Politics and Investing

Should politics impact our investing?

Source: Wikipedia

Many folks are concerned about the upcoming presidential election. The two major party candidates elicit strong reactions. Three quarters of those surveyed think it will have a big impact on their personal finances. And many folks are pulling out of the market in response to their fears of a Clinton or Trump presidency. Is this a good idea?

It’s helpful to look at a little history. During the dot-com busty from 2000 to 2003 the Nasdaq index was crushed, falling 78 percent. Alan Greenspan took rates down to 1%, and the Bush administration pushed through about $1 trillion in tax cuts. With a trillion dollars, you can throw a pretty good party. Many people opposed to Bush thought the stimulus was bad: it would balloon the deficit, the tax-cuts were a giveaway to the wealthy, this was just more trickle-down economics, and so on.

While those may have been good points, they were largely irrelevant to the stock market. All the fresh cash supported a strong cyclical rally over the next four years. The S&P 500 rose 100% from 2003 to 2007.

The same thing happened to those critical of the Obama administration. After the Affordable Care Act was enacted in 2010, many critics thought that it would destroy the health care sector—creating distortions and perverse incentives. While the ACA may have done this, it also added 40 million new health care consumers. And the health care sector has rallied 140% since the law was passed—40% more than the general market. Those who expected Obamacare to destroy the health care sector missed out.

Source: Bloomberg

When it comes to politics, investors need to vote at the ballot box, not with their portfolios. Our investments should be driven primarily by our own personal circumstances, not our political convictions. Short-term thinking rarely helps us meet our long-term financial goals.

Political campaigns engage our emotions. When it comes to investing, though, emotions aren’t usually very helpful. This extraordinary election gives us an extraordinary opportunity to keep calm and invest rationally.

Douglas R. Tengdin, CFA

Chief Investment Officer

No Safety in Numbers

When are sovereign bonds no longer safe?

Global Yield Curves, 10-28-16. Source: Bloomberg

For decades people have invested in stocks for growth and in bonds for safety. But the global financial crisis and its economic aftermath have changed that. Now sovereign bonds around the world have extremely low yields. 30-year bonds in the US yield just over 2.5%, and that’s the highest yield anywhere. You can get higher yields in emerging markets, but those come with currency, credit, and inflation risk.

There have been two prior periods with low nominal bond yields like this one: the 1890s and the 1930s. Both were times of restrained economic growth following a financial crisis. Both were also periods of populist sentiment and public hostility to bankers. “Burn down your cities,” William Jennings Bryan intoned, “and they will spring up again; but destroy our farms and the grass will grow in the streets of every city in the country.”

To be sure, today’s economy differs significantly from that of the ‘30s or 1890s: the service sector is much larger, the government plays a much bigger role, and monetary policy is more flexible—we’re no longer on a gold standard. Also, the economy is more diversified. But the decline in nominal yields is striking: after the prior two crises, yields remained depressed for at least 20 years.

Source: Credit Suisse

For investors, this is important. A prolonged period of very low rates means that traditional asset allocation models won’t work the way they used to. Robo-advisors and passive strategies may be well-intentioned, but they’re not the solution in a sustained low-yield environment.

Times change, and investors need to change with them. If we want to reach our financial goals, we’ll need to be more creative.

Douglas R. Tengdin, CFA

Chief Investment Officer


We all love rags-to-riches stories.

Seabiscuit with trainer Tom Smith. Public Domain. Source: Wikipedia

Like the story of Seabiscuit—a short horse with an old trainer and a history of injury—we’re captivated by the turnaround. The Apple Computer that Steve Jobs brings back from near bankruptcy, so he can introduce the iMac, iPod , iPad, and iPhone. Apple has been so successful that almost every active manager is now under-weight the stock.

Or a plucky emerging market company, like Infosys, that markets its outsourcing services to an increasingly interconnected market and ultimately becomes one of the largest programming companies in the world. We like to cheer for underdogs.

That’s why so many people are enticed into buying penny stocks and hard-luck stories. An internet ad or hot tip from an acquaintance promises stunning wealth in a very short time. Just look at what $1000 invested in Apple in 1994 did, they say. It would be worth $50 thousand today. We’re pre-programmed to listen to narratives.

But lottery tickets rarely pay enough to justify their purchase. That’s why states sell them. For every Apple out there there’s a hundred “Innovative Software” or “Magnetic Technologies” that either go nowhere or into bankruptcy. That’s why they call it speculation. We don’t think about them because they don’t make much of a splash. Rags-to-rags stories don’t sell papers.

