Four of the Most Reliable Words in Investing, Coaching, and Parenting.

Patience, Discipline

“It’s tough to make predictions, especially about the future.” Yogi Berra

Armed with brainpower, insider information, and sophisticated tools, even the most powerful global institutions cannot outguess economic data and financial markets. One such institution, the U.S. Federal Reserve officially diverged from other central banks with a much anticipated December monetary policy  announcement, and Fed Head, Yellen, steadfastly exuded confidence in an ability to execute on central plans. While seemingly small now, this historic event does signal added change, uncertainty, and hypersensitivity to future news-flow.

Default risk, volatility and extreme downside in security prices were reintroduced in 2015. Well-intended 2016 forecasts are on the way to our inboxes, and these notes often serve only to confuse yesterday’s confident beliefs. Stocks, bonds, commodities, emerging markets, and currencies will continually jostle investors and prognosticators.

No crystal ball or “black-box” strategy guarantees consistent and successful market timing, so let us briefly examine four words able to more reliably trigger clearer thinking in times of added stress.

Patience, Discipline, Process and Customization have proven a helpful and mightily resilient decision-making framework throughout a career of investing, coaching, and parenting.

#1 Patience helps to promote less emotional decision-making. We have all been in that daunting place, a moment where reactions, words, and instructions are paramount to a more successful outcome. Take a mental moment or even physically remove yourself from a tough situation. Intentional breaths also enhance one’s ability to patiently respond when control is momentarily lost.

Quick Tip: Avoid an immediate investing decision if you have recently been exposed to the flashing of red and green price-change indicators.

#2 Discipline reinforces adherence to well-grounded investment strategies and financial plans. The temptation to impatiently chase the latest fad, change styles, or to abandon the “game plan” out of fear, often leads to instability more detrimental than whatever short-term deficit or problem exists.

Quick Tip: Avoid compromises or exceptions only made to make a decision work this time.

Fearful headlines and twitter feeds sell ads and keep people glued to screens, but fear does not make money in the stock market.

#3 Process translates into effective execution of less emotional disciplines. Successful investors, coaches, and parents rely on consistent process methods to evaluate reward-to-risk relationships. This ability is wired into survival–Is that a stick or a snake? Should we kick an extra point or go for two? What will tomorrow bring if the kids win the battle to stay up too late? Investors should define and document reward and risk targets to compare with current prices. Key stats and ratios can help to set the limited price you are willing to pay and the point at which a sale is appropriate for each holding. This preparation should be done prior to the potential constraints of euphoria or despondency.

Quick Tip: A scheduled routine to review financial plan health, asset, sector and security allocations, tax efficiency, all-in expenses, and risk-adjusted performance is important and helps to avoid random thoughts and decisions.

#4 Customization can produce more optimal bottom-lines over robotic or glide-path plans. Armed with patience, discipline, and a process for execution, the flexibility to adjust for the conditions on the field is critical. Hard-earned wealth is proactively built, so unique circumstances deserve collaboration and measured decisions. Simple strategies to achieve low cost, diversification, and risk management can be achieved while paying attention to the changing complexities of taxes, special requirements, and crazy markets.

Quick Tip: Be wise with model recommendations found in newsletters, popular media, or other widely distributed platforms. While often good advice on the surface, what is right for your neighbor is not always right for your family.

Happy New Year and Best Wishes for 2016!

It is tough to predict any 12 month period. This investing year is especially difficult with so many large players like China, the U.S. Federal Reserve, and the European Union attempting historic shifts alongside a daunting list of uncertainties. Besides turbulent markets, our basketball team is struggling, and we “welcome” our first teenager into the house. The written words of Patience, Discipline, Process and Customization will literally be turned to as reliable triggers to handle tough decisions (see pictured office whiteboard).

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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Navigating The Global Market Selloff

Bull and Bear

Wealth is most often built through risk-taking, hard-work, blood, sweat, and tears, so never be passive about its management and preservation! My 90’s Bull and Bear artwork was unearthed this weekend from a dusty box. The old pic was an early career motivator to keep me focused on serving financial advisors and private clients no matter the market direction.

Always be PROACTIVE with the proper balance of capital appreciation and rewards as well as wealth preservation and risks.

A market sell-off swept Asian-Pacific stock markets Monday, led by China’s Shanghai Composite, which gave up 8.5%. Hong Kong’s Hang Seng Index dropped 5.2%, Japan’s Nikkei 225 lost 4.6%, Australia’s S&P/ASX 200 fell 4.1%, South Korea’s Kospi declined 2.5%, India’s Sensex was down 5.8%, and U.S. Dow Jones Industrials dropped over 1,000 points on the open. Market volatility, as witnessed by the widely followed VIX indices, had the greatest week to week percent increase on record. As expected, all kinds of assets start to correlate-downward.

This Post is not about fear or encouraging unnecessary action: It is also not about complacency or ignoring the world around us. Families deserve, require, and desire financial stewardship.

