The Dollar Ain’t Worth a Nickel Anymore?

The US dollar has become the Rodney Dangerfield of currencies: “it gets no respect!”

There are some compelling reasons for this lack of respect, the greatest of which is the flood of dollars that have magically appeared on the Fed’s balance sheet (which were then used to bail out large US banks).  This flood of liquidity averted a global financial meltdown.  But even Ray Charles can see that doubling the money supply will lead to inflation.  This is not going to happen until banks start lending again.  Right now banks are licking their wounds and recapitalizing.  When they start to lend freely, inflation will kick in.

The Fed is planning to mop up that liquidity before the next big growth (and lending) cycle begins.  Its success in reducing the money supply and raising interest rates, while not stunting the expansion of the global economy, will determine how much inflation we experience.  The likelihood that they will time it exactly right is small, so we are likely to see inflation in the future.  The best way to mitigate this risk is to own “stuff”: real estate, foreign stocks, domestic stocks with some exposure to foreign earnings, and commodities.

Two thirds of the world’s reserves are held in US dollars.  Talk of other currencies usurping the dollar’s leadership role is interesting but I don’t see a serious contender to take its place.  We might be at the beginning of the end of the dollar’s post World War II reign.  If so, it’s the very beginning, and it will take a few years before a better option rises to the top of the currency heap.  The demise of the dollar as the primary reserve currency is a long story and most of it has not been written yet.  A lot of it will depend on how the Federal Reserve plays its cards over the next few years as we enter the next phase of the global business cycle.  I believe the Federal Reserve has more mojo than the European Central Bank, or any other central bank for that matter.  During the worst economic crisis in recent economic history, investors piled into US dollars, not the Euro (and not gold either).

I’m not a market technician, and I don’t play one on TV, but I suspect the dollar has been oversold. It’s a popular whipping boy and it’s trendy to rail against its inadequacy as a worthy store of wealth.  But if we see some uncertain economic data, we’ll see it bounce back with a vengeance as investors flee gold and commodities to cash in their gains and protect their wealth in the lowly, United States greenback… or will it be the Euro?

How to Make a Small Fortune in the Stock Market

In late February I was on the phone with my uncle Jim.  We were discussing economics, politics, history and ranch management.  Global asset prices (and I mean ALL asset prices) were valued at 50% of what they had been valued the previous year.  People were convinced that we were slipping into the next Great Depression.  In one of the darkest moments in post World War II economic history, my uncle me asked this question:  “Do you want to know how to make a small fortune?”

“Well, sure I do!”

“Todd, the secret is this: first, you gotta start out with a large fortune!”

Thankfully, financial markets have stabilized and healed significantly since March 9.  Large fortunes that had become small have become large again, although not quite as large as they were a year ago.  But time heals all wounds and I am confident that we will see a return of global  economic expansion and that the market will make up its lost ground and then some.

The folks that made a small fortune out of a large  fortune were the ones that went to cash in anticipation of jumping back in before the market rebounded.  They will likely never recover from that decision.  I know how hard it is to stay the course and maintain discipline when the entire world is losing its mind.  Sometimes the desire to do something, anything, to stop the pain seems like the only reasonable thing to do. 

Everyone suffered in the global financial meltdown.  There was nowhere to hide.  Our wealth management discipline was to turtle up and ride out the storm.  It was painful and stressful but it appears to have been the prudent thing to do.  This is how we survived the last bear market and our clients are participating fully in the stock market recovery, just as they did earlier this decade.

Design a prudent asset allocation and populate it with solid components and your fortune will gradually grow.  Don’t lose long term perspective.  Frequent trading and market-timing is the surest way to make a small fortune out of a large fortune.

The Art of Receiving a Financial Gift

At a conference several years ago I met an estate planning attorney who was telling me about a young client that had inherited wealth from a trust.  According to the provisions of the trust, the young man was allowed to have $500,000 on his 25th birthday.  He arrived in the attorney’s office, with an entourage of eager friends, and collected his check.  The first thing the young man did upon leaving the attorney’s office was visit a luxury car dealership where he purchased a Mercedes and a BMW.  Then he lived the lifestyle of the rich and famous (with a little help from his “friends”) until it was all gone, which took six months.

Many of my clients give financial gifts to their children and grandchildren.   There are estate planning benefits, but most importantly, they want to give the subsequent generations an “edge” that they didn’t have in the creation of long-term wealth.  They want to see the subsequent generations attain at least their level of financial success, or ideally, much better.

