Managing Volatility

Markets are becoming volatile or so it appears. Most wealth advisors define volatility as the likelihood of losing money. The greater the market volatility, the bigger the risk of loss. I take a different interpretation of risk.

I define “risk” as the chance of realizing a permanent loss of capital. My definition is very common among value investors. Charlie Munger, Vice-Chairman of Berkshire Hathaway Corporation and Warren Buffett’s right hand man, has written extensively on this topic. I share his view that you have to be properly compensated for any risk that you assume.

Another belief that most advisors misconstrue is how to mange volatility for someone who has 20 more years to go until retirement vs. someone who is living in retirement. Their thought process is that someone younger can handle more volatility.

If you define risk as the permanent loss of capital, then it makes no sense that a younger investor should take more risk. You should try to avoid a permanent loss of capital at all times. As Albert Einstein stated — ‘Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.’ If you take a large loss when you’re younger, it will compound significantly over time.

I believe all investors should do their best to avoid risk, young or old. All investments should be selected based on the underlying value of the business. A common mistake investors make is selecting an investment based solely on the dividend yield or where the stock price has traded in the past. I find that the financial advisors who pay no attention to value, face higher odds of permanently losing their clients’ money. This year happens to be a great litmus test if your portfolio is in good hands.

I believe we are in the middle of a period of huge risk. Especially, if you take the wrong view of volatility. There has been an enormous permanent capital loss realized across commodities, and in particular, the energy sector. Through the end of last week, the Dow Jones Industrial Average is down -1.94% while the S&P 500 is up 1.59%. The volatility is under the surface. As of last Thursday, 56% of the S&P 500 stocks were down 10% more from their recent highs. Most energy/commodity names are down over 30%. My bet is if your portfolio took the wrong view of risk or if you are not properly diversified, then you may have big permanent capital losses this year.

At CGF, I invest clients’ money in high quality businesses. I do my best to avoid big mistakes and diversify all of my investment portfolios. For my clients that are retired, I analyze the ability for a company to pay a dividend from free cash flow rather than basing my decision on the size of the dividend. I am comfortable investing in companies that have an appropriate level of margin of safety for my retirees. For younger clients, I analyze the level of return for the given risk that will be assumed over the long-term of the investment. At all times, I try to gauge the potential for a permanent loss of capital.

The next time you read or have another advisor try to label you as an aggressive or conservative investor, ask them first how they define risk.

Please read my disclosure statement regarding the contents of this post.

The material on this site represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed to be accurate, does not purport to be complete, and is not intended to be used as a primary basis for investment decisions. It should not be construed as advice meeting the particular investment needs of any investor.

When is it time to buy commodities?

The cover story of Barron’s Magazine this week was titled, “Time to Buy Commodities.” My first thought upon reading this article was when did this analyst say it was, “Time to Sell Commodities”. The most critical question you should ask yourself when it comes to investing, is how much can I afford to lose. It is safe to say that if you invested in commodity stocks, then you are well past the pain threshold. We have entered the capitulation phase of panic selling. The charts below highlight the capital destruction that has occurred in the commodity/energy sector.

Untitled

A buy and hold strategy does not work too well when volatility works in reverse.  Over the past year, I have maintained a negative position on the commodity sector for a number of reasons. My view was based on a slowing Chinese economy and an oversupply of commodities. Both of these trends could soon be reversing. What makes this sector so attractive to value investors now, is the law of compound finance. The table below highlights that if you lose 50% of an investment, you will only have 50% of your capital remaining. To get back to even, you now need to make 100%.

If You Lose: Gain Required to Break Even:
10% 11%
20% 25%
30% 43%
40% 67%
50% 100%

The best way to apply this logic is through an example of a commodity company that has seen the price fall over 80%. An investor with a $100,000 investment will now have an account value of $20,000. A 50% rebound will result in the account appreciating back to $30,000. This unfortunate shareholder will still be down 70% while a new shareholder who invested $100,000 will find their account value move to $150,000. This simplified example shows the potential for enormous gains in the sector if you are able to catch the next cyclical rally.

