Author Archives: c10627327

Real Monsters

Monsters are real, and they are us.  I know Halloween is a distant memory already, and adults know the real monsters are misshapen and malformed people.  But central banks have created a monster, or perhaps a better way to say it would be they brought out the monster in all of us.

When the global financial crisis hit, the central banks were asked to fulfill their role as buyer of last resort and get the gears of the debt markets moving again.  We’ll never know what might have happened had they decided not to do what they did, but it’s safe to say things likely would have gotten a lot worse than they did and got better faster than they would have otherwise.

Most central bankers are economists, and most economists operate on theory.  Theoretically speaking, the monetary stimulus they provided would, by course of nature, go to investments that engender greater long-term growth.  Things like technology to improve work force productivity and efficiency, and research and development toward new technological breakthroughs.  Theories are great.  In theory.

In practice, they don’t always hold up.  Especially when they rely on human beings acting rationally with respect to money.

Past readers will recall me saying money is not math and math is not money. Money is emotional.  Well, this is true, but as it turns out, a more accurate way to put it would be to say that it’s chemical.

See, when we experience financial gain, it triggers the same response that things like drinking, eating, and sex do.  Our “reward system” is activated by releasing dopamine into the nucleus accumbens.  And on the other side of the deal, when we experience a financial loss, the stress hormone cortisol is released into the hypothalamus by the amygdala.

All that to say, the stimulus central banks injected in the economic bloodstream did not go toward these long-term economic growth initiatives. It was a satisfying hit of dopaminein the form of share buy backs. These are great for short-term growth, especially if you’re a CEO that receives half your annual pay in your company’s shares, but not so much for the long-term.

Because remember: when asset prices get too far ahead of real economic growth, you get bubbles. You’ve all heard the financial media say the Fed has been confounded all these years by trying to achieve “sustainable” 2% inflation, while stock and bond prices have rocketed into the stratosphere.  That’s another way to say asset prices have gotten ahead of economic growth. When that happens, we might be in store for a hefty dose of cortisol.

Jerome Powell, the Federal Reserve Chairman appointed by Donald Trump (though it’s worth noting that Powell’s nomination to the Federal Reserve Board of Governors by President Barack Obama was the first time that a president nominated a member of the opposition party for such a position since 1988), is not an economist like Janet Yellen, Ben Bernanke, or Alan Greenspan before him.  He’s a market guy. He studied law and has worked as an investment banker or in Government roles throughout his career. In other words, he’s seen how the investment banking world works in practical terms.

Powell’s language and actions so far indicate that he, and those on the board who are voting with him, recognize asset prices have run away from economic growth and that their policy implementation has (my words), created a monster. The cash they handed to the banks in exchange for all their bad mortgage backed securities were the corpse of body parts sewn together, and the four and a half trillion dollars they created out of thin air and dumped into the bond market was the lightning bolt through the neck electrodes that brought it to life.

Now Frankenstein, that’s Frankenstein (I can’t even type that without laughing hysterically), wants to kill his monster. Again.

Alan Greenspan admitted his error when he said he didn’t think banks would take risks that would jeopardize their own livelihood. And I think there will be a panel of Senators wagging their fingers and grilling Ben Bernanke and/or Janet Yellen at some point in the future too.

But in the meantime, acting Fed Chairman Jerome Powell and the current board are talking and acting a lot like they know they’ve revived the monster. In us.


Cause and Effect

Something we tell all prospective clients is we will never ask you to break something so we can fix it because our experience lends to a good understanding of the cause and effect of doing so. We don’t need or want our clients to sell investments, close accounts, or fire other advisors that are working efficiently for them and fit well with their short and long-term strategies. When we identify relationships and areas that have a place in the plan, we don’t have to bash these other firms or advisors to make ourselves look better.

I know I don’t have to tell you this is not the case in many places.

