World events and changes are challenging but not as Glum as they seem.
As I sit here at the end of the first quarter of 2022 I am struck by a few things. The first is that our world has changed significantly over the past few years. The second is many have been complacent for far too long. The third is, as a portfolio manager and financial advocate for our clients, that these changes and said complacency have created massive challenges for proper allocation of assets. I feel that our process of e3 has helped to mitigate these challenges but for many the changes have forced them to make decisions that are impacting their portfolios, their way of life and ultimately the global markets.
It is easy to be glum. Things have been difficult. Today we have all lived through 2 years of Covid and it seems a lifetime of Covid related news. To a certain extent many are intellectually and emotionally ‘done’ with the virus. Yet the impact, apart from the health issues, will be felt for many years to come as we deal with the new reality that some people can work from anywhere, many don’t feel they need to work, in a traditional sense, at all and some industries have seen 10 years of growth in this short period where others have been tossed on the pile of buggy whip manufacturers. New technologies are enabling this new world and are changing how people think and interact. Covid certainly has also changed the investment landscape and the impact of the flood of capital in the form of free money from the government is just beginning to be seen. But of course, there is way way more to consider...As Covid related news wanes and we better understand the virus and how to adapt to living with it, the news has moved on to the next significant world change.
The next reason to be glum comes from the international sector. For years, the un-written rule was that 'wars of acquisition' were rarely profitable and carried not only the risk loss and death but the risk of incurring the ire of the western world. In short economic suicide. Forget Kim in North Korea (for now) as its Mr. Putin who has challenged this convention, first in Georgia, then Crimea and now the Ukraine. And accordingly, this morning the headlines have replaced Covid with the current geopolitical event. The outcome of the Russian attack on their neighbor is uncertain, in many senses, but in a real way it is again altering Europe and dividing the rest of the world. It is also altering the investment landscape with Europe headed for a recession and a humanitarian crisis unlike any in the last 70 years. Monies that would have been earmarked for the humanitarian crisis will go elsewhere. Defense spending will once again take center stage as will the conversation over cheap fossil fuels and green, expensive ones. (Oil prices have once again spiked, not only because of Mr. Putin but perhaps because of the West's hubris...more on this in a second...)
This ‘green’ conversation is not new, in a basic way, as the West has been looking to wean itself off fossil fuels for years. But today the idea is part of what is being called a ‘Corporate Recast’. In the March edition of www.Investmentnews they summarized this concept:
Previously, the primary job of a corporate executive was to maximize shareholder wealth. Adam Smith captured the thought with his Wealth of Nations which suggested that by pursuing profits, each individual was benefitting society. The author Milton Friedman updated the concept in his essay, “The Social Responsibility of Business Is To Increase Its Profits”. That concept has been replaced by the notion that corporations should take an active interest in making the world a better place. The latest manifestation is the SEC’s recently-released climate change/ ESG disclosure requirements. Additionally, Goldman Sachs Assets Management announced it would vote against management of firms which did not disclose greenhouse gas emission data and JPMorgan, Citigroup, and BlackRock agreed to racial-equity audits.
Social responsibility, environmental impact, and governance (ESG) is now disclosed on annual reports and has risen to the level of equal importance as profitability at many of the institutions teaching our children and in todays financial press as well as in the board rooms and the rating agencies. Firms that are viewed as uncooperative or willfully remain focused on profit and not on societal ills are often shunned by the newer crop of investment managers. This leads to less funding for some companies and more for others. Unfortunately, there are no real standards for ESG at this time and investing in companies with high marks for ESG has been shown to be less than fruitful, and expensive. (https://www.quantumprivatewealth.com/post/green-is-good-but-esg-isn-t-what-it-seems) Further, the approach may need to be reexamined, as noted by Egan- Jones: “evidenced by the disruptions in the energy market; petroleum producers are often viewed as major contributors to the carbon footprint and have had restricted access to capital as a result. Most countries still use gasoline-powered vehicles and depend on natural gas for heating. Disruptions in Russia-based energy are causing major problems.”
Regarding the West's hubris...With only 340 million people in the US and over 1.2 billion in Africa, 1.4 billion in China and 1.3 billion in India, we, in the US, need to be mindful of that we are not the whole world...and that we need to remain competitive in the global economy…not just at home. Not all countries can go ‘green’ and not all will want to. Exporters of fossil fuels will argue, effectively, that the only way to bring the third world into the 22nd century is using what is the most efficient and cheapest energy source around. Fossil fuels meet this criteria. In short, changing the world takes time and punishing companies that produce our energy, that are not viewed in today’s lens as being highly ranked on the ESG scale, may be not only short sighted but may lead to unforeseen outcomes similar to the ‘brown outs’ we see in California, the power shortages in fossil fuel rich Texas and the invasion in the Ukraine. It may also hurt the US on the world stage from an economic standpoint. It is nice to be the 'pretty country' but being intelligent and industrious are more important. As is making sure that inflation does not hurt our more economically vulnerable.