At current price levels, oil production is no longer profitable. Energy producers will soon be forced to cut back on production and we could see a sharp drop in supply. Investors will closely be watching supply and any new information which will create huge volatility and uncertainty. In the past, I’ve written that dividend cuts could be a sign that it’s time to buy. Managements had been hesitant to cut dividends without alienating their shareholders base. Similar to the banking crisis in 2008, the time to buy the banks was when they announced dividend cuts. We are starting to see dividend cuts across the commodity sector.

I actively manage a well-balanced asset allocation for my clients. I do my best to control investment losses and understand how much I can afford to lose. I have maintained a higher allocation to cash in anticipation of these types of opportunities. All of my portfolios are well diversified enough to allow me take a little more risk for investors who are appropriate to buy this sector. If my timing is wrong, the losses will be small, as I won’t invest too aggressively in this sector to start. However, I believe the risk-reward is starting to become more positively skewed for higher returns. As I tell all of my new clients, down markets are actually good if you have a long-term investment horizon, take an optimistic view, and invest with a wealth manager that has experience analyzing and uncovering new investments.

Please read my disclosure statement regarding the contents of this post.

The material on this site represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed to be accurate, does not purport to be complete, and is not intended to be used as a primary basis for investment decisions. It should not be construed as advice meeting the particular investment needs of any investor.

July 2015 Client Letter

This quarterly investment summary covers view on the market and current portfolio positioning. I believe what is measured will be managed. I measure the investment results daily and manage the portfolios with the objective of outperforming the S&P 500. For my retirees and more conservative investors, I blend the S&P 500 with an appropriate bond fund index. Individual portfolios are further tailored to align client’s goals with their risk tolerances.

Year-to-date results through July 2015

I am unable to show you in print my investment track-record due to laws and compliance. I can say that managing an asset allocation using active and passive investing has been the right call so far this year. Earlier this year we found a few very undervalued companies and took advantage of select stock prices.

The majority of my clients’ assets are invested in my two asset allocation strategies. On request, I can provide you with the holdings of each of these asset allocations. My clients will receive their actual returns quarterly, direct from Interactive Brokers.

My view on the markets

Investors are starving for income due to the results of the low rate environment. With interest rates near zero, many investors find themselves taking more risk in equity markets. Given that the S&P 500 has returned close to 16% per year over the past 5 years, I find that the risk tolerances of many investors has become more aggressive.

This year is clearly a stock pickers market. On 7/27/15, the Wall Street Journal reported that so far this year, Amazon, Google, Apple, Facebook, Gilead and Walt Disney Co. have accounted for more than all of the market-capitalization gains in the S&P 500. In such a low growth, low interest rate, economic environment, investors will pay a premium to own innovation companies that are growing revenues faster than the economy. We wrote about this trend last week before the Wall Street Journal article. My view is that you need to blend active management with passive exchange-traded funds (ETFs). If you want to have a chance to outperform the S&P 500, you will need to be able to select a few individual companies that are growing faster than the economy.

Current Portfolio Positioning

Here is how I have achieved my investment results:

Energy Sector

I have maintained a zero weighting to the Energy sector in the portfolio. The only exposure the portfolio has to Energy companies is through exchange traded funds (ETFs). I have been writing all year about the poor fundamentals in this sector. My negative call began on December 11, 2015. The post is here. The Energy Select Sector SPDR ETF is down 11.18% through July 2015.

China & Commodities

There is no exposure to Emerging Markets companies in my clients portfolios. We also do not own any commodity stocks. It has been wise not to own this sector. Many commodity stocks are down over 50% this year. Gold, copper, and other metals are at the mercy of the Chinese government. The Chinese stock market is being artificially supported and we believe that volatility will continue. I don’t believe any news coming out of China and wrote two weeks ago how I have no trust in global markets. Overseas investing should come with a label warning, “Investing in global markets and commodities can be hazardous to your portfolio.” With commodity prices being so low and investors so fearful, we could see a large rebound in this sector. We will be just watching for now. There could be many investment opportunities once prices stabilize.

European Stocks

I currently have only a small allocation to European stocks. Europe is looking more interesting based on cheaper valuations and a recovering economy. I prefer to own U.S domiciled companies because I believe that they are growing faster than their European counterparts. Investors also face currency risk when they invest overseas. With U.S markets off the highs set this year, we are actively seeking opportunities in the U.S. and not in Europe.