There is an art to receiving a financial gift.  Each person’s situation and stage of life is different, but generally speaking, if you are receiving a financial gift from your parents, grandparents or a trust, there are good, bad and ugly uses for the proceeds.

Here are a few of the bad ways to use gifted funds:

1. Buying  a luxury vehicle that you couldn’t afford otherwise. 

2. Taking extravagant vacations. 

3. Buying prestigious luxury items that give the impression of showing off wealth.

 

 Here are some of the best things you can do with a monetary gift:

1. Pay off debts, especially student loans or credit cards.

2. Invest the money in an account that will grow your balance sheet.  That would include savings and retirement accounts (like Roth and Traditional IRAs).

3. Save the money in a college fund for your children or apply it towards school tuition.  If grandchildren are receiving financial gifts from family, set up a 529 plan and deposit all proceeds there.  Then let family members know about it.  Most of them would rather send a check to the college fund than buy them a toy anyway.

All of these recommendations also pertain to inheritances.

Always write a thank you note and explain how you’ve  used the funds.  It pleases the giver of the gift because you recognize and appreciate their values  and generosity. It will also likely increase the likelihood of more, and perhaps larger, gifts in the future. 

These are rules of thumb and each case is unique.  Each family dynamic is different. Sometimes the gift giver wants his beneficiary to take the family on a cruise or do something extravagant to enjoy the gift, and that’s wonderful.  The recommendations I have made show gratitude and respect for the giver and it puts the beneficiary of the gift in a better financial position, which is usually the motive for financial gifting in the first place.

Do You Know What You Don’t Know?

“What gets us into trouble is not what we don’t know. It’s what we know for sure that just isn’t so.”  Mark Twain

I’m a people person. I love people and economics (in exactly that order).  I’m a good listener and my friends and family (also known as “clients”) often ask my advice on personal as well as financial issues.  I know what issues I can give advice on and which I can’t.  That’s a very important distinction to make.

A few times a year, I’ll have requests by clients to meet with their high school or college-aged children to discuss finances and investing.  I’ll meet the young man or woman for lunch and ask them open-ended questions about what they want to be when they grow up.  This is a lot of fun for me, and I often give financial advice to these children as they become adults.

Once a client’s child called and asked me a question that absolutely stumped me.  

“Mr. Black, I need your advice on a very important decision I have to make.” 

“Of course, anything I can do for you.  What are you trying to figure out?”

“Well”, he replied sheepishly, “I think I’ve found ‘the one’.”

“‘The ‘one’ what?”

“The girl I want to marry.”

“Well that’s great!  Congratulations.” I said.  “But what does that have to do with me?”

Then he asked me, “How does one go about buying an engagement ring?”

I laughed and told him, “You’re outside of my expertise.  You’ll have to ask Mrs. Black about that!”

I’m not qualified to give advice about a lot of things (particularly jewelry).  But I know someone to ask or to refer my friends and family to for just about every conceivable piece of advice they are seeking.  I’m always looking for the best qualified, nicest people to turn to when I get a question I don’t know the answer to.  I’m not a jack of all trades.  I’m a good wealth manager and I do my best to take care of the families that have entrusted their futures to my care, and they deserve to have the best advice possible for their unique situations.  I have a lot of very smart colleagues who specialize in investments, taxes, estate planning and insurance.  I read voraciously and it’s all I can do to keep up with my area of expertise.  Consider carefully the source of your advice and the values that your advisor holds because they do flavor the recommendations that he or she is giving you.

Hot Retirement Destinations

Growing up in Arizona, we referred to retirees that lived the summer months somewhere up North and the winter months in the Southwest as “snowbirds”.  Increasingly, snowbirds have been shedding their Northern nests and settling in the desert in massive retirement communities like Sun City in Phoenix and Las Vegas.    In the Southeast we have similar developments in Peachtree City South of Atlanta and the Villages in central Florida. These communities offer a fantastic quality of life, but they are hot.  I mean blazing hot.

Last week I helped my mom and stepdad move from Las Vegas to Tucson, which is a retirement mecca.  The temperature hovered at 108 degrees.  I don’t care if it is a dry heat, that’s hot!  When I offered to help my parents move, it didn’t occur to me they would choose the first week of August as the ideal time to do it.  But I’m not complaining too much.  At least I didn’t have to go to Houston, TX.