Generally speaking, one of the ways the financial institutions make money is by moving ours around. So, many advisors are trained and compensated to convince clients that the other investments and relationships they have are bad, and the client should break them, so they can fix them. It’s an everyday occurrence and millions of people end up paying taxes and fees they didn’t have to as a result. Cause and effect.

Here’s an example on a larger scale. American and foreign politicians have weakened their currencies in an effort to make the goods and services they export to other countries more competitive. This too is a very common sales practice. Sometimes openly; other times more subtly.   When the dollar is weak compared to other currencies, the goods American manufacturers export to the country with the weaker currency become cheaper relative to the same product produced domestically. There is a trade-off, naturally. There is with every financial decision. To make the dollar weak, the Treasury can borrow and spend more, or cut taxes, which by design, causes inflation. Cause and effect.

Then of course, there are the effects from changing trade policies—expected and unexpected. Over the past couple of weeks, the Argentine peso and Turkish lira have crashed, putting pressure on emerging markets worldwide. When trade policies impact the Gross Domestic Product in other countries, they have to take steps to support their currencies and exports. Cause and effect.

One of the biggest problems, in my humble opinion, with our current political and economic structure is that politicians can hold their seats in government for long periods, and transition to comfortable positions in the industries they have curried favor with in their policy implementation afterward.  This engenders very short term thinking as the sole focus becomes re-election in the next cycle.

Most financial or policy decisions we make, good and bad, have intended and unintended consequences. Shortening the term for the cause dramatically increases the likelihood of more, and worsening, unintended effect.

I think sometimes the best way to help is by giving credit where it is due and leaving things that are working well alone, to continue working well.  Even if it doesn’t provide an immediate gratification of one sort or another.

Labor Day Knowledge

Labor Day is a creation of the labor movement dedicated to the social and economic achievements of American workers. It’s a yearly tribute to the contributions workers have made to the economic strength and defense of our country.

During the peak of the Industrial Revolution, work conditions were pretty grim.  Twelve-hour days, seven-day work weeks, kids operating machinery no kid ever should, and generally exploitative situations for all but the employers themselves.

Historians disagree about who to attribute the concept of Labor Day to but suffice to say it took years of organizing, and surely a lot of pain and suffering, for employees to band together and demand and win basic protections. It’s also worth noting that our constitutional rights, and the very spirit they were written in, are what allowed these brave people to organize in the first place, making Labor Day a uniquely American holiday.

This introduced a period of unparalleled expansion of equality and the birth of the middle class.  This period also saw two World Wars fought primarily by laborers and tooled by a united and eager labor force, on all sides.  To be sure, there were also employers who made sacrifices, willingly and otherwise, to fund those wars, and some who profited significantly from them as well.

Years later, technology advanced and afforded employers the ability to transfer labor costs to other, less organized countries.  American worker incomes stagnated, that new middle class came under pressure, and with the aid of our own government, American Corporate interests made foreign workers in those emerging countries the exploited.

The perception of Labor Day, and that of organized labor itself, has changed over the years.  The causes of those changes are too many and complex to cover in a simple personal finance blog like this, so I won’t try.  Rather, I’ll close with a quote from The Department of Labor itself;

“The vital force of labor added materially to the highest standard of living and the greatest production the world has ever known and has brought us closer to the realization of our traditional ideals of economic and political democracy. It is appropriate, therefore, that the nation pays tribute on Labor Day to the creator of so much of the nation’s strength, freedom, and leadership — the American worker.”

Have a safe, relaxing, and enjoyable Labor Day weekend all.

The Inverted Yield Curve and You

One thing Republicans and Democrats generally agree upon is the importance of avoiding interference with central bank policy. If central bank leaders are politically motivated, they will naturally tend to implement policy that stimulates the economy leading up to elections, which causes high inflation and unfair political advantages.

