Portland Private Wealth Management Blog

May, May, Please Go Away

noreply@blogger.com (Portland Private Wealth Management Group) — Fri, 28 May 2010 17:36:00 +0000

Winter: Cold Then Hot
The story begins January 20th when morning headlines read ‘Greece to Crack Down on Tax Evasion’. From that day forward, the market (the S&P 500) would fall 9.2% through February 9th. By that date, chatter of the PIGS (Portugal Ireland Greece and Spain) was gaining momentum. But the mood changed and positive news of an economy on the mend took the market 16.7% in other direction until April 26th peak. Quietly, the Euro had shed 7% since mid January.

Spring: Cold
On April 27th, the headlines read Greek Debt Rating Cut to ‘Junk’ Status. Two days later I wrote an email to a client for whom I had promised a trading proposal: “I have been a little hesitant to make any suggestions. The market had essentially made no moves greater than 1% in the last 2.5 months, and it has moved over 2% in both directions in the last 4 trading days. I have been trying to get a feeling for how it might break.”

Now we know. The euro would fall another 8% over the next 4 weeks and the U.S. stock market would fall 14.6% peak-to-trough through early Tuesday morning May 25th. A headline that morning from a budget conscious NYT travel writer was ‘Greece - Why Now’. The last time we had such volatility was late February / early March 2009, the final capitulation phase of the 2008/2009 bear market.

Greenback: Warming
I have heard from TV pundits that Obamanomics is creating mountains of public debt, its regulatory zeal is spooking corporations, and his tax policies are forcing business owners to tighten their wallets undermining job creation. The combination of all this is a hostile investment environment for the greenback and at any time China might pull the plug. Despite the hostile environment, big budget deficits and the $13 trillion mountain of debt, the dollar is on the rise and the real bottom started in March of 2008, long before Lehman and Obamanomics.

Money Flow: Climate Change
On the surface, it would appear the dollar is doomed. But understanding the nature of money in our global system may help investors understand why the dollar has been on the rise for nearly two years despite dim prospects for the Land of Liberty. Expensive Euros will buy lots of cheap greenbacks, or U.S. dollar denominated assets. Just as air will move from areas of high to low pressure, money will flow from expensive assets to cheap assets until they are no longer cheap. Until 4 months ago, €1 would buy a $1.50. 10 years ago the Euro would only buy 85 cents USD. Those are likely two extreme levels. The right level is probably somewhere in between. But many investors have been positioned for a weak dollar / strong euro environment which has been the proper posture for the last decade.

Weather Front
The weak dollar / strong euro era has probably come to a close with the accelerated drop in the Euro in recent weeks. Many private investors, hedge funds, governments, corporations, pensions and endowments are realizing they are on the wrong side of that trade. When air moves from areas of high to low pressure it is preceded by bursts of warm or cold air followed by weather. Atmospheric change is a seemingly chaotic event that can result in wind, rain, sleet, hail or snow, all swirling about. But as pressure finds new equilibriums, the sky begins to mellow out and the disturbance eventually disappears. The end of weak dollar / strong euro has upset the global equilibrium and money is flowing from one place to another find a new equilibrium. This process increases uncertainty and volatility.

Nasty Squall
On April 22, a deep-water drilling rig off the coast of Louisiana exploded and sank to the bottom of the Gulf of Mexico with 11 people aboard. By April 27th, news reports were suggesting it would be a serious oil spill. That same day, selling began in earnest when news hit the wires that Greek debt was now junk. The next 5 trading days were volatile with the market moving over 2% in each direction. On May 5th, 100,000 people took to the Greek streets in protest of government austerity measures. On May 7, the stock market fell roughly 9% in course of about 10 minutes (the so-called unexplainable Flash Crash) leaving most market participants with a knots in their stomachs. Though the stock market recovered 6% of those losses by the close that day, shockwaves hit debt markets and ancillary markets like preferred stocks.

Over the next few days the market rallied and made a full Flash Crash recovery, but violence in Bangkok reached new crescendos that lasted for the next week. Sellers returned, driving stocks down for the next 9 sessions. On top of all this, the House and Senate spent these days debating financial reform legislation. This issue, like the health care debate, is fraught with divisive prescriptions and remedies. Now in reconciliation, the uncertainty of the outcome and the potential unintended consequences of a major piece of legislation have all parties on pins and needles.

The bottom came on May 25th as investors awoke to headlines that Kim Jong-il, Supreme Leader of North Korea, was mobilizing his army for war with South Korea. The market fell 3% at the open, but buyers came in accumulating stocks all day with the session ending at nearly the highest print. Nothing like the potential for a nuclear war to bring buyers into U.S. stocks. On May 29th, after a few good days, Fitch downgraded Spain from AAA to AA+ in the middle of Friday’s trading session before the Memorial Day weekend. All this begs the question – ‘Was this just the squall before the hurricane?’

Weather Cycle
One way to think about financial markets is think about the annual weather cycle. If we are truly at the beginning of a new economic expansion, early cycle, then we are probably in spring. With spring come some nice days, but also a lot of cold, rainy days. As spring progresses, the weather improves. From time to time, you may have a thunderstorm, or a tornado, if you live in such a place. When summer comes, the weather is generally nice. This period is called mid-cycle for economic expansion. You are past peak tornado season and before hurricane season. It is the longest phase of the economic cycle and the stock market cycle.

The fall could be considered late cycle, the point in the economic cycle where inflation pressures are building up and the prices of things are reaching extremes. During this time, bank coffers are full and lenders want to find places for their depositors’ money. Early contraction begins in the late fall and is marked by mostly cold October and November days. The rain and sleet return, maybe even an early blizzard. When there are no more warm days, this is the end of expansion. Full contraction is winter. Day upon day of gray skies, cold and snow turned to ice that won’t melt. The economic cycle is generally 4 years, but it has gotten longer since WWII. The 1980’s and 1990s had very long expansions that made some observers think we had licked the business cycle. But this last recession has brought people back down to Earth.

Spring
When I look at the market action of recent weeks, I have to raise my level of apprehension as the Euro area debt problem, or even the U.S. debt problem may derail this economic cycle. I have to ask myself – “Have we entered a major cooling period like the ice ages where great expanses of the economy become frozen and the last 3 quarters of economic growth will be snuffed out by a this super cycle looming just over the horizon. Or are the events of May just a squall and summer is just around the corner.’

My gut tells me that the economy will be better off 6 or 12 months down the road. While European bond vigilantes give me worry, I think the EMU is on the right track to stave of global cooling. With $1 trillion just off the presses to buy debt of the PIGS, snowplows are on the streets clearing this late spring blizzard. Deflation is a symptom of excessive debt and inflation is exactly what central bankers are using to fight it. I am generally not one to fight the Fed.

Just Another Storm?
It has been my observation that these kinds of storms eventually pass. In 1994, in order to bring soaring budget deficits and debt under control, President Clinton abandoned his campaign promise of tax cuts. This was the result of advice from his Treasury Secretary, Robert Rubin, former co-Chairman of Goldman Sachs. U.S. government debt was under significant selling pressure as so-called bond vigilantes shunned treasuries. James Carville, Clinton’s top political adviser, said,

“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody."

In 1995, Newt Gingrich would lead a Republican charge that shutdown the Federal government for several weeks. Through bi-partisan efforts and austerity, the deficit would fall and surpluses would come from 1997 – 2001. (Source: www.whitehouse.gov/omb)

Severe Weather Watch
Deflation is still the problem and inflation will have to wait its turn. Inflation is a symptom of excessive money supply and is a late cycle phenomena. We have a few more seasons that must pass before we get there. But do not get me wrong. If I sense that a much nastier storm is coming, we may have to batten down the hatches.

It rained again all day. The high was 52 degrees. It will be June in four days and the summer solstice is June 21.

Jason McMillen, Chief Investment Strategist, PPWM

This is the DISCLAIMER: Information, data and attachments contained on this website are from sources considered reliable but their accuracy and completeness is not guaranteed. Investing entails risks, including possible risk of principal. An investment in any equity, bond, fund or other financial instrument may be speculative and involve significant risks. We do not offer tax advice. Individuals should consult their personal tax advisor before making any tax-related investment decisions. Past performance is not a guarantee of future results.

Securities offered with and through First Allied Securities, Inc., a Registered Broker Dealer, Member FINRA/SIPC. First Allied Securities, Inc., is not affiliated nor endorses Portland Private Wealth Management or any other affiliated firms.

If you would like to contact us feel free to email as at jason@portlandprivatewm.com or we can be reached at 503-703-4067.

Thank you.

© 2010 All Rights Reserved Portland Private Wealth Management Group.

Prognosticating

noreply@blogger.com (Portland Private Wealth Management Group) — Wed, 19 May 2010 17:52:00 +0000

Fall 2009 was the last time I brought you Prognosticating. Spring is here and perhaps it is a good time do it again. Previously, I mentioned that forecasting is potentially a futile exercise, but it is kind of fun. At the end of last year, I wrote a 3-piece blog essay titled Unprecedented that may shed some light on why I think ‘future tripping’ is often pointless. Basically, we have been talking about the end of the American empire since the empire started.