Three Things You Can Do Right Now

  1. Check Your Risk Attributes. Security-level modeling is fine; however, I suggest you heighten priority on portfolio-level characteristics like forward-looking valuation ratios (reward-to-risk, price-to-sales, PEG, Yield), draw-down metrics (return dispersion, Sharpe & Sortino, duration, value-at-risk, up/down capture), and sensitivities to varied economic scenarios (including disinflation & recession). Know where you stand — Is your portfolio suitable and aligned with expectations of the future (long and short-term)
  2. Cash is King, Queen, Prince & Princess. The appropriate “pruned” level is investor-centric; however, cash tends to be the simplest and most effective method to satisfy volatility reduction and emotional satisfaction. Why not target a security you never liked anyway, has above-average fees, or generally was not a complementary fit? The psychological impact of taking action (no matter how small) is often rewarding.
  3. Tax-Loss Swaps. In taxable accounts, when multitudes of securities experience large moves down, it makes a lot sense to capture paper losses, turn them into an economic benefit for the future (carry-loss forwards can even offset a little ordinary income) and immediately regain market exposure through another equally attractive security. This is one of the great proactive moves you can make in this market without attempting market timing or outguessing new moves from the People’s Bank of China.

A Few Pictures to Contemplate

1Fred Graph 8-25
The character of the world’s financial markets has changed as easily seen through market breadth, volatility, and sentiment; therefore, it is generally smart for investors to at least appreciate that expectations should adjust. The $4.4 trillion U.S. Federal Reserve balance sheet shown above is one anecdote that clearly illustrates the unusual and unprecedented nature of our economic world. For this reason, and even though I am a student of market history, I cannot accept advice like “this is just a normal and healthy pullback.” The world’s central banks have not a clue how to unwind this experimental game. See, Don’t Roll the Dice with Your Retirement.

2Fred Graph 8-25

The 2015 summer market selloff is blamed on a powerful U.S. dollar surge versus other currencies, plummeting commodity prices (led by oil), earnings and GDP slowdowns in China, Europe, Japan, and the United States. Incoming data is fairly mixed; however, the distribution of risks to global economic activity is still tilted to the downside with deflationary forces gaining momentum.

It only takes one snowflake to cause an unexpected avalanche.

3Fred Graph 8-25

Three More Points to Think About

  • Know Thy Messenger. As you seek guidance and read commentaries, watch for biases and conflicts. This is true whether listening to someone who is always talking market crashes or Armageddon, a strategist paid to keep you in their firm’s asset management products, or a salesperson disguised as an “advisor.”
  • Proactive Preparation, Reaction, and Communication. It may not be necessary to change your asset allocation, safety cash levels, or solid financial plan based on 2015 market dislocations. An allocation to “passive” and “cheaper” index investing has its place, too. Still, organization, scrutiny, and awareness of your portfolio’s expected rewards & risks, diversification, liquidity, credit, leverage (direct or indirect), and fees (on the statement and hidden) is important. How else will you know if a “reaction” is warranted? Whether an advisor(s) is present or an investor is self-reliant, other interested parties (like spouses and children) benefit from an increased level of awareness and communication: where we stand, the game plan, how we implement said plan, and the method of supervision/monitoring.
  • Focus on the More Controllable vs. Less Controllable. Most of us do well to place energy in estate and tax planning, social security strategies, and the fundamentals of diversification and risk management. Even if you 1) knew the exact outcome of potentially significant market moving events like the September Federal Reserve meeting or a surprise People’s Bank of China stock market intervention, you still have to 2) guess market reactions and then 3) the duration of those reactions. That’s a difficult trifecta!

In 1995, an early mentor required me to read and hand record daily levels of copper prices, 10-year bond rates, major currency levels, and about 70 other market inputs. I am not suggesting you watch that closely; however, a proactive approach with your hard-earned wealth is warranted!

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

9 Bond Fund Risks To Evaluate

10-Year Yields last year

Now that’s price volatility! Government Agencies, Exchanges, Major Bond Investors, and Main Street Investors are again preparing for the long awaited upward shift in interest-rates and a potential collapse in bond market prices and liquidity. Deja Vu, right? Know your risk exposures and understand the location of your hard earned dollars!

The thought of bond market liquidity evaporating or double-digit drops in bond investments is unnerving enough; however, I am especially concerned where investors are exposed to two trends often seen in 401(k) plans, 529 College Savings Plans, Target Date Funds (TDF), and certain other ‘glidepath’ robotic advice formulas: 1) massive use of bond funds and exchange-traded funds (ETFs) in lieu of direct bond ownership and, 2) traditional advice of raising allocations to bonds as investors age or move closer to goal dates. As an illustration of size, Vanguard expects TDF adoption to hit 50 percent in 2015 and reach 63 percent of the 3.9 million participants enrolled in Vanguard-administered plans by 2018.

