The New World-Part 2

Blog post #437

As I write this Wednesday evening and early Thursday, global stock markets have had 2 very good days in row, and Thursday is starting out well.

I want to be positive and optimistic, as that is my nature, but I think we are far from out of the woods yet. The patient (unfortunately, far too many real patients, as well as the US and global economies) are still on life support.

Just to be clear….my first concern is for everyone’s health. But as a financial advisor, and not a scientist or medical professional, these thoughts are only about the financial implication of the crisis we are now in. All of us.

The strong stock market this week was due to the positive news that the US Congress and President are “close” to reaching an agreement on the largest fiscal stimulus / bridge loan / corporate financing package in the history of the world. They have been close to getting this done for days, but as of my writing, the Senate, but not the House, has passed the legislation and the President still has not signed it.

Note to clients….when the final legislation is enacted, we will send out an update. Our back- office firm’s national Direction of Education (tax and financial planning expert) sent out 56 tweet thread late last night….we are on this!)

This legislation is vital and necessary, along with the strong action and quick responsiveness by the Federal Reserve to keep the financial markets flowing well, especially the corporate and municipal bond markets.

Ever heard the saying “progress not perfection?” This is the case. The legislation and Federal Reserve actions are to save the US economy and to try avoiding an economic calamity….not all the details matter…preventing an economic catastrophe during or after the health crisis is what matters. These programs are intended to provide various forms of liquidity, or bridge loans/financing, so as many people and businesses can remain afloat through the health crisis.

Without these actions and programs, companies large and small, as well as individuals and small businesses, could face horrible liquidity and financial problems.

Let’s be realistic. This may not be the bottom for the stock market. We just don’t know.

  • Historical financial data teaches us that when markets begin to be very volatile, they tend stay volatile for a while.
  • This is important information that you need to understand, internalize and get used to. 

With this much uncertainty….and there is a lot of it, markets will likely continue to be very volatile for a while. We have planned for this. We are acting accordingly, on your behalf. You need to continue to be mentally prepared for the possibility of worse health and financial news, and stock market declines, especially if the health news worsens or does not get better within the next month or so.

This is just a guess, but I don’t think this will be the final major legislation that will be necessary before this crisis is over. There were many programs and legislative acts during the 2008-09 crisis. This legislation and Federal Reserve liquidity steps are already way larger than all the 2008-09 actions, by multiple times (per CNBC this morning). The markets were wanting good news this week and traded higher on it. That’s how markets function. Financial markets react quickly to news, good or bad, as we have clearly seen in recent weeks.

We just want you to be realistic and prepared for either outcome, good or bad. And this is the basis of our investment strategy right now.

  • We can’t predict the timing of any of this, which is why we are recommending to gradually rebalance, to gradually buy stocks at these levels.
  • We know it makes sense to follow the discipline of buying low and selling high… and we will continue to do that, but with caution, for most clients.

What the world is experiencing is far from normal. It has affected our everyday lives in many ways. Companies and health professionals are innovating. Ford will be producing ventilators. I read last night that anesthesiology machines may be able to be converted to ventilators with a simple change in parts, which could provide tens of thousands of ventilators very quickly. Solutions will be found. Hopefully those with knowledge and expertise in many areas (medicine, leadership, technology, supply chain, manufacturing, etc.) will adapt, be creative and resilient.

But in terms of the stock market, this is normal. Yes, fortunately and unfortunately.

  • Stock markets annually go down temporarily (peak to bottom) on average about (14%) most years.
  • And one in every 5 years or so, stocks temporarily go down much more, sometimes 20% – 30%, or way more, which is called a “bear market.”

Since the end of World War II, in 1945, there have been 16 bear markets in the S&P 500, which I am defining for this purpose as declines of around 20% or more (there were a few that were almost 20%, so I’m counting those…a temporary loss of 19.5% feels almost like a temporary loss of 20%, right?).

That is an average of 1 bear market every 4.7 years, which is around the long-term average.

But this is the key…and thank you for those of you who are still reading…

The bottom point of the S&P 500 at the end of some recent bear markets….