My bride’s grandparents grew up in Texas and lived in Houston for over 60 years.  Granddaddy’s birthday was August 9th.  Every year since he turned 98, the family would go to Houston and throw him a birthday party, and it was a lot of fun.  He enjoyed it so much, he kept having them so we could come back and visit him.   Granddaddy lived to be 104 years old.

One year we had an ice cream social at the fellowship hall of Granddaddy’s church (South Main Baptist).  I offered to ride with Grandmother and Granddaddy in the car to the party.  I was wearing a suit and a tie and I was sweating profusely because it was over 100 degrees with 110% humidity (mild August weather for Houston).  Granddaddy was sitting in the front seat with the air conditioner blowing on him.  He got cold, so he kept opening the windows to “let the warm air in”.  I thought I was going to die of heat stroke.  I would rather go to Vietnam in August than go to Houston.

Warmer climates are a great retirement destination for retirees, especially if they live in a low maintenance community.  Our retired clients live predominantly in the Southern states and are quite active.  Most of our clients are in North Georgia, which is far enough North that you see four seasons but far enough South that you don’t have to shovel snow.  We also have clients that live in Nevada, the low country of South Carolina and the Florida coast. 

Retirees are the busiest people I know.   Living in a climate where they’re not shut in for the winter months adds a lot of quality to their lives.  For folks that have settled into retirement up North, come on down to the South and look around!

Selling People Short

Short-selling is making a bet that a company’s share price will decline.  Brokerage firms loan shares of stock to the short-seller who assumes the risk of the trade.   If the short-seller is correct, he will profit from the trade.  If he is wrong, and the share price appreciates, he will lose money on the trade.  The brokerage firm earns margin interest either way.  Short-selling is particularly prominent in the hedge fund industry.

When the uptick rule was changed (which specified that one cannot short a stock unless the previous trade for the stock was an uptick in its value), I thought it was a good thing, that it would make markets “more efficient”.  I didn’t really think about the law of unintended consequences.  But now that I have seen the human cost of short-selling, I deplore it. 

I don’t aspire to profit from the failure of a company and I don’t want to willingly contribute to its demise.  Each ticker symbol that trades on an exchange (whether it is a stock or an ETF) represents the hopes and dreams of countless scores of employees, investors and their families.  Those people have dignity and value. 

Granted, not all companies are good companies.  That might be due to industry circumstances or human (i.e. management and/or labor) factors, and if I make that assessment, I simply sell the shares.  That is the dignified way to manage money.  There are countless good companies and opportunities to make money by investing in positive development.

Shorting a company’s stock destroys the wealth of its shareholders and stakeholders.  The short selling of financial stocks in 2008 was the equivalent of a back-door run on the banks.  It was like holding a drowning man’s head underwater and refusing to let him up to breathe. Short-selling traders made a killing by undermining our financial system and the security of billions of people around the world.  The human cost to the financial industry employees and shareholders and the panic that ensued around the world will probably never be adequately measured.

 The problem with the investment industry today is not that it is under-regulated or overly greedy (it has always had an ample measure of both).  The problem is that it does not recognize the dignity of people, which is the essence of fiduciary responsibility.

Chasing Returns for Fun and Profit

Theoretically, disciplined traders do very well in periods of extreme volatility.  I am told that steely-eyed professionals can make money even in a down market.  The Crash of 2008 was special (not in the good way) and took its toll on trading desks around the world.  Frankly, I’m surprised the hedge fund industry didn’t completely disappear during the crisis. 

Trading is synonomous with gambling and speculating.  It’s not a nefarious activity.  In fact it helps markets work smoothly (despite the protestations and finger-wagging of economically inept Congressmen).   Traders are professional risk-takers that add a lot of value and liquidity to the market.  But their strategies should not be a part of an individual investor’s investment plan.  It’s like letting your eight year old play poker at the adult table.  Despite the advertisements on television touting the benefits of engaging in this activity, the vast majority of individual investors that trade actively lose money (greater than 80%, some say closer to 90%).

Traders chase returns for fun and profit.  Sometimes they buy in before the asset starts to appreciate, but mostly they are jumping on the band wagon and betting with the herd.  Each trader has his own exit strategy or system that he employs to judge the right time to sell.  His time horizon is usually very short (seconds, minutes, hours…).  It is costly in time, energy, and financial resources to be a successful trader.