Fun Fact: Outstanding U.S. bond market debt
has grown from $31.7 trillion in 2007 to
$39.2 trillion in 1Q 2015. Source: SIFMA

No wise Advisor can assign certainty to the proximity nor consequences of this highly anticipated change in U.S. monetary policy. There are plenty of reasons to believe a Federal Reserve driven rate increase may be postponed beyond 2015due to deflationary forces such as weak global growth and employment, instability in Europe, Middle East, and Asia, shifting demographics, and the exponential price destabilizing impact of technology. However, Fed Chair Yellen seems determined to continue a stated gradual path to “normalcy,” and any move away from the 0-0.25% range in the Fed Funds target will be highly symbolic.

Suitable bond mutual funds and ETFs used in isolation or in combination with individual bond strategies can be very effective. Still, financial market participants may collectively induce higher interest-rate risks, so take heed of nine not-so-obvious risks to evaluate in your bond exposures.

  1. The “Bond” label is not always synonymous with conservatism or lower risk. For illustrative purposes, the opening graphic plots daily percent yields for the “risk-free” U.S. 10-Year Bond from 6/19/2014 to 6/19/2015. Price movement in this key benchmark rate is likely to experience historic volatility in the future. Other segments (high yield, municipal, emerging, mortgages) of the massive bond market are smaller and less liquid than Treasuries.
  2. Principal, maturity, and credit features are not guaranteed or insured–Many investors do not realize, understand or appreciate that bond funds can fall in price. Bond funds are not insured or guaranteed by FDIC, the U.S. Securities Investor Protection Corporation (SIPC), or by any other government agency, regardless of underlying holdings, or how a bond fund is purchased or sold—whether through a brokerage firm, bank, insurance agency, financial planning firm, registered investment advisor or directly.
  3. A net asset value (NAV) of fund shares is no guarantee. An ability to sell fund shares on any business day does not translate into the characteristics of “liquidity” in the sense of price and bid protection for underlying holdings. Funds make assumptions in their daily pricing matrices and actual future sales (especially forced) of holdings can receive prices much lower than modeled assumptions. Note: Closed-end bond funds trade at premium and discounts to underlying NAVs.
  4. Embedded leverage–The proverbial double-edged sword. Funds use yield enhancement strategies to try and boost returns and market their portfolios to attract or maintain investor dollars. This activity can translate into less obvious risks and the use of reverse repos, commitment agreements, and exposure to floating-rate credit lines with banks or bank syndicates should be noted too.
  5. Is the Fund 100% committed to owning actual bonds? Whether due to Fund size or purposeful strategy, additional counter-party and contract liquidity risks are introduced with the use of synthetic positions. Derivative contracts may also involve implied or economic leverage.
  6. Date & Data Matching on Fund Report Cards. Always check the “As of” date on top holdings, risk metrics, returns, credit weightings, and asset breakdowns. Look closely, and you may see inconsistency with the published report issue date–Are you sure you know what you own?
  7. Speaking of Holdings. Among other reasons, unprecedented low rates and high prices have forced some fund managers to reach for yield outside stated comfort zones or core competencies. For example, “conservative” funds with heavy exposures to potentially high risk Puerto Rico and Tobacco bonds.
  8. Metric Effectiveness. Listed durations are very popular and convenient numeric gauges of interest-rate sensitivity. Unfortunately, these generic stand-alone descriptions of price sensitivity can mislead investors due to straight-forward assumptions and limitations. Realized prices and actual market bid adjustments always trump mathematically derived estimates. Any assumed downside needs to consider the size of yield changes, yield volatility, and the new shape of the yield-curve. Most bond funds consist of hundreds or even thousands of bonds across a spectrum of maturities, sectors, credits, and bond features–so accurately portraying a full portfolio’s risk is more complex.
  9. Historical “average” returns, dispersion of said returns, and the degree of like movement with other assets should not be extrapolated. The chart below shows a clear example of unprecedented U.S. Central Bank activity beginning in 2008; whereby, the Federal Reserve increased the size of its balance sheet five‐fold from $900 billion to $4.5 trillion. Translation: Objects as seen in the seven year rear-view mirror are very distorted.

Key Rate Factor: Federal Reserve Activity

On June 17th, the FOMC reiterated that “The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.”  In March 2015, 15 of 17 FOMC participants judged that the first increase in the target federal funds rate (now 0-0.25%) would occur in 2015 even though the same contributors expect inflation to be well below the 2% target with a central tendency at 0.6% to 0.8% in 2015.

Key Rate Factor: Inflation Expectations

Below is a representative graph of the Fed’s preferred inflation gauge, PCE Inflation—as measured by the percent change in the personal consumption expenditures (PCE) price index is headed downward. Graph retrieved from FRED, the excellent resource at the Federal Reserve Bank of St. Louis: https://research.stlouisfed.org/

It has been more than a decade since the Federal Reserve raised interest rates and nearly seven years since the fed funds rate was set near zero. Still not a forgone conclusion that a new rate regime starts in 2015, government agencies, exchanges, major bond investors, and private investors are again preparing for significant changes. So join them in preparing your mind and portfolios.