Do you see the clear long-term trend? The losses are temporary on the long upward trend of our society. Stocks have far outperformed cash, or other types of fixed income, over the long term. Stocks have provided more than 7% annually over the long-term inflation rate.

With rewards, comes risk. Keep the faith. Buckle in for more volatility. And stay healthy and  safe!!

As always, we are here for you, and family members or friends who could use our guidance and assistance during this crisis.

 

 

Note: The S & P 500 Index is an index of companies, of which the companies in the Index has changed dramatically over the years. It is composed of 500 of the largest publicly held companies in the US. Our firm believes in global diversification as well as holding small and medium sized companies, both in the US and Internationally. Using the S & P 500 Index is for educational and illustrative purposes, and the trends explained above are generally representative of global stocks.

Responding to a New World

Blog post #436

The world financial markets have been crushed by the Covid-19 outbreak.

But we are here for you and working hard, taking actions, thinking about the future and relying on rational thinking.

As I write this Wednesday night and Thursday morning, I will try to explain a few things and tell you what we have been doing and how we are proceeding, on behalf of our clients.

We are not panicking. We have all been calm, rational and dealing with this day by day….talking, planning, coordinating and communicating with each other and with you, our clients. Please contact us if you need to talk to us. That is what we are here for.

We have been through financial crises and other large market declines before, and we will have to deal with other crises again in the future. This time feels very different, because of its health-related cause. But every past and future problem that becomes a financial crisis just starts with a different event. This time will not be different….we will recover.

The health concerns and reality may worsen before they get better. The personal, economic and stock market toll may continue to worsen, as well, before they improve. Positive signs are out there, as it seems like federal, state and health leaders, as well as the corporate community, have realized the seriousness of the situation, and creativity and leadership are becoming more effective. Examples are that drug testing and medical solutions are occurring at a more rapid pace, and companies in the auto industry may begin to produce much needed ventilators.

Be safe.  Be healthy. Be responsible for yourself and your family.

We have been doing tax loss selling and will continue to do so, as warranted. As discussed last week, this will save you money in the future, when taxable dividends or capital gains are recognized, and they will be offset by the tax losses that we are recognizing very aggressively right now. These are important actions that will save you real money in the future.

We are beginning to purchase stocks, in a gradual and disciplined manner, in accordance with your Investment Policy Statement (IPS) asset allocations. We are beginning to rebalance client accounts, and will be reaching out to you, regarding these steps. We talk about this discipline with every client, before we start to invest for you. We don’t know where the bottom will be, so we do not plan to rebalance client accounts all at once, unless someone wants to, at this time. We will most likely do this in a gradual, disciplined and unemotional manner, over a period that will be based on future market movements.

In the long term, it is best to buy stocks when others are scared. We can’t predict the bottom. We may be far from the bottom. But we know that stocks are much cheaper than they were a month ago. If you believe that we will survive and recover, then history teaches us to gradually start buying at times like this.

If you have excess cash, consider a gradual program of purchasing. If you participate in a work related 401(k) or similar retirement plan, you should consider accelerating your funding, as long as you have ample cash reserves.

We have reviewed the fixed income holdings of our client accounts. This is one area that this crisis is very different than past ones, as most businesses are facing almost a complete loss of revenue for future weeks or months. Strong government and Treasury Department action will be needed to provide bridge funding for many large corporations. Similar creative vehicles will be needed to be established for small and medium sized businesses. At the time of purchase, all fixed income securities were investment grade, as well as FDIC guaranteed CD’S, government and municipal bonds. We are carefully monitoring these. We have strict diversification guidelines in place, which we have again reviewed, to ensure that each client only holds a very small amount, generally not more than 1-2%, of any one issuer. While it is possible that some bonds may be sold prior to maturity, due to economic stress or difficulties, we are being conservative and pro-active in our actions. We do not purchase any junk or below investment grade securities, if they are not investment grade at the time of purchase.