Below are some topics that often come up with clients. I have included comments from the Fall so you can see how these thoughts have progressed over time. Please take them with a grain of salt as the following disclaimer warns:

All estimates, opinions and views expressed are our own and constitute our best judgments as of the date of this podcast or email and may be subject to change at any time without notice. These opinions and views are made under conditions of great uncertainty and there is a good possibility that our judgments could be completely wrong. However, we hope for your sake and ours that we are more right than wrong of which there is no guarantee.

The PPWM Outlook Spring 2010

Economy

Fall 2009 The global economy is nearing a trough in the business cycle marked by the early phase of a cyclical bull market in financial markets.

Spring 2010 The global economy turned the corner. Economic growth returned in the middle of 2009 and has been stronger than expected. The U.S. is expected to grow in foreseeable future, but the rate of growth will be below 3%, which does not bode well for job growth. (Source: IMF WEO April 2010) The Depression sale is over in financial markets and with moderate economic growth we should expect moderate rates of return.

Stimulus

Fall 2009 Coordinated global fiscal and monetary stimulus provides a positive environment for investors.

Spring 2010 Fiscal stimulus will fade in 2010, but monetary accommodation is alive and well. While the Fed has stopped purchasing mortgages, interest rates are at historic lows. European central banks recently pumped more money into the EMU by purchasing debt of troubled governments. This a positive backstop for investors.

Rates

Fall 2009 Global interest rates will remain low for a significant period of time as central bankers work aggressively to stimulate risk taking behavior and economic activity.

Spring 2010 One year ago, the yield on a 10-year treasury note was 3.89%. Today, that same rate is 3.76%. (5/18/2010) Real estate has a long way to go to get banks out of the ditch. Unemployment is high. I don't see rates going anywhere for a while.

Commodities

Fall 2009 We are in a long-term bull market for commodities, driven by new demand from emerging markets.

Spring 2010 Asia is expected to grow at a rate of 7% for the next two years. Latin America, Emerging Europe, Middle East and North Africa are looking at 4%+ growth rates. This kind of growth underpins global demand for commodities. (Source: IMF WEO April 2010)

Moderate Growth

Fall 2009 The developed economies will grow slower than emerging economies.

Spring 2010 The U.S. is forecasted to grow at less than 3% over the next couple of years. Europe is expected to grow at a rate less than 1% and that may be optimistic. (Source: IMF WEO April 2010) Such growth rates are below the long-term averages.

Emerging Markets

Fall 2009 Companies in the developed world that can sell products into the developing world are attractive.

Spring 2010 The rapid economic growth in emerging economies provides opportunity for all sorts of companies -- heavy equipment, high tech machinery for manufacturing, energy infrastructure, consumer electronics, trendy global brands, entertainment, etc. The rise of the third world takes pressure off the Core to always be consumer of last resort.

Global Linkages

Fall 2009 The rest of the world is geared toward selling consumer products to the U.S. consumer. They have a huge stake in the revival of U.S. consumption.

Spring 2010 Understanding the global flows of money, goods and services is critical to understanding why countries like China would buy trillions of dollars of U.S. government and corporate debt despite our apparent mismanagement of those funds.

Consumer

Fall 2009 The U.S. economy and the consumer are resilient and will be highly adaptive to the headwinds they face, despite opinions to the contrary.

Spring 2010 When U.S. companies can shed millions of jobs to maintain profitability, governments can provide an effective safety net in the form of unemployment insurance to keep families in their homes, paying rents, and shopping at the corner store, it is no surprise that our economic system can take the blow it did, get back up and keep playing. This is why they call it mixed capitalism, and not capitalism. We have an enviable social safety net which makes are system more resilient shocks. Developing economies like China are emulating our system by building out a social safety net that will make them more stable, not less.

Inflation

Fall 2009 When (assuming) the global economy starts growing robustly again, inflation will come back quickly.

Spring 2010 Inflation is the symptom of excess money printing. Deflation is the result of excessive debt. Once markets have cleared and deleveraging has run its course, the forces of inflation will have their time in the limelight.

Unemployment

Fall 2009 U.S. unemployment rates may not come back down in the near-term as the U.S. economy must make a tectonic shift from the hyper-activity of building automobiles, houses, condos, strip malls and office buildings – to doing something else – at least for the next 5 to 10 years.

Spring 2010 Unemployment will be a nagging problem for years to come. When politicians tell you that they can make jobs, or that the one's policies are not making enough jobs, just nod and smile with skepticism. All the data of past experience suggests that unemployment in the U.S. will get back under 6% in no less than 5 years time. (Source: IMF WEO April 2010)

Deficits

Fall 2009 The fiscal deficits of the U.S. government are unsustainable and highly problematic without serious sacrifices.

Spring 2010 Greece is the canary in the coalmine, so they say. The drop in tax revenues due to the global financial crisis has exposed governments around the world. The resulting deficits raise the specter that bondholders, the lenders to governments, may not be paid back in full.

Austerity

Fall 2009 Industrialized governments have made significant promises to their retirees that are significantly underfunded.

Spring 2010 Austerity is perhaps the new buzzword for the media, pensioners and governments alike will need to face the reality that there is not enough money to fulfill all their dreams and promises.

What’s new? We have been talking about reforming social security since the Advisory Council Report on Social Security in March 1975. Unions have been facing austerity for 30 years, but the economy seems to find ways to grow. Spain has defaulted 13 times since 1800. Greece has defaulted 5 times. (Source: Reinhard and Rogoff) Why is this time so calamitous?

Taxes

Fall 2009 Higher taxes are on the horizon.

Spring 2010 While not the only answer to global deficits and debt, higher taxes will play a role to reducing deficits and paying off the government debt bubble incurred over the last 20 to 30 years. During the 1990s, a bipartisan commitment to deficit and debt reduction provided a foundation for a vibrant economy. Pray that factious politicians can find common ground again.

Let us be real – slower economic growth is the result of excessive debts built over a generation. Not because of lack entrepreneurial ingenuity. We will muddle through as history can attest, but we have now entered a time to pay the piper.

Real Estate

Fall 2009 Financial markets still have significant negative exposure to commercial real estate assets that could be disruptive to economic expansion.

Spring 2010 Commercial real estate prices may have stabilized taking the pressure off bank balance sheets and lowering the probability of a systemic risk event related to these debts. Residential markets, while seemingly on the mend, are stymied by shadow inventory, those bank repos not on the market, which means years, not months before the market can clear.

Bailouts

Fall 2009 The government may to have to make additional capital injections into financial institutions in order to absorb future losses due to write-downs associated with commercial real estate (which have not yet been taken). Such injections may destabilize financial markets once again.

Spring 2010 Something that will no doubt be studied by academics, the Private Public Investment Partnership (PPIP), Geithner's silver bullet to remove toxic assets from the banks balance sheets, never left the bullet chamber. Upon the government's announcement of the program, the so-called toxic assets rallied so much that the financial elite like PIMCO took a pass on the program. Originally slated for up to $1 trillion, the mere creation of the program deemed it nearly unnecessary. Where are those toxic assets now? Still at the banks but not as toxic.

Secular Bear

Fall 2009 A multi-year bull market may take stock market indices back to old highs, but a return to the good old days like the 1980s and 1990s where indices rose 15-fold is probably not in the cards until the ‘structural headwinds’ mentioned above have been addressed. This may mean another decade of volatile markets similar to the 1960s and 1970s.

Spring 2010 A term thrown around by market historians, secular bear markets are periods where returns for investors fall well below the average returns like the late 1960s and 1970s. Secular bull markets are periods when market returns are well above average, like the 1980s and 1990s. The Dow Jones rose 10-fold from 1982 to 2000. Today, it is still below the peak set in 2000. From 2003 to 2007 to Dow Jones nearly doubled, only to give back all those gains. Buy and hold? I don't think that is the best strategy right now.

Euro

Spring 2010 The euro has been under significant pressure recently as the aftermath of the global financial crisis left the Greeks unable to make debt payments that came due. The EMU and IMF came to the rescue but not before the markets let us imagine a cascade of European defaults, the seizing up of global financial markets, the return of the Deutschemark and German nationalism, and the end of the Pax Europa. The media loves all the innuendoes with minute-by-minute coverage of disgruntled hoi polloi and Molotov cocktails, stoking the pandemonium.

Despite the scary sound bites, the probable outcome is EMU will tighten its fiscal belts, impose austerity despite the political costs and emerge leaner and meaner at the end of the decade. Watch the prequel called the Asian Financial Crisis from 1998 when it looked like Korea and several others would default.

Wealth Destruction

Spring 2010 At the end of WW II, much of Germany and Japan were destroyed, two of the biggest of the economies in the world at that time. (For further reading see Wikipedia Strategic Bombing WWII or the The Fog of War documentary film with Robert McNamara.) It is estimated some 60 million people died from combat, disease, starvation or genocide. The direct costs of the war, widely debated, are estimated at anywhere from $1.5 to $3 trillion in current U.S. dollars. Somehow, the global economy was back on track by 1948 even with U.S. debt at 120% of GDP, Britain’s at 260%, Germany’s at 217%, and Japan’s at 200%. (Source: Wikipedia, www.whitehouse.gov/omb, Ritsch 1996, Kudo 2006).

Is wealth destruction a lower valuation on your real property at a point in time or the literal destruction of that real property? It is important to have the proper perspective on things to make good investment decisions. One-way to think about wealth is that is not destroyed except by natural disaster or war, it merely changes hands.