A choice not to lose can be a winning strategy, and prudent portfolio management always considers potential reward units versus potential risk units. Each investor and their trusted advisors should follow a continuous wealth management process of Discovery & Diagnostics, Planning, Implementation, and Supervision. As you work through the review steps, note that the “bond” label is not always synonymous with conservatism, low risk, or stability. Please evaluate your obvious and not-so-obvious risk exposures to bond funds and exchange-traded funds.

I welcome your thoughts in the comments section below. 

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. He has directly managed over $5 billion in growth and retirement assets, and his proactive advice has 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 l mdhakerem@gmail.com
Twitter | @MichaelHakerem

An Ark, a Speedboat, a Tight Bathing Suit

Famous investor, Warren Buffett is credited with the following quote, “You never know who’s swimming naked until the tide goes out.”

ArkBoatSuit

China, Japan, and Europe are cannonballing into high tides with new stimulus announcements. Downward global GDP growth and lower price pressures are clear on the horizon, even as metrics ebb and flow. At the same time, the U.S. central bank has indicated an end to one element of its monumental wave of Quantitative Easing (QE).

My Asset Allocation Strategy

Ark: This core and stable vessel is built to last, to withstand storms, to leave mostly untweaked in times of stress–emotional or market related. This majority of my portfolio should be untethered to a reliance on any one central bank, one asset class, one direction of interest-rates, or my ability to outguess new bulls or bear markets. This is not to say that significant shifts in underlying investments simply stay put forever or that damage will not occur.  More importantly, this reliable piece of my asset allocation remains steadfast in its character traits.

Speedboat: This satellite and more aggressive watercraft is built for quick maneuvers, possibly fun and entertaining, and an opportunity to impress myself (or teach humility). This smaller allocation should demonstrate my most active portfolio management, style, and security selection skills. Rockin’ and Rollin’, these investments better take advantage of great ideas, dislocated markets, and short-term behavioral mistakes made by my fellow investors. These vehicles provide an opportunity to earn much greater returns than those generated by the more passive portion of the portfolio.

Tight Bathing Suit: I wholeheartedly pay attention to risk management. Famous investor, Warren Buffett is credited with the following quote, “You never know who’s swimming naked until the tide goes out.” A rising tide of asset prices like we have lived through since 2009 can make a lot of people and investments appear intelligent. Over my twenty-year career, many of my most important lessons occurred when I realized just how dumb I could be. More importantly, with so many boats lifted in the high tides, consumers of financial advice and even Do-It-Yourselfers may miss indiscretions, poor advice, lack of stewardship, and inferior tools and techniques. You worked hard to build wealth so avoid getting caught showing your assets at the wrong time!

Central-Bank activity, global interest-rates and currencies are interconnected with your portfolio and retirement goals!

The European Central Bank (ECB), led by Mario Draghi, holds its next monetary-policy meeting January 22nd of next year with high anticipation for its own bond buying QE program. Somewhere in the vicinity of a 2% sustained pace is the goal-line target for official inflation measures. Germany is close to 1% price increases, however, the rest of the Eurozone is struggling at 0.3% in November as energy prices fell. Source: Eurostat. Data prior to 1996 are estimated on the basis of non-harmonised national Consumer Price Indices (CPIs).

Stage 3 graph

The Federal Open Market Committee (FOMC), led by Janet Yellen, concludes its next monetary-policy meeting December 17th with high anticipation for the associated Summary of Economic Projections release and press conference. Yellen has clearly reiterated that the timing and path of the target federal funds rate is data-dependent. Financial market reactions and preemptive interpretations by systemically important financial institutions will be important inputs.

Sales at the holidays are good, right?

Like most things in life, balance and stability are the keys to success. Central banks attempt to stop severe deflation (price drops), along with severe inflation (price increases), in an attempt to keep the excessive volatility in prices to a minimum.

Deflation is in almost all cases a side effect of a collapse of aggregate demand – a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers. -Dr. Bernanke

Deflation is viewed as the greater and less “controllable” threat, and it can be caused by a decrease in government, personal or investment spending. The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to economic depression. For example, Eurozone headline unemployment stands at 11.5%.

U.S. asset investors have benefitted greatly from the reflation of stock and bond prices. The FOMC leads an interesting experiment on how to safely exit the high tide environment of unusually accommodative or even emergency-like monetary-policy. U.S. growth, prices, and employment are thought to be stable. China, Japan, and the Eurozone are not in exit mode. In fact, Japanese Prime Minister Shinzo Abe’s ruling party may claim a fresh mandate for his economic revival policies as his coalition is projected for victory in recent elections; after all, the Japanese stock market (Nikkei) is at 7-1/2 year highs.

Thoroughly review all your taxable and tax-deferred accounts. Make sure you and the advisors who work on your family’s behalf have coordinated strategic (long-term) and tactical (short-term) estate, asset allocation, and margin-of-safety plans. The tides will inevitably change so do not wait to hear the thunder before the next big storm!