We do not invest in funds or products that limit liquidity in advance. Some investment managers utilize funds that restrict when you can sell or get out of an investment. We have never recommended these types of products. While we cannot guarantee that every security will be able to be sold in a distress-type situation, we have designed your portfolio to be able to be as liquid as possible, within the investment objectives that were agreed upon.

We have reviewed all our client accounts who regularly withdraw funds, to ensure that there is adequate money (at least 6 months of withdrawals) in money market funds. This has been a cash management practice, to maintain ample cash reserves, so we are not forced to sell, for regular withdrawals. We reviewed these types of accounts again in the past week, to ensure that we have taken the appropriate steps so you will have adequate liquidity, as desired.

Make sure you have ample, or extra, cash on hand….either in your bank account or in the fixed income portion of your accounts with us. If you are not sure, contact us. This is very important during times of uncertainty.

Diversification is working, even though you may not realize it. Yes, the stock funds that we invest in are down significantly. However, there are other investment styles that may be facing much greater losses, which were preventable and controllable. For example, if you had loaded up on dividend paying energy stocks or certain other stocks, your losses over the past years would be huge and more than double the decline of the S&P 500 this year alone. Energy stocks such as Exxon-Mobil, Enterprise Products Partners and Chevron are down 60-70% over past years, and Boeing is down almost 80%. This is why we believe in diversification and do not recommend owning individual stocks for the majority of your investments.

What you should NOT be doing:

  • Do NOT invest short-term money into the market.
  • Do NOT take more risk than you can stomach or handle, for your long-term financial plan.
  • Do NOT borrow money or invest on margin.
  • In general, do NOT prepay very low interest rate loans, especially if you are concerned about your job, income or cash reserves. In the longer term, we will review these issues with you individually, based on what happens with interest rates.

We have a disciplined philosophy and one that we are confident in. We are adhering to our long-term plans and reviewing what we think needs to be modified. We encourage you to do the same. We know that it is not always easy, but those who can be resilient and patient will get through this.

We made it through 2008-09. We are doing our best to help you make it through this crisis.

Again, please contact us by phone or email if you want to reach us. 

Please do what you need to….. to be healthy, both mentally and physically.

 

Dealing with this situation

Blog post #435

 

The world has changed significantly, which has affected health concerns and investors’ finances.

What has happened?

The coronavirus outbreak was the first negative to impact global, then US stock markets, in past weeks.

On Monday, US and International stock markets were dramatically impacted by the unprecedented steps taken over the weekend by Saudi Arabia, to both increase oil production and reduce the price they charge for oil. These actions, along with the already reduced global demand for oil due to the coronavirus, caused the price per barrel of oil to plummet from $63 per barrel at the beginning of 2020 to around $33 at mid-week.

As this week has progressed, stock markets continued declining sharply as the reality of the Covid-19 outbreak and the lifestyle changes that will be required, have taken hold.  The economy will slow dramatically and many economic sectors will be greatly impacted.

Interest rates, which were already at historic lows, have fallen even further. Credit markets are concerned about weakening economies, companies that may have difficulties due to lack of demand due to coronavirus, as well as energy companies and their lenders, due to the huge decrease in oil prices.

What do we think going forward?

Clearly the world has changed significantly over the past few months, and even over the past week.

We do not know when financial markets will stop failing, when the coronavirus outbreak will be contained or mitigated, or when oil prices will return to rationale levels.

What we do know is that we must focus on key things…such as what we can control and what matters to each of us.  I will be blunt, the health issues are very concerning. I have tried to keep this mantra in mind, as I try to focus on what we can control, and not control. Our everyday lives are going to be disrupted for a period of time…and none of us know for how long. The health issues have now been compounded with financial concerns, due to the drop in stock values. Hopefully, our federal, state and local leaders, both medical and political, as well as those leaders across the globe, take serious, appropriate and necessary actions in the immediate future.

In terms of your portfolio, the pain of losing money is not pleasant for anyone. I am invested in similar or identical stock funds and fixed income securities as our clients, so my family has lost money in stocks and been cushioned by fixed income, just like you have.