Cash Weighting

All of my clients’ portfolios have between a 10–25% allocation to cash depending on the client’s personal risk tolerance. My investment philosophy is to always hold some cash in the event that markets drop or new opportunities arise. In addition, cash helps to reduce volatility. The portfolios would have a lower cash allocation if I believed stocks were undervalued or bond prices were going to rise. For now,I feel comfortable holding cash and being ready to buy into any market drop.

U.S Markets: Health Care & Technology

The sectors that I’m most interested in owning are Health Care and Technology. I actively maintain a shopping list of new buys that I will make if markets do fall. As I tell all of my clients, down markets are good if you are prepared for them in advance. Part of me is now hoping we see a short-term market drop so that I can take advantage of potentials new buys. The aging global population, increasing demand in emerging markets, and innovation in biology have me very excited about opportunities in the years ahead for all of my clients.

Health Care companies have been one of the best sectors to own over the past 5 years and I believe that sector has the potential to be the best to own over the next 5 years. You will see a large overweight to Health Care companies in all my portfolios.

Conclusion

I want to thank all of my clients for trusting me with managing their wealth. We are off to a great start so far in 2015. I promise you that I will never advertise awards such as I’m a 5-star advisor or how I’m the fastest growing registered investment advisor firm with xx amount of assets. I believe investment results, professional investment experience, continuing education, and designations such as CFA and CFP are how you should judge your advisor. But what is most important, is that I’m helping you reach your goals. At the end of the day, it is actual investment returns that will help you meet those goals and not award plaques hanging on walls.

Nothing on this site should ever be considered to be advice, research or an invitation to buy or sell any securities. All performance is based on data gathered from Morningstar.com.

The material on this site represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed to be accurate, does not purport to be complete, and is not intended to be used as a primary basis for investment decisions. It should not be construed as advice meeting the particular investment needs of any investor.

Past performance does not guarantee future results.

Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

Exchange-traded funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

Neither Asset Allocation nor Diversification guarantee a profit or protect against a loss in a declining market.
They are methods used to help manage investment risk.

The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market value weighted index with each stock’s weight in the index proportionate to its market value.

Constant Guidance Financial LLC does not offer legal or tax advice, individuals are encouraged to discuss their financial needs with the appropriate professional regarding your individual circumstance.

Please feel free to contact us with any questions.

Time for Active Management

This is starting to feel like the later stages of a bull market. We have entered the stage of unrealistic expectations. Historical market indices now appear as though you can gain over 15% by just investing in the S&P 500 index. The opposite held true back in early 2009. So which is it?

The “better way” to invest is to create a global asset allocation of low cost exchange-traded funds (ETFs). This marketing message is how Robo-advisors have been gaining market share away from active managers. It is a “set it and forget it” approach. Somehow they try to make you believe that taking a passive approach is an advanced strategy.  I always thought the “better way” of investing and more advanced strategy was through fundamental analysis and active portfolio management.

If I answer these 5 simple questions, using their “sophisticated software” I will get a personalized investment plan with low fees.  For starters, there is nothing sophisticated about creating a basket of ETFs. Second, these plans should be free. The investment advice is worthless and is not customized to any client’s particular situation.

I tested the asset allocations of the leading Robo-advisors a few months ago. At that time, I wrote how the allocations seemed very aggressive (see last post) and thus far I have been right. My 5% Natural Resources allocation is down over 10% and the 15% I was allocated into Emerging Markets is down almost the equivalent.  The 20% Foreign Stock component is down around 5%. My risk tolerance was only 7! I feel bad for that guy who had a risk tolerance score of 10.

As the world moves to passively managed funds, I find myself moving back to actively managed funds. This year has been a stock picker’s market.  This week, The Wall Street Journal reported that six companies have been responsible for 100% of the return in the S&P 500.  Many of the active managers I follow are returning over twice as much the S&P 500 this year. My belief is all of this blind ETF buying has made markets even more inefficient. Gaining market exposure through ETFs makes sense when markets are undervalued and you can throw a dart to pick a winner. With markets near all-time highs, the dart throwing strategy of gaining market exposure through ETFs is not working as well as it used too. You will experience 100% of the downside if markets fall and potentially even more because the asset allocations created by these “sophisticated” software is seriously flawed.