It’s also worth mentioning that the outcome when they have interfered has been pretty horrific. Two examples? Richard Nixon nominating Arthur Burns as Fed Chairman with instructions to loosen the money supply, leading to the runaway inflation of the late seventies. And Treasury Secretary Robert Rubin influencing Alan Greenspan to lobby Congress to let investment banks keep their derivatives trading completely unregulated, leading to the global financial crisis.

Last week Donald Trump sent tweets indicating his disappointment in the Federal Reserve’s policy decision to raise interest rates, raising question over whether he’ll take steps to erode the Fed’s independence. I’ve been talking about how and why interest rates will go up for a while now (years in fact). But it seems to me that until now, retail investors, and even many institutional investors have been either oblivious to or selectively distracted from what is happening in the bond markets. With the President tweeting about it, ignoring this situation will not be an option any longer, and investors will be forced to take notice.

Additionally, Fed officials may well decide to continue raising short-term rates in an effort to maintain the appearance of independence, which in turn could raise inflation concerns among bond market participants, leading them to sell, putting upward pressure on rates. In other words, calling attention to the issue will likely exacerbate the very thing he’s expressing dissatisfaction with.

Short-term interest rates, the ones the Fed has greater influence (not complete control) over, started creeping up back in 2013 when the Fed announced it intended to “taper” it’s quantitative easing action, that it began as part of their efforts to revive the economy after the GFC (Global Financial Crisis, and yes, it deservedly has its own acronym). The yield on the two-year Treasury Bond went from a quarter of percent to over two-and-a-half percent over the last five years, with the sharpest increase coming from November last year until now. Long-term rates, which the Fed has far less influence over, have increased too, albeit at a slower pace, leading to a flattening yield curve.

I find again and again in conversations I have in our business that people believe the Fed has complete control over the interest rate marketplace. It’s understandable because messages the Fed and the media send say as much. And as I say, the Fed does have significant influence over rates, but they do not control them. The collective sentiment, or more specifically, perception of risk, of bond investors, dictates the direction and volatility of the interest rate market. When bond investors perceive greater risk to lend, they sell, and/or demand higher interest for what money they do lend. And with the amount of debt outstanding at the government, corporate, and consumer level, the perception of risk is bound to increase sooner or later.

You see, in the end, market stability relies entirely on a little thing called trust. In an age when trust in institutions is crumbling, politicizing the most influential central bank in the world is not likely to instill greater confidence in bond investors. Somehow this dynamic appears to be lost on the President.

Beware the Hooks

When my kids were little we watched a lot of SpongeBob SquarePants—so much so that my now 18-year-old still calls up references to it in everyday conversation. SpongeBob aficionados will get this reference.

It is just a cartoon, but the subtle messages are often very deep and very real. I tell you all this upfront because the tone of this post takes a darker turn and I don’t want my reference to a cartoon to trivialize the matters herein.

In this episode, the main characters (small underwater sea creatures) find themselves in a field where human fisherman on the surface above have cast their lines. Grabbing “The Hooks” results in a sudden, adrenaline fueled “ride” to the surface, where they can let go, and drift slowly and safely back down to the bottom. But only if they let go before being pulled out of the water.

The symbolism should be apparent now. “The Hooks” in real life take so many different forms it’s difficult to know exactly when we’re being lured. From the slower, more insidious dietary or overspending variety that could kill us or drive us to bankruptcy, to the more sinister, and immediately threatening, illicit and dark. While we may not be completely conscious of the lure, at some point soon after we begin thinking about grabbing the hook, our instinct tells us we should turn away from it.

When a celebrity dies, especially at a young age by taking their own life, we all mourn publicly in social media because, in a small way, we knew them. When that friend from years ago dies too young from their vice, again, we mourn. Succumbing to temptation is human, and so are the feelings of shame and self-degradation that stem from it. Of course, this doesn’t always lead to suicide or death. But it can. Some might argue that thoughts of suicide themselves are a form of temptation. Non-celebrities die from overdose, war veterans commit suicide, and we all play on the hooks. Every day.

