In my short time in the field of financial services, the
normal conversation started with “how about these markets?!” Now you don’t need to be a genius to
understand the basic movement of the equity and debt markets foreign and abroad. If you have been following recently I’m sure
you have been a little confused but optimistic at the same time.
History says that commodities rise when the prospects of
growth on a macroeconomic level decrease (hence the recent record highs for
gold, silver, and other commodities).
Gold has been on a decline recently though, each trade dependent on
unemployment and GDP numbers. By definition,
we are out of the recession but that doesn’t mean that we are actually out of
the recession. Ask nearly 9% of
Americans if they feel as if we are out of the recession. Ask 1 out of every 2 college graduates that
is either unemployed or underemployed if they feel as if the recession is
ended. The fact of the matter is that
the economy is not where it should be, GDP growth is soft, and job growth is
weak. We may not be in the same
predicament as Spain, Greece, or Portugal but we are most definitely not in the
clear.
So why is this? Why
after almost 4 years have we still not recovered? Why is it that corporations are continuing to
grow, but maintaining the same amount of employees? The answer is uncertainty. There is uncertainty on a massive level,
created by the public sector. We are currently
watching the unraveling of governments who have created an unreasonable amount
of debt in which before they thought was sustainable. Now they are watching their best case scenario
financial model deteriorate before their own eyes. The unfortunate part of this, is that the
people are suffering from the indiscretion of the few. The majority loses its strength when the financial
well being of all parties is compromised.
What investments are safe?
Where should you put your money?
Below I will summarize what I think is going on in each category of
investment and what you should do.
Domestic Equity
Right now, if you live in the US or abroad you need to have
your money invested within the United States.
We may not have superb growth, but currently we are the best area to
invest. Our currency, diluted as it is,
isn’t in danger of being eliminated. Our
economy isn’t ideal but it is functioning.
And regardless of crap economic numbers we are still growing. Businesses large and small still have access
to credit to either start up or grow their business. This is what’s needed to keep an economy
going. The access to credit is the most
important part of the private sector.
The ability to RESPONSIBILY leverage yourself is how you take a mom and
pop shop and make it into a multimillion dollar conglomerate.
I would recommend investing in large to mid cap equities in
this area of the market. This will
provide you with moderate growth and atleast an almost guarantee that your
portfolio will not go down to 0. On a
side note, if you are invested in large cap blue chip stocks and your portfolio
goes belly up, then we have bigger issues then your 401k to worry about.
Domestic Fixed Income
To those not familiar with this terminology, fixed income
means bonds. Bonds come in all forms including
but not limited to treasuries, corporate, municipal, and junk. These are used to hedge your portfolio to the
implied risk of equity markets. Normally
these are pretty safe investments with a pretty regular rate of return. Like any investment though, they can prove to
be problematic if purchased at the wrong time with the wrong mindset.
I would say that currently bond funds are not safe. Interest rates on bonds are established by
the rates offered by the Federal Reserve.
If the Fed is lending money to other banks at 2% then chances are the 10
yr treasury will pay a 5% return, the 10 yr well rated corporate bond will pay
7% and the 10 yr junk bond will offer 12%.
These rates are always a function of what the Fed is lending at. Now right now, I’m sure you have noticed that
rates are extremely low. They are low on
mortgages, treasuries, corporate debt, and of course at the Fed. So if you’re buying a house right now you are
making out, but if you are looking to make your portfolio more conservative
with bond funds then you are in for an unpleasant surprise.
Sooner or later the Federal Reserve will be forced to raise
rates. They will do this when they feel
as if the economy is at a point in which the credit markets will still continue
to flow when funds are lent out at 6% instead of 3%. Here is when the issue arises. If you buy a 10 yr corporate bond fund when
fed rates are at .25% and your portfolio is planned to pay out 5% annually then
an increase in fed rates is going to hurt the present value of your
portfolio. Now, comparable 10 yr bond
funds are paying out 7% instead of your 5% so people are going to pay less for
the bonds that make up your fund. Your
bond fund manager is going to sell, because he/she can’t afford to hold them to
maturity. He/she is going to want to get
into the higher rate paying bonds being issued.
This means that you are going to take a loss on your fund in the short
term. If your 25 yrs old and just messing
with bonds that’s fine, but if you are 75 yrs old and retired in which your
portfolio is 100% in fixed income then there is an issue. That retired person is going to take a very
large loss on their principal and it will most likely affect the pay out of the
bond fund as well.
All in all, bond funds are not a good place to be in right
now because of the interest rate risk currently out there. One may argue that there is less risk and fluctuation
in a blue chip equity fund than there is in a bond fund. So if you do decide to go the route of fixed
income please go with a short maturity fund that is staying in AAA+ rated
corporate debt. At least, with this
strategy you are gaining the consistency of a bond fund but you’re not leaving
yourself out there for heaving fluctuations in interest rate changes.
