crises must change to reflect the nature of the risks we face.  At Silver Oak, we are convinced that the critical element of investing in today’s world is controlling risk.  During normal times, designing portfolios with numerous asset classes that move in somewhat opposite directions to market stimuli and that create textbook diversification is smart.  However, using those techniques when it is obvious that they are not keeping portfolios safe in this new paradigm is not smart.

Risk-controlled investing is a systematic methodology to investing during periods when black swans and other unusual but potentially catastrophic financial crises occur with more regularity than could ever be predicted.  Silver Oak has been a leading proponent of this technique since 2008 and with great success.

We are eager to share our approach with anyone who has concerns about their own portfolio management.  There is an excellent article written by a prominent money manager on creating portfolios by focusing on controlling risk that we would like to share with you.  Please contact us to request a copy of this article.

Answering Tom Keene’s question as to whether tax increases should have been part of the so-called “Grand Bargain” which capped the debt negotiations on Capitol Hill, Professor Sahlman noted that we have just been levied with the largest tax increase in U.S. history: he called it the “Uncertainty Tax.”

Fear and uncertainty are a pervasive undercurrent now, and markets (investors) hate uncertainty.  No wonder markets are gyrating all over the world.  Down 600 points + on Monday; up 430 points on Tuesday, down another 500+ on Wednesday and up 400+ on Thursday … this feels like the “Tornado” at Magic Mountain, without safety belts.

The recent downgrade of our national credit rating by S&P served as a trigger for the recent global markets volatility that we experienced last week.  However, it is already largely being ignored as the world continues to grapple with the European debt crises and mixed signals from our own economic data.

It is clear that raising taxes during a weak economic recovery would cause a train wreck, potentially pushing our economy back into recession.  Most of our politicians are trying to steer clear of that course.  Yet the inability of our government to rise above ideological extremism has frozen our political system and rendered policy-making bankrupt.  Meanwhile, the Eurozone is experimenting with economic policy to avoid potential national bankruptcies while inventing responses to overcome the economic slowdown which is plaguing the contintent.

These issues represent only the more obvious examples of uncertainty and instability.  And so, as with other imposed taxes, this de facto “uncertainty tax” continues to suck value and peace of mind from our global wellness.  Although our politicians will be loathe to acknowledge this climate they have helped create as having fostered a new tax, when their actions negatively impact our wealth and leave us without recourse, we must recognize that our collective pockets are being picked once again.

In 2008, we at Silver Oak recognized and wrote about the fact that the global financial marketplace had suffered serious structural damage.  We then turned our macro-economic research and investment focus toward lessening the uncertainty impacting our portfolios by modifying our investment selection criteria.  The success of our decision and methodology has been consistently reflected in our investment results.  By choosing to build portfolios on a strong foundation of diverse income producing assets, we have created stability and steady growth in a period marked by extreme volatility.

We expect the US market to continue its almost daily wild gyrations during this period.  Our market’s blue chip companies are now awash in liquidity, with little intention to invest in growth; investor and business confidence is sinking.  High unemployment will persist for the foreseeable future, causing consumers to further cut back the discretionary spending that is needed to resume a healthy level of corporate growth.  By and large, we do not expect our portfolio gains to arise from U.S. stocks.

Our skepticism and cautious, outside the box approach has served our clients well.  We have striven hard to reduce the tax toll levied by uncertainty; our strategies have worked well and continue to do so.  We are happy to share details of our successful approach.  Please feel free to call us to learn more.

As always, we welcome your questions and comments.

THE WORLD ECONOMY & THE CASE OF THE DOG THAT DID NOT BARK

I have always liked detective stories. Judging by the popularity of the character and series “Columbo” starring the late Peter Falk, I’m certainly not in the minority.

Sherlock Holmes was one of my favorite sleuths. I wonder how he would have approached solving the enigmas that currently perplex our global financial leaders.

One of the most memorable of the Sherlock Holmes short stories was “Silver Blaze”, a tale about the disappearance of a race horse. The most important clue in solving the mystery came not from the obvious clues, including the events leading up to the crime, but from a dog that did not bark… Click here to view the pdf article.

Welcome to Silver Oak Wealth Advisor, LLC’s quarterly letter covering the first quarter of 2011. This quarter, we will address a couple of themes that will impact our portfolio allocation decisions over the rest of 2011 and, perhaps, over the next few years.

1. Global and emerging market investments should receive higher portfolio allocations.

2. The U.S. equity markets, if not currently overvalued, could produce significantly lower returns than the long-term averages would suggest.

Our goal is to share with you pertinent financial information and timely economic data that shapes the investment decisions we make on your behalf. While there is a science involved in portfolio design, a significant amount of artistry is also involved. As a sculptor works with clay to create a pot, we utilize the type of financial data we will share with you in this letter to mold our asset allocation decisions… Click here to view the pdf article.