We eat the garbage, take the drink, gamble, or just spend the money, when deep down, we know when we shouldn’t. The gleam of the pointed barb underneath that enticing lure warns and hypnotizes us at the same time.

You might say I’m stretching here. This is a personal finance blog after all, and I’m talking about personal vice. Two counter points to this claim. First, there are no lawyers on a broker dealer payroll scrutinizing everything I say. So it’s my blog and I’ll write what I want. Second, I’ve played on the hooks all my life, and while I may rationalize and live in denial about my own, I immediately recognize when one of our clients is playing on them. Money is emotional, and yes, the money hooks do lead to suicide or death for some.

In fact, much of what concerns our clients and leads them to our door in the first place can be traced back to the hooks. One of our primary responsibilities is listening to what concerns them. After we’ve done that, we give them an honest read back of what they’ve just said to us. I am not afraid to tell a client when I recognize the situation, and sometimes my telling them to beware the hooks is enough to convince them to turn away. Not always, but sometimes.

Whatever your personal hook might be, there is no debating one fact. There will come a time when you are open to a message from within or without that you need to stop. Or there won’t be, and you’ll be hooked forever. Being open is the key phrase in that statement. So open yourself to that message. And beware the hooks lad. RIP Cubby.

Tax Returns: Your God-Given Right as an American

Recently CBS Sunday Morning published a story on the idea of automating the preparation of our tax returns. This is not a new idea. I hope it never becomes law.

Sunday Morning interviewed a Stanford professor named Joseph Bankman. Bankman developed a program designed to have the systems already in place pre-fill our tax returns to save us all time, stress, and in an ideal world, money. He tried, through California’s legislature, to make this program (or one like it) the way Californians file their tax returns, but the effort failed thanks to opposition from corporate lobbyists.

If you’ve read any of our other posts in this blog, you’ll know I’m not one to defend big corporations and their lobbying efforts. But in this case, they make a valid point. They declined a request from CBS for an interview, but offered a statement: “Self-determination powered by an individual’s active participation in the tax preparation process is the backbone of the American tax system.”

That might sound a little hokey, because it is. But truthfully, there is nothing more American than the privilege of calculating your own tax liability and telling your government know how much you owe them, rather than the other way around.

Some countries, like Britain and Norway, use a “Pay As You Earn” automatic tax collection process. But many others do make residents file tax returns. Those that do typically have filing requirements— as the U.S. also does, in fact— which limit the number of people who must file a return.

Of course, the government does know about a lot of our income well before we tell them about it in our returns, but the government doesn’t always know how much of it is taxable, or at what rate. Our tax returns fill in those gaps. Under the current system, the IRS does not have the resources to collect all of this data without our participation. And they say as much in this piece by CBS.

We could all benefit from dedicating more time to monitoring our income and expenses and participating in the preparation of our returns. If you think you can hand a shoebox of papers to a tax preparer and expect that you’re not going to end up paying too much, well, I hate to say it, but you deserve to.

As noted above, in the CBS story, it’s suggested that eliminating our participation would be beneficial because the tax code is too complicated and doing so would save us all time, stress, and money. This is the premise when politicians claim they’re going to pass a law simplifying the tax code, too. Ronald Reagan said it. So did Donald Trump. We’re going to be able to file our returns on a post card. It sounds good, and it does win votes, but it’s not reality.

The tax code is too complicated. But this is because it’s the American way to try and game the system, and every time someone tries a new end around, the IRS has to make a new rule.

Would it be possible for the US Government to take away our ability to participate in the process?  Probably. I value all the rights we enjoy as American citizens, but this one especially. The IRS does not have the same incentives we do to ensure we pay as little as we legally have to. Do we really want to give them all the power over this determination? I sure don’t.

So as April 15th approaches, consider yourselves lucky to have this privilege.  It’s a central part of your freedom.