Investing is hard work and people can be pretty successful if they establish disciplines, manage risk, and learn from their mistakes: that is, if they do the work! That’s the side of Horatio Alger stories that’s often forgotten—the sweat equity of equities. Equity investing can be profitable, but only if you work at it.

Douglas R. Tengdin, CFA

Chief Investment Officer

Trust, Trusts, and Family

Trust, Trusts, and Family

Who do you trust?

King Lear and his daughters, by Benjamin West (1793). Source: Folger Shakespeare Library

When people make an estate plan, they need to decide what to do with their money. One of the most important decisions is choosing a trustee. Because a trustee will control the assets, usually for a long time. So making the right choice will have far-reaching consequences.

Shakespeare writes about this kind of decision in King Lear. At the beginning of the play, Lear says that he plans to retire. He wants to divide his possessions among his three daughters. The elder two heap praise upon flatter him, and Lear just laps it up. But his youngest is disgusted by her sisters’ cloying speeches. When called on to speak, she has almost nothing to say. “Nothing will come of nothing,” Lear rages, and he settles her portion on the other two.

As the play goes on, the character of the two older children becomes clear. They are manipulative, deceitful, and grasping. They cut the level of their Father’s support; they even lock him outside during a violent storm. They conspire against him and later turn on each other. Reading King Lear gives us an excellent lesson in family dynamics.

People planning to name family members as trustees should ask themselves if their relatives are suited for the role—how well they get along, what skills they have, if they are prepared. Sibling rivalry can be an issue, and even if relations are good, putting one person in charge of the others’ money will create a lot of issues. Having multiple co-trustees may just make things worse, though: decision-making is difficult, and often, nothing gets done. A neutral third party may be better equipped to referee disputes and say “no” when necessary.

Lear eventually comes to grief because of his rash choices. Never underestimate the power of an estate. People do all kinds of surprising things when money is involved.

Douglas R. Tengdin, CFA

Chief Investment Officer

[tag trusts, family, Shakespeare, King Lear]

Pennies from Dividends

What good are dividends?

Public Domain. Source: PD Photo

It’s a good question. Dividends can limit a company’s options, forcing them to cough up cash that could be used to run the business. If they money flows out of the company, they might have to increase their borrowings. Ford paid a big special dividend in 2000—they called it their “Value Enhancement Plan.” Management probably wished they still had that cash a few years later during the financial crisis.

You’d expect that paying dividends would make those companies more risky. But in fact, the opposite is the case. It turns out that the stocks of dividend-payers are less volatile than non-dividend payers. Why?

Part of the reason is the accountability. When a company pays a dividend, they have to come up with cash every quarter. This keeps them from doing anything too foolish. Investment bankers can cook up some awfully creative structures. Dividends require a certain amount of management discipline. Second, dividends are totally transparent. You’ll never hear about an accounting scandal where dividends were misstated. Earnings, cash flow, and even revenues can be fudged, but if a company says it’s paying a 50-cent dividend, there better be a check for 50 cents per share in the mail.

Finally, dividends are an admission by management that the shareholders—not the managers—own the company. If a company generates free cash flow—the cash from operations that remains after capital expenditures—it can do three things with the money that directly benefit investors: pay down debt, buy back shares, or pay dividends. Because boards are reluctant to cut them, dividends represent a concrete statement of faith—by those in a position to know—in the company’s stability and potential for growth.

Photo: Emmanuel Douzery. Source: Wikipedia

It’s easy to get distracted by PE ratios, Sharpe ratios, cash flow yield, and other metrics. These are important, but we should never forget that a stock represents a real company making real business decisions. When companies decide to give consideration to their shareholders, that’s always a good thing. After all: ultimately, it’s our money.

Douglas R. Tengdin, CFA

Chief Investment Officer

Trade is Hard

Why is free trade so hard to understand?

Source: Moeconomics Blog

The idea is simple: when everyone does what they do best, we’re all better off. Like a Mark Zuckerberg giving up coding to run Facebook. He knows how to code, by all reports he’s a good coder. But it wasn’t a productive use of his time. His time was better spent acting as Facebook’s CEO—managing his sector leaders, understanding where the business is moving, working out financial issues. So he gave up coding, even though he was good at it.