To be a successful long term investor requires resiliency, which nearly every client we have has shown over the past weeks.  The coming weeks and months may continue to be very challenging. To reap the long-term rewards of the stock market, you need to remain invested during both good and bad markets.  No matter how difficult, this will be temporary.  There will be medical solutions and an economic recovery from this health outbreak.

When we meet with clients at or near retirement age, we frequently discuss their allocation to fixed income and their withdrawal rate. We remind them that their fixed income assets should last them for many years, and in many cases, for 10 or more years.  We call this your foundation. This means that if you can live off of your fixed income assets for a long time, you have a strong foundation and you don’t need to be as worried about what the stock market is doing today, or even over the next few years.

The reality of living through a sharp and scary decline like we are experiencing can still be difficult, so let’s go through the scenario and then some history. These are important concepts.

For example, if someone has a $3 million portfolio and is allocated 50% to stocks and 50% to fixed income, they would have $1.5 million of fixed income investments. If this hypothetical client was withdrawing $150,000 per year from this portfolio, that is a 5% withdrawal rate. That is realistic. The $150,000 per year is 10 years of their fixed income assets ($150,000 / year x 10 years), not including any interest earned on the fixed income. Thus, they don’t need to actually use the stock market investments for at least 10 years. There will be time for the stock investments to recover from periods of decline, such as we are incurring now. This is the type of portfolio and mentality that we want to develop with all of our clients.

If you are younger, and in the accumulation and savings phase of your life, you should continue to invest and save for the long term.  You should want to buy when others are scared and are selling. Keep adding to your retirement and regular savings plan. Make contributions now, for retirement plan contributions that may be due later in 2020 or even 2021.

We don’t know when global stock markets will recover, but we are confident that they will. We are quite confident that 3-5-10+ years from now, diversified holdings of global stock markets will be higher than they are today.

Some facts and history….

Since 1979, the US Russell 3000 Index (the 3,000 largest US traded companies) has averaged about a 14% decline at some point during each year (called an “intra-year” decline). While we invest in a globally diversified portfolio and the 2020 intra-year decline has now far exceeded 14%, this data is still instructive.

  • About half of the years since 1979 have had declines of more than 10%.
  • About 1/3 of the years had declines of more than 15%. (Significant declines are not fun, but more normal than most of us realize).
  • However, calendar year returns were positive for 34 of the 41 past years.**

This shows that intra-year declines are normal, but positive years and recoveries are even more the norm. While the cause for the steep decline is different this time, as it is health related,  we don’t think the long-term effect will be different….there will be a recovery.  You will need to be patient and are advised to adhere to your asset allocation plan.

From July, 1926 until December 2019, for almost 100 years, the broad US stock market has returned around 9.6% per year, before fees and trading costs. Obviously, there has been great year-to-year variability (many up and down years) to reach that 9.6% per year average.

As the chart below shows, after declines of 10%, 15% and 20%, the broad US stock market (comparable to the Russell 3000 Index) has generally performed better than average in the 1, 3 and 5 year periods following such declines. Stocks generally show strong returns after steep declines.*** This is the reward for the risk and volatility you need to endure.

What are we doing and recommending?

Most importantly, we are here for you, if you want to talk to us. Please call or email us. We know this is a difficult time, and may likely continue to be, especially with both health and financial concerns.

To save you future taxes where possible, we have placed trades all week to recognize tax losses, especially for newer clients and those that have added money to their accounts this year and in recent years, depending on the specific investment. We are not waiting until later in the year or until year end to do this. We aggressively monitor your taxable accounts for these opportunities…..providing a silver lining to the market turbulence, whenever possible.

We will be reviewing client accounts for stock purchasing opportunities, by rebalancing or if you add new money to your investments. For the long term, the coming weeks and months offer times to buy. We can never know when the market bottom will be. But just as investments were very profitable for those that had the courage to buy during the declines of 2008-09, we expect those that buy over the coming days and weeks will be rewarded in the long term. We call this rebalancing, as your fixed income allocation has increased and your stock allocation has decreased in the past month, we would recommend to sell fixed income and buy stocks.