Now is the time for active management and investing with managers that value companies and don’t pay any attention to market levels or correlations. My investment approach is to blend passive investment with active management. This year I have avoided the Energy sector and all of Emerging Markets. It was an easy call to make if you knew how to read a balance sheet or cash flow statement. Many of the active managers that I follow are outperforming this year using fundamental analysis and investing in companies growing faster than the overall economy.

I can’t show you in print my investment track-record due to laws and compliance. I can say that managing an asset allocation using active and passive investing has been the right call so far this year. If you would like to speak with me about building a diversified portfolio through customized portfolio management that aligns your risk tolerance with your financial goals, feel free to send me an email to mitch@cgfadvisor.com.

Please read my disclosure statement regarding the contents of this post.

Market Outlook: Differentiation vs. Commodities

The one investment theme that is working well this year is investing in innovative and differentiated companies. Investors are paying big premiums to invest in start-ups and technology companies that are disrupting traditional sectors.

If a company has not been able to differentiate, there is a high probability it has been a poor investment this year. We categorize any company or industry that is undifferentiated as a commodity. Take a look at commodity-price index, which is now at a multi-year low.

Commodity Price

Back in early December 2014, we warned that the Energy sector was setting up to be a classic “value trap”. We believe the entire commodity sector remains a “value trap”. This week gold hit a five-year low, oil is now down another 20%, and the price of copper has fallen 15%. Those are just a few examples of commodity prices getting pummeled. The entire commodity sector looks oversold and hopefully we see a relief rally soon. If not, we believe that a further drop in commodity prices may signal an economic slowdown.

The two main reasons why commodities are crashing, is a drop in Chinese demand and the Federal Reserve shifting interest rate policy for the first time in nearly a decade.

Our portfolios are positioned away from commodity prices and interest sensitive assets. Our belief is if a company can take a commodity and create a differentiated brand, then it has the potential to be a great investment. For example, Starbucks is really a commodity company with a brand. Amazon is an innovative company that competes on low cost. Today, Amazon now has a market capitalization of $40 billion more than Wal-Mart ($262B vs. $233B). Competing on just low cost has not translated into a high stock price. You need to be innovative as well.

We believe that the best way to take advantage of these opportunities, is to take a “barbell” approach to asset allocation. All of our portfolios are now allocated to cash with an overweight to Health Care and Technology related Exchange-Traded Funds (ETFs). We are also holding a large allocation in cash to give us an option to take advantage of any possible market correction. This high cash position allows us to take more risk in sectors that are driving innovation. Sometimes it is best to win by not losing.

Markets will remain volatile as investors rotate out of companies that are undifferentiated and have no pricing power. We are differentiated from other advisers in that we manage and monitor your investments daily and will adjust your portfolio to changing economic environments. If you would like to learn more about how we can help you navigate these uncertain markets, please give us a call at 508-207-8049 or send me an email to mitch@cgfadvisor.com.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.

The material on this site represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed to be accurate, does not purport to be complete, and is not intended to be used as a primary basis for investment decisions. It should not be construed as advice meeting the particular investment needs of any investor.

Unconventional Thinking in Retirement

The biggest investment challenge that a retiree faces is how to maintain their wealth while they live off the wealth they accumulated. The Certified Financial Planner™ in me believes that retirees need to remain diversified and spread their risks across bonds, equities, annuities, and whole life insurance policies. The most common advice from financial planners for retirees is to invest in variable annuities, long-term bonds, Real Estate Investment Trusts (REITs), and energy stocks.

The Chartered Financial Analyst (CFA) in me thinks this is bad investment advice. Let me explain with an investment example.

Investment A –Has revenues and earnings that are tied to the price of a commodity. Investment A continuously needs to reinvest in machines and in capital equipment to maintain the business. They are heavily in debt from buying property and replenishing depleted assets. The shareholder base is dependent on receiving a 3-4% dividend each quarter.

Investment B – The balance sheet is pristine and they have little to no debt. There is no reliance on buying equipment and they are not dependent on a commodity. The company creates their product through human capital. The highest cost is people.  It’s a 100% human capital business. This business is built on ideas, brand recognition, and patents. The only way this company losses market share is if another business out thinks them. They generate significant free cash flow but the valuations always seem to be overpriced.