Please visit my October 29th piece on the U.S. central bank’s policy dilemma and scroll to the conclusion for an investor checklist of more controllable factors, ex. Take charge of the collaboration amongst your tax, legal, and business advisors to maximize your family’s financial, tax, and investment planning–do not assume this is taking place without your encouragementhttp://bit.ly/1vsCTRk

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I welcome your comments.

Michael embodies client-stewardship in all his work and happens to be a passionate expert in securities analysis, asset allocation, economic analysis, and wealth management solutions.

Email: mdhakerem@gmail.com & Twitter: @MichaelHakerem

House of Horrors? Prepare to Get Spooked!

Opportunities for investment return treats exist in many sectors and securities as we enter the backdrop of a historically favorable November-April money flow season and mid-term election cycle. Still, tricky twists, feelings of lost control, and shadows of uncertainty may loom just around the corner.

US_Federal_Reserve_Eccles_Building_1937-2Opportunities for investment return treats exist in many sectors and securities as we enter the backdrop of a historically favorable November-April money flow season and mid-term election cycle. Still, tricky twists, feelings of lost control, and shadows of uncertainty may loom just around the corner. Central Banks bear the queasy burdens where politicians and ugly structural dynamics fail to deliver the goody bags. Broader markets could be in for a real scare or two so our smart preparation will translate into a steadier pulse if fear really accelerates. Lessen the potential for emotional decision-making and focus on those things which can be better controlled. Please review the concluding checklist to help control your fears and advantageously position your comprehensive plan.

Not Quite Campfire Worthy–A Tale to Set the Scene 

One beautiful fall day in 2014, they walked along the streets paved with greenbacks. The skies were blue, and the air was refreshingly crisp. Perhaps ready to embark on a different journey, they reminisced the ups and downs of a six year history since the miserable fall of 2008. Tears and smiles were shared as they chronicled times of fear and euphoria. At some point on this fine day, the road became twisted, winding aimlessly, briefly directionless. The skies were suddenly grayer and less reflective. Look! Ahead there…a house! An eagle sculpture above the federal entrance signaled prestige and power. They huddled, and the group thought, this place will provide the guidance we seek. They approached the monumental iron doors and grasped the ice cold lion’s head door knocker. A pleasant and welcoming white haired hostess invited them in as the door slowly creaked open. The foyer was extremely bright with sudden flashes of extreme darkness. The new air felt cold as it occassionally drifted across the back of their necks. The smell turned foul as the uninvited musty taste breached their tongues. BOOM! The door abruptly shut behind them, and despite the hostess’s assurances of safety, the group’s confidence and expectations were terribly shaken…

The World Relies on the U.S. Federal Reserve

October 29th marks the next scheduled policy announcement from the most powerful central bank in the world, and investors, media, and politicians will parse every word for signs of confidence and expert guidance. U.S. monetary policy is made by the Federal Open Market Committee (FOMC), which consists of the members of the Board of Governors of the Federal Reserve System and five Reserve Bank presidents. The FOMC holds eight regularly scheduled meetings during the year, and it is widely anticipated that the Committee will officially cease material additions to its QE3 bond buying program at October’s meeting.

A few key goals of this so-called Quantitative Easing (QE3) program:

  1. maintain downward pressure on longer-term interest rates
  2. support mortgage markets
  3. help to make broader financial conditions more accommodative, which, in turn, should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate

All three QE3 goals impact your retirement portfolios, college savings accounts, and “fun money” brokerage accounts. Your willingness to become an astute watcher of market inputs such as FOMC activity and the inverse relationship between interest rates and bond prices will increase your basic understanding of fluctuating account values, and it will enhance your potential success as an individual investor and consumer of financial advice. Never rely 100% on an advisor with sole discretion over your accounts and the directive, “just make me money!”

Thank you to my friends at Intrinsic Research for supplying charts for three of the key market proxies spooked this October: daily S&P 500 stock index, weekly US 10-Year Bond yields, and weekly Crude Oil prices. Explanations for soaring market volatility range from Ebola, terrorism, European woes, politics, and concerns over top-line revenue growth. Bottom Line: The complacency of clearer skies has been replaced with a cloudier picture; whereby professional, novice, and machine-driven traders demonstrated an ability to accelerate out of assets such as lower rated corporate bonds and stocks.

30322fd

Current Chair of the Federal Reserve, Dr. Janet Yellen, has pointedly reiterated that interest rate targets are “data-dependent” and not based on a calendar projection; that is, when economic conditions and the economic outlook warrant a less accommodative monetary policy, the Committee will raise its range for the benchmark interest rate it targets (federal funds rate). Many powerful market participants are betting that early to mid-2015 will mark the beginning of a new higher rate regime. This dynamic relationship between two sometimes opposing forces (central banks & traders) will likely cause great angst, volatility, and uncertainty in many portfolios over the coming quarters as the Federal Reserve attempts to tip-toe in and out of the lurking economic shadows. Home mortgages, business loans, corporate deal-making, global trade, a range of asset classes, currencies, and critical decisions will be impacted. Make sure to solidify your well grounded short and long-term plans in order to avoid the emotional decision-making that overwhelms so many people at dark moments.

