CONSIDERATIONS, December, 2019

Considerations, December, 2019

A Decadal Change

It’s more than that time of the year again. The New Year in front of us is one of those infrequent decadal turns: 2020. So, it’s an opportune moment to sit back, breathe deeply, and take a longer view.

A clear-headed, open-hearted, carefully examined, and historically relevant assessment would be ideal. But our attention spans seem increasingly short (except for Netflix binges). Multiple distractions abound. Your phone pings for your attention. Busy-ness and impatience seem quite the norm.

This exposes us to two biases: recency and confirmation. Recency bias means we overweight whatever is happening right now. Confirmation bias is when we quickly accept that which agrees with our pre-existing beliefs. Neither serve us well.

So, in the spirit of brevity-- because I know you have a lot of shopping to do-- here are the key take-aways for the next decade:

  > Every decade has its unique qualities and hallmarks. No decade looks quite like the last one. *

  > Expect the 2020’s to be volatile, uncertain, complex, and ambiguous. Be ready to adapt. *

  > Time-tested principles, evidence-based strategies, and discipline will carry you through. *     

This applies everywhere-- to our physicality, relationships, and “the world out there”—as well as to our personal finances.

*All the reference resources that led me to this are listed below.

Now, recall what you’ve done, how you’ve changed, and what you’ve believed over the course of the last ten years. No matter what your current age is, we’re all ten years older. Think back ten years and just recall your high (or low) points. What inspired you? What gave you hope? What disappointed?

Maybe you had just graduated college. Or had become established in a career. Or changed careers. Or got married. Or divorced. Or got a diagnosis. Or retired. It all matters in the arc of your life.

The next ten years will bring new challenges and changes. So, here’s a question to ponder during this last month of the 2010’s:

What can I do now-- that my future self or family will thank me for-- ten years from now?

As Sam Altman wrote, “The days are long and the decades are short.”

May you have a Joyful Holiday Season and Flourish in the New Year!

Reference resources are in alphabetic order by title.

All-Time Highs Are Both Scary and Normal
Every decade except the 30’s and 40’s has had new all-time highs. Chances are, the 2020’s will too.
https://awealthofcommonsense.com/2019/11/all-time-highs-are-both-scary-normal/

Avoid News: Towards a Healthy News Diet
This is the antidote to news. It’s 11 pages and you probably won’t be able to skim it. Once you’ve weaned yourself from “the news,” you’ll have time for in-depth, long-form reflection.
https://www.gwern.net/docs/culture/2010-dobelli.pdf

Bull Markets Last Much Longer than You ThinkIt’s quite unrealistic to think we can draw conclusions about a future based on the recent past.
https://awealthofcommonsense.com/2019/12/bull-markets-last-much-longer-than-you-think/

Callan Periodic Table of Investment Returns
This is a graphical depiction of annual returns for various asset classes, ranked from best to worst from 1999-2018. The key point is that no one asset class consistently dominates or lags. Strategic diversity matters.
https://www.callan.com/wp-content/uploads/2019/03/Classic-Periodic-Table-2019.pdf

Common Plots of Economic History
There are five of them.
https://www.collaborativefund.com/blog/common-plots-of-economic-history/

Dow by Decade
A table shows that only two decades out of the last 12 have had a negative return. In retrospect, those two decades were “back up the truck” buying opportunities. Really good decades, like we’ve just had, are often followed by mediocre ones. Go figure.
http://www.crossingwallstreet.com/archives/2019/11/dow-by-decade.html

Global Debt
Global debt has grown by nearly 5% annually for at least the past 20 years, outpacing global GDP. When does this become unsustainable? No one knows.
https://www.cnbc.com/2019/11/15/global-debt-surged-to-a-record-250-trillion-in-the-first-half-of-2019-led-by-the-us-and-china.html

Paradigm Shift
This long (45 page) essay by Ray Dalio is a key reference for this Considerations. Dalio challenges us to identify the paradigm we’re in, examine if and how it is unsustainable, and visualize how a paradigm shift might transpire when that which is unsustainable stops.

Further, he reminds us that theories about how to invest usually explain how the past few years made sense. These backward-looking theories typically were strongest at the end of a period and proved to be terrible guides for the future. The worst thing one can do is build a portfolio based on what worked well over the last 10 years.
https://economicprinciples.org/downloads/Paradigm-Shifts.pdf

Silicon Valley Economy
In the last decade, Silicon Valley has outpaced every other major region in gross domestic product growth. It’s become one of the most expensive places to live. A “gold rush.” What’s next?
https://sanjosespotlight.com/silicon-valley-economy-frothy-and-facing-headwinds-says-market-expert/
San Jose is now one of the most “unequal” cities in America.
https://www.nytimes.com/2019/12/02/upshot/wealth-poverty-divide-american-cities.html