I believe we need to throw away the textbooks and listen to the CFA and buy investment B no matter your age. Here are my reasons why:

  • Dividends do not matter unless they are paid with free cash flow.
  • Retirees need to first think safety and then invest in companies that generate free cash flow rather than divided yield.
  • Energy company dividends may not be safe. There are many energy companies on the verge of cutting their dividends.
  • Always think valuation first and not dividend yield. Traditional retirement planning places too much emphasis on focusing on above-average dividends. It’s usually the higher yielding companies that are the riskiest.
  • It is best not to favor businesses with high capital expenditures and higher debt levels. I believe you should pay the higher premium to buy the brand. In retirement, your portfolio should be built with companies that have healthy free cash flow growth.
  • Invest in human capital sectors that are driven by innovation rather than focus on dividends. Technology today is much different than 10 years ago. Many larger technology companies are now mature and generate huge cash flows. It is critical to stay diversified across the technology sector. The winners of today will mostly likely not be the same market leaders of tomorrow.

Everyone’s situation is different and your personal circumstances should be aligned to your portfolio. We believe that you should think unconventionally and invest in Vanguard and other Exchange-Traded Funds (ETFs) that are aligned to your goals. Your strategic asset allocation should be managed to reduce volatility through global diversification, but, at the same time, be tactically managed to take advantage of market opportunities. At any age, you need to invest with a focus on valuation rather than dividend yield. Working with an advisor that has professional experience managing investments and educated in valuing businesses is the first step to creating an appropriate retirement plan.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.

The material on this site represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed to be accurate, and is not intended to be used as a primary basis for investment decisions. It should not be construed as advice meeting the particular investment needs of any investor.

Past performance does not guarantee future results.

Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

No Trust in Global Markets

This week investors were once again reminded that a combination of debt and leverage can have the same consequences as playing with gas and matches. Mainland Chinese stocks experienced a 1929 style meltdown after a 30% crash in the past month. European stocks were down nearly 10% in the past few weeks. The price of crude oil and many other commodities which have high correlations to Chinese markets have fallen between 10-15%. We believe that overseas securities should come with a label warning, “Investing in global markets and commodities can be hazardous to your portfolio.

On Friday, a number of world markets had rebounded over 4% as investors cheered the possibility of a deal in Greece. U.S markets rebounded with over a 1% gain. However, there remains significant financial damage done to world markets. China equities had wiped out roughly $4.1 trillion in value and Greece still needs to sign a $83 billion bailout. I believe there is even a bigger issue and that is trust.  I personally don’t trust any reports coming out of China and I am skeptical that you can trust any Greece deal. There are bigger structural issues that still need to be addressed.

Without trust in the financial institutions, it becomes difficult to make prudent investment decisions. I don’t trust the Chinese government or the management of any Chinese company for that matter. I also don’t trust the Greek government. I don’t trust Fidelity and Goldman Sachs call this week to buy China stocks after the market rout. I recall about three weeks ago that a Managing Director from Goldman said on CNBC to buy China stocks just before the wipe-out. As for Fidelity, they own the largest China mutual fund and they are trying to turn outflows into inflows. I do think fundamentally that valuations are cheaper but I don’t trust the system. There are many investors who will now try to trade the bounce because of the technicals and oversold position. These same investors would all agree that they have no idea of the leveraged inside of the Chinese financial system. We all learned back in 2008 that leverage and debt can take down an entire major financial system.

Chinese financial officials are now pulling out all the stops. They have created a fund to buy the dip and are using a playbook created by Greenspan/Bernanke to support the system. Contagion is the real fear. As we head into earnings season, investors will begin to question the earnings of U.S companies that generate sales from China and Europe.  For example, Apple Inc. generates the same amount in sales in the Americas as it does from China and the rest of Asia Pacific. In 2Q15, 36% of sales in Americans and 36% in China/Asia Pacific.

Going forward the news flow out of China could have more of a material impact on corporate earnings than the Greece/European saga. We are clearly in a period of uncertainty and volatile markets. Our strong belief is that it best to stay diversified and invest in markets that you can trust. We will remain positioned more conservatively until we can gain more trust in overseas markets. One thing is for certain and that is markets will remain volatile until a Greece deal is signed and the Chinese markets have stabilized.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.

