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3 Things I Think I Think – Crashing Up And Down Edition

Here are some things I think I am thinking about recently: 1) What a boring year! The Global Financial Asset Portfolio is down about 1.2% year to date. This might come as a shock to people who are glued to financial TV all day and think of the “market” as the stock market. Yes, some stock markets are down quite a bit, but the aggregate “markets” really haven’t budged much. And this goes to show how damaging it can be to constantly be obsessing over the daily moves of your investments. (click to enlarge) More importantly, it shows how crucial it is to remain diversified and to avoid paying too much attention to the media’s infatuation with every minute-by-minute move in the stock market. Stocks are an important, but relatively minor slice of an aggregate portfolio. Odds are, if the stock market’s daily moves are driving you mad, you have misinterpreted your personal risk profile and might need a change… 2) The S&P 500 (NYSEARCA: SPY ) has value because of people like Donald Trump. I notice a lot of Donald Trump wealth bashing in the media. This story usually goes something like this – “Donald Trump isn’t nearly as wealthy as he claims”, or “Donald Trump is only rich because his daddy was rich”. These statements might be true to some degree. But there’s a good bit of hyperbole going on here. For instance, take this piece in VOX today claiming that Trump would have been better off if he’d just invested his inheritance in an index fund. The author writes: ” Trump is one of five siblings, making his stake at that time worth about $40 million. If someone were to invest $40 million in a S&P 500 index in August 1974, reinvest all dividends, not cash out and have to pay capital gains, and pay nothing in investment fees, he’d wind up with about $3.4 billion come August 2015. ” This is unreasonable on so many levels. First, Trump probably didn’t inherit a lump sum of cash. He probably inherited part of the family business, real estate and many other assets valued at $40 million. Second, NO ONE just invests their whole net worth in a zero-fee, zero-tax, zero-withdrawal all-stock portfolio and lets it ride. So, the assumptions here are totally unfair and reflect nothing more than a fiction. But let’s go further and apply something somewhat realistic. Let’s assume Trump had decided to be a “fat loser” (his words, not mine) and just let his daddy’s inheritance ride in the S&P, while spending a small portion of his net worth each year. For instance, if he’d withdrawn 5% of his portfolio per year so he could do nothing all day every day, he’d have compounded his S&P 500 portfolio into about $400,000,000 as of August 2015. Not bad, but well below the misleading billions that many assume. And keep in mind, that’s before taxes and fees. He’d likely have less than half that if he’d been paying taxes and fees every year. The more important point is that Trump inherited a lot of money and DID SOMETHING with it. He didn’t just turn into a slacker, like a lot of people do when they inherit money. He took a successful company and built it into something bigger and better. And that very production is why index funds have any value in the first place. The S&P 500 doesn’t just rise because some slacker waves a magic wand at higher prices. It rises over time because people like Donald Trump work their butts off to make companies more valuable. I find myself in a weird position here, because I think Trump has said a lot of awful things about people recently. So, there’s no denying he’s been rude to a lot of people and could benefit from a bit more humility. But people who try to make Trump out to be some rich, lazy slacker are barking up the wrong tree. 3) Stop the currency hedging madness! Vanguard has a wonderful piece of research out on currency hedging (see here ). Their conclusion – it’s just more fees cloaked in complexity. They conclude: ” For us, hedging equity exposure isn’t worth the added costs in those strategies that still have considerably less than half their assets in international equities and that have broader investment objectives than controlling volatility. ” This makes a lot of sense to me. If you’re using a passive long-term vehicle like an index fund, then why would you layer on a short-term, zero-sum trading vehicle on top of it? This is a total contradiction of strategies! Low fee indexing and currency hedging are not synonymous. After all, when you hedge currencies, you are essentially timing a zero-sum relative market. Over long periods of time, we should expect that currencies will generate a negative real return because they are zero-sum relative markets. It makes no sense to layer on a currency hedge if you’re adhering to a low-fee indexing strategy. I’ve noticed a lot of these currency hedging products coming on the market lately. They’re very likely just high-fee versions of index funds that come with a slick marketing campaign and little more.