Drowning in a Sea of Cash

I’ve been reminded a few times this week of how little there is in the way of investment opportunity in the current marketplace, and that we are drowning in a sea of cash.

Recently I read an article about how Warren Buffett (or to be more specific, Buffett’s company Berkshire Hathaway), has $116 billion to spend.  Berkshire Hathaway got shut out of a few deals last year so their cash hoard has gotten bigger. A lot bigger. Buffett said part of the reason they got shut out of the two big deals they worked on last year was because interest rates are so low, the other suitors were able to borrow and offer a lot more than he and Charlie Munger were willing to spend. Buffett and Munger will use debt when called for, but always evaluate a deal on a cash basis first.

So on the big stage, the deals are harder and harder to find, and there’s clearly a lot more competition for them when they do eventually present themselves. What does this mean for people like you? Decent investment opportunities dry up like rain drops in Death Valley.

Stock prices have been higher only once before. Can you say party like it’s 1999?  I guess we might as well.

A lot of our clients invest in real estate, and more of our clients are headed that way as stock prices soar.  But now real estate prices (and property taxes) are skyrocketing too. Even in places that have never been hot markets before, hedge fund managers are deploying cash in amounts never seen before to buy up everything and anything they can in the search for yield.

In 2014 oil went from over $130 a barrel to under $40 a barrel, and the other commodities followed it off the cliff. So I told clients to emphasize commodities in their portfolios. Now even commodities are well off their lows and I’ve read about investment managers recommending them. Prices in this asset class are no where near those of the paper assets (stocks and bonds), but there’s still a sea of cash swishing around.

There is simply too much cash chasing too few investments.

I’m reading Mohamed El-Erian’s The Only Game in Town. In it, he staunchly defends decisions made by central banks, but cautions that they have been asked to do too much. (It’s a great book by the way.) I beat up on the Fed in this blog a fair bit, but I’ve also acknowledged that without their intervention in 2008/2009, we’d probably be in the depths of a global depression to this day. The problem is monetary stimulus has its limits, and without reformative economic policy, it’s limits will be seen.  Probably sooner than later. We’re drowning in a sea of cash right now.  Let’s hope it has a shred of value when the tide finally goes out.

So, you may be wondering: OK, what the heck do I do about it?  And you’d be wise to question this.

To be clear, buying assets at high prices just because markets are appreciating does not make good financial sense (not to me anyway, and not to Buffett and Munger, either, apparently). Sometimes accumulating cash, or its equivalents, makes good sense.

When I say there are high valuations everywhere you look, I’m generalizing. Obviously there are opportunities in every market, but at times like this, you have to be patient, very patient, and look long and hard to find them. When you do, there will be lots of competition for them, so having a pile of cash will help you to capitalize when you find yourself in the right place at the right time.

That said, be mindful of getting caught up in bidding wars if others sniff your deal out before you close on it. Also, if you have not allocated any of your long-term investment money to commodities and natural resources, there’s still time.  As an asset class, they have not been driven into la-la land, yet.  They say patience is a virtue. In the world of investing, it can make or break you.

The Writing on the Wall

They say every prognosticator is eventually right, and I’m starting to feel like it might be my moment.  But it’s a moment I never wanted to come, and it does not feel good.

The bond market is finally opening its eyes to the handwriting on the wall. I’ve been saying interest rates are going to go up for so long I sound like a kook. When I’ve said those words, a few clients have replied “you’ve been saying that for years.” Because I have.

I’m not an economist. But you don’t have to be one to know central banks can only manipulate markets for so long before nature takes over, and the lid they’ve kept on rates wouldn’t last forever.

At the nadir of the last debt crisis in March 2009, The Federal Reserve handed US mega banks a mountain of tax payer cash, with no restrictions, and set them right back to doing the business that brought the crisis on in the first place. Yes, their intervention precluded a much deeper economic decline, which could easily have been a global depression. But they did practically nothing to address the structural problems that lead to the crisis. And neither did Congress. So the stage was set for the next crisis.