Last year, Paul Krugman, a Nobel Prize winning economist, wrote a blog called 1945 where he made the point that the U.S. has been in a tough spot before and dealt with it. In response to criticism to his blog, he made another interesting point that people have ways of making analyses in hindsight that suggests the wind was always at the back of that Great Generation, so it was natural they would escape their predicaments.

Today, has the wind stopped blowing, or is it always a headwind? I guess it is just how you look at things. I really doubt we are at the end of progress and wealth creation, or on the precipice of the new economic Dark Ages.

Investment Implications

As we have said before, we believe investors may need to be more proactive and nimble than they have been in the past. This may require considering new investments ideas, timing strategies and examining yield as an important slice of total return. We will continue to make investments in companies with exposure to basic materials (commodities) and emerging markets, either through the purchase of fixed income or equity instruments. In addition, we want exposure to investments that benefit from an improving global economy or can benefit from an inflationary environment. If you want specifics, we encourage you to contact us. These are our prognostications -- for now.

Jason McMillen, Chief Investment Strategist, PPWM

This is the DISCLAIMER: Information, data and attachments contained on this website are from sources considered reliable but their accuracy and completeness is not guaranteed. Investing entails risks, including possible risk of principal. An investment in any equity, bond, fund or other financial instrument may be speculative and involve significant risks. We do not offer tax advice. Individuals should consult their personal tax advisor before making any tax-related investment decisions. Past performance is not a guarantee of future results.

Securities offered with and through First Allied Securities, Inc., a Registered Broker Dealer, Member FINRA/SIPC. First Allied Securities, Inc., is not affiliated nor endorses Portland Private Wealth Management or any other affiliated firms.

If you would like to contact us feel free to email as at jason@portlandprivatewm.com or we can be reached at 503-595-1059.

Thank you.

Unprecedented - Part III

noreply@blogger.com (Portland Private Wealth Management Group) — Thu, 07 Jan 2010 17:30:00 +0000

Random as a Coin Toss

When I hear people say ‘It is different this time.’ I usually try to think -- what is the contrarian bet? For example, if everybody is saying we are in the early phase of the Japanese style deflation, as a contrarian, I might suggest we might be on the verge a new productivity cycle instigated by Internet 3.0 and the integration of a huge quantity of highly educated labor from emerging market nations. Who really knows? I think such a prediction is as random as a coin toss.

The New Economy

In the late 1990s, people said we were in a ‘new economy’, free from the boom and bust of the business cycle that plagued the ‘rust economy’. In the new ‘information economy’, just-in-time manufacturing and real-time logistics had solved the dilemma of inventory cycles that led so often to the boom and bust of business cycles. The new economy would ride smoothly as omnipotent central bankers like Alan Greenspan, referred to as the Maestro, would engineer soft landing after soft landing. We now know this kind of thinking was horse manure. It is true that advances in manufacturing enhanced the profitability of firms, but it did not make them immune to the business cycle.

Move On

In meetings with clients, I often say that most people will remember 2008/2009 like they remember the Crash of ’87 (1987), the S&L Bailout (1989), the Bond Crash of ’94 (1994), the Asian Contagion (1998); or the Tech Crash (2000), or the housing busts of 1979/1980, 1989/1990, and 2006/2007. Or O.J. Simpson’s murder trial, or Janet Jackson’s wardrobe malfunction, or Brittany Spear’s tribulations or Tiger Woods’s indiscretions. While the media may want to exploit these events in order extrapolate broader implications about society or the economy -- life simply moves on. People’s attentions move on. The economy moves on.

The Education

In college, I spent a whole semester studying an autobiographical book called the Education of Henry Adams. Intercollegiate Review ranked it the best book of the 20th century and Modern Library (a division of Random House) ranked it #1 in its list of Top 100 Non-Fiction books. Adams released the book privately in 1907 to his friends and it was eventually published after his death. To give some color on his station in life, his great grandfather and grandfather were the 2^nd and 6^th Presidents of the United States.

Henry Adams was born in 1838 and died in 1918. He was an American intellectual and represented himself as a journalist, historian and writer. During his lifetime he observed significant changes in society and technology. He witnessed the rise of steam powered rail transportation (1830s), electric light (1880s), motion pictures (1890s), and the automobile (1900s) – just to name a few of things that impacted the world he lived in.

In the latter part of Adam’s life he explored the idea of applying the laws of nature (Newtonian physics) to explain or even predict the course of human affairs. But eventually, by the end of his life, he decided this was a futile exercise as life unfolded in ways that were truly unpredictable, or at least that is what I thought he was trying to impress. The Education was one of those books that had a profound impact on my understanding of the world and history.

Maybe A Couple Paragraphs

While the Financial Panic of 2008/2009 has been an important event in terms of affecting millions of people all over the world, it is not, in my opinion, some watershed moment, or one of the more important events in history. It will get a paragraph or two in a history book, and perhaps a few pages in an economics textbook, maybe a chapter. The economics profession will likely have to integrate more ideas from behavioral economics to provide a more robust understanding of how financials markets really work. But has this event torn asunder the idea of the efficient market hypothesis, the idea that markets are made up of participants acting rationally on all known information, public and non-public? No. This financial panic has only demonstrated, once again, our limited understanding of the world around us.

Rational Until Panicked

Humans are rational, until they are panicked. Panic is born from truly unpredictable and random events, and that is why humans become panicked in response to those events. In our attempt to master everything, to predict every possible outcome or reaction to every set of inputs is truly a futile exercise. There will always be a set of circumstances in financial markets that will lead to financial panic despite the fancy risk models of the quants[i], or the best efforts of policy makers and politicians to create a more perfect order.

Enforcing Common Sense

We can make our financial system more stable by enforcing the rules we already have; we can limit excessive risk-taking by curbing the amount of leverage in the system (or clearly segregating highly leveraged entities and providing transparency so markets can assess the risk), we can minimize bad debts by employing prudent lending standards – these are not new ideas or rules – it is common sense. We have had laws in place to prevent such calamities, some born out of the experience of the Crash of ’29 and S&L Crisis of the 80s and early 90s. Financial institutions have simply gone around these rules by developing new kinds of entities or new kinds financial instruments -- all under the guise of financial innovation (driven by greed and hubris). We simply need our old rules to adapt to these new innovations and we move on – until the next financial -- crisis which I am sure will be unprecedented.

[i] See http://en.wikipedia.org/wiki/Quantitative_analyst

DISCLAIMER: Information, data and attachments contained on this website are from sources considered reliable but their accuracy and completeness is not guaranteed. Investing entails risks, including possible risk of principal. An investment in any equity, bond, fund or other financial instrument may be speculative and involve significant risks. We do not offer tax advice. Individuals should consult their personal tax advisor before making any tax-related investment decisions. Past performance is not a guarantee of future results.

If you would like to contact us feel free to email as at jason@portlandprivatewm.com or we can be reached at 503-703-4067. Thank you.

Unprecedented - Part II

noreply@blogger.com (Portland Private Wealth Management Group) — Fri, 25 Dec 2009 17:27:00 +0000

It Is Different This Time

Potentially one of the most costly trappings for investors is succumbing to a belief that ‘it is different this time’. For instance, assuming that the economic engine of the United States is permanently broken or we are destined to the Japanese experience of permanent malaise may lead us to make the wrong choices when it comes to investment strategy. Just over a year ago we experienced a ‘financial panic’. It was not the first and it will not be the last. A financial panic is characterized by a ‘run on the banks’. Our recent experience was a ‘run on the system’. What happens in a financial panic is that all financial players move in unison to ‘safe assets’ leaving financial institutions without risk capital to operate.

Banker Panic of 1907

While the Great Depression was kicked off with a series of ‘bank runs’, the most similar episode to recent Panic of 2008 was the Banker’s Panic of 1907. The stock market peaked in 1906 and fell 40% over the next year during a time of recession. In the fall of 1907, with the economy and financial markets already on shaky ground, a number of financial institutions extended money to a group of investors (think subprime lenders) making big one-way bets. When the investor bets soured (think housing bust) it led to the collapse of a prominent broker dealer in New York City (think Lehman) that caused another and much larger financial institution to fail (think AIG). As news spread, depositors across the nation became nervous and began withdrawing their funds from all types of institutions (think of the mass exodus from money market funds after The Reserve Fund, a money market fund with a small position in Lehman, ‘broke the buck’.) From there, the entire system began to unravel.

John Pierpont Morgan, the wealthiest and most prominent banker of the day (before the Federal Reserve Bank existed) stepped into the fray by making capital injections into several prominent banks (think Bernanke/Paulson with their Maiden Lane loans to AIG and the $250 billion TARP injections into the largest U.S. financial institutions.)[i] John D. Rockefeller, the wealthiest person in America at that time, made a large deposit into Citigroup’s predecessor (think Warren Buffet investing in Goldman Sachs and GE Capital). After these initial injections, over the next few weeks, and through some serious banker wrangling, Morgan was able to pony up enough bankers and money prevent the total implosion of the financial system (think of the $500 billion in the 2^nd round TARP, as well as the TALF, CPFF, PPIP).[ii]

Past Performance Does Not Predict Future Performance

The economy did shrink in 1908, but it grew again until it was stymied by the outbreak of World War I in 1914. And in the aftermath of the 1974 ‘Great Bear Market’, the economy grew until 1980 despite double-digit interest rates and double-digit inflation during that time period. It is hard to say if the Panic of 2008 was any worse than the Panic of 1907. Or the economy of 1975 was more resilient or in better shape than the economy of 2009. Whatever the case, unprecedented is not a word I would use to describe the events of the last year or so.

