Fed Week: 3 P’s of Portfolio Management a Better Focus

Trifecta

Portfolio Management efforts can focus on more controllable and proactive themes like Protect, Prune and Plant. Countdown to the FOMC’s September 17th target rate decision is beyond our control and demands the perfect trifecta of outguessing Action, Reactions & Duration of Said Reactions. Good Luck!

When will the Federal Open Market Committee (FOMC) raise the target Federal Funds Rate and move the U.S. out of the zero interest rate policy (ZIRP) environment? The last tightening came in 2006, and based on recent Fed Funds futures prices and trading activity, the probability for a hike on Thursday has dropped from 50% to 25%. The likelihood rises to 74% for March 2016. Interest rates are the price of money which reflect supply/demand balances as well as inflation, credit, and other risks. Demographics, technology, structural unemployment, and muddle-through global demand will continue to deliver counter-punches to expectations for higher rates and inflation.

Bottom Line for Me: Deflationary counter-forces are powerful and Mr. Market will ultimately prove more powerful than what you see in the below Effective Fed Funds graph.

Whether it is former Treasury secretary, Larry Summers or The New York Times, smart people take polar opposite sides of the interest rate debate that will impact benchmark rates all along the curve (10-Year Treasury shown below). Stock markets throughout the world, as well as global currencies and capital flows, will be heavily influenced by the FOMC’s every word or lack of words. Let’s pretend you know the decision to hike is a foregone conclusion. Will the “market” react favorably or unfavorably? Okay, let’s pretend you rightly picked a 25 basis point increase and the market roars up as an indication the economy is strong enough to withstand the marking of a new interest rate regime. So what happens Friday or next month as investors, traders, speculators, and sovereigns digest the implication on their books? Can you pick the FOMC Trifecta?!

Advice: Spend more mind-share on the portfolio(s) you manage.

Similar to outguessing a room full of brilliant economists, forecasting the weather that impacts our future lawn and garden is fairly difficult. Still, here in North Carolina, we take more controllable and proactive actions in the fall to reduce soil compaction, save water, and enhance root growth in order to rejuvenate a lawn full of summer stress. Global portfolios have experienced summer stress with large losses experienced in numerous asset classes, geographies, market caps, sectors, credit grades, and investment style boxes. Sixty-five percent of the companies in the domestic S&P 500 have negative year-to-date price returns in 2015, and international currency translation is brutal with the strong dollar surge.

PROTECT. PRUNE. PLANT.

There are numerous proactive methods and techniques to pursue portfolio management/asset allocation goals that include less compacted correlations and exposures, savings of taxes, and enhanced future reward-to-risk opportunities. Here is a small sample with no FOMC Trifecta required!

Protect:

Cash is “King, Queen, Prince, and Princess” when uncertainty reigns, volatility and correlations rise, and markets are downright mean. Lots of methods to choose source of funds; however, an example is to quantify and rank reward-to-risk ratios for every holding/exposure and remove a percentage of those with the least favorable margin of safety. With a Growth-at-a-Reasonable-Price (GARP) investment philosophy, I like to rank valuation metrics such as PEG ratios and a proprietary view of estimated Price-to-Sales versus Profit Margins. Dry Powder is never a bad thing and so-called “Cost of Opportunity” is a protection risk I am willing to absorb.

In-depth analysis will look beyond simple stock, bond, cash, and security-level allocation modeling. I focus heavily on portfolio character, risk budgeting, and overall posturing; therefore, protective decision-making can shape a 100% invested portfolio.

Prune & Plant:

When a tide of losses hits 65% of the S&P 500, it is a superb opportunity to proactively harvest tax losses by swapping dollar for dollar into securities with equal reward-to-risk opportunity sets: This captures the economic losses which may be used to offset current gains or banked into carry-loss forwards. Of course, you can modify the type of exposure you have at the same time, but in this case the same amount of dollars remains exposed.
Note: Avoid Wash Sale Rules. 

Isolate and cull through the non-market/price related characteristics of your holdings and prune securities that have failed to meet fundamental or quantitative expectations over your tolerance of time. Perhaps, the business model is shaky, currency risk is too high, dividends are subject to change, the fund manager left, earnings estimates dropped, debt coverage breached your preferred ratio, valuation is too high, or liquidity, spreads, relative strength have weakened. It is rare for a portfolio to be blemish or disappointment free–just the laws of probability and no reflection on your security selection skills 🙂 

There will be no escaping the media and market’s desire to correctly pick the FOMC Trifecta in September, December, March…

Every investor and portfolio is unique so take more controllable and proactive actions that reflect your unique circumstances–In my experience, taking action (no matter how minute) is often worth the behavioral reward when market and events are highly volatile and uncertain.