We are in a trader’s market.  The major indices are trading in a range and the professionals are jumping in and out in an effort to recoup what they lost in 2008.   Individual investors, who have no business trading, are also attempting to make up the ground they lost in 2008.  Many sold at the bottom in March and subsequently watched their portfolio components bounce up 2o% to 40% since then.  They’re wondering if the train has left the station without them.  They piled into gold and commodities and financials in an effort to recoup.  Gambling with what is left of one’s retirement assets is not the way to recover from the crash.  Being properly diversified with the best components (indexes and mutual funds) in each asset class is the least risky course to pursue.  Dollar-cost-averaging into the market over the next year would be a wise way to re-enter the stock market.

I know that diversification didn’t work during the crisis, but we have seen significant stabilization since then. I am anticipating a return to asset class correlations that resemble our historical experience.  We will likely see choppy markets through the end of the year and several quarters of mediocre earnings.  This will be an improvement over what we have experienced recently, which should have a positive impact on global asset values. 

In the immortal words of Mark Twain:

There are two times in a man’s life when he should not speculate: when he can’t afford it and when he can.
- Following the Equator, Pudd’nhead Wilson’s New Calendar

Are Commodities the Answer for Inflation?

Inflation is the hangover that comes from an expanding money supply and an overheating economy.  Our money supply has grown exponentially over the past year and the global economy is far from overheating.  Investors are scared that inflation is likely to happen and eventually it will.   There is a food fight between prominent economists about whether or not we’re going to see a surge in inflation sooner rather than later.  Its’ a fascinating discourse, but I’m leaning toward the camp that it’s unlikely to happen soon.   When global economic growth rebounds, it’s time to pay attention.

The Federal Reserve was very artful in the means it used to shore up our financial system.   It dropped the Fed Funds rate to 0% and used other measures (massively expanding its balance sheet) to inject liquidity into our financial system.  It wasn’t an overnight success but it did prevent a global financial meltdown.

Investors are understandably concerned that the Fed is going to have to start mopping up the ocean of liquidity it unleashed upon our financial system to prevent inflation from getting out of hand.  The Fed’s success in accomplishing this will determine whether we have the doomsday stagflation scenario that all the television commercial purveyors of gold are expounding or a boring cyclical recovery along the lines of our historical experience.

Some investors, who are very concerned about inflation, and  in the belief that they are being safe, are piling into gold and commodities.  Gold is a very emotional asset class.  It has industrial uses but fear is a big driver of its price.  Fear is a horrible motivator for financial decisions.  Overall commodities prices are being distorted by the same market forces.  Commodities prices rise because people expect economic growth to happen, or because they are scared, or because they are speculating on a combination of the two. 

I don’t mind a little bit of gold or commodities in the mix, but I consider them speculative and volatile, so I wouldn’t put a huge chunk of a portfolio in them.  The Gold SPDR (GLD) has a three year return of 14.41% and a standard deviations of 20.69.  Considering the market conditions of the last three years that was pretty spectacular.  But I think the likelihood we’ll see the same performance over the next three years isn’t that high.  

We can use the average rate of return and the standard deviation to create a normal distribution, or a range of likely returns (to learn more about this fascinating statistical concept,  please read my blog post “50% of the Time That Works All the Time” dated April 16,2009).  Sixty-seven percent of the time (or two out of three years) the Gold SPDR’s likely range of returns fall somewhere between -6.28% (14.41% – 20.69%) and 35.10% (14.41% + 20.69%).    I think going forward we’ll see that normal distribution curve take a shift to the left.  If the standard deviation remains about the same the downside range of likely returns for gold could be lower than -6%.  Of course, there is a one in three chance that the return will fall below -6% or above 35% anyway.  Professional traders and speculators leave hapless individual investors holding the bag with commodities every time.  Folks that chased returns and bought gold when it was close to $1,000 per ounce know exactly what I’m taking about.

A small percentage of commodities are a part of the solution to hedge against future inflation, but it is not the silver bullet.  Investors would be better off in the long run being broadly diversified in stocks and bonds (and a dab of commodities) than gambling with their life savings by putting a large percentage of their portfolio in commodities and speculating about the direction of the market or the impact of inflation.  I prefer owning companies that profit from commodities like Freeport McMoran or Exxon Mobile (both of which are present in broad market and sector index funds) rather than owning the commodities themselves.

The global economy is cyclical.  It always has been and always will be.  Being positioned to participate in the recovery, when it happens, is the most prudent thing to do.  Since March 9, we’ve seen a 30% to 40% recovery that millions of investors completely missed.  Now they’re wondering if the train has left the station without them.  What should they do?  The answer is to reinvest their cash allocated to the stock market a little each month (via index mutual funds) for the next year or so to get fully invested again.