Stock Market Returns Across Decades
Markets rarely match up well with fundamentals. The 1940s saw exceptional earnings growth combined with a 5% dividend yield but investors were still scarred from the Great Depression. Massive repricing occurred in the 1980s and 1990s. The 2000s saw corrections in terms of both fundamentals and sentiment. Dividend yields are lower now than they were in the past, and earnings growth is unsustainable at current rates. Exceptional recent growth contributes to the controversy surrounding equality, mobility, and opportunity. Returns should be lower over the next decade, but no one can predict whether that will be today, tomorrow, or 10 years from now. https://awealthofcommonsense.com/2019/12/where-have-all-the-stock-market-returns-come-from-this-decade/

“The days are long but the decades are short.”
Sam Altman, age 34, re-discovers what those of us with a few more years under our belt have learned. The kids are OK.
https://blog.samaltman.com/the-days-are-long-but-the-decades-are-short

Three Big Things: The Most Important Forces Shaping the World
Demographics, inequality, and access to information changes everything.
https://www.collaborativefund.com/blog/three-big-things-the-most-important-forces-shaping-the-world/

Visual History of the S&P500
This is a great illustration of how “the top companies” come and go. Over any ten-year period, about half of the Top 10 companies on the S&P500 change.
https://etfdb.com/history-of-the-s-and-p-500/#2009
Now take a look at the current list and ask, who will still be here ten years from now?
https://www.slickcharts.com/sp500

VUCA 2.0: Volatile, Uncertain, Complex, Ambiguous
Those are the key words people at the Harvard Business School are using to describe the world for future business leaders.
https://www.forbes.com/sites/hbsworkingknowledge/2017/02/17/vuca-2-0-a-strategy-for-steady-leadership-in-an-unsteady-world/#371c633613d8

CONSIDERATIONS, October, 2019

Considerations, October, 2019

“Change your words, change your world.”

Words matter.  What we say and how we say things reflect and shape our attitudes and behaviors. Meanings and intent change over time. Remember when gay just meant happy? It still means happy. And more.

Here are three personal finance topics whose meanings and intent need to change.

 

Expenses

People use expenses to mean the money they must spend. But often it sounds like they’ve just had their pocket picked-- that they’re victims or innocent bystanders. This makes it very easy to excuse away impulses, poor money management habits, and thoughtlessness.

Let's call it what it is: Spending.

Spending is something we actively choose. So, if we can choose it, then we can exercise proactive control and responsibility over it. This makes it more powerful than trying to figure out market or economic trends.

 

Emergency Fund

Maybe it’s just me, but demands on my cash can seem notoriously random and unexpected. I could make the case for an emergency happening nearly every month.

So, it's useful, convenient, comforting, and even essential to have a cache of cash set aside to cover those things. Call it a Reserve. That way you don’t have to wait for an “emergency.”

The size of a sufficient Reserve will vary from household to household. And because its key features are its Safety and Liquidity, it’s never invested in the stock market. Reserves are found in savings accounts, money market funds, CD’s, bond funds. Do your investing elsewhere.

 

Risk Tolerance

Investment ads and financial advisors quickly get you thinking about risk tolerance. It’s essential to talk about risk, but the “risk” they’re talking about is the wrong one. They’re talking about tolerance for volatility. That’s not risk. Risk is…

·       The impact of your investment capital losing its purchasing power.

·       The consequences of your investments not growing enough to meet an important goal.

·       The destruction of capital through confiscation, taxation, stupidity, or fraud.

Impacts. Consequences. Destruction. Those are real risks. They are forever. There are no do-overs. Your tolerance for these risks can easily be quite low.

Volatility is not risk. It's the price we pay to avoid real risks. Don’t be swayed by attempts to minimize volatility at the expense of failing to meet important goals. Your volatility tolerance should be as high as you can stand it and your real risk tolerance can reasonably be zero. 

“Change your words, change your world.”

 

CONSIDERATIONS, AUGUST 2019 

 

The economy.

Peter Lynch, legendary Fidelity fund manager is known to have said, "If you spend more than 13 minutes analyzing economic and market forecasts, you've wasted 10 minutes."

Well, I'm not Peter Lynch, so you'll have to bear with me for just a little more than 3 minutes. This brief, no-nonsense, drama-free treatment is meant to get you comfortably on with a worry-free financial life. It'll also shield you from the pernicious effects of what other people might be telling you and what you're hearing in your self-imposed echo chamber.

Here are the paragraph headings if you want to scroll down fast. In some paragraphs, there are clickable links. Just use those if you're interested in the background or want to take a deeper dive.

The normal yield curve.

The yield curve right now.

Why is this?

Well then, who sets all the other interest rates?

Is there something special about a flat or inverted yield curve?

Are we close to a recession now?

Will tariffs or trade issues cause a recession?

What will happen to real estate if there's a recession?

Bottom line, what should I do?

Press on.

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The normal yield curve.