A Famous Chart & Unprecedented Efforts

As provided by the St. Louis Fed’s fantastic FRED database and courtesy of S&P Opco, LLC, the below graph illustrates the total assets of the Federal Reserve, which have grown considerably from $869 billion pre-crisis levels during the summer of 2007 to today’s levels of nearly $4.5 trillion (left-axis). The leader of this growth effort is an American Hero, Dr. Ben Bernanke, former Fed Chair, who succeeded Alan Greenspan in February 2006. Bernanke’s outstanding reputation included his thorough studies on The Great Depression and Japanese deflation. In 2002, one of Bernanke’s first speeches as a Federal Reserve Governor, was entitled “Deflation: Making Sure ‘It’ Doesn’t Happen Here.” A so-called Bernanke Doctrine emerged to identify specific measures required to combat or prevent deflation. There is little doubt that heroic actions were taken during the Great Financial Crisis of 2007-2009, and there is little doubt that the S&P 500 stock index (right-axis) benefitted greatly from unprecedented and continuous support.

fredgraph

Deflation is in almost all cases a side effect of a collapse of aggregate demand – a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers. -Dr. Bernanke

Bernanke theorized that a central bank should always be able to generate inflation. Ironically, I believe the Federal Reserve’s decision to continually add post-crisis stimulus through QE2 and QE3 programs, its attempts to modify the natural course of business cycles, and its promotion of a whatever it takes now and forever rhetoric has actually aided and abetted other deflationary forces. Of course, a strong argument can be made that other parts of Washington failed to be as heroic in efforts to restore our sub-optimal economic growth and prosperity.

Global debt burdens, demographics, impacts of technology, skills degradation, and plummeting velocity of money are structural forces that compete hard against Dr. Bernanke and his best laid plans. -Michael (no doctorate)

Global stocks, bonds, property, and numerous other assets’ prices have risen and probably contributed to some rough wealth effects; that is, some aggregate upward change in demand encouraged by more spending and less saving. Of course, a major risk factor is the potential reflation of yet another set of asset bubbles caused by excess central bank liquidity and credit rather than “fixing” economic fundamentals. Whatever the case, it is hard to argue “mission accomplished” as large and small economies face growth fears and fragility this fall of 2014. Therefore, any change in U.S. monetary policy runs the risk of igniting a chain reaction of extreme volatility throughout the globe.

Smart Preparation Goes A Long Way

As the Federal Reserve soon attempts to lead a new confident path, a trajectory of structural resolutions is unclear and negative side effects loom large. I fear Bernanke’s, and now Yellen’s, traditional econometric modeling will reveal numerous break downs in theory as the Federal Reserve shifts its unconventional policies. Unfortunately, market players put too much faith in the ability of humans (or machines for that matter) to legitimately map flawless outcomes for real growth, unemployment levels, interest rates, credit markets, and behavioral reactions. Smart market strategists believe the European Central Bank (ECB) will take the global baton with its own rumored unconventional programs. Again, not a fix for long-term structural problems, and this notion of a global market fully confident and supported by a non-unified group of Euro Nations to replace the United States Federal Reserve provides no comfort to this investor.

Previous attempts by the FOMC to exit QE programs in March 2010 and June 2011 were met with significant volatility and lower asset prices.

8655576585_d0621b62a4_kThe FOMC’s announcement on October 29th may not spook market participants due to its widely anticipated outcome; however, just like expecting to be scared at a Halloween haunted house, an expected “BOO!” can still raise the hair on your arms and make you jump! Let’s avoid complacency or delays in necessary portfolio adjustments even if financial markets seem settled and the S&P 500 (1,971) again surpasses the 2,000 level. The next Summary of Economic Projections and press conference by Chair Yellen (pictured) will be December 17, 2014: It is sure to be interesting and educational!

Focus on more controllable fear factors:

The below topics are important, and I wish to 
empower you with more specific tools, tips, and experience. 
I feel strongly about efforts to shape a trustworthy, forward-thinking
financial industry where families’ interests are served first. 

  • Communicate, Educate, Empower with all close family members;
  • Take charge of the collaboration amongst your tax, legal, and business advisors to maximize your family’s financial, tax, and investment planning–do not assume this is taking place without your encouragement;
  • Assess your family’s unique growth, income, tax, risk tolerances, and asset location needs–be your best advocate and communicate with your advisors;
  • Revisit portfolio diversification within and across all taxable & tax-deferred accounts–examine holdings beyond broad buckets of stocks, bonds, cash to ensure comprehensive suitability, proper risk alignment, and balance;
  • Be more selective with the evaluation of reward-to-risk factors among your individual securities and less reliant on “a rising tide lifts all boats” strategy;
  • Note: Cash is an important asset class with its own characteristics of safety
    and future opportunity–even worth paying a fee upon;
  • Maximize retirement strategies (Social Security, Roth, 401k, insurance);
  • Know all your costs such as quarterly fees based on assets, transaction costs on trades, additional fees not easily seen from owning and trading mutual funds, closed-end funds, and exchange-traded-products–hint, the trend is down; and
  • Check conflicts of interest (too many to list) among your advisors, investments owned, products sold, trade execution & allocation, and actual services rendered versus those promised before you signed the dotted-line

Previously, I suggested that the FOMC invest in a classic econometric tool (a family game of Monopoly) to simulate what happens when you dramatically change the rules of the game and then attempt to “normalize” back–not pretty: http://bit.ly/1uFITDA

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I welcome your comments. 

Michael embodies client-stewardship in all his work and happens to be a passionate expert in securities analysis, asset allocation, economic analysis, and wealth management solutions.

Email: mdhakerem@gmail.com & Twitter: @MichaelHakerem

Photo Courtesy of U.S. Federal Reserve: Eccles Building 1937
Photo Courtesy of IMF Staff Photograph/Stephen Jaffe: Dr. Janet Yellen

The S&P 500 index is proprietary to and is calculated, distributed and marketed by S&P Opco, LLC (a subsidiary of S&P Dow Jones Indices LLC), its affiliates and/or its licensors and has been licensed for use. S&P® and S&P 500®, among other famous marks, are registered trademarks of Standard & Poor’s Financial Services LLC, and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. © 2014 S&P Dow Jones Indices LLC, its affiliates and/or its licensors. All rights reserved.

How to Exact Revenge on a 1979 Gas Line & Pump Your Portfolio

Several recessions and crises later, I have learned to exact a little revenge as a professional who researches and successfully invests in North American energy, infrastructure and engineering stocks and bonds.

Gas LineShould you avoid stocks? Are interest rates about to skyrocket?  Is the economy about to go into recession? The answer is…”it’s possible!” Regardless, my wish for you is to be informed and focused on the right reward-to-risk opportunities.

It was a blistering hot day in 1979, sweat stinging my eyes as we sat in line among the many seeking to fill their gas tanks. The Country’s second energy crisis of the decade was triggered by widespread panic surrounding geopolitical events. A recession came in 1980, and I remember the burdens my single-mother had to endure in order to keep us clothed, fed, and sheltered. Several recessions and crises later, I have learned to exact a little revenge as a professional who researches and successfully invests in North American energy, infrastructure and engineering stocks and bonds.

People often get emotionally charged about “Big Oil” and “Rich Fat Cats,” and you have most likely seen many magazine covers, newspaper articles, and television interviews on the global fortunes won and lost in the energy sector. Still, thirty-five years after my miserable experience in line at the local Texaco filling station, the United States, Canada, and Mexico are only at the cusp of an exponential energy renaissance. It is not too late for you and your portfolio to benefit and to take a little something back in capital gains and income.

Tip: Never make investment decisions
when feeling euphoric or despondent.

U.S. oil production peaked in the 1970s, and U.S. dependency on foreign oil grew with the ensuing 30 years of production declines. To be sure, this subject is not without its controversies; however, the North American energy landscape is quickly evolving into a revolution:

  • technological advances worker
    (safer hydraulic fracturing and horizontal drilling)
  • massive and economical shale discoveries (fossil fuels, i.e. dead dinosaurs)
  • tenacious oil and gas workforces (Pride, Hard Work, and Skills)
  • gradual political and regulatory shifts (drilling, exporting, transporting)
  • efficiencies in use, transport and renewal (highway & light bulbs, ships, garbage)

According to the Energy INet Importsnformation Administration (EIA), total U.S. energy reliance on non-domestic sources could be as low as 4% in 2040, compared with 16% in 2013 and about 30% in 2005. Said another way, it is estimated that domestic production satisfied 84% of total U.S. energy needs in 2013 versus only 70% in 2005! The EIA estimates that at current consumption rates there is enough natural gas in the U.S. to last about 100 years. The combined potential of the U.S., Canada, and Mexico are ranked top in the world and may surpass the natural resources discovered in the Middle East, South America, and Russia. The United States is the clear leader in technical expertise and energy innovation. Shaded areas of natural resources are shown on the U.S. map further down in this post. You may have heard of abundant areas like Marcellus, Barnett, and Permian.

The Energy Value Chain

810_Oil_Gas_Value_Chain_Diagram

Tremendous momentum in oil and natural gas production continues to drive opportunities across a wide spectrum of sectors and regions. Thank you to Boston Strategies International for the above illustration that encapsulates much of the energy value chain. A series of activities must occur to ultimately deliver valuable resources, products, or services to end users who love to drive, grill, and stay warm or cool. The United States has the potential to massively expand its capabilities as an exporter of energy products. Negative headlines, doubts, and drops in investment values will occur from time to time. View these inevitable market worries as potential opportunities to wisely invest, as the energy independence story is real, growing, and likely to be a solid foundation for North American economies for decades to come.

Below are five categories of the energy value chain for you or your portfolio advisors to research. There are ample investment opportunities that will range in company size, income production, and level of risk.

  • Upstream investments include exploration, drilling, and production
  • Midstream investments include pipelines, storage, and processing facilities
  • Downstream investments include power generation, transmission, and distribution into your home, industrials, and transportation vehicles
  • Supportive investments are available in engineering, field services, materials, supplies, equipment, and environmental protections
  • Natural Gas Liquids (NGLs) and refined crude oil byproducts are inputs into a wide range of products, including fertilizers, plastic containers, tires, carpet, and paint so there are positive implications for manufacturing industries too.

20+ years of investment experience have kept me true to my framework: Be Patient, Possess a Defined Discipline and Process, Customize Selections and Decisions Based on Your Unique Portfolio-Period!

While much of the world was knocked off course by the financial crisis of 2007-2008 and its aftermath, the energy sector has added fuel to the otherwise mediocre economic recovery. States like Texas, Wyoming, Pennsylvania, Louisiana, and West Virginia are known for their respective energy production rankings. North Dakota is the fastest growing state with unemployment below 3% and has an economic growth rate in the double-digits. The Utica Region in eastern Ohio is one of the fastest growing natural gas production areas.

Utica Ohio

The below Bureau of Labor Statistics (BLS) chart illustrates 10 years of
employment growth in Oil & Gas employment.

employment oil and gas

US Shale MapOne of the greatest potential percentage growth opportunities resides in the global demand for liquefied natural gas or LNG. This predominately methane product has been converted to a liquid form through a cooling process to minus 259 degrees Fahrenheit. LNG is a clear, colorless, odorless liquid that occupies only a fraction (1/600) of the volume of natural gas making it easy to store and transport.

Why use LNG?

Natural gas is considered the cleanest burning fossil fuel. It produces less emissions and pollutants than either coal or oil. Historically the United States imported LNG to numerous import facilities along the Gulf Coast and on the East Coast. Many existing and proposed LNG facilities have applied for licenses to export LNG to foreign countries who view the fuel source as an extremely price-competitive means to help meet future economic needs. For instance, Japan is actively seeking strategies to meet shortfalls caused by the Fuksuhima nuclear power disaster.

Panama Canal Expansion

panama-canal3As early as the 16th century, American and British leaders and businessmen wanted to ship goods quickly and cheaply between the Atlantic and Pacific coasts. The Panama Canal opened officially on August 15, 1914 after many lost investments and lives. President Theodore Roosevelt oversaw the realization of this goal as shown in a photo of the President on a steam-powered digging machine during construction of the Panama Canal. (Photo Credits: H.C. White Co., N.Y)

Today’s ongoing expansion of the Panama Canal is the largest project at the Canal since its construction 100 years ago. Objectives call for a third set of locks, a Pacific access channel and dredging of existing navigational channels. The completed expansion should double the Canal’s capacity, having a direct impact on economies of scale and international maritime trade. This will prove hugely beneficial to accommodate LNG carriers who cannot currently pass through the Canal’s walls. For instance, one shipper from a terminal in Louisiana estimates its shipping time to Asia may be reduced from 64 days to 44 days.

How is LNG transported?

shipShipping companies are building 1,200 foot long vessels, and buyers are signing contracts for the double-hulled ships specifically designed to handle the low temperature of LNG. These carriers are insulated to limit the amount of LNG that boils off or evaporates. As of December 2013, the LNG fleet stood at approximately 387 ships with new and larger vessels on the way. (Source: IHS Fairplay)

Please visit the official website of the Canal De Panama Project for great photos, video, and updates of the expansion: http://micanaldepanama.com/expansion/

Is the sweat beading up on your brow as you try to outguess the next crisis or market drop? Are you sitting in line with the crowd, beholden to fill-up on group-think stock, bond, and economic analysis? The clouds may darken overnight; however, I want to throw down a challenge for you to remain calm as a fellow educated investor in a magnificent shift as powerful as demographic trends, tax reform, or any other human constructed crisis.

There is an Energy Revolution in North America–It is just taking hold and you have an opportunity for your family’s portfolio to exact revenge on those gas lines, “fat cats,” and missed investments.

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I welcome your comments and please stay tuned for future articles where I plan to offer a range of insights and solutions — from battle-tested fundamental and quantitative active management approaches to the qualitative side of being a professional investor.

About Michael Hakerem, CFA:

Michael embodies client-stewardship in all his work and happens to be a passionate expert in securities analysis, asset allocation, economic analysis, and wealth management solutions.

Email Michael at mdhakerem@gmail.com
Follow Michael on his LinkedIn and Twitter