Looking forward, a belief that America is permanently broken, or on the wrong path, or is an empire in decline is generally a bad bet in my view. In 1989, the Nikkei would peak at 38,000. Japan was on a roll. It had a vibrant economy, great manufacturing acumen, they were buying up the most precious real estate in America, and everybody wanted a Sony Walkman. In America, our financial system was in shambles as we shuttered thousands of S&Ls, Citigroup fell to less than a $1, Michael Moore made his first movie about a dying U.S. auto industry, and Apple’s first portable computer was a piece of crap.[iii] Over the course of the next decade, the Nikkei would lose 66% of it value and U.S. stock market would rise 450%. Do you think most pundits were betting on Japan or America in 1989? Perhaps I am wrong, but I caution those that think it is different this time.

If you would like to contact us feel free to email as at jason@portlandprivatewm.com or we can be reached at 503-703-4067. Thank you.

[i] TARP - Trouble Asset Relief Program

[ii] TALF (Term Asset-Backed Loan Facility), CPFF (Commercial Paper Funding Facility), PPIP (Public-Private Investment Program)

[iii] The Citigroup low is a split adjusted number. Source: Goldman Sachs

Unprecedented - Part I

noreply@blogger.com (Portland Private Wealth Management Group) — Mon, 21 Dec 2009 17:23:00 +0000

One editorial writer for Bloomberg suggested that unprecedented was the most overused word in 2009. I think she was probably right. 2008/2009 was a year of tumultuous financial events. But was it unprecedented?

This year is ending with much of the nation in a state of deep anxiety over the course of the economy. Wall Street is flooded with red ink, but some of the biggest investment banking houses in the country are nevertheless paying year-end bonuses.[i] The recession will represent the longest slowdown since the 1929 – 1933 experience.[ii] There has been nothing like the present degree of apprehension since 1930. The question on everybody’s mind is whether years like 1931 and 1932 lie ahead. If the nation is to avoid another Great Depression, it has to face up to the real problems and dangers that lay ahead.[iii]

Feeling the Pressure

Many individuals are cutting their expenditures because their pocket books are pinched, they don’t have the means to dip into their savings, and unemployment rolls are lengthening. Businesses see new orders shrinking, unsold inventories piling up, costs rising and profits eroding.[iv] Last week, the largest airline in the nation said it would be forced into bankruptcy without a federal subsidy.[v] The Mayor of New York City has launched the toughest austerity measures since the Depression laying off thousands of employees and is seeking help from Washington.[vi] The depressing economic news has sent the stock market to the lowest levels in more than 12 years, as the government’s index of leading business indicators fell to its lowest level in 24 years and the unemployment rate reached its highest level in 13 years.[vii] [viii] [ix]

Negative Wealth Effect

There is a real sense of wealth lost from the roughly 40% drop in the stock market since last year. To the extent is impossible to quantify, this loss of wealth cuts into consumer spending, therefore total demand and production in the economy. The drastic decline in the price of stocks (which some argue started at the beginning of this decade) eventually has an effect on the process of ‘capital formation’ in the American economy. This is the means by which savings is transformed into the creation of new businesses and increased investment in plant and equipment.

Prognosticating

There are some people on Wall Street that recommend investors should stay away from stocks all together.[x] One of the President’s top economic advisors suggested the recession would continue into the middle of next year.[xi] Another prominent economist said his personal view was that a new bull phase in stocks would not occur until spring at the very earliest.[xii] On the flip side, gold prices have soared. This clearly reflects a wave of private demand by people worried about the state of the world economy and particularly about inflation. Some people regard gold as the only safe store of value at a time of global inflation and depreciating value of paper money.[xiii]

So Goes The Auto Sector, So Goes The Economy

Automakers have been under heavy pressure as new car sales have slumped.[xiv] The problems with the auto industry are not limited to Detroit. Employing some 750,000 people directly, it is estimated that indirectly the industry creates another 13 million jobs in steel, aluminum, glass, fabrics, electronics as well as a whole host of other industries. One automotive executive said the biggest deterrent to new car buying has been the sharp rise in the cost of vehicles because of federally mandated safety and emission standards. On the other hand, some experts have argued that auto companies would be more profitable if they simplified their offerings and made fewer kinds of cars.[xv]

Politics in Flux

The country is eagerly seeking Presidential leadership, not more of the same rhetoric it has ceased to believe or respect.[xvi] The President has said he would be willing to revise the current economic program he has presented to Congress if economic conditions worsened.[xvii] The Administration should have the courage to stimulate the economy through tax cuts and socially desirable expenditure increases.[xviii] What inhibits the present Administration is the double fear of increasing the budget deficit and regenerating inflation.[xix] The Chairman of the Ford Motor Company has suggested a gas tax to benefit those hit hardest by the recession – the poor and unemployed.[xx]

Energy Policy: Getting Off Foreign Oil

Measures to strengthen the domestic economy will require a strong national energy policy, whose centerpiece should be to conserve energy and reduce uncertain foreign oil supplies. Doing without foreign oil supplies will reduce our trade deficit and avoid another Middle Eastern war. As abundant as the supply of petroleum may seem, it is ultimately a wasting asset that will ultimately vanish. It is time to consider new technologies like solar, wind and hydrogen.[xxi]

Don’t Know How Good You Have It

Despite the economic gloom in America, foreign observers ask – ‘Why should so vast an economy such as ours, which depends to such a relatively small degree on exports, be more nervous than its trading partners who are wholly dependent on foreign trade to survive?’ The United States has immense natural wealth and requires only minimal discipline to regain its self-sufficiency.[xxii]

Plagiarizing

The paragraphs above have been cobbled together directly from newspaper articles written during the last months of 1974 with minimal change except to improve the readability. It has been just over one year since I printed out and highlighted these articles, but it is still a worthwhile exercise to examine these writings as though they were current news to potentially help investors gain a deeper understanding of market psychology. In early 1973, the stock market peaked and fell over 45% over the next two years. It was a slow, grinding bear market called the ‘The Great Bear’ that ended in December 1974 around the time the articles referred to above were written. The economy would contract the first quarter of 1975, but it started growing again until the recession in 1980 (the last great housing bust in the U.S.). And the stock market would find a bottom in first week of December, 1974, and rally 73% returning to its the old highs by 1976. While we do not know what may lay ahead in 2010, listening to the media or pundits may not help very much. What we do know is that the events of recent months were not unprecedented and it is difficult to predict the course of future events.

If you would like to contact us feel free to email as at jason@portlandprivatewm.com or we can be reached at 503-703-4067. Thank you.

[i] Cole, Robert J., Wall Street in Red, But Bonuses Flow, The New York Times, December 18, 1974.

[ii] The Economic Threat, Recalling the 30s, What to Do About It, The New York Times, December 18, 1974.

[iii] The Economic Threat, Recalling the 30s, What to Do About It, The New York Times, December 18, 1974.

[iv] The Economic Threat, Recalling the 30s, What to Do About It, The New York Times, December 18, 1974.

[v] Stocks Decline in Heavy Trading, The New York Times, August 29, 1974.

[vi] The Major Events of the Day, The New York Times, November 23, 1974.

[vii] Hammer, Alexander, Dow Stock Average Drops 9.46 Point to a 12-Year Low as Volume Increase, New York times, December 7^th, 1974.

[viii] Sears, Roebuck Planning Layoff, New York Times, November 6, 1974.

[ix] Dow Soars 25.5 as Volume Rises, The New York Times, October 30^th, 1974.

[x] Vartan, Vartanig, Analysts Pick Some Winners for 1975, December 29, 1974.

[xi] Hammer, Alexander, Economic Gloom Weakens Stocks, The New York Times, October 27, 1974.

[xii] Vartan, Vartanig, Will 525 Be the Bottom?, December 8, 1974.

[xiii] Dale, Edwin, Gold for Sale: It Probably Will Make No Difference, December 29, 1974.

[xiv] Dow Soars 25.5 as Volume Rises, The New York Times, October 30^th, 1974.

[xv] Mullaney, Thomas, What Will Help Detroit?, November 3, 1974.

[xvi] The Economic Threat, Recalling the 30s, What to Do About It, The New York Times, December 18, 1974.

[xvii] Hammer, Alexander, Ignoring the Bad News, Market Advances on Broad Front, October 30, 1970.

[xviii] The Economic Threat, Recalling the 30s, What to Do About It, The New York Times, December 18, 1974.

[xix] The Economic Threat, Recalling the 30s, What to Do About It, The New York Times, December 18, 1974.

[xx] The Major Events of the Day, The New York Times, November 23, 1974.

[xxi] Sulzberger, C.L., Let Them Eat Petroleum, November 13, 1974.

[xxii] Sulzberger, C.L., The Gods That Are Failing, The New York Times, December 1, 1974.

