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History Doesn’t Repeat Itself. Headlines Do!

This is the first part of a series (Part 1Part 2Part 3, Part 4)

We’ve seen these headlines in the news over the course of the last few months:

“The U.S. Is Going Broke”

“Social Security’s Coming Crisis”

“There’s No Way Out of this Unemployment Crunch”

“Exploding Federal Debt – Why so Dangerous”

From an economist’s standpoint, these problems aren’t new. We’ve seen these exact problems before in our lifetime. In fact, these headlines aren’t new either – they were all written between 1972 and 1984!

Sure the details may be different, but the overall issues have always been there, percolating on the back burner. Once the media picks up on the problem, they package it up in a way to grab your attention so you buy the publication, see the banner ad, or watch the advertisement.

What is behind the Italian elections?

The introduction of a common currency, the Euro, created a potent cocktail for the less industrialized nations involved, especially the Mediterranean countries (including France). It allowed the highly efficient industries of the northern European powerhouses countries (Germany) to compete with their southern brothers on equal footing. The southern nations, with their relaxed lifestyles and less than robust industrial infrastructures, were unable to compete. Before the Euro, they were able to devalue their currency and thus lower the price of their goods (in terms of their competitors currencies). However the Euro locked them in. Instead of facilitating trade, industries in the south were outcompeted and hollowed out. Imports grew while exports shrank. Goods imported from Germany were increasingly being financed with more and more debt, not earnings.

(Un) Fortunately, because the southern brother’s currency was now the Euro and devaluation was not a concern; banks everywhere were willing to lend these nations money with abandon. While exports (earnings) and thus their private productive sectors declined, governments of these southern nations bloated up to fill the void left by their declining productive sector. Government, which of course earns nothing, financed itself by borrowing even more money. Government expansion maintained the illusion of economic activity. The problem was solved for a while.

So here we are now. The southern Euro nations have a shrunken and uncompetitive productive sector burdened with a huge government, and an enormous debt which cannot possibly be paid back. Austerity, or ‘internal devaluation’, is being pushed on them by the northern banking/political class. They want their southern brothers to start ‘living within their means’. However, as Milton Freedman proved, it is easier to spend more than it is to spend less. A gradual devaluation used to keep things in check, no longer. Now the northern Eurocrats are trying to hold back the inevitable by forcing their southern brothers to cut wages, employment, and benefits to kept the euro intact. The Italians are pushing back.

Watch Italy. I think Europe may devolve into class warfare. The Euro is a failed experiment.

Furthermore, it is a warning to others that a debt financed, bloated government is not the solution.

Overcoming Volatility in Confidence

Some refer to the past decade as “the lost decade” due to market volatility that seemed to send many investors back to where they started.

It also marked tremendous volatility in confidence, with investors finding it difficult to believe in their investments and in the market itself. As a result, investors faced a new risk – allowing fear to stand in the way of capturing future market gains.

These concerns can vary in degree and change depending on the state of the market. The following stages reflect a common progression of mindset during most economic cycles, while suggesting a way to rebound from volatilities in returns and in confidence.

1. Herding: Confidence builds. Doing what everyone else is doing creates the feeling of safety in numbers.

2. Anchoring: Confidence is high. As investors fixate on a high-water portfolio value, confidence can hinder the ability to rationalize a normal cyclical decline.

3. Information Overload: Confidence is questioned. Investors cannot stop listening to news reports and opinions which, more often than not, feed into doubts and pessimism.

4. Straight Line Projections: Confidence wanes. Investors sometimes forget that most broad markets are cyclical and never go in a single direction forever.

5. Despair: Confidence is shattered. Conclusion that the financial markets, government oversight and the global economy are broken beyond repair.

6. Change of Strategy: Confidence returns. Investors begin to again feel positive about market participation when they are confident their strategy is built from knowledge gained through past downturns and reasonably promises to avoid similar outcomes.

Stages of volatility

Part II: What’s going on

The preliminary Gross Domestic Product for the 4th quarter of 2012 printed minus .01%. That is not good. True, looking at the individual components shows some upside. Consumer spending grew 2.2%. Housing advanced off a low bottom. Tech spending was up. Inventories and exports fell while government spending, which needed to decline, did. However, our Government still borrowed a huge amount; $312 billion in the fourth quarter alone. (link). Overall, 2012’s GDP was about 2.2%. That is not good (link).

