Sunday, April 14, 2013

Current Worries Obscure Long-Term Portfolio Thinking

There is too little enthusiasm about investments these days despite the fact that we have just slightly breached the old highs on the popular US stock market indexes. This weekend I seem to be besieged by too many worries to enjoy either my market price gains or a wonderful concert by the New Jersey Symphony Orchestra playing three Tchaikovsky pieces very well, plus a spirited encore. (As my wife Ruth is Co-Chair of the NJSO, it should have been exhilarating for me.) Somewhat like Tchaikovsky’s tragic to triumphant Fifth Symphony, my investment worries obscure the good results we and our clients have achieved, and what should be an attractive long-term future.

I find it difficult to rank worries as any one of them could be the proverbial canary in the mine shaft. Thus, I am just listing them in the order that they hit me.
1.    The demand for US $100 dollar bills is up, particularly in Europe. I take this to be showing a concern about the value of various European currencies rather than a money transfer tactic of the global underworld.

2.    Most of the financial press is devoted to the problems of Cyprus and some of the other peripheral economies rather than paying attention to the remaining parts of the world. China now has reserves of $3.44 Trillion which is about the same size of the entire economy of Germany. Interesting the last time China published its gold holdings was 2009.

3.    Due to the fact that governments are trying to dictate to their economies through the banking systems, financial transactions including loans are moving out of the depository banks and into “other’ financial institutions, often called the shadow banking sphere. In China for instance the growth in commercial and personal credit is greater than in the regulated banks. In the US a portfolio of bank stocks has been recovering, but is still behind the other financials’ stock price performance.

4.    The current chatter of the talking heads in the financial press is focused almost exclusively on the pace of the expanding economy. People seem to have forgotten that in every decade there is at least one economic recession and often two. Where this plays a role is in the “happy talk” emanating out of Washington about reaching a balanced budget over the next ten years. According to John Mauldin, there is not any suggestion that the period will include one or more recessions which could balloon government social spending.

5.    A recent census report adding all the levels of US government spending per household concluded that the average is approximately $50,000 and the median household income is about $49,000. No wonder that there is not enough consumer saving to pay for the physical infrastructure needs and intellectual infrastructure needs to create the knowledge and work habits to fuel this economy.

6.    The price, volume, and shorting actions in Exchange Traded Funds (ETFs) suggest to me that an important part of the trading in these vehicles is being conducted by short-term traders similar to hedge funds. If more individual investors were using them I would be worried by a recent study by Mark Hulbert as published online in Barron’s on Thursday. Mark compared the performance of a number of ETFs to actively managed funds within the same organization. He found that, on average, the active managers out-performed their less expensive stable mates. This may be particularly important in the next major market decline where the active managers can either raise some cash and/or get out of some of the larger volume stocks that are leading the market down. (Of course when there is a rally, as they say “cash is trash” and can hurt performance.)

7.    This weekend some of us will be watching the Asian markets and later the opening of the European markets to see what the price of gold will be doing after a major fall at the end of last week. As a well-known and respected non-gold bug said to me this weekend, “The reason to own gold, in some form, has to do with fundamental concerns about the continuing value of paper money; it is just as present today as it was last week month or year.”  The purpose of gold is as an insurance policy within a portfolio of other assets. For generations European private bankers have urged their wealthy clients to own 5-10% of their portfolios in some form of gold. Just as I don’t like to drive on the road with drivers that do not have appropriate auto insurance, I hope that a few do not use the drop in the price of gold as an excuse not to pay their “value of money insurance policy.”

Analyzing your long-term investments

As indicated, the list of worries above is obscuring what you and my fellow long-term investors should be focusing. I am an advocate of dividing one’s portfolio into different time horizon and special pocket investments. At the moment I want to focus on the longer-term time horizon bucket. This is the bucket to fund multi-generational needs for both families and charitable institutions. 

One useful exercise is to look at the current market weighting of each of your investments and assign them into these somewhat distinct categories:

Category one: The portion of your portfolio which is the result of the accident of gains. One never expected this to be such a big winner, even if it was the family company. Now one has a very large unrealized capital appreciation = tax and/or disposal issue.

Category two: Holdings that are selling at very deep discounts compared with other market indicators. The future price potential is large and if successful in later years could be moved up into category one.

Category three: Some investments that are selling substantially below what a knowledgeable buyer would pay for the company, particularly if a new management could be installed. Dell?

Category four: There are some very high quality companies whose shares most of the time reflects their quality, but not all the time. This weekend I read the very long proxy and annual report of Goldman Sachs, a stock that is owned in my private financial services fund. For some this may be a controversial firm, but I find in general in most of their varied businesses they do conduct their activities in a high quality fashion according to the ethics of the business. I own other high-quality names but I was using Goldman just as an example.

When you get all through assigning weights to these and/or other categories see whether they are in an appropriate mix for your long-term needs. I would be pleased to discuss this exercise with you if it helps to bring some additional clarity to your investing.
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