ABOUT THE AUTHOR:

Michael loves to empower investors with his expertise in securities and economic analysis, goals-based wealth management solutions, and FinTech smart decision-support tools. While directly managing over $5 billion in growth and retirement assets; his proactive advice and software innovations have influenced thousands of fiduciary advisors to better their practices and service to clients. He enjoys spending time with his wife and three boys, competing in USTA tennis, and mentoring others to succeed.

Email | Michael@empoweredportfolios.com

Twitter | @MichaelHakerem

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9/11: A Journey of Remembrance and Perseverance

Twin TowersI can still feel the tremendous breeze flowing across my body. I stood as high as we could go atop the World Trade Center as my ears rattled. It was the late 70’s, and I was a boy anxious to soak up the view and all the world had to offer. I vividly recall life dreams taking shape on a canvas of blue sky.

I cannot begin to imagine the feeling atop those same buildings surrounded by a tornado vacuum of wind, flames, fuel, tears and screams. At that tragic moment on September 11, 2001, my friends, whom were never found, may have looked into the cool, crisp blue skies, anxious to end their view and never to again experience all the world had to offer. Their vivid dreams literally crushed or burned away…

Born in the Bronx, I grew up walking the streets of NYC as I visited family. Yes, I even ventured into Times Square before I really understood what all those XXXs meant. I often traveled to the Financial District and the magnificence of it all inspired me professionally. My career journey almost brought me back to World Trade Center plaza in 2000. Instead, my wife, Jenn, and I moved to Raleigh to achieve a balance of life and career. September 11, 2001, a seemingly ordinary day, a fall day once filled with hope, found me walking into my office to lead an investment committee meeting and watching, first-hand, as a second plane unleashed its fury on New York City. A City etched deep into my soul.

During the week following 9/11, I retrieved several pieces of paper mail as part of my afternoon routine at the office. Approximately four steps later, I froze and tears welled-up in my brown eyes. My heartbeat accelerated as I discovered the large legal sized envelope in my hands was postmarked WTC-Tower 1, the very building where my office may have resided. My mind journeyed back in time, I recall thinking that young boys and girls will never experience the view which meant so much to me twenty-years ago. Impossible, the buildings are gone! They are just gone!

Without hesitation, I boarded a plane to Boston the following month and experienced the German Shepherds, the heavily weaponed personnel, and the loss of naivety. Travelers and workers alike appeared to be on-edge but also numb in their existence. In December 2001, Jenn and I personally paid our respects at the site. During this visit, recorded only in our minds, I recall looking into the eyes of smiling faces…happy friends, relatives, and co-workers. Only these faces were taped, glued and pinned to a wall of hope–they were the missing loved ones gone too soon. I longingly stared at the pictures of fathers, mothers, and children and was lost in my own imagined sketch of their lives left an unfinished masterpiece. The smoke continued to rise above the ruble as Jenn crossed the street to offer her condolensces to an NYC police officer. It was dark and the silhouette of his form in the streetlights laid testament to a man who lost many brothers only months prior and now stood solo as guard to their memory.

I made a prayer promise to childhood friend, Rick, who at 38, was among the missing. He was an adored husband, father, brother and son. That promise: To always work hard with the blessing of life and to never forget. Each September 11th, I attach Rick’s obituary to the portrait of the Twin Towers that hangs in my office. Each day the very same portrait inspires me to pay tribute to all those lost in New York City, Washington D.C., and Pennsylvania. I think of those civilian and military heroes and their families who risk their lives for my family’s freedom and safety. My eyes well-up again as I think of dreams on a blue sky canvas, dreams I still have an opportunity to pursue.

In 2013, my wife and I experienced the memorial on Liberty Street with our three young boys. Our wish for them was to understand the tragic reality of the events and to also feel the power of hope and the strength of the human spirit. I urge you and your family to experience the spirituality of the Survivor Tree and to take your mind on a powerful journey of remembrance as you stand beside the twin reflecting pools.

