Just a few weeks ago, the headline risk was all negative. The narrative was that Covid-19 was spreading throughout the world in a second wave. Countries were closing down again. Would the U.S. be next to close down like in early 2020 and it was rumored this would most likely happen with a Biden win?
Speaking of the Presidential Election, the main-stream media did a pretty good job of fear mongering regarding that election. What if Trump won? Would there be rioting in the streets and general unrest? The narrative went that such unrest could be very negative for your portfolio and for America!
Turns out the Trump has not won (at least not yet as he pursues legal action in various swing states). Instead, Joe Biden appears to be the overwhelming favorite to assume the role of President come January.
Then recently, Pfizer announces a possible vaccine for Covid-19 with 90% effectiveness. Stocks of course are rallying like there is no tomorrow on the news and breaking to fresh highs clearing technical hurdles that just a few days ago we thought might lead to a market reversal.
The cynic in me wonders if Pfizer had a possible vaccine prior to the election but waited until Biden’s win to announce the trial effectiveness, but I digress. Maybe it’s just me, but it seems the good news is now coming in batches.
No matter the reason, my point here is that the market will do what it wants. It is an untamed animal that requires it be followed, not forecast.
Why Forecasting Doesn’t Work?
Have you noticed how many guests on CNBC are clamoring to give their market forecast? The reason is that it cost them nothing to do so, but if they are lucky enough to get it right, it could change their standing forever.
As I think back over time, I can remember a CNBC guest named Elaine Garzarelli. She was credited with calling the bottom of the 1982 and 1984 Bear Markets and the top of the 2000 Bull Market. However, where is she today? I don’t even know. You rarely see her anymore on any news channel. I can tell you it’s pretty hard to get the calls consistently right or we would hear more from or about her.
The constant flow of news and changing market conditions is what makes forecasting markets so tough. As an example, we have been using a service called Hedgeye to provide us fundamental data on global economies and the markets. The founder of this group is a pretty brash guy named Keith McCullough.
He and his group are constantly updating their subscribers on the economic quad that they believe the data is telling them that we are entering. Mr. McCullough bad mouths the Old Wall and investors who see the markets differently.
However, like Elaine Garzarelli before him, the constant change in the market narrative, the amount of market control now exercised by global Central Banks and the monetary policy (stimulus) that governments keep implementing has made their forecasts all but worthless. We recently cancelled our agreement with them as a result.
The Key to Success
We continue to believe the key to success is to follow the market until it tells you the trend is reversing. We call this Trend Following and it is something that is built into every portfolio we run.
It is not perfect, and we usually give up some upside and give back some profits waiting on the signals. However, it is a discipline and allows us to stay focused on the trend and not the short-term noise.
We like it for a number of reasons:
This latter point I believe is one of the most important. When the election approached, our models had us reduce exposure, which is good money management. However, those same models did not have us out of the market.
Now that the market is rallying again, we are participating in the rally and not sitting on the sidelines. Had some of the doom and gloom occurred that we mentioned previously, we would have limited downside risk.
We may now be underperforming on the upside as we look for the right time to possibly add back some exposure, but we did what our clients pay us to do and that is to “manage risk” first and foremost and generate positive returns as a secondary goal.
Maybe our process could help you? If so, please click here for a free consultation.
“Beware of wolves in sheep’s clothing” is a common quote that I would imagine that just about everyone has heard at least a few times during their lives. The saying goes all the way back to biblical times where Matthew warns believers to “Watch out for false prophets. They come to you in sheep’s clothing, but inwardly they are ferocious wolves. – Matthew 7:15.”
During the day, the religious elite used a series of expanding rules and regulations to ensnare the faithful, while in many cases disregarding or excepting out of those same rules.
Huh, what does that sound like today?
Wall Street Perfected Wolves in Sheep’s Clothing
Wall Street perfected the art of wearing sheep’s clothing! Never has there been a more ferocious group than the wolves of Wall Street.
A recent examples is its exemplary work to confuse retail investors over the issue “best interests.” Best interest is whether your advisor is looking out for your interest or his/her. Clue – it is supposed to be in your best interest.
As a registered investment advisor, it has been mandated for as many years as we have been advisors (and then some) that we must look out for the best interest of the client, even if it is not in our best interest. This is the way it should be!