As interest rates have dropped, if you have a mortgage that is above 4-4.5% and you plan to stay in that home for at least 3-5 years, you should consider refinancing. If you want to discuss this with us, please contact us.

If other tax or financial changes are enacted in response to this situation, we will update you on those as they occur.

We are prepared to work remotely, if that is recommended or required. If that becomes a reality, we will provide clients with the necessary contact information. We have procedures in place and each member of our firm has worked and done business remotely many times in the past, within a secure technological environment. We have also discussed these scenarios with our business partners and are confident that we can function property and be able to provide you with excellent service, remotely.

We hope each of you and your families stay in good health.

Sources:

** Recent Market Volatility, Dimensional Fund Advisor’s, Issue Brief, March 4, 2020.

***US Equity Returns Following Sharp Downturns, Dimensional Fund Advisors, March 9, 2020.

Berkshire Hathaway Annual Letter thoughts

Blog post #434

Warren Buffett’s Berkshire Hathaway Inc.’s 2019 Annual Shareholders Letter was released Saturday, February 22nd, before the coronavirus outbreak had a major impact on US stock markets.

This letter has been required reading for me for as long as I can remember. There are always lessons to be gleaned from Buffett’s letter which can help all of us to be better investors and smarter financially.

Due to the additional market volatility caused by the coronavirus outbreak, we wrote about that last week. If you have not read it, the link is HERE.

Below are my comments, followed by selected portions of Buffett’s writings (in italics)from the 2019 Berkshire Hathaway Annual Letter.

WWM: Buffett stresses the value of long term investing every year, and this year he emphasized this point through the importance of compounding…how money grows in value over time by compounding.

Buffett: He cites a book review written by economist John Maynard Keynes, of a book written in 1924, Common Stocks as Long Term Investments, by Edgar Smith. “…Thus there is an element of compound interest operating in favour of a sound industrial investment. Over a period of years, the real value of the property of a sound industrial is increasing at compound interest, quite apart from the dividends paid out to the shareholders…

Buffett: “…when business ownership was sliced into small pieces – “stocks” – buyers in the pre-Smith years usually thought of their shares as a short-term gamble on market movements. Even at their best, stocks were considered speculations. Gentlemen preferred bonds.

Though investors were slow to wise up, the math of retaining and reinvesting earnings is now well understood. Today, school children learn what Keynes termed “novel”: combining savings with compound interest works wonders.”

WWM: The following are Buffett’s thoughts on investing, interest rates and the future. THE FOLLOWING PARAGRAPHS SHOULD BE REQUIRED READING. He feels that in the long run, stocks will far outperform fixed income investments, but you must be prepared to handle huge declines in stocks along the way. If you can do that, he feels you will be well rewarded. We agree with this analysis.

Buffett: Buffett does not view Berkshire’s vast stock holdings “as a collection of stock market wagers – dalliances to be terminated because of downgrades by “the Street,” an earnings “miss,” expected Federal Reserve actions, possible political developments, forecasts by economists or whatever else might be the subject du jour.

What we see in our holdings, rather, is an assembly of companies that we partly own and that, on a weighted basis, are earning more than 20% on the net tangible equity capital required to run their businesses. These companies, also, earn their profits without employing excessive levels of debt.

Returns of that order by large, established and understandable businesses are remarkable under any circumstances. They are truly mind-blowing when compared to the returns that many investors have accepted on bonds over the last decade – 2.5% or even less on 30-year U.S. Treasury bonds, for example.

Forecasting interest rates has never been our game, and Charlie and I have no idea what rates will average over the next year, or ten or thirty years. Our perhaps jaundiced view is that the pundits who opine on these subjects reveal, by that very behavior, far more about themselves than they reveal about the future.

What we can say is that if something close to current rates should prevail over the coming decades and if corporate tax rates also remain near the low level businesses now enjoy, it is almost certain that equities will over time perform far better than long-term, fixed-rate debt instruments.