It’s the same with countries. One country may be better at everything they do than another. But it still makes sense for them to specialize in what they do best—leaving others to do what they do best—comparatively. This is called the “Law of Comparative Advantage,” and it was first articulated by Robert Torrens in 1808, when he suggested that if England traded cloth and lace with France—England’s mortal enemy—both countries would be better off. The idea was further developed by David Ricardo in 1817, in his book “On the Principles of Political Economy and Taxation.”

In this work, Ricardo considers an economy consisting of two countries that produce two goods of identical quality. But the relative costs of producing the two goods differ within each country. If each country specializes in the good for which it has a comparative advantage, global production increases—with no change in technology or labor. The mathematical logic improves conditions on both sides.

Yes, the world is more complicated than just having two countries produce two goods. And yes, the benefits of trade are not evenly distributed. David Ricardo himself discussed technological unemployment in the third edition of his book, published a few year later. But the general Ricardian equilibrium model—which accounts for thousands of goods and hundreds of countries—has been in place for decades, and a lot of folks still don’t get it.

Public Domain. Source: NOAA

Part of the reason is intellectual fashion. International trade isn’t cool—it seems to exploit sweatshop labor and cheap capital. Also, the very fact that free trade has been economic dogma for a long time counts against it. Another of the reason is xenophobia. We all prefer that which is familiar to that which is foreign. It’s why we see a home-bias in many investment portfolios, and grocery stores resist putting country-of-origin labels on their food. And part of the reason is that free trade is a harder idea than it first seems. It’s part of a matrix of concepts like efficient pricing, free exchange, flexible wages, and perfect information that aren’t always intuitive. Just because an idea has been around a long time doesn’t make it obvious.

Free trade rests on a mathematical foundation, and math can be challenging. Calculus was “discovered” centuries ago, but students still struggle with derivatives and integrals. But calculus proved essential to making the modern world. As is free trade.

Douglas R. Tengdin, CFA

Chief Investment Officer

Great Expectations

Is the market suffering from a case of mistaken identity?

Public Domain. Scene from “Great Expectations.” Source: Wikipedia

In Charles Dickens’ novel “Great Expectations,” his main character Pip is a poor orphan who suddenly starts to receive money from an unknown source. He thinks his mysterious benefactor is the cold and eccentric Miss Havisham. Miss Havisham is wealthy but mysterious, and she had taken Pip on as a companion for herself and her adopted daughter, Estella.

In reality, though, Pip’s money was coming from a formerly escaped convict, Magwich. Pip brought Magwich some food and a file after the convict scared Pip into helping him. Even though Magwich was recaptured and sent off to Australia, he remembers Pip’s kindness and starts to support him after Magwich gains his freedom in New South Wales.

Today, the market is hyper-focused on our global central banks—obsessing whether Janet Yellen’s Fed will raise rates ever-so-slightly in December, or put off the decision to a later date. Like Miss Havisham, the Fed is mysterious and full of strange omens. And our economy keeps moving forward, in spite of the many problems we’re facing.

In fact, however, the economy’s real support is coming from China. China’s economy has grown by almost $5 trillion over the past five years, while the US, Europe, the UK, and Japan combined haven’t expanded by even $1 trillion. All the machinations of our various central banks haven’t been able to overcome the problems posed by the hangover from the financial crisis, the Euro, terrorism, and other issues. Although China faces some serious difficulties, they are the complications that come from growth—from over 300 million peasants moving from the countryside into an urban, industrial economy. Frankly, these are problems the rest of the world would like to have.

Source: World Bank

Towards the end of Dickens’ novel, Miss Havisham eventually tells Pip that all her actions were designed to make him miserable—shortly before she accidentally sets fire to her dress. Let’s hope we never find our central bankers with their hair on fire.

Douglas R. Tengdin, CFA

Chief Investment Officer

Dreamers and Doers

Why do people start new companies?

“Wisteria” by Claude Monet. Source: Claudemonetgallery.org

At the heart of capitalism is the start-up—a new project founded on an idea and some hustle that creates a business out of nothing. If the idea catches on, the founders can make a lot of money. If it flops, the founders learn what doesn’t work and move on.

Many folks fail in their first attempts. It’s a costly tuition. That’s because there are so many ways for things to go wrong: growing too fast, moving too slow, hiring the wrong people, being over-controlling. It’s like science: knowledge grows by proving what doesn’t work through experimentation. But experimenting with your life can be a volatile experience.

Most startups are founded by technicians—engineers, design professionals, real-estate developers—who may understand how to make a product, but who don’t necessarily know how to run a business. They pick up the business skills along the way—or not. Sometimes, the idea is so good that it succeeds in spite of their mistakes. But entrepreneurs don’t usually upend their lives for the money: they do it for the adventure, they have a vision, or because it gives them a sense of control over their own future—instead of wilting inside a bureaucratic structure.