A Casino? Really?

noreply@blogger.com (Portland Private Wealth Management Group) — Tue, 15 Sep 2009 13:45:00 +0000

It has been exactly one year since Lehman Brothers declared bankruptcy and sparked a financial panic that substantially changed the trajectory of the already sluggish U.S. economy. The spillover effects rippled through global markets and global trade came to a virtual halt. The U.S. economy contracted by roughly -6% in the 1^st quarter and U.S. imports fell by 34%. (Source: JPMorgan / www.imf.org). The repercussions to our trading partners were substantial. During the first quarter Taiwan’s economic activity (GDP) fell -10.2%, Japan -11.7%, German – 13.4%, Hong Kong -16.1%, Mexico -21%, Russia -33.6%. (Source: JPMorgan)

So what was the series of events that precipitated this shock?

I. The Real Estate Peak, Subprime Collapse & Stock Market Peak

In August of 2006, the real estate market peaked. Falling prices put pressure on lenders and by the summer of 2007 the subprime lending market collapsed. In October 2007, the stock market (S&P 500) peaked.

II. Bear Stearns, Freddie & Fannie

By March 2008, reverberations of falling estate prices led the failure of Bear Stearns, a large Wall Street investment bank. Over the summer of 2008, it became clear that the government would need to support mortgage markets as lending was drying out. The stock market was down over 20% signifying a bear market in equities. By September, Freddie Mac and Fannie Mae, two government sponsored lending giants, were placed into government conservatorship.

III. Merrill, Lehman & AIG

As summer came to a close, several investment banks were desperate for cash. Trust among big institutions was eroding and the spigots of capital were shut off. On September 15^th, Merrill Lynch sold itself to Bank of America, the largest bank in the country at that time, and Lehman Brothers, another large investment bank, failed as it could not find a suitor. The next day, to prevent imminent collapse, the government extended a loan of $85 billion to save AIG, the world’s largest insurance company at that time. That same day, a large money market fund ‘broke the buck’ due to its exposure to Lehman. The failure of this money market fund was significant in spreading panic throughout the financial system.

IV. Financial Shock & Capital Injections

What had begun as a housing bust / credit crunch morphed into a full-blown financial shock. Over the next 6 months, the stock market would fall 57% from the peak in October of 2007, representing one of the worst bear markets in history. The government would take extraordinary actions in an attempt to restore confidence in the financial system and inject significant amounts of capital into U.S. banks. The impact of the financial crisis caused economic activity to contract considerably. It now appears that the U.S. economy is on the mend.

V. Aftermath: Impact on Efficient Market Hypothesis

The impact of this event on investors, bankers, regulators, policy makers and academics has been substantial. Alan Greenspan, a former Chairman of the Federal Reserve told congress last October – “Those of us who have looked to the self-interest of lending institutions to protect shareholder's equity (myself especially) are in a state of shocked disbelief.” (Alan Greenspan, Testimony to Congress, October 23rd, 2008).

I was taught in school (I majored in business economics) that financial markets are efficient, rational and inherently stable – a concept commonly known as EMH (Efficient Market Hypothesis). This concept was essentially handed down to me as cutting edge thinking about the way financial markets truly operated. I, among others, thought it was generally correct given the evidence produced by Nobel Prize winning formulas. Some now maintain that the application of these formulas encouraged excessive risk taking (meaning utilizing massive amounts of leverage to purchase mountains of debt instruments) because the data used in these models ignored the possibility of highly catastrophic and unpredictable events, like the collapse of Lehman Brothers which would set-off panic selling of money market funds, a seemingly irrational behavior, or that liquidity might dry up completely in mortgage markets, and not just the market for subprime mortgages.

However, before EMH, a guy named John Maynard Keynes (1883 – 1946), the highly influential economist of his time, believed that speculators dominated markets, were prone to exuberant mood swings and the whole shebang was essentially a giant casino. (Krugman, NYT, 9/6/09)

One of most interesting things about Keynes was he was well known as a speculator as well as a respected academic. I think if anything results from this crisis is that people will dust off some of Keynes’s old books and see if he still has anything to add to the conversation.

Written by Jason McMillen, Chief Investment Strategist, PPWM

Prognosticating

noreply@blogger.com (Portland Private Wealth Management Group) — Thu, 03 Sep 2009 13:57:00 +0000

I watch Bloomberg television everyday. It is something that plays in the background as I work. The primary reason is because I like to know what is going on with the economy and financial markets, and I like to hear what other professionals and pundits are saying about the markets. It is called infotainment.

After thirteen years in this business, what I have learned is most people do not have any special insight on the direction of economy or financial markets. In fact, many so-called experts are either too bullish or too bearish. However, there is an old adage on Wall Street that ‘If you say the same thing for long enough you will eventually be right.’

When I sit down with clients many of them want me to look into a crystal ball and tell them what I see. What I tell them is few people, if any, can accurately predict the future. If there are any absolutes, it is to ‘Expect the Unexpected’ which is a magnet on my refrigerator (next to my ‘Take a bath in the real estate market with Mr. Hou$ing Bubble’ magnet).

So why make any predictions or forecasts if it is a seemingly futile exercise? When it comes to investing all of the old pros provide the same advice which is -- 1) develop your own ideas, 2) have some convictions, 3) admit when you are wrong.

Below we have developed some of our own ideas that we often discuss with our clients. Please take them with a grain of salt as the following disclaimer warns:

The PPWM Outlook Fall 2009

A) The global economy is nearing a trough in the business cycle marked by the early phase of a cyclical bull market in financial markets.

B) Coordinated global fiscal and monetary stimulus provides a positive environment for investors.

C) Global interest rates will remain low for a significant period of time as central bankers work aggressively to stimulate risk taking behavior and economic activity.

D) We are in a long-term bull market for commodities, driven by new demand from emerging markets.

E) The developed economies will grow slower than emerging economies.

F) Companies in the developed world that can sell products into the developing world are attractive.

G) The rest of the world is geared toward selling consumer products to the U.S. consumer. They have a huge stake in the revival of U.S. consumption.

H) The U.S. economy and the consumer are resilient and will be highly adaptive to the headwinds they face, despite opinions to the contrary.

I) When (assuming) the global economy starts growing robustly again, inflation will come back quickly.

J) U.S. unemployment rates may not come back down in the near-term as the U.S. economy must make a tectonic shift from the hyper-activity of building automobiles, houses, condos, strip malls and office buildings – to doing something else – at least for the next 5 to 10 years.

K) The fiscal deficits of the U.S. government are unsustainable and highly problematic without serious sacrifices.

L) Industrialized governments have made significant promises to their retirees that are significantly underfunded.

M) Higher taxes are on the horizon.

N) Financial markets still have significant negative exposure to commercial real estate assets that could be disruptive to economic expansion.

O) The government may to have to make additional capital injections into financial institutions in order to absorb future losses due to write-downs associated with commercial real estate (which have not yet been taken). Such injections may destabilize financial markets once again.

P) A multi-year bull market may take stock market indices back to old highs, but a return to the good old days like the 1980s and 1990s where indices rose 15-fold is probably not in the cards until the ‘structural headwinds’ mentioned above have been addressed. This may mean another decade of volatile markets similar to the 1960s and 1970s.

Investment Implications

Based on the outlook above, we believe investors may need to be more proactive and nimble than they have been in the past. This may require considering new investments ideas, timing strategies and examining yield as an important slice of total return. We will continue to make investments in companies with exposure to basic materials (commodities) and emerging markets, either through the purchase of fixed income or equity instruments. In addition, we want exposure to investments that benefit from an improving global economy or can benefit from an inflationary environment. If you want specifics, we encourage you to contact us. These are our prognostications -- for now.

Written by Jason McMillen, Chief Investment Strategist, PPWM

Waiting for Gisele

noreply@blogger.com (Portland Private Wealth Management Group) — Fri, 22 May 2009 01:03:00 +0000

On November 5, 2007, it was reported that Gisele Bundchen, the world’s richest super model, told Bloomberg News that she would no longer accept payment for her modeling gigs in U.S. Dollars – she was only taking Euros. It was said Ms. Bundchen, who was 27 years old at the time, earns about $30 million a year peddling products like Pantene shampoo for the likes of Procter & Gamble and perfume for Dolce & Gabanna. The headline at Bloomberg was Supermodel Bundchen Joins Hedge Funds Dumping Dollars.

A few days later Gisele’s manager said she had never made any such comments. But the story sparked a furry of negative comments about the old Greenback and brought a story mostly confined to the financial media into the mainstream. That same month, a popular rapper named Jay-Z flashed Euros in his new video. The basic drift was Dollar days were over and it was time to make way for a new world order. From government officials to currency traders, from economists to academics – America was over. Back in those days, everyone was a real estate mogul and hedge funds were the smart money. We now know that the real estate boom was a bubble built on poor lending standards and too much leverage, some high profile hedge funds have closed their doors after severe losses, and one of the biggest and most exclusive hedge funds was just a Ponzi Scheme.

When financial news becomes general news, it can often mark an important turning point. Negative dollar sentiment climaxed right at the end of a long decline (-42%) in the U.S. Dollar Index. The Dollar peaked in 2001 after a long rally (+51%) that began in early 1995. Five months after Gisele’s comments, the Euro Index ($XEU) peaked and then declined (-23%) into the October 2008 lows. The Dollar Index ($USD) bottomed around that time and rallied (+27%) through March of 2009.