After they handed banks all that cash, they proceeded to create and spend four and a half trillion more dollars to buy Treasuries and mortgage backed securities (MBS), in an effort to further contain interest rates. The message they sent us was that this would encourage borrowing and spending, which will stimulate economic growth. And that was accurate. But the other motivation behind keeping a lid on rates has been to contain the cost of borrowing for the drunken sailors in Congress.

Actually, I take that back. Drunken sailors have nothing on Congress.

All that spending in the Treasury and MBS markets drove bond prices higher, and interest rates lower.  But every check they wrote had less and less impact on rate containment. So clearly they saw the hand writing on the wall well before bond investors, and announced they wanted to get out in front of inflation risk, stop all the bond buying, and begin raising rates. Slowly and incrementally.

That messaging has worked brilliantly. When I say rates are going to rise, people say to me, “But she says she’s only going to raise them slowly and a little at a time.” As if to suggest that Janet Yellen has had the interest rate markets on a string, and has complete control over everything.

To be clear, Janet Yellen is a very intelligent woman. Much smarter than me. But she and her successor Jerome Powell and her colleagues at the Federal Reserve Board do not have complete control over everything. In fact, they are in uncharted waters, and I suspect are feeling quite naked right about now.

As the Fed increases the amount of maturing debt proceeds they remove from the market, interest rates have nowhere to go but up. And the nine-year bull market in stocks, which was built on a foundation of more cheap, easy debt, will end by its removal.

We’re Growing!

Last week at QLC we hired a new Associate Financial Advisor, Alison Davis.

Alison has a wealth of experience in managing an office and customer service. She will be shadowing Brendan while learning about the personal and small business planning concepts Quantum leap Capital employs with our clients. We are very excited to have her with us and for this next phase of growth in our little firm.

In time this will enable us to provide service to a higher number of clients.  So keep your referrals coming.

Our business plan calls for me to do less and less of the computery, paper worky stuff, and more of the case analysis, advisory stuff.  Because that’s what I do best, it’s what our clients need most, what separates us from the hordes of other financial firms, and what drives profitability for us as a company.

I’m telling you this because I want you all to know that word about the unique work we do at QLC is being spread far and wide, and I am keenly aware that I have all of you to thank for that.

Your confidence in our advice and the introductions to those you care about it has inspired are the lifeblood of our business. And for this we are eternally grateful.

Welcome to the team, Alison! And many thanks to all of our devoted and loyal clients!

Crisis Breeds Opportunity

No matter how you see things, 2017 was a tumultuous year. Some say we’re in a state of crisis.  Others say we’re on our way out of one. Your perspective may fall in between these two extremes, but one thing is certain: crisis or not, opportunities for improving your financial position are always present if you look hard enough.

To me, financial planning is the ongoing process of examining one’s current position as a collective unit with an eye to mitigating as many of the prevalent risks as possible, thereby minimizing the effect of the things that erode and jeopardize our financial well-being.

In other words, pay attention to the things you have control over, and plug the leaks where money is leaking out, rather than the one thing you have absolutely no control over, and picking the stock or fund that will go up the most.

Taking this approach not only helps us keep more of our money, it gives us financial flexibility, so we can take advantage of opportunities.

Adopting this mindset and executing on it consistently takes practice, presence of mind, and patience. Our ever more short-sighted culture encourages the opposite, though, and this creates even more opportunity for those who have the muscle memory to step back and look for that space when crisis hits.

Flexibility is strength, and developing it takes time, discipline, and planning.

While I can’t help but worry over what’s to come, and every passing day seems to present a new challenge, I’m ready to look for the opportunities that these challenges present. Our business plan for 2018 is done and we’re ready to move forward into 2018, come what may.

From all of us at QLC, here’s wishing you all a happy, healthy, flexible, and prosperous 2018.