Start-ups struggle to succeed because new ideas often do not scale well—you can’t just add more people to make something big. There may be a payout at the end; more often there isn’t. But a startup allows its founders to dream. And the founders believe, as some have said, that if you can dream it, you can do it.

Douglas R. Tengdin, CFA

Chief Investment Officer

Right Track / Wrong Track / Off Track

What makes some companies thrive while others struggle?

Photo: Lexcelsior. Source: Animal Photos

We see lots of examples in the marketplace: Facebook created the dominant digital social network, while other platforms—MySpace, Friendster—never took off. Costco has grown as a discount club while Wal-Mart struggled. Johnson & Johnson has succeeded across a range of health-care businesses, while others faltered—brought down by scandals or shrinking markets. What’s the difference?

It comes down to management. Successful companies need visionary leadership—leaders that create a sense of community where their people have a chance to grow and develop, to try out new ways of doing things, where workers know that someone takes a genuine interest in them—not only as workers, but as people, too.

The military has a phrase for this: “officers eat last.” The higher ranking you are, the further back in the chow line you’re supposed to stand. The brass may represent the brains, but the enlisted folks are the brawn. Without enlisted men and women, there’s no need for officers. The attitude of those on the front lines is critical to any mission’s success. And morale can’t be commanded. It has to be nurtured.

Photo: Mary Vogt. Source: Morguefile

But leadership isn’t enough. To succeed on the battlefield, a unit can’t just believe and trust in its commanders. It also has to be going in the right direction. Having the right strategy is critical. Steve Ballmer was seen as a visionary leader at Microsoft. But they missed to boat on mobile applications and devices. Their software become over-engineered with “feature-creep” that made it confusing and difficult to use. And they focused on their desktop platform for too long. During his tenure at the helm, Microsoft became a wealth-destroyer.

Leaders inspire their people to outperform because they present a vision that’s bigger than themselves. But they need to be going the right way. Proctor & Gamble had a vision for where they wanted to go when they acquired Gillette. They paid a very high price, and the market was skeptical that the acquisition would be successful. But P&G used its expertise to create an ecosystem of shaving products around the already-dominant shaving brand, and the merger created value for everyone: consumers, employees, and shareholders.

Source: Bloomberg

An important investment theme is quality. When investors look for quality companies, they need to look beyond the bottom line: return on assets, cash-flow management, financial structure. Those metrics are important, but they’re not enough. We need to look at people across the firm to see if they’re inspired—and inspiring others—to move in the right direction.

Douglas R. Tengdin, CFA

Chief Investment Officer


Why is the economy growing so slowly?

Source: St. Louis Fed

Since the Great Recession, the economy has never gotten back into high gear. We’ve always seemed to be teetering on the edge of another downturn. Quarterly economic growth has averaged 2%, while a normal recovery is usually above 3.5%. Why?

First, the workforce is changing. We are now entering the period where baby-boomers are beginning to retire. Like most things the boomers have gotten involved with, they are transforming retirement. Their family finances may be stretched by having debt from putting kids through college, or because one in four have adult children living with them. Also, the changing nature of health care is changing everyone’s work patterns.

Second, there are some special factors that have made this recovery more difficult. Because the boom was in housing—creating oversupply—lower interest rates have not been able to stimulate the homebuilding sector very much. The Euro crisis and China’s economic restructuring have put a serious dent in demand for US exports. Long-term financial challenges in the States have reduced government hiring.

GDP Composition. Source: FRB Richmond

Finally, there are some long-term trends in productivity that began about 10 years ago. Growth in technology has been centered around software—an informational product—which doesn’t get consumed when someone uses it. My web-search doesn’t prevent you from searching the web. There’s also evidence that much of our newest economic activity isn’t being measured. For example, more pictures are being taken than ever before. But the GDP contribution from photography has actually plummeted over the last decade, as many people use smart-phones to take, upload, and share photos. This is a way that the measured economy is depressed by new technology.

There’s no magic here. Our slow-growth economy hasn’t developed because rates are too low or the Chinese are stealing our jobs or unicorns in Silicon Valley are too greedy. If we want to get the economy moving again, we need to encourage what creates economic growth in the first place: innovation, ingenuity, and productive people.

Douglas R. Tengdin, CFA

Chief Investment Officer