The Stock Market’s Best Shot? A Fed Promise To Move Slower Than A 3-Toed Sloth

Uncle Sam is spending borrowed dollars at an alarming clip, guaranteeing that higher and higher percentages of total tax revenue will be used for debt servicing. If the Federal Reserve hikes borrowing costs, consumers will have to pay more to service adjustable loans and mortgages; businesses will have to pay more to service the interest on corporate bonds. Until investors learn the what, when and why of Fed policy guidance, riskier assets will remain volatile. Consumers, as opposed to manufacturers, represent two-thirds of the U.S. economy. Indeed, Americans love to splurge. We buy sneakers, iPhones, home furnishings, real estate, cars, jewelry, concert tickets, and meals at our favorite restaurants. We even buy chew toys for our pets. Many of us, however, do not have enough cash saved up to acquire the things that we want when we want them. So we borrow. We satisfy our cravings through instruments of debt – credit cards, mortgages, “refis,” equity lines and school loans. Like consumers, there are scores of corporations that borrow more than they should and gorge when ultra-low interest rates beckon. How do companies do it? They issue low-yielding bonds to yield-seeking investors. Theoretically, companies can use the newfound dollars on research, development, marketing, equipment and human resources. In 2015, though, public corporations are spending an estimated 28% of their available cash on acquiring shares of their stock. That’s the highest percentage since 2007. Why do companies buy so much of their own stock in what the investing community calls “share buybacks?” Less stock in the marketplace limits supply, boosts the perception of profitability per share and artificially boosts buyer demand; prices tend to move higher. Stock prices rise in the early stages of accelerating corporate share buybacks. For instance, in the bull market of 2002-2007, public companies committed more and more of their total cash; the higher the prices moved, the less shares that corporate borrowed dollars could afford. As buybacks peaked in 2007, they rapidly descended during the 2008-2009 financial collapse. Now look at the current economic recovery since the 2nd quarter of 2009. Share buybacks have been on a strong upward trajectory, pushing stock market benchmarks to new heights. In fact, one of the big reasons that so many executives have been lobbying the U.S. Federal Reserve to hold off on hiking borrowing costs in September is because those costs would adversely impact the financing of stock buybacks at ultra-low bond yields. Are consumers and corporations the only groups that salivate over ultra-low interest rates? Hardly. The federal government debt is rapidly approaching $19 trillion. In particular, obligations have grown by approximately $8 trillion since the recovery’s inception – a pace that is more than twice as fast as the growth of the U.S. economy itself. That’s right. Uncle Sam is spending borrowed dollars at an alarming clip, guaranteeing that higher and higher percentages of total tax revenue will be used for debt servicing. (Recognize that nobody believes in the notion that debts could ever be paid back.) Why might this be troublesome at this particular moment? The Federal Reserve has wanted to hike borrowing costs as early as mid-September. And that means that Uncle Sam will likely be paying higher rates to service the interest charges on its treasury bonds very soon. What’s more, if the Federal Reserve hikes borrowing costs, consumers will have to pay more to service adjustable loans and mortgages; businesses will have to pay more to service the interest on corporate bonds. The probable result? The economy slows and possibly contracts such that Uncle Sam brings in less-than-anticipated tax revenue. Indeed, the Fed has been spooking markets with its desire to move toward “rate normalization.” If committee members spoke candidly about a more realistic intention – a plan to move no more than 1% off of the zero percent anchor by the end of 2016 – there would be an end game that global investors could factor into decision making. Instead, there is fear that the Fed is misreading the tea leaves on the health of the U.S. economy as well as fear that the central bank would move to far in the wrong direction. Consider the manufacturing slowdown – the “less important” one-third of the U.S. economy. Does anyone doubt that U.S. manufacturing has suffered due to the global manufacturing slowdown and the outright recessions in places like Canada, Brazil and parts of the euro-zone? The recent jobs report by ADP confirms it. Of the 190,000 jobs created, 173,000 received the tag of “service-providing” whereas a meager 17,000 had been deemed “goods-producing.” Should we dismiss that oil giant Conoco Phillips (NYSE: COP ) is laying off 10% of its global workforce? What about critical metrics such as factory new orders and product shipments? The percentages for both are negative on a year-over year basis. Global manufacturing woes did not just hit the investment markets in August; rather, the declines have been developing in key economic sectors since the fourth quarter of 2014. Every significant manufacturer-dependent sector in the exchange-traded investing world- the iShares Transportation Average ETF (NYSEARCA: IYT ), the Industrials Select Sector SPDR ETF (NYSEARCA: XLI ), the Energy Select Sector SPDR ETF (NYSEARCA: XLE ), the Materials Select Sector SPDR ETF (NYSEARCA: XLB ) – is down 10% or more year-to-date. It follows that the U.S. economy is even more dependent on the consumer than it ought to be. And by extension, consumer credit as well as service-oriented business credit become more critical than they might otherwise be. And what affects credit more than the Federal Reserve? Until investors learn the what, when and why of Fed policy guidance, riskier assets will remain volatile. Intra-day price swings of 300 points on the Dow? We should feel lucky if it remains that subdued. As regular readers already know, I began reducing client exposure to risk before the mid-August price plunge. We raised cash/cash equivalents in our accounts . Those levels are roughly 25% for moderate growth investors. The cash is there to reduce portfolio volatility, minimize depreciation in portfolios and provide opportunity to buy quality assets at lower prices. We also have 25% allocated to investment-grade income. Whereas moderate risk clients may typically have 65%-75% in stocks, we gradually reduced that level to 50% across June and July. Our reasons for the tactical asset allocation shift? I presented them in ” A Market Top? 15 Warning Signs ” when the S&P 500 traded in and around the 2100 level. The 50% allocated to stock is spread across a variety of large-cap U.S. ETFs, including but not limited to, the iShares S&P 100 ETF (NYSEARCA: OEF ), the Vanguard High Dividend Yield ETF (NYSEARCA: VYM ), the Health Care Select Sector SPDR ETF (NYSEARCA: XLV ) and the Vanguard Mid-Cap Value ETF (NYSEARCA: VOE ). Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