The fewer moves one makes, the more likely one is not to have made the wrong one.  Get properly diversified and ride it out.  We are much closer to the end of the recession than the beginning.

An Economic Character Defining Event

Throughout history there have been events that shape the perceptions and expectations of generations of investors.  Wars and natural catastrophes (like hurricanes), and the grandaddy of all  character defining economic events for Americans in the 20th centrury: the Great Depression.

A popular euphemism about the greatest generation is that they had a “Great Depression mentality” that shaped their saving and spending habits.  They lived within their means, wasted little and saved a significant amount of their income.  They did without.  Debt was abhorrent to them.

I don’t know what historians will say about this decade and the Great Crash of 2008 but we’re seeing a noticeable shift in consumer spending and saving habits. I spoke with fifth graders about investing in March and half of their questions pertained to the Great Depression.  It’s absurd to compare our current economic situation with that period of history, but our generation has not endured economic uncertainty like this before. 

PIMCO, which is a well respected fixed-income money manager, projected a lower GDP growth rate and a higher than average sustained unemployment rate.  We were used to 5% unemployment and 3% GDP growth and they are projecting 8% unemployment and 2% GDP growth, which is much more in line with Europe’s trendlines (as are our expected tax burdens, which I believe is a critical variable in their projection). 

I don’t know if their predictions will come true, but I believe there has been a noticeable shift in the way people view their lifestyles and gauge needs versus wants.  I know many people who are simplifying their lives by downsizing (even in this difficult real estate market), selling stuff, paying down debt and saving more.  Dave Ramsey, a popular radio and television personality, has created a whole industry around this ten years before it came into mainstream vogue.  If we sacrifice some GDP growth for paying down debt and saving more, its worth it if our balance sheets (i.e. our individual wealth) are more secure.

As a wealth manager, the Crash of 2008 has caused me to re-evaluate everything I do and why I do it.  From asset allocation design to component selection.  Our approach has always been conservative.  We don’t swing for the fences.  We use time tested strategies that have worked through good times and bad (our clients weathered the bear market of 2000 to 2002 brilliantly).  But even our conservative strategies suffered under the onslaught of  investor sentiment that bordered on sheer terror as institutional and individual investors dumped all assets to flee into treasury bills.

The Crash of 2008 is an economic character defining event.  It will shape perceptions and impact investor behavior for at least the next ten years and probably many years beyond that.   Statistically this is a once in a lifetime market experience, but from now on, we’ll have this scenario hovering in the backs of our minds as we design our portfolios and will plan accordingly.

How is Wealth Created?

There is a fallacy that being wealthy is predominantly a function of choosing one’s parents wisely.  The vast majority of the wealthy people I know started out with nothing, and most of them are small business owners.  By starting small businesses, they created jobs and goods and services that created wealth, not only for themselves, but for others in their community. Small business owners, by definition, create something out of nothing, and that something is GDP.

The number one driver of economic prosperity is small business.  Large businesses, like General Motors, get a lot of press and everyone knows their name, but most people work for small businesses.  Most small businesses create enough income to feed the family that owns it and perhaps a few more people.  But some small companies grow up to be Microsoft.  In both cases, the consumer benefits from the product or service that the entrepreneur provides and our society is better off as a result. 

My Uncle Jim (who is part of my investment policy committee) suggested a raw test of capitalism to gauge how easy it would be in a particular location to start a business and thus create wealth:  What if an aspiring entrepreneur wanted to buy a pack of hotdogs at Costco and sell them out of a cart on a street corner.  How hard would that be to accomplish? 

In Mexico City, it would take over a year of red tape, permits and costly bribes to get the required licenses.  In California, I speculate it wouldn’t be a simple task either (and we would probably need an environmental impact study).   In the town where I live, Cumming, GA it would take approximately two months, which is why our county (Forsyth) is one of the fastest growing in the country.  I’ll bet that the country with the highest immigration rate is probably the one that it’s easiest to start a small business in.

For families that are not entrepreneurial, which are most of us, the next best way to grow wealth is to spend less than we earn and invest in the stock market.  A good way to get exposure to small companies, mimicking the effect that entrepreneurs experience is to buy the Russell 2000 index.  Owning larger company stocks like those that comprise the S&P 500 is also a key strategy in designing a properly diversified portfolio.