Yet the stock market looks to continue to rally. Is the market wrong? No. Up is up.

Lazlo Birinyi, a veteran market historian to be respected, argues that bull markets have cycles. He breaks these cycles into four stages: Reluctance, Consolidation, Acceptance, and Exuberance. These cycles are driven by psychology and play out despite other factors. Of course, a major event will dominate. However, desperate U.S. Government policy and the failing economic recovery, the debt tsunami in Europe, or the Arab spring have not broken this cycle.

Birinyi remains positive for 2013. He believes the fourth stage of Exuberance began last July. Furthermore, his analysis shows that, historical bull markets he sees as similar to today’s resulted in a 38% average gain.

“History never repeats itself, but it often rhymes” – MARK TWAIN

Heady stuff.

A Golden Age

It’s easy to forget and lose perspective about what is happening in this world. From uncertainty in our economy and in Europe, the looming fiscal cliff, and most recently the tragedy in Newtown, we may be feeling lost and unsure about the future. Just turn on any news program. The pundits, news anchors, talking heads, supposed experts, and politicians are talking about the problems we face.

But let’s not forget some amazing accomplishments that have occurred in recent years:

· People throughout the world are now living longer than ever before, here.

· Extreme poverty has been dropping year over year, thanks in a large part to the improving economies in Asia, here. . (For a fascinating comparison of population size and prosperity over the past 200 years, visit here. )

· The cell phone is playing a huge part in reducing poverty. “A 2010 U.N. study, for example, found that cell phones are one of the most effective advancements in history to lift people out of poverty.” Time Magazine.

· Global food production continues to increase, here.

· GDP per capita has been rising throughout the world, here.

· Scientific and technical journal articles have been increasing each year, leading to more and more health and science breakthroughs, here.

· On a global scale, people are building and inventing more new technologies than ever before. Patent applications have been rising each year, here.

· Deaths related to battles, conflict and wars are showing a downtrend, meaning there are fewer death than ever before due to conflicts, here.

· For more trends that point to an improved and improving world visit here.

“Never has there been less hunger, less disease or more prosperity. The West remains in the economic doldrums, but most developing countries are charging ahead, and people are being lifted out of poverty at the fastest rate ever recorded. The death toll inflicted by war and natural disasters is also mercifully low. We are living in a golden age.” (link to full articlelink to full article)

The above article is a fresh perspective and provides a positive view of a world that many are unsure about. The fiscal cliff just doesn’t seem as important now as it did a few moments ago.

We hope that you have a wonderful holiday and when you have a conversation with family or friends that delve into what this world is becoming, think back to this newsletter and all the good things that are happening.

Maybe we are living in a golden age and we can’t see it.


Part I: Ignoring the Fundamentals?

Is The Fiscal Cliff is now behind us?

“…$620 billion in tax increases is spread over 10 years, so it is only $62 billion in 2013. To put this in perspective, the Federal budget deficit in 2011 was a whopping $1.089 trillion. This amounts to only 5.7% of the 2011 budget deficit!” (link)

Not 6% of the total debt, not 6% of the Federal Budget, but just 6% of the $1 trillion-plus deficits to be incurred in each of the following years. Moreover, this assumes that revenue (taxes) meets projections. Remember that the rich are also the successful and have proved adept at changing behavior to manage their tax bill.

So, the answer is: no. The Fiscal Cliff is still very much unsolved.

Furthermore, a measure of how expensive stocks are relative to earnings is the Shiller Price/Earnings ratio. It is above historic averages at 22x’s. This generous premium surely signals good times are soon to appear. Or are they? Chart after chart of economic data still shows little sign of this. So what’s up?

This stock market is on a liquidity-driven rocket ride as the U.S. Federal Reserve mints new dollars from nowhere to accommodate the massive debt binge of our Government. Currently, our Federal Reserve is purchasing $85 billion of bonds per month to maintain our record low-interest rates. This is $1 trillion per year compared to U.S. GDP of about $16 trillion. It is estimated that 42 cents of every dollar spent by our Government is borrowed (link). All this liquidity pumped into the system by not just our Federal Reserve but, by the Bank of Japan, and European Central Bank, is driving stock prices with no apparent end in sight. This market is on a rocket ride.