On the flip side, commission-based broker and advisor competitors, regulated by FINRA under Rule 2111, have only had to meet a “suitability standard” for any investment or product that they might push your way. This suitability standard requires that the adviser or firm have a reasonable basis to believe a recommended transaction or investment strategy involving a security or securities is suitable for the customer.
This standard is the rough equivalent of licking one’s finger and sticking it in the air to determine which direction the wind is blowing. It is inaccurate at best and highly suspect in its application, especially when a big sales commission is at stake. This is why there are shops today where the solution to every financial issue of their clients is an annuity or some other financial product. How can such narrow products be suitable for everyone? Clue – they are not!
Our industry has attempted to clean up this behavioral discrepancy between advisors, like us, and the average commission based broker or adviser, but even the best attempts to do so by the Department of Labor (DOL) and the Securities and Exchange Commission (SEC) ended up as hollowed out versions of the originally proposed legislation after Wall Street’s lawyers and lobbyists got involved.
This has left the general public confused and allowed those same FINRA regulated brokers/advisors to hide behind fancy disclosures that proport to look out for your best interests but in reality are full of so many holes that they are really nothing more than a modified version of the suitability standard.
Wolves in the Multi-Family Office Space
Securities are just one element of what we do as a boutique, multi-family office. We provide a rather lengthy list of services to our clients, which are customized to each. Here are just a few of the more common services we provide in addition to wealth management:
These services are both technical and expensive to provide given the depth of knowledge required to provide such services.
However, in our bubble economy, the multi-family office has become all the rage and quite frankly our competitors, in most cases, are far better marketers. Family offices are popping up everywhere and multi-family offices are doing the same to handle the needs of those with significant wealth, but not so much as to justify a dedicated office and staff just for that family.
So naturally many advisors have seen this rise in interest for multi-family office services and have adjusted their business to meet this need. The problem is, just like our brokers friends, they are really nothing more than “wolves in sheep’s clothing.”
How do I know this? Because we deal with them every day.
Part of our competitive advantage is to say to the wealthy family that we can help you with family office services even if you would prefer others manage your investment assets. As a small firm, this has allowed us to grow and overcome an objection of being smaller, despite what I believe are substantial abilities in the area of investment management.
This position, as the trusted advisor, then allows us to see how the ultimate investment manager meets the client’s needs. In many cases, these investment managers likewise claim to provide family office services. I will let you in on a bit of a secret, they don’t!
They convince the family that they can do more than investment management and then mainly focus on the investment management while doing as little as possible to slide by on the family office side of the equation. These firms are nothing more than “wolves in sheep’s clothing,” deceiving the family while attempting to lock them into a relationship whereby the family feels they cannot effectively leave.
What is the solution? Naturally, it is to vet the firm harder and not be mesmerized by fancy marble flooring and expensive offices. I often find that the client believes “bigger is better” when in reality bigger equals impersonal, cookie cutter and bottom line driven.
May I suggest, smaller is better! Smaller in this space means intimate, boutique and a relationship that is more partnership and more family, than institutional. Isn’t that what families want? Next time, why not give smaller a try?
Let us know in the comments if you have had a “bigger is better” experience that maybe didn’t end up as expected
If you are like me, you have probably been rubbing your eyes, cocking your head to the side and looking perplexed. No amount of CNN or Fox News, depending on your political perspective, can sooth the gnawing feeling in your stomach that something is not right, something has changed!
Our founding fathers regularly gathered at taverns to discuss the politics of the day. There were surely differences of opinion, but somehow, in most cases, they were able to discuss those differences and agree to disagree. But not today, we are strongly divided today, and it appears to me there is little tolerance for opposing points of view. It is “my way or the highway buddy!”
The pandemic has not helped as it is now harder than ever to meet and gather to discuss the news of the day without of proper mask or social distancing. Even the favorite meeting places of our founding fathers (the local bar or tavern) are now closed or only partially open due to the virus.
Life has certainly entered a “New Normal” or paradigm and it’s much more stressful, at least to me.
However, what seems like chaos is really part of God’s bigger plan and the changes in our attitudes towards one another and our economy, part of cyclical changes that have occurred in the past and strangely tend to repeat themselves throughout history over and over again.
The Coming Cycle
Although we can paint a short-term picture of rising markets, which will benefit investors, we would also like to counter that optimism with what we believe is knocking on the proverbial financial door and that is a more difficult cycle.