That rosy prediction comes with a warning: Anything can happen to stock prices tomorrow. Occasionally, there will be major drops in the market, perhaps of 50% magnitude or even greater. But the combination of The American Tailwind, about which I wrote last year, and the compounding wonders described by Mr. Smith, will make equities the much better long-term choice for the individual who does not use borrowed money and who can control his or her emotions. Others? Beware!

WWM: Berkshire has owned energy / utility companies for 20 years, starting with an Iowa based utility. Their use of converting wind to electricity and how Berkshire Energy has gone from a traditional to a wind-based utility, while keeping rates far lower than their competition, which benefits the residents and users of this utility, is quite instructive. This Iowa based utility will be wind self-sufficient by 2021 (a feat he says no other investor-owner utility located anywhere can state)….and profitable and providing huge cost savings to their client base. Sounds like win-win to me. Required reading!

Buffett: We’ll start with the topic of electricity rates. When Berkshire entered the utility business in 2000, purchasing 76% of BHE, the company’s residential customers in Iowa paid an average of 8.8 cents per kilowatt-hour (kWh). Prices for residential customers have since risen less than 1% a year, and we have promised that there will be no base rate price increases through 2028.

In contrast, here’s what is happening at the other large investor-owned Iowa utility: Last year, the rates it charged its residential customers were 61% higher than BHE’s. Recently, that utility received a rate increase that will widen the gap to 70%.

The extraordinary differential between our rates and theirs is largely the result of our huge accomplishments in converting wind into electricity. In 2021, we expect BHE’s operation to generate about 25.2 million megawatt-hours of electricity (MWh) in Iowa from wind turbines that it both owns and operates. That output will totally cover the annual needs of its Iowa customers, which run to about 24.6 million MWh. In other words, our utility will have attained wind self-sufficiency in the state of Iowa.

In still another contrast, that other Iowa utility generates less than 10% of its power from wind. Furthermore, we know of no other investor-owned utility, wherever located, that by 2021 will have achieved a position of wind self-sufficiency. In 2000, BHE was serving an agricultural-based economy; today, three of its five largest customers are high-tech giants. I believe their decisions to site plants in Iowa were in part based upon BHE’s ability to deliver renewable, low-cost energy.

WWM: A huge portion of Berkshire Hathaway’s profits and growth has come from their massive insurance business. Buffett states that while they have had underwriting profits in 16 of the last 17 years, he does not expect that to repeat. The risks are massive and he is prepared for huge negative outcomes. He knows catastrophes will occur….he (and we) just don’t when or why.

Buffett: “Danger always lurks. Mistakes in assessing insurance risks can be huge and can take many years – even decades – to surface and ripen. (Think asbestos.) A major catastrophe that will dwarf hurricanes Katrina and Michael will occur – perhaps tomorrow, perhaps many decades from now. “The Big One” may come from a traditional source, such as wind or earthquake, or it may be a total surprise involving, say, a cyber attack having disastrous consequences beyond anything insurers now contemplate. When such a mega-catastrophe strikes, Berkshire will get its share of the losses and they will be big – very big. Unlike many other insurers, however, handling the loss will not come close to straining our resources, and we will be eager to add to our business the next day.

WWM: Berkshire Hathaway pays billions of dollars a year in Federal corporate tax….and hopes and expects to pay even more in the future. Incredible statistic for a company that started 55 years ago and generated losses for many years.

Buffett: In 2019, Berkshire sent $3.6 billion to the U.S. Treasury to pay its current income tax. The U.S. government collected $243 billion from corporate income tax payments during the same period. From these statistics, you can take pride that (Berkshire Hathaway) delivered 1.5% of the federal income taxes paid by all of corporate America…In most future years, we both hope and expect to send far larger sums to the Treasury.

Source: 2019 Berkshire Hathaway Annual Shareholder Letter, released Saturday, February 22, 2020. See Berkshirehathaway.com.

Disclosure: Brad Wasserman, author of this blog post, owns a small number of Berkshire Hathaway shares, which were purchased to enable me to attend Berkshire’s annual meeting. All my other stock investments are in DFA mutual funds, which is one of the primary mutual funds companies that we recommend to our clients.