This news is not new. It was the case a year ago when I was recommending caution. It seems nothing has changed. Our government is still irresponsible, the economy is still mired down, the Euro is still a bankrupt idea, and the stock markets continue to go up.

After proofing the above for me, one of my managing partners sent me a copy of the Daily News dated 11/29/1949 titled “Ode To The Welfare State”. This article foretold the end of American prosperity. It reminded me that our Country has been here before and survived to scale to new heights. He also reminded me that there are currently many highly successful companies driving their stock prices higher.

Laszlo Birinyi, a veteran market historian to be respected, was right last year and is still bullish. His recommended portfolios were up 3%, 7%, and 15% for 2012. He chooses his words carefully and, is very positive for 2013 (link). Birinyi’s newsletter is provided to me by my other managing partner.


Are You at Risk of the Tail?

If you’re an investor worried about another major decline in the markets like the one experienced in 2008-2009, then you’re worried about something called “tail risk”. Just like the probability illustrated on a bell curve, the majority of gains and losses are usually within a certain range. But there is a chance that your portfolio could decline so much that it hits the far tail of the curve. PIMCO has an excellent illustration of tail risk.

Bell curve showing tail risk

You’re not alone in thinking that another major decline is on the way. A recent survey reported by Financial Times shows that many of the worlds biggest investors foresee another major market drop (Read more: Investors fear imminent tail-risk event).

As discussed in the article, some of the strategies that could limit your losses if such an event were to happen again include: managed volatility equity strategies, direct hedging and other alternative asset allocations (such as property or commodities), or going all to cash since inflation would likely be low. And for what it’s worth all of these strategies are included in The Active Asset Allocation Portfolio.

Then again, have you considered the possibility that we are entering a significant bull market and that we at the other end of the tail?


Five strategies to fix the biggest problem with your portfolio

The single greatest factor to affect your financial goals for retirement has nothing to do with investment options, asset allocations, bonds or stocks. Rather, it’s the amount you save for retirement year over year. And yet, many struggle to save for retirement despite the facts. Business Insider recently published an excellent article that detailed some of the reasons why individuals are not saving enough for retirement.

So now you know why you aren’t saving enough, here are a few top strategies you can use to improve how you save for retirement:

1) Aim to save about 10% of your gross pay for retirement. It’s a rule of thumb – if you’re starting to save later in life, that rate will have to be higher.

2) Double check that you are taking advantage of matching programs with your employer’s 401k.

3) Save in addition to your 401k contributions. Just because you’ve maxed out your matching contribution, doesn’t mean that you should stop there. Consider opening a Roth IRA to save more.

4) Track expenses. To reiterate one of the tips in the article, by reducing how much you spend on non-essential expenses you can end up with a nice contribution to your retirement accounts. You can track expenses yourself or use a site like

5) Set up systematic contributions. It’s very easy to link your checking account to your retirement account and have contributions made to your investment account automatically. You can even explore the option of a payroll deduction.

Regardless of the strategy you adopt, remember that it will require self control. It’s very easy to shift dollars you earmarked for retirement to pay for that unexpected expense. Develop a plan, stick to it and review it periodically.


Duration Duration Duration

Duration is a very important concept for bondholders in today’s world of low dividend yields. It measures the degree of risk of principal loss should interest rates rise from our current historically very low levels. For example, a leading investment company offers an exchange-traded fund (ETF) which I believe they correctly state is “representative of the broad, U.S. investment-grade market.” It has an
SEC yield of 1.6% and a duration of 5.0 years. Simply put, if the relevant interest rate rises by 1%, the current market value should drop about 5%. Given a meager 1.6% SEC yield, that is not much reward for
that much risk.

It is no secret that our Federal Reserve is ‘managing’ interest rates in an effort to generate economic growth. Many argue that this policy is unsustainably suppressing interest rates and that the free market or ‘correct’ level of interest rates is much higher.

Predicting and timing moves in interest rates is a “fool’s errand”. The world is full of turmoil. U.S. interest rates could remain low for an extended period. However, government policies often fail and interest rates could spike upward. This would leave many investors with unexpected losses.

One must consider that current dividends may not be sufficient to pay for the potential risks. Caution is recommended.