One of the most frequently heard terms these days is yield curve. Good grief, what's that?! We actually wrote about it in our blog back in March. You don't have to go back and read it. This note is a re-cap and update.

Here's a normal yield curve. It shows the interest rate that lenders receive for loaning money for different lengths of time. Notice how interest rates go up from the lower left to the upper right. In a normal world, the longer you loan money, the more interest you earn, yes? 

 

Lenders are ordinary folks like us as well as pension plans, insurance companies, mutual funds, and so on, all over the world. For example, you're a lender when you buy a CD.

The yield curve right now.

It's pretty flat. Everything is squeezed in between 1.5% and 2%. No one is earning more for lending longer.

Data from the US Treasury Department

Why is this? 

Some people might want you to believe that the Federal Reserve, aka "the Fed," "controls" interest rates. That's only partially true. The only thing the Fed does is set the Fed Funds Rate. That's the rate they charge banks and other financial institutions for overnight loans to clear the previous day's financial transactions. On the yield curve, the Fed Funds Rate is just one point at the far left or in the lower left corner.

Well then, who sets all the other interest rates?

The bond market!

Like stock prices are set in the stock market between buyers and sellers of stocks, bond prices are set in the bond market between buyers and sellers of bonds. Keep in mind that when bond demand is high, interest rates fall. When bond demand is not so strong, interest rates rise. Interest rates have been in a general downtrend since the early 1980's.

Is there something special about a flat or inverted yield curve?

As we pointed out last Spring, a flat or inverted yield curve has often presaged a recession. But the yield curve by itself is neither a cause nor a tripwire for a recession. It's just a picture of the bond market's assessment of future economic conditions. The actual causes, timing, and severity of any slowdown or recession are highly variable. So, there's no point in trying to game it.

Are we close to a recession now?

This 50-year graphic from the ECRI (Economic Cycle Research Institute) suggests that we're near the edge of slipping into a recession. But as you can see (1988, 2010, 2012, 2015), it's not 100% reliable. Nothing in markets is perfectly reliable. Furthermore, none of this says anything about the depth or duration of a recession, if it does happen. But I'm sure that Tweeter-in-Chief will keep us informed.

Will tariffs or trade issues cause a recession?

Global economies and financial markets are complex, chaotic, adaptive systems. What happened in a prior similar situation may not happen again. Yet, we ignore history at our peril.

Tariffs, trade issues, and executive orders have been a feature of the US economy since the beginning. George Washington issued the first tariff. Presidents Clinton, Bush, and Obama declared 42 national emergencies. Trump has signed four, so far.

We press on, regardless.

The lesson is that we've been here before. History may not repeat, but it rhymes. It's not different this time. There's always something to worry about. Trade is an ongoing, troubling, yet manageable challenge. Stay the course.

What will happen to real estate if there's a recession?

As we've all been taught, real estate is about location x 3. It's also about affordability.

According to Zillow, in the past year, median property values are -9% in the San Jose area, -13% in Palo Alto, -7% in San Mateo, flat in San Francisco, and -1% in Walnut Creek and Santa Rosa. Wow. If stocks had that kind of widespread downturn, we'd certainly be hearing about it.

These modest declines have nothing to do with location or recession and everything to do with affordability. Employment and incomes must keep growing to support rising real estate values. In some places, they are not. A recession will be a headwind for real estate. But that will also make it a buyers market, and with low mortgage rates to boot.

Bottom line, what should I do?

There are three things you can do-- three things over which you have absolute control:

1. Ignore the Tweeter-in-Chief's tweets. He's totally talking his re-election book. And by extension of that, avoid letting your political preferences-- whatever they are-- drive your investment strategy. That dog don't hunt; those dots don't connect. Remember when Trump was elected and "everyone" thought the market would tank? Those "everyones" missed a 100% advance.

2. Advisors and investment firms always talk about knowing your risk tolerance. We take a different view on that. What you need to know is your volatility tolerance. How much tolerance do you have for watching your portfolio's value decline? Think in dollars, not percentages. A 25% decline (not that unusual) would trim $250,000 from your $1,000,000 portfolio. Would you be OK with that? Maybe this deserves a conversation. Call us. That's what we're here for.

2.1 Sidebar: People with large holdings of their company stock curiously seem to believe that their company's stock would not suffer in a market downturn because their company is just so good. Don't be one of those people. Jobs and even whole companies can evaporate in a recession. I know; not yours, your neighbor's. Single issue risk can be devastating.

3. Find the places in your portfolio where bonds and other fixed income assets are sitting. That's what you'll want to use if stocks go into a funk. Have 3-5 years worth of likely withdrawals in sight. That way, you won't have to sell stocks low when they're becoming the thing you should be buying!

Any other questions? Contact a Jim.

In the Dallas-Ft Worth Metroplex    jim.cosgrove@verizon.net   972-489-0262 

In the San Francisco Bay Area       jimcos42@gmail.com          408-674-6315