The material on this site represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed to be accurate, does not purport to be complete, and is not intended to be used as a primary basis for investment decisions. It should not be construed as advice meeting the particular investment needs of any investor.

Past performance does not guarantee future results.

Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

Independence Day and Greece

Happy 4th from Constant Guidance Financial!

Today, we celebrate the birth of our nation and the remarkable Founding Fathers who led us to Independence. Many take for granted that the founding of our nation was an easy process and not without controversy. The actual Declaration of Independence was not signed until August 2nd. The delegates from New York happened to be on the wrong side of history and never signed the document at all. John Dickinson and Robert Livingston were the politicians who thought that declaring independence was premature even though the Battles of Concord and Lexington had taken place a year prior.

There was a real fear that the signers of the declaration would ultimately be hanged for treason. In one famous story, John Hancock supposedly said that Congress, having signed the Declaration, must now “all hang together”, and Benjamin Franklin replied: “Yes, we must indeed all hang together, or most assuredly we shall all hang separately.”

In times of crisis, strong leadership is needed for the ultimate good of the people. The amazing leadership of Washington, Jefferson, Adams, Franklin, Hamilton, and others took center stage of history. The vision of these leaders were influenced by the ancient Greek form of a democratic government. Today, Greece could use some real leadership. The citizens of Greece are on the verge of losing everything if they default on their debt. The stem of the problem in Greece is that they cannot print their own currency because the Euro is their central currency. Without the ability to create new money, they missed a debt payment to the IMF. This was the first default by a developed country and led to the collapse of the banking system. As we celebrate the 4th, the Greeks will be voting on whether to overthrow their government or default on their national debt.

I have read financial commentators state that the events in Europe do not matter because Greece is such a small country and our markets can overcome any setback in Europe. My only concern is that the markets do not like uncertainty. Bull markets are created and sustained by confidence and are driven by innovation. Confidence is weakened when uncertainty enters the equation. Unexpected events such as the IMF default payment caused most portfolios this week to lose between 1-3%. The only place to hide was in cash.

A Greece vote “no” could add even more uncertainty to the markets and may create a cascade of losses. My belief is that losses can beget losses because of negative momentum. Much of the confidence in the US economy has been financially engineered by the Federal Reserve through trillions of dollars printed which has ultimately ended up in asset prices. The Federal Reserve understands that a strong stock market is best for the overall economy. A clear “yes” vote removes uncertainty and markets may respond with gains. We hope that the vote will be “yes” and this game of brinkmanship will end. The Greeks will get a new prime minister and confidence will return. If it is a “no” vote, we expect a short-term drop in stocks followed by a period of uncertainty as world leaders decide how to handle this situation.

As always, our long-term shareholders should not be concerned by either a “yes” or “no” vote. We are managing risk accordingly and have been positioned defensively well before this event. A “no” vote will create many new opportunities and we are well positioned to take advantage of these potential new bargains. We are differentiated from other advisors in that we continuously assess risks and will adjust our portfolios accordingly to market shifts. We could be entering such a time when there is the potential to take advantage of market imbalances.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.

The worst and potentially best trade I have ever seen

On January 30, 2009 the VXX began trading. Since this time the VXX is down an astounding 99.65% (it could be even more but my calculator had trouble rounding an investment down so much.) Even though this investment has lost almost 100%, many new unsuspecting victims are drawn to the gravitational pull of this horrible investment. Why?

Many investors lose sleep over staying invested in stocks and losing their retirement savings. One day back in 2008, a marketing guy at Barclays got the idea that one way to hedge a portfolio was to buy volatility. The idea goes like this: bad news + volatility = stock losses. If we financially engineer a product that tracks volatility, investors will have an instrument that hedges losses in their portfolio. Please note that this product began trading in 2009, immediately after the credit crisis.

You want to own this ETF when the financial world is going to collapse. Adjusting for reverse stock splits, Yahoo Finance shows how VXX went from $7,000 to around $17.50. The average daily volume over a 3 month period is still 39 million shares! Yes, investors are still buying this thing. Investors who bought and held this speculative “investment” are down 40% from the beginning of the year.