One method of investing, called ‘contrarian investing’, means doing the opposite of the herd. For instance, when every other commercial on TV is an infomercial for buying real estate it is probably not the best time to be buying real estate. This analysis can also apply to market bottoms. A couple of months ago, I was getting calls from people who said they had heard the Dow Jones Industrial Average (DJIA), an index made up of the 30 largest companies in the U.S., was going to 5000, maybe even 4000. The DJIA peaked just over 14000 in March of 2007. These calls were coming in March of 2009 when the index was under 7000. Contrary to general sentiment, the market went 2000 points in the other direction.

There is an old saying on Wall Street that ‘When the market goes on sale nobody wants to buy.’ It is a natural human behavior to be afraid when we sense danger. But a contrarian investor understands that the fear factor creates opportunity. Now I am just waiting for Gisele to say she will no longer be contributing to her 401K because the stock market and economy are so bad. That could be a good contrarian sign.

Written by Jason McMillen, Chief Investment Strategist, PPWM

What would Friedman do?

noreply@blogger.com (Portland Private Wealth Management Group) — Sat, 07 Mar 2009 19:05:00 +0000

Milton Friedman (1912 – 2006) is possibly the most influential economist of all time. His ideas have been woven into the DNA of American economic and political life by the likes of Barry Goldwater, Ronald Reagan and Alan Greenspan. In a nutshell, Friedman is among the great advocates of free markets, deregulation and arguably his influence has been very beneficial.

In 1963, Friedman co-authored a book titled the Monetary History of the United States:1867-1960. In this book, he laid out his argument that the Great Depression began as a typical business cycle recession and mutated into major depression because the Federal Reserve Bank contracted the money supply between 1928 and 1933.

In an interview in 2000, Friedman said:

“We have to distinguish between the recession of 1929, the early stages, and the conversion of that recession into a major catastrophe…. What happened is that [the Federal Reserve] followed policies which led to a decline in the quantity of money by a third….And that extraordinary collapse in the banking system, with about a third of the banks failing from beginning to end, with millions of people having their savings essentially washed out, that decline was utterly unnecessary. At all times, the Federal Reserve had the power and the knowledge to have stopped that. And there were people at the time who were all the time urging them to do that. So it was, in my opinion, clearly a mistake of policy that led to the Great Depression.”^

In the late 1920s, the Federal Reserve believed that speculative excesses of the ‘Roaring Twenties’ needed to be purged. Any government intervention to the contrary would only slow a necessary and natural process. In terms of the banking system, weak banks needed to close and the strong would survive. That was the policy prescription that carried the day. But in retrospect, allowing the banking system to fail caused the economy to collapse. By 1933, roughly 1 in 3 Americans were unemployed. In some places it was 1 in 2.

Friedman strongly believed that the government should tinker as little as possible in the private sector except for controlling the supply of money. When asked if he supported the policies of Franklin Roosevelt and the New Deal, he answered:

“Because it was a very exceptional circumstance. We'd gotten into an extraordinarily difficult situation, unprecedented in the nation's history. You had millions of people out of work. Something had to be done; it was intolerable. And it was a case in which, unlike most cases, the short run deserved to dominate.” ^

On nearly a daily basis I am told that government should let the banks fail and the government’s stimulus plan is a waste of money. People ask why should we (the taxpayers) borrow massive amounts of money to bailout irresponsible investors, bankers and borrowers? That answer may lay in the thoughts of Milton Freidman. We can go the route of Great Depression II or we inject the billions, probably trillions needed to stabilize the banking system. I hope that the powers that be in Washington do what needs to be done.

^ Source: www.pbs.org, Commanding Heights, 10/01/00.

Written by Jason McMillen, Chief Investment Strategist, PPWM

Financial Pandemonium

noreply@blogger.com (Portland Private Wealth Management Group) — Fri, 27 Feb 2009 15:48:00 +0000

Metastasis

What began as a housing bust and credit crunch has metastasized into a full-scale financial meltdown. Banks have found that the securities they bought with depositors’ money are now worth far less than they could imagine. Bank write-downs have reached $792 billion offset by $826 billion in capital raised. ^ $380 billion of the capital raised represents public monies. ^

Lender of Last Resort

Several first-round investors, including sovereign wealth funds, billionaire financiers, private equity and hedge funds have lost their investments. It now appears no one will give financial companies any more money. As a result, the taxpayers, through their proxies – the Treasury and the Fed – are the ‘lender of last resort’.

Shouldn’t We Just Let Them Fail

The alternative to the lender of last resort is to allow the financial system to implode and see what rises from the wreckage. This solution may not be particularly palatable as the adjustment could be harsh (riots, populism, massive layoffs, deflation, hyperinflation) and what could emerge on the other side is a much smaller economy, lower incomes, higher unemployment, and potentially a much different political landscape.

Seizure and Liquidation

When a bank’s reserves fall below a certain level we have instructed the FDIC to seize those banks and liquidate the assets. When this happens to our biggest banks, we have to decide if this liquidation process would heighten the level of anxiety, induce further financial pandemonium and potentially compound the problems in the economy.

Capital Injections and Nationalization

The alternative to seizure and liquidation is for the taxpayer to inject capital into these institutions. Nationalization is the process where the taxpayer takes ownership stakes in systemically important financial firms. The dilution of the existing shareholders is good because it essentially makes them pay dearly for their foolishness.

Eatin’ Boiled Crow

Hopefully, we are getting closer to the beginning of the end of this mess. A healthy and efficient financial system enables our economy to be far more productive than otherwise. To return to health will likely mean that the so-called toxic assets are quarantined. The quicker we ‘eat crow’ – i.e. the banks clean up their balance sheets -- the sooner the economy can begin a recovery.

Written by Jason McMillen, Chief Investment Strategist, PPWM

^ International Monetary Fund, Global Financial Stability Report, Update, January 2009, Updated as of January 26^th, 2009.

Toxic Assets

noreply@blogger.com (Portland Private Wealth Management Group) — Sat, 14 Feb 2009 19:22:00 +0000

“In the past ten years, the field of money, banking, and financial markets has become one of the most exciting in all of economics. Financial markets are changing rapidly, with new financial instruments appearing almost every day; the once staid banking industry is now highly dynamic, with the distinction between commercial banks and other financial institutions becoming increasingly blurred.”

Frederic Mishkin, Professor of Economics, Columbia University, The Economics of Money, Banking & Financial Markets, 2^nd Edition, 1989

MIshkin was a former Member of the Federal Reserve Board of Governors from 2006 to 2008.

In 1990, I was a sophomore at a small liberal arts college in Salem, Oregon. Money and Banking was a second level course for students majoring in economics. The topic that dominated economic lectures during my time in college was the Savings & Loan Bailout. Thousands of small banks were seized and subsequently liquidated by the federal government. At the same time, one of the largest bank in the United States, was teetering near insolvency due to soured loans in emerging markets and commercial real estate. (Financial crises are like movie sequels -- the same characters and a slightly modified plot line.)

Roughly two pages of Professor Mishkin’s 500-page textbook published in 1989 are devoted to the subject of securitization. Securitization is the very much the root of the troubles facing today’s financial system. Professor Mishkin described securitization as the process of transforming otherwise illiquid financial assets into marketable capital market instruments.

Securitization was born in the 1970s, but in the 1980’s it gained momentum. Little did Professor Mishkin know that securitization would eventually bring the global financial system to a standstill. Ironically, 20 years later, these illiquid assets have been transformed, but into instruments that are still illiquid. These assets are more commonly know as toxic assets that sit on balance sheets of our biggest banks.

The problem facing Timothy Geitner, our new Treasury Secretary, and it is the same problem that faced former Treasury Secretary, Hank Paulson, is that banks believe these securitized instruments are worth far more than the market is currently willing to pay. Since no one will pay the banks what they are asking, these instruments cannot be converted to cash to loan out to borrowers, or pay out depositors if there was a run on these banks.

If we are to get the financial system working again, this problem must be resolved and it seems likely that the Federal Government will have to put taxpayer money at risk to create liquidity. If the government does nothing, the economy may spiral into a deflationary depression. And if government does something, we still have a very nasty recession and the taxpayers may be stuck with a substantial loss. But addressing the problem in a timely manner may pave the way to a stronger and more stable financial system in the future.

Written by Jason McMillen, Chief Investment Strategist, PPWM

C + I + G + (X – M)

noreply@blogger.com (Portland Private Wealth Management Group) — Sat, 14 Feb 2009 19:14:00 +0000

The amount of the fiscal stimulus plan is not some random number. It is not calculus, quantum mechanics or rocket science. It is arithmetic. In Economics 101, every first year student is taught the equation for aggregate demand (a term used to describe total spending in any economy generally referred to as gross domestic product (GDP).

Consumption (C) is all consumer expenditures for goods and services. Investment (I) is private sector spending on capital goods (i.e. a factory or equipment). Government (G) is expenditures for publicly provided goods and services (i.e. military expenditures and social security payments). Exports (X) are revenues for goods and services shipped internationally. Imports (M) are payments for foreign goods and services from places like China, Canada and Mexico.

