OUT OF STOCKS
Let’s be clear. This is not a case of Chicken Little crying “the sky is falling.” Pieces of the sky have, in fact, been falling.
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:
- 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.
- 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.
- 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.
- 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.
- 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.