I would consider this ETF as the panic button. If Greece collapses or a terrorist attack or stock market meltdown, this ETF has the potential to go up 100% overnight. But the wealth that has been lost is truly staggering. Where has this money gone?

I believe that some smart MIT guy have figured out a way to continuously bet against this ETF and make a fortune. In 2012, a few MIT students figured out how to make winning the Massachusetts lottery a sure bet. They won close to $8 million. I wouldn’t be surprised if someone has made $100’s millions on this ETF.

According to investorplace in 2012, “Like most commodity price curves, the VIX curve increases as the maturity date becomes more distant — a condition known as “contango.” For VXX, this has represented a serious problem because the fund continuously rolls the first-month contract to the second-month contract as each month progresses. The result: The fund, by its mandate, is forced to sell low and buy high in perpetuity.”

This VXX is an exchange-traded fund (ETF) from Barclays that supposedly tracks the Volatility Index (VIX) futures. This index is the S&P 500 VIX Short-Term Futures Index Total Return which is a strategy index that maintains positions in the front two-month CBOE Volatility Index (VIX) futures contracts.

This ETF is cursed by roll risk or time decay. Every two months this product will roll into another contract and loss money. Over the long run this product (and others similar) are all going to zero.

As policy, I normally do not discuss trade ideas and do not recommend shorting or even buying this security. I’m just informing you that there will be a story one day on 60 Minutes about a few guys that bought an island from shorting this ETF.

This is for informational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy any security.

The material on this site represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed to be accurate, does not purport to be complete, and is not intended to be used as a primary basis for investment decisions. It should not be construed as advice meeting the particular investment needs of any investor.

3 Investment Tips to Reduce Risk

Alarmist’s are ringing the bells. The stock market is headed for an imminent correction. The market noise this week was the loudest I’ve heard in a long time. You would think by the doom & gloom warnings that another 2008 crisis was around the corner. What will be the trigger? Here are a few possibilities in the media –

1) We are now entering the 3rd longest bull market since 1900 where we haven’t experienced a market correction of 20% or more. As the chart indicates below, this is the third longest stretch without a 10% market correction.

150604123754-trading-days-780x439 4

2) According to FactSet, valuations also are slightly elevated as the forward P/E for the S&P 500 Index is 17 and the 10-year average is 14.1. The market is trading at a premium.

3) Greece has delayed it’s debt repayment to the IMF and has until June 30 to pay or it could go bankrupt.

4) The Euro currency has fallen substantially, interest rates are rising, and the Federal Reserve could begin to raise rates.

5) Central Banks around the world are printing trillions of dollars and inflation may return.

Which event will trigger this correction? Well, lucky for all of my clients, I’m not in the market timing business. I believe Warren Buffett wrote it best in his annual report to shareholders this year,

Anything can happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.

There are many investment strategies and tactics that you can implement before a significant market correction. The 3 best ways that I believe to reduce risk in your investment portfolio are as follows:

  • Diversify across asset classes, sectors, geographies, and market capitalizations. Even better is to diversify your portfolio to reflect your objectives, risk profile, lifestyle expectations, and cash flow needs. I’d bet that the market forecaster does not have the same goals, values, and risk as you.
  • Keep an allocation in cash to buy when markets do correct.  Investors have a tendency to become fearful by listening to these commentators. If you have no cash to reinvest, then dollar cost averaging will be of no help to you.
  • Invest in dividend paying companies that fund payments from free cash flow and not by issuing debt. Overweight in companies that have excess free cash flow to raise dividends, buyback shares, and takeover weaker competitors during troughs in the business cycle.

These three tips to reduce risk will help make you become a less emotional investor. Volatility in markets is just noise and should never be directly related with risk. Risk to me is when you do not follow an investment philosophy of my 3 tips.  I believe there still remains many good undervalued stocks and sectors in these markets. If you would like to learn more on how I can help you navigate these uncertain markets, feel free to give me a call at 508-207-8049 or send me an email    to: mitch@cgfadvisor.com.

Please read our disclosure statement regarding the contents of this post and our website as a whole.

Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

Neither Asset Allocation nor Diversification guarantee a profit or protect against a loss in a declining market.
They are methods used to help manage investment risk.

The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market value weighted index with each stock’s weight in the index proportionate to its market value.

Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.