According to the Bureau of Economic Analysis (BEA), GDP ended the fourth quarter of 2008 at $14.2 trillion.* GDP decreased 4.1% from the end of the third quarter of 2008. If we assume the economy will decline 4% for next year, roughly $568 billion in economic activity will disappear relative to the prior year. In other words, C (Consumption) and I (Investment) will decrease by $568 billion if economy contracts by 4% in 2009. If this is the case, the fiscal policy prescription is to increase G (Government) by some amount to offset that decline. In fact, the government intends to increase G by nearly $787 billion of which 74% will be spent by September 30, 2010.

A poll of economists on February 12, 2009, estimate that the U.S. economy will shrink by 1.9% in 2009.^ I assume their assumptions include some level of fiscal stimulus by the U.S. government. However, the majority of economists are in agreement that the fiscal stimulus plan will not be enough to stop economy from contracting. The Congressional Budget Office (CBO), a non-partisan government agency, reported that the fiscal stimulus plan will increase GDP somewhere between 1.8% and 3.8% in 2009, 1.3% and 3.3% in 2010, and .4% and 1.3% in 2011.^^ The CBO also estimates that the stimulus plan will increase employment between .8 million and 2.3 million in 2009, 1.2 million to 3.6 million in 2010, and .6 million and 1.9 million in 2011. But despite the fiscal stimulus plan we are still facing negative GDP growth and a nasty recession.

In March of 1933, Franklin Delano Roosevelt launched a series of fiscal stimulus measures to stabilize the U.S. banking system and promote economic growth. Past performance is no guarantee future performance, but 1 year later the S&P 500 was 72% higher and 5 years later the S&P 500 was 190% higher than the day FDR become President. Perhaps better times are not too far ahead.

* Bureau of Economic Analysis, Press Release, January 30, 2009.

** New York Times, A Smaller, Faster Stimulus Plan, but Still With a Lot of Money, February 13, 2008.

^ The Economist, February 12, 2009.

^^ Congressional Budget Office, February 11, 2009.

^^^ Robert Shiller, Irrational Exuberance.

Written by Jason McMillen, Chief Investment Strategist, PPWM

The Core / Satellite Strategy

noreply@blogger.com (Portland Private Wealth Management Group) — Sun, 09 Nov 2008 23:43:00 +0000

Listen to Podcast

We like a core/satellite approach because it has several features in terms of portfolio design that is often ignored by rigid ‘check-the-box’ wealth management strategies. First, it has built-in modularity and by that we mean it can be easily adjusted and tweaked. For instance, suppose you wanted to increase you exposure to consumer cyclicals, financials and technology stocks. This could be easily accomplished by purchasing exchange-traded index funds for the core or satellite portion of the portfolio. Let’s suppose you wanted to reduce your exposure to energy and basic material stocks or increase your weighting to income producing instruments within in your core portfolio. By design we build the portfolio so that the exposure to any individual security, industrial sector or asset class is readily transparent and easy to modulate. The core/satellite approach enables us and provides you the flexibility to be more opportunistic or more defensive when market conditions change. A common complaint from new clients is that they have no idea where their exposure exists and their previous advisor had very little incentive or ability to manage it. The general explanation is that professional managers will make the proper adjustments to your portfolios when market conditions change. The reality is many so-called professionals are too big to be as nimble as they claim to be. Basically the investment process has been de-personalized and there is little accountability for the clients. We build clients a truly unique and transparent portfolios and then we work with them to help them understand what they own, why they own it and what the risks are. Clients deserve more than check-the-box wealth management and they deserve a personalized portfolio.

Investment Discipline

noreply@blogger.com (Portland Private Wealth Management Group) — Sun, 09 Nov 2008 19:04:00 +0000

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We are bottom-up. That means we start by looking at individual companies and we build our investment themes from there. Initially, we look at company earnings, profitability, cash flow, products and management. We like companies that make money on a consistent basis, the earnings stream grows at a reasonable rate, the management is bullish on their businesses going forward and they have a good history of execution. The ultimate question is what will these company be worth if they execute their business plan, what is the price today and can we make money as investors assuming they are successful. This is called fundamental analysis. The second step is to utilize tools that enable us to purchase securities at opportunistic price points. Some people never pay retail prices because they always hit the sale when they go shopping. That is what we try to do. We like to buy when securities are on sale. The study of price movement is called technical analysis. As we go through this research process investment themes begin to emerge. Based on these themes we find investment vehicles for our client’s portfolio that are consistent with their investment objectives, time horizon and risk tolerance.

For example, based on our research process, we noticed that the companies that provide equipment, services and technology to companies that explore and drill for oil and natural gas have good earnings, profit margins, cash flow, and their earnings are not as sensitive to the price of oil as are the exploration and production or the refining companies. The managers in this industry are bullish on the long-term prospects of their businesses. Recently, oil prices fell from $149 per barrel to around $65 per barrel and these stocks have lost 50% to 70% of their value. We think this sell-off represents an opportunity to accumulate these securities as our current bottom-up research indicates these companies represent long-term value for our clients relative to other investment alternatives. For our client’s portfolios, we can achieve exposure to these companies through individual stocks, sector specific exchange-traded funds (ETFs) or even call options for our most aggressive clients. The solution depends on the client’s investment objectives, risk tolerance and time horizon. It is not rocket science, it is just work and we have a passion for it.

Be Global

noreply@blogger.com (Portland Private Wealth Management Group) — Wed, 05 Nov 2008 23:44:00 +0000

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The total equity market capitalization of public companies globally is around $42 trillion.^ The U.S. represents about 39% of the world’s equity market capitalization. The U.S. economy represents about 21% of world’s economic output.* That means that the majority of world’s investment opportunities lie outside the U.S. When we are building investment portfolios for our clients we look for the best companies in their respective industries no matter what country their global headquarters may reside. We believe an investor’s core portfolio should be made up of a group the world’s best global companies through a combination of stocks, preferred stocks and bonds. In the U.S., we are particularly fortunate that many of the world’s best companies have taken steps to make their listings available to U.S. investors. Although, the world has become increasingly global we are still limited in our ability gather the all of the necessary information to make good investment decisions for some foreign securities. As a result, we rely on investment managers that are on the ground in places like Asia, Eastern Europe and Latin America to augment what we can do for our client’s from our corner of the world.

^ Source: World Federation of Exchanges, September 2008.

* Source: imf.org (as of 2007)

Demand More than Check-Box-Wealth Management

noreply@blogger.com (Portland Private Wealth Management Group) — Tue, 04 Nov 2008 22:21:00 +0000

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In our opinion, investment advice has been increasingly commoditized. Wall Street, along with the massive mutual fund complex, has taught investors that proper asset allocation will help them achieve their financial objectives. In order to help investors develop a proper asset allocation strategy they have designed a system of boxes that most investors have seen. It divides investment strategies into value and growth; large, mid and small companies; international; emerging markets; real estate; commodities; alternative strategies; fixed-income strategies of short, medium and long maturities, varying credit quality, international bonds, bonds of emerging countries, etcetera. This is not meant to be an exhaustive list but is meant to illustrate the multitude of boxes that many advisors suggest investors ‘check’ to achieve a diverse mix of assets. Essentially, the product du jour of recent years for the mutual fund complex has been to create the new ‘must have’ box for investors. Check-the-box wealth management is a valid investment strategy, but we believe it is a commodity service. We think too many investors overpay for these asset allocation strategies and we attempt to provide more value to our clients than check-the-box wealth management.

Avoid Complexity & Financial Burritos

noreply@blogger.com (Portland Private Wealth Management Group) — Mon, 03 Nov 2008 23:56:00 +0000

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It is our opinion that if an investment is difficult to understand or lacks transparency, then it should generally be avoided. In recent years, Wall Street has created a massive debacle as they have become victims of their own excessively complex financial products.

One such product is called the Structured Investment Vehicle (SIV). A SIV borrows money by selling short-term paper to one group of investors at low interest rates and then they use that money to buy longer-term instruments with higher yields. They enhance the yield by utilizing leverage up to 15:1. SIVs are then sold to another group of investors in chunks of $1 to $30 billion.

Essentially, a SIV is what we call a ‘financial burrito’ with all sorts of goodies inside including some spicy leverage. Many SIVs invested in solid long-term investments including mortgages, credit card debts, auto loan debts, student loan debts, royalties of various kinds, credit default swaps and complex derivative transactions. What really got SIVs in trouble was a class of investments now referred to as ‘toxic subprime debt’.

The marketers of SIVs went up and down the financial world selling these ‘financial burritos’ to banks, insurance companies, pension funds, endowments, investment companies, brokerage firms, governments, sovereign wealth funds – you name it – anybody with a billion bucks to pony up. When the housing market peaked in the United States in August of 2006, the falling prices of homes reduced the value of mortgage debt in these SIVs. The leverage factor compounded losses and once yield-hungry investors quickly shunned these investments.

As home prices continued to fall in 2007 some SIVs completely imploded. The so-called ‘smart money’ ran the for the exits all at once and many SIVs lost significant value putting additional pressure on the balance sheets of the financials institutions who owned them. In fact, the ironic double whammy came for some institutions who had loaned money to these SIVs. As losses piled up, liquidity evaporated and the value of SIVs continued to plummet and banks were strapped to make loans even to their most credit worthy customers. By the middle of 2008, over ½ trillion dollars has been lost by financial institutions and some people have estimated that the total losses will eventually be over $1 trillion^.

The lesson we take away from this along with many other examples from Wall Street is that investments that appear overly complex, illiquid and lack transparency should be viewed with a large degree of skepticism. And make sure you know what is in your burrito.