Foreign Equity &
Fixed Income
For the past 3 years, Financial Advisors have been selling
foreign funds because of their high returns in comparison to the US
markets. At the time, they were correct
with their recommendations. Are
businesses overseas subpar? Are
corporations over leveraging themselves like we see at times in the states? For the most part, no they are not. The issue is with the governments overseas. The financial distress of certain nations
creates issues for the private sector.
If a government can’t pay its debts, what does it do? It raises taxes. This is the issue with investing overseas in
the EU and also in emerging markets. Their
governments are the biggest hindrance for growth. The uncertainty on high taxes, increased
social programs, and the overextension of investing in foreign equity is why
you should stay away from these funds.
From 2000 to 2008 the United States was the place to invest
if you lived overseas. Governments,
Businesses, and people were throwing money to us because of the almost 12%
perpetuity we were offering with our equity and debt markets. The choice investment was a AAA rated
investment on par with US treasuries but offering a higher rate of return with
the same amount of risk. The investment
of choice was CMO’s (collateralized mortgage obligations). I don’t think I need to go into this
investment, because we all experienced first hand the volatility of this
perceived safe investment. If we can
learn anything from this it’s that if there are two investments out there with
the same risk, A and B, and A pays more than B then only two things can be
true. One, A is either going to decrease
in return eventually because the market will correct itself or A is riskier
than B. The frequency of arbitrage
investments is very slim, especially in the fixed income arena.
Foreign investors learned the hard way and individual
investors, companies, and governments suffered because of it. Companies and individual investors can work
themselves out of losses, but governments can’t. They either increase taxes or default. If the people they are taxing don’t have the
taxable income to raise tax revenues then the government will fail
(Greece).
In one way or another, all foreign nations are subjected to
this type of risk if they overextend themselves on debt. If these same governments offer a lot of
social programs and spend at a high % of GDP then losses from investments can
put them in the red permanently. This is
precisely why it is important to stay away from overseas investing. As exciting as it may be, as much research as
you do, you can’t take into effect the stupidity of governments to ruin a good
thing.
Overall
We are currently in a very difficult arena for
investment. The exciting part of it is
that we aren’t in a period of bad business, we are in a period of bad government. I’m not going to tell you that we need 0 government
interference, no social programs, and only pro business policy. The fact remains that government is needed to
keep countries going; although we need to redefine what is needed to facilitate
private sector growth but also take care of the less fortunate. Investing is the simpler aspect of this
question. Once we figure out the proper size
of government, the proper amount of taxation, and the proper amount of
regulation the private sector will thrive through those advancements.
I feel that if I were responsible for a federal budget I
would want to treat it as my own budget.
I would plan with the worst case scenario in mind, plan with frugality
so you can absorb future fluctuation in costs or costs not expected. The overextension of personal debt, on a
massive level is what put us into the predicament that we are in
currently. In order for us to learn and
adapt, we need to live more frugal and we need our government to spend more
frugal.
We need government to provide the necessities. They need to protect us abroad, protect our
borders, and enforce our laws. They need
to help people that can’t help themselves, but at the same time show them a way
out of poverty. We can’t continue to
have generation of families stay at the same income level because of the lack
of opportunity across the board. In the
investment world, past performance is a good predictor of future performance. I don’t believe we can accept this when it
comes to how we treat our less fortunate citizens.
I’m currently working on an extensive report on the
connection between economic reform and social reform. My thesis is based on the fact that if you
balance the importance of the two then the country will consistently
improve. If you have read anything I’ve
written before, I base all of my political ideology on bipartisanship. This isn’t because I want everyone to get
along, it’s because I understand and believe in the importance of working
together to achieve both wants/needs of both parties. The relationship between republican economic
reform and democrat social reform should be connected in a way in which they
balance themselves out. Economic reform
should occur in low income areas across the nation, this would reduce the
reliance on social programs offered by the federal government. This is how you fix an economy. Not by across the board tax cuts. You fix the economy by fixing parts of the
economy that are always forgotten. All
people need the same opportunities, they all need an opportunity to provide a
living for themselves and their family.
If you think this is off topic, I urge you to
reconsider. A more productive economy
will be reflected in GDP growth, GDP per capita, and more importantly it will
be reflected in the equity markets. A
more productive economy means higher consumer consumption which drives
growth. As cliché as it sounds,
everything is connected. And if we don’t
want to end up like the EU we need to start implementing policy aimed towards
creating a sustainable economy. I know
our leaders won’t allow us to end up like Greece, but if they falter I can
assure you that I will not allow us to end up like Greece.
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