The Tribute in Light is seen in the background of the 9/11 Memorial in September. (Jin Lee photo)

CHINA: YEAR OF THE SCAPEGOAT 2015?!

scapegoat

It is a mistake to place sole rationale and therefore sole resolution in headlines like: China Fears Slam Stocks. China Data Hits Markets. China to Blame. Occupying the 8th position in the Chinese Zodiac, the Goat (or Sheep) symbolizes such character traits as creativity, intelligence, dependability, and calmness. Half-way through the Chinese New Year that began in mid-February, investors are steered to solely focus on Beijing’s corruption, lack of control, manipulation, and extreme volatility.

There is no doubt that China is HUGE in terms of the mood of her populous, politics, internal objectives, economy, and massive historical demand for Western luxury goods and infrastructure inputs like Copper, Iron Ore, and Concrete. It is disturbing to read stories of the Chinese government arresting and detaining traders to “resolve” its stock market problem. An extremely tense Pacific will become further inflamed as China celebrates the 70th anniversary of the defeat of Japan in WWII. A parade of 12,000 troops, 200 aircraft and dozens of tanks and missiles are expected to march down Beijing’s central Avenue of Eternal Peace and through Tiananmen Square on Sept. 3 — the day after the Japanese army surrendered to Allied forces in 1945. Still, global stock market turmoil, plummeting currencies, crashing commodities, and economic instability are problems not entirely “Made in China.”

The Maestro (I admit the pic is my cMaestroopy.) of the real orchestrated manipulation that impacts us today dates back many Lunar
cycles and from the United States. With complete humility, I will note there is no crystal ball at my shop. However, the source of the 2015 pullback is potentially deeper, more problematic, and more painful than simply laying blame on the recent Chinese stock market rout and slowing manufacturing data. The U.S. Federal Reserve as directed by Greenspan to Bernanke, and now Yellen, have led the world’s most powerful central banks into the most manipulated (no matter how well intended) and experimental monetary phase of our lifetimes.

The lack of control, manipulation, and volatility your investments are experiencing is most likely not China-centric so do not ignore the plethora of other concerns, risks, and opportunity sets. 

Unconventional tactics were used to counter the late 90’s Asian currency crisis, hedge fund blowups, and Y2K cash build-out. The bursting of the dot-com bubble in 2000 kicked off massive interest rate cuts via the Effective Fed Funds from 6.5% to 1% (2000-2003) with a repeated playbook during the 2008-09 Financial Crisis. When interest rate options ran dry, Fed Chair Bernanke revealed experiments like Operation Twist and a series of so-called Quantitative Easings (QE). The Fed balance sheet has skyrocketed from $600 billion to $4.5 trillion! Perhaps the counter-factuals would have been worse–the unwind from unconventional to normalcy represents an unknown larger than China.

Throw away advice lines like “normal pullback,” “another buy the dip opportunity,” or “healthy return to volatility” are less useful for concerned families no matter what happens this fall. 

Zero interest rates plus QE1, QE2, and QE3 created a massive misallocation of capital that has affected everything from rental properties, fracking, high yield bonds, share-buybacks and dividend payments, the US dollar, and stock market valuations. These trends have been on a tear so perhaps the recent weakness is the painful process of deflating back to reality–you or your trusted advisor should not completely discount this possibility.

So what is useful?

An emphasis on market-timing, outguessing economic releases, or using gut feel to manage portfolios is foolhardy for most of us. There are tremendously positive innovations in medicine, technology, and consumer goods worthy of your hard-earned investments. You still need to identify and navigate the right investing paths, know your portfolio’s return and risks trade-offs, and plan for the future with foundations based on your family’s realities.    

  •  Real communication and proactive, goals-based wealth advice: Watch out for canned, standardized, and biased steering.
  • Implementation should include a combination of core strategic investments, tactical satellite investments, and a relentless focus on client-centric management of risks, taxes, and fees: Watch out for mass produced, standardized, and advice that comes too quick and easy.
  • Special attention should be paid to the more controllable aspects of planning, spending, saving, and an extra margin of safety: YOU are the best qualified and most accountable for this part.

ABOUT THE AUTHOR:

Michael loves to empower investors with his expertise in securities and economic analysis, goals-based wealth management solutions, and FinTech smart decision-support tools. While directly managing over $5 billion in growth and retirement assets; his proactive advice and software innovations have influenced thousands of fiduciary advisors to better their practices and service to clients. He enjoys spending time with his wife and three boys, competing in USTA tennis, and mentoring others to succeed.

Email | Michael@empoweredportfolios.com

Twitter | @MichaelHakerem