PIMCO Total Return: 1 Bill Gross-Less Year Later

Summary The PIMCO Total Return Fund assets under management have shrunk from $293B in early 2013 to less than $100B today. The new managers of the fund were part of the investment committee working with Bill Gross during his tenure so management style should remain consistent. The fund, at least in the year-to-date period without Gross managing, has outperformed its benchmark and Morningstar category. The managers are currently retaining a cautious approach to the portfolio in anticipation of future rate hikes. In the relatively mundane world of mutual fund investing there was perhaps no news bigger than last year’s surprising announcement that Bill Gross was leaving PIMCO – the company he founded – to jump over to Janus. The move resulted in a mass exodus from Gross’ Total Return Fund (MUTF: PTTRX ). Once the largest mutual fund in the world back in 2013 with $293B in assets now has less than $100B. Many investors felt that Gross was the key that drove the engine and fled for greener pastures when he departed (although his current fund – the Janus Global Unconstrained Bond Fund (MUTF: JUCDX ) – has just $1.5B in assets). For investors that have stuck around it’s worth wondering if the “new” PIMCO Total Return fund is the same now as it was when Gross was in charge. Gross himself has said in the past that investors maintain at least a five year outlook when formulating their portfolios. However, Gross has been known to quickly change directions. This is perhaps most notable in his 2011 call on interest rates. Gross thought that interest rates would rise once QE was done and took his portfolio’s allocation in Treasury bonds all the way down to zero. Of course, interest rates went down, the fund badly underperformed its benchmarks and the flow of money out of the fund began. The new fund managers for their part have pledged largely to maintain the groupthink investment style that was part of the decision making process even when Gross was involved. Style-wise, the fund still falls into Morningstar’s intermediate term bond category where it’s been for the last many years. There are a couple of important things to note in the figure above. First, performance on a one year basis can’t really be used as a long term predictor of success but at least the new managers are off to a reasonable start. Year-to-date, the fund is beating its benchmark index by 27 basis points and the broader intermediate term bond fund category by 64 basis points. That puts Total Return in the top 15% of funds – a notable departure from recent performance that saw the fund fall into the bottom half three of the last four years. Second, turnover and trading frequency remain at comparable levels to the end of Gross’ tenure. The fund is running at a turnover rate of about 265% which is fairly comparable to the past two years’ rate of 227%. Going forward, the fund’s managers are limiting duration in the United States anticipating coming rate hikes maintaining roughly ⅔ of the portfolio in government and mortgage-backed securities. Smaller allocations to corporates, high yields and even some emerging markets adds return potential and yield to the portfolio. Consistent with its more defensive outlook, the current portfolio duration is around 4 years – much lower than the benchmark’s 5.6. Conclusion It’s understandable that investors would begin looking elsewhere following Gross’ departure. But shareholders who have stuck around have done just fine in the meantime. I think we’ve seen in the first year post-Gross that the fund is managed in a substantially similar way. The consistency of the portfolio management team that worked behind Gross is still largely intact. Gross’ decades of expertise may no longer be around but Total Return is still in able and, at least thus far, in solidly performing hands. Despite the wave of outflows that is still occurring yet today there’s no reason why the current PIMCO Total Return fund shouldn’t at least be considered for the income part of a portfolio. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.