In a whitepaper entitled, The Allegory of the Hawk and the Serpent, the hedge fund group, Artemis Capital Management, makes the case in a 100 year back test of the markets that there are periods of secular growth and periods of sec
The secular growth stages they call The Serpent. They define these periods as times when secular growth is driven by positive demographics, economic expansion, technological innovation, globalization and economic prosperity. These periods eventually become corrupted by greed, as fiat devaluations and debt expansions replace fundamentals as the drivers of asset price gains that are not unlike a Serpent devouring its own tail.
The Hawk signifies the forces of secular change and ultimately destroys the corrupted growth cycle of the Serpent. The left-wing of the Hawk represents the deflationary path, whereby an aging population leads to low inflation, faltering growth, a financial crash and then debt default. The right-wing of the Hawk represents inflation, fiat default, and helicopter money. According to the writer, neither path is mutually exclusive, and they often occur sequentially.
The reason we are outlining these secular forces is that we believe the cycle is changing and we are transitioning from the Serpent to the Hawk. This transition will be more challenging and involves a different approach to money management than what has worked so effectively over the past 30-40 years.
The Under-Performance of Traditional Portfolios
I was recently on a client call with an investment manager in Pennsylvania. I raised the possible scenario of declining equity markets and rising bond yields (causing bond prices to decline). I asked what happens to your so called “safe assets” (i.e. bonds) if this scenario unfolds?
Their response was “that they build portfolios for the long-term and that over the long-term a pure equity and bond portfolio complement each other and produce good risk adjusted returns.” Now I don’t disagree with this statement, but how do you define long-term? If it is longer than ones working lifetime (time to save) then it is really of no value to the average investor in my opinion.
It seemed to me to be rather a close-minded response, especially when I asked if and how they might transition the portfolios for rising commodity, precious metals or volatility in the coming years should we transition to a more inflationary environment or even a stagflationary environment?
As you can see from the Artemis Capital graphic below that during a transition from the Serpent to the Hawk, we tend to be at secular lows for volatility, correlations and yields.
These above lows are what propelled traditional equity and fixed income portfolios to new highs but with these market constructs now moving off the lows and potentially higher, it is time to think differently.
We cannot do this paper justice in the time and space we have in this blog update, but the bottom line of their research is that periods of deflation and then sequential inflation require the traditional portfolio of stocks and bonds be augmented with holdings in precious metals, commodity trend following and volatility trading strategies to perform well in the New Normal of the secular Hawk.
The following chart from the Wall Street Journal demonstrates just that for the inflation side of the equation:
Notice how the S&P 500 and Intermediate Bond returns suffer in such an environment.
The whitepaper instead argues that non-correlated holdings in precious metals, commodity trend following and volatility trading work with the traditional equity and bond holdings to stabilize returns and reduce risk in the Hawk period, as seen below.
They further make the point that a portfolio that is roughly equal in allocation between equities, bonds, precious metals, commodity trend following, and volatility trading has outperformed the more traditional 60% equity and 40% bond portfolio over the past 100 years, especially in the Hawk periods and likely will do so again in the coming Secular Hawk period. They call this portfolio a Dragon Portfolio (see below).
We are not trying to scare you with this information, instead what we are suggesting is you need to make sure your investment advisor or manager is focused on this potential cycle change and has a plan for when and how to transition your more traditional stock and bond portfolios into other more favorable asset classes, like commodity trend following, precious metals and volatility trading, when the time is right.
A pure stock and bond portfolio will likely struggle in this cycle’s periods of alternating deflation and then inflation as seen in the chart below, especially in the periods like 1964-1983 when stagflation was prevalent.
On the other hand, our trend following models are already hard at work identifying turning points whereby equity portfolios need hedging or fixed income portfolio duration should be neutralized (i.e., hedged).
Those same models are also used in determining the best time to be in assets that benefit from deflation (where we are now) and inflation (where we expect we will be in the future). We have even rolled out a brand-new portfolio similar to the Dragon Portfolio outlined above to help clients best thrive during the coming cycle.
So, when you sit down with your investment advisor or manager and you ask the question I asked above and they give you same kind of close-minded response, maybe it’s time to explore your options? As you can see in the above 100 year back test from Artemis, such a close-minded approach could be extremely costly to your portfolio(s) in the future.
Let me know what you think in the comments section below.