I have wanted to write extensively on the title of this posting because I consider it to be of the utmost importance. Everyday I think to myself that there are so many investors losing out on one of the greatest bull markets of all time. With the stock market up over 20% in 2017, and up almost 10% so far in 2018, so many investors have wasted a once in a lifetime return with financial advisors that do not have their best interest at heart. I will continue this discussion in greater detail later in this posting.
Lucy & Harper Wilcox
Lucy (6) and Harper (8)
Eddie Wilcox and wife, Jennifer
Before I discuss that topic, I have to discuss the extraordinarily good month of August 2018 from an investment standpoint and once again emphasize the strength of the U.S. economy and why markets are likely to continue to advance even after they hit all time highs in August. The economy at the current time could not arguably be better. GDP was adjusted higher for the second quarter and unemployment actually ticked down. Corporate earnings are now exceeding the 20% year over year estimates and the consumer has the highest optimism levels in over a decade. What is even more important is interest rates continue to be unbelievably low, despite being higher this year, and inflation is moderate. All things considered it is the perfect Goldilocks economy. Not too hot, not too cold - just right.
For the month of August, all the major market industries posted all time highs. The Standard and Poor’s index of 500 stocks was up 3.3% during August and up 9.9% for the year to date in 2018. The one-year period it reported an excellent 19.7% increase. The Dow Jones industrials average was up a more moderate 2.6% during August and it is up 6.7% for the year 2018. For the one-year period it is up 21%. The real winner during the month of August was the NASDAQ composite, it was up 5.8% in August and is up 18.3% for the year 2018. For the one-year period the NASDAQ composite is up a sterling 27.4