^Bill Gross, PIMCO, Investment Outlook, Moooooo!, August 2008.

Invest for the Long Term

noreply@blogger.com (Portland Private Wealth Management Group) — Sat, 25 Oct 2008 19:46:00 +0000

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We call our investment philosophy the ‘new old school’ because it is getting back to what we consider the basics of investing. When we study some of our favorite investment heroes such as Warren Buffet (1930 – present), Sir John Templeton (1912 – 2008) and George Soros (1930 – present), a general theme emerges – they bought and held investments for significant periods time. Buffet is well known for buying basic businesses with strong management and good cash flow. Templeton’s legacy is to not follow the herd. Soros, who is often referred to as a speculator, was and is no ‘day trader’. Soros's investment strategy is based on long-term macroeconomic themes. He is recognized for pricking economic bubbles, crushing excessive valuation and punishing greedy and naïve speculators. These notable investment moguls were long-term investors and we believe much can be earned by studying and emulating their actions.

Independent Thinking

noreply@blogger.com (Portland Private Wealth Management Group) — Fri, 24 Oct 2008 00:56:00 +0000

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Independent thinking is one of the cornerstones of successful investing. When you read the histories of investment icons like Warren Buffet, Sir John Templeton and George Soros, their best investments were not popular or well-known ideas at the time. These ideas were based on an assumption that the ‘crowd’ had not recognized the correct future value of the investment in question. In order to be a successful investor, you have to look into an uncertain future and make correct assumptions today. This is a counter intuitive exercise because by the time the bad or good news arrives it is too late. The basic theory of the efficient market hypothesis is that the value of an investment will be fully realized almost as soon as any information affecting its value becomes public knowledge. When the peddlers of investment ideas from Wall Street make recommendations public knowledge then that news should already be priced into or will be rapidly priced into the investment as soon as news is released to the public. Therefore, you need develop your own ideas long before the Wall Street ‘crowd’ jumps on board because it will be the crowd who will move prices to where you think they should be. That is why you must utilize truly independent thinking and develop your own investment ideas. It is probably no coincidence that Buffet is from Omaha, Templeton stayed in the Bahamas and Soros had to start his own firm to pursue his own investment ideas.

Do Your Own Homework

noreply@blogger.com (Portland Private Wealth Management Group) — Tue, 21 Oct 2008 18:08:00 +0000

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'I trust only those statistics I have manipulated myself’ is a quote often attributed to Sir Winston Churchill. When it comes investing, and speaking from experience, it is best to do your own homework. Wall Street is a business of selling information to people to get them to buy or sell something in order to generate a fee. While some research from Wall Street is very good, most of must be taken with a grain of salt. There is no definitive study that proves that Wall Street research is good, in fact, it is quite the opposite. Analysts tend to be overly bullish most of the time and then overly bearish when they should be bullish.^ They are just human beings after all. But don’t get us wrong, there are some good analysts out there. Further complicating this matter, the media gives you snippets generally showing pundits with opposing points of view. So how do you make sense of this noise, or know what to do or whom to trust? Well, the only way we know how to do this is by doing our own research. We trust ourselves. This is truly independent thinking.

^ Cusatis, Patrick, and Woolridge, J. Randall, "The Accuracy of Analysts' Long-Term Earnings-Per-Share Growth Rate Forecasts,” Press Release, Penn State Smeal School of Business, March 2008.

Generate Good Ideas

noreply@blogger.com (Portland Private Wealth Management Group) — Sun, 19 Oct 2008 00:45:00 +0000

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In the increasingly commoditized market of financial services it has become more important for investment advisors to differentiate themselves. One method has been to offer a new financial product that either has more bells or whistles such as an insurance product. The strategy of the mutual fund complex is to offer the next ‘must have’ investment product that will help you ‘check off’ another box in your asset allocation or peddling the fund-of-funds retirement product with a name of the year you would like to retire. Another recent fad has been to offer exclusive access to the hottest ‘hedge fund’ manager last year. While each of these investment strategies may be appropriate for some investors, we believe the simplest approach that can achieve a client’s goals with less fees and is easy to understand is probably the best. For instance, a client may want income in retirement. An old-fashioned laddered bond portfolio combined with a simple term life insurance policy may achieve the same objective as a fancy insurance product at a fraction of the cost. In fact, you might not even need the insurance. We like the idea of a laddered bond portfolio because we can control what we own in terms of the credit quality, yield and maturity of the portfolio. It is transparent, there is minimal complexity, we control the turnover of these bonds and it has modularity meaning we can sell any of the bonds, at any time, for whatever reason. We keep it simple. It seems like a good idea to us.

Know What You Own and Why You Own It

noreply@blogger.com (Portland Private Wealth Management Group) — Mon, 13 Oct 2008 21:21:00 +0000

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Our core philosophy can be summed up with the phrase ‘know what you own and why you own it’. If your financial advisor cannot adequately explain to you why you own something or what your underlying investments are, then you probably should not own it. If you cannot easily understand all of the fees and are able to make a true assessment of your total cost of ownership, then you should probably skeptical of such an investment. If you feel you are part of the investment ‘herd’ or paying to much for a ‘cookie cutter’ asset allocation strategy then you probably are. If you feel that you have to much turnover or trading in your account, then you probably do. If your statement is full of pages and pages of transactions and you are uncomfortable because you are not sure what is going on in the account, then you should probably make some changes. If your advisor doesn’t do his or her own homework and is peddling his or her firm’s latest ‘best idea’ then you should probably think twice. If your advisor does not develop his own independent ideas or has not brought you a truly unique investment idea, then you are probably a member of the Wall Street crowd. We call our philosophy the new old school because it is about getting back to the basics of investing, avoiding complexity, minimizing extraneous fees and investing for the long term.

Back-to-Basics

noreply@blogger.com (Portland Private Wealth Management Group) — Tue, 23 Sep 2008 18:20:00 +0000

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There are essentially two core investments instruments. The first is stocks or equities that make investors shareholders or owners of companies, and the second is bonds or fixed income that make investors lenders to companies. Stockholders enable investors to share in the profits of the company whereas bondholders are entitled to a periodic interest payment from the company. Investors, either as stockholders or bondholders, can manage their risk by the number of securities they own and the credit quality of these companies. Individual investments or sector specific investments have more risk whereas widely diversified investment vehicles such as mutual funds have less risk. At the end-of-the day, we believe investors either want to be stockholders or bondholders in what we believe are great companies. Somewhere along the way investing got really complicated for the majority of investors. We try and help investors get exposure to great companies in a sensible and transparent way while minimizing fees and other layers between the investor and their investments. We call it getting back-to-basics.

Minimize Extraneous Fees

noreply@blogger.com (Portland Private Wealth Management Group) — Tue, 16 Sep 2008 00:14:00 +0000

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Most investors have no idea what their real cost of ownership is for many investments. The popular mutual fund-of-funds comes to mind to illustrate the potential fees incurred by investors. Initially, the investor may pay an ‘advisory fee’ or a ‘load’ to buy or sell the fund in order to compensate the investment advisor or broker who recommended the purchase of the fund. A fee is paid to the manager of the fund-of-funds who selects which funds to invest in. Another fee is paid to managers of the actual funds inside the fund-of-funds. Each fund at both the fund-of-funds level and the underlying fund level have operational and marketing expenses it may charge. The fund may pay a marketing fee often referred to as a ‘trailer’ to the advisor or broker who sold the fund. The underlying funds have transaction fees in the form of commissions paid to buy or sell the underlying investments in the funds, which may include the purchase of even another fund product with its own layer of fees. The more turnover, i.e. the purchase and sale of securities, in the underlying funds increases the amount of fees paid by the investor. If this sounds complicated then it probably is. All of these fees are a ‘drag’ on the potential return to be enjoyed the investor. A fund-of-funds may be an appropriate solution for a client. We are open-minded. However, simple is better in our view and keep the fees down.

Minimize Turnover

noreply@blogger.com (Portland Private Wealth Management Group) — Sun, 07 Sep 2008 14:32:00 +0000

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We try to minimize the amount of turnover that a portfolio will incur. Turnover is the number of times a portfolio is traded relatively to its total value. 100% turnover would mean that the entire portfolio was traded at least once during the year. Many studies have shown that turnover leads to inferior investment performance mostly due to transaction costs (and taxes) even at the institutional level. Some portfolio managers have superior trading skills and generate extraordinary returns through their trading activities. However, this is the exception rather than rule.^ In recent years, many investors have been introduced to the separately management account (SMA). This investment product allows one investment advisor to hire another investment advisor to manage the portfolio of his or her client. While this may make sense for some clients, our general experience is that many investors find themselves having several managers and owning hundreds of securities in tiny amounts relatively to their total portfolio. Sometimes these portfolios have significant amounts of turnover. New clients routinely testify that on a monthly and quarterly basisthey receive pages and pages of statements that make little or no sense to them, and their advisors know very little about the investments in the portfolio. They also have very little access to the person(s) whom they pay to manage their portfolio. Our clients usually want fewer investments, less turnover and want to own companies for the long-term. We help clients simplify their investments and their statements.

^Bauman, W. Scott, Managing Portfolio Turnover: An Empirical Study, Quarterly Journal of Finance and Accounting, Summer 2005.