So hey, no reason to be glum, all we have to worry about this quarter are a virus, inflation, oil prices, a change in what is important at the C suite level, higher food prices, a humanitarian crisis, a war and a congress that is wasting time deciding on if we need to keep Day Light Savings Time.....and as I stated, all of this information, all these events, all this stress...perhaps its information overload, perhaps its we are weary, but it has led to a level of complacency...
This complacency is evidenced by Wall Street firms still suggesting, in an inflationary period, a rising interest rate period, that individuals remain in long bond positions. And in some case increase their bond exposure. Its also evidenced by comments from Wall Street pundits who remain fully rooted in the past. And while I fully endorse looking at history as a guide one must look forward as well. And, the history that many of these pundits are looking at is a very short period....or is not relevant to today's facts.
An example of this is those individuals and institutions that still maintain a 60-40 portfolio allocation. When I started in this industry over 35 years ago the general rule of thumb was that a persons portfolio should be invested amongst two asset classes. Stocks and bonds. The percentage was easy to figure as your stock percentage was supposed to be your age subtracted form 100. So if you were 30 years old you would have 70 percent of your assets directed towards stocks and 30 to bonds. When you were 70 it would reverse with only 30 percent in stocks and 70 percent in bonds. Now interest rates were 8.99 percent on the 10 year treasury in November of 1987 so the math made sense. Since ’87 rates on the 10 year treasury dropped all the way to .64 in August of 2020 where they bottomed out. When bonds were under 1 percent the 60-40 portfolio was a little challenged...Actually a lot challenged. Since that date the 10 year has risen to 2.5 percent. Anyone who invested in August 2020 in that bond would have an unrealized loss of over 15%. Investing in a bond ETF that mimicked the return of the 7 to 10 year Treasury bond would have a negative 12 percent rate of return.. Which brings me to the complacency. Many advisors and firms have maintained a ‘newly updated’ yet similar model to what was in existence in 1987. Today for a moderately conservative portfolio, a general allocation of 63% fixed income and 37% equities is what Merrill Lynch Edge Select Conservative Portfolio recommends. Vanguard LifeStrategy Conservative Growth Portfolio is 60% Fixed income and 40% Stocks..
If you believe, as most pundits do that rates will continue to rise (the CPI is currently at 7.9% and the Fed has signaled it will be aggressive infighting inflation) then these models will help you lock in losses for your portfolio. Go ahead, click the link on the two portfolios mentioned to see what their returns have been ..and remember ...that's been in a 'good market'. Going forward, these 'Conservative' portfolios , if rates continue to rise, will not look so good. The bonds will lose money, the income will not keep up with inflation and the principal, at maturity will have lost a significant amount of its purchasing power…because that’s what inflation does…it eats away at the value of each dollar you have. ( See the following link to a video on our website for more information How Inflation Affects Fixed Investments (quantumprivatewealth.com)).
At the same time there is a belief that in a rising interest rate environment growth stocks don’t do well. Now although in the past 12 months the Russell 2000 growth index is actually down 29.9% ( down 12.63% in the first quarter of this year) there is no logic in the price movement. In fact this happened while the S&P500 was reporting their earnings for last year...Final Q4 '21 Earnings - in the S&P 500 - and only 75.3% have surprised to the upside. ONLY. Earnings are up 28.9% from a year ago. Overall, consensus was estimating 19.8% YOY at start. revenues are up 16.1% YOY.
Profits are up almost 29%... But if you want to see the actual results of a rising interest rate environment on the growth sectors (very different from what is in the popular Wall Street culture) then see my post There will be no Growth...growth is DEAD. (quantumprivatewealth.com).
So why do the big firms suggest models like these? Models that suggest large fixed income allocations and small growth allocations. Models that help you lose money slowly. A lack of foresight? Its what has worked in the past? Its not because they have dumb people working for them. Complacency?
After +30years in this industry I decided it was time to change that dynamic. Thats when we opened Quantum Private Wealth and adopted the e3 model for our clients. Empower, Enhance, Elevate. This model helps alleviate the angst of market moves, helps quiet the fears that are the result of the information overload and in short, help allocate your portfolio based on your needs... not some made up hypothetically 'conservative' 70 /30 portfolio mix. One can be glum or one can take advantage of opportunities. We chose to be opportunistic and e3 gives us the time and latitude to benefit.
Finally, I want to once again stress we are aware that we are here only because of you. You are the reason we strive to do better each day. Thank you for your support, your trust and equally important, your friendships. If you have any questions or just want to say ‘hi’ we have been and are open in downtown Market Square , Lake Forest Illinois. Andrea, Jen and I would love to have you stop by if you are in the neighborhood.
Enjoy the coming spring and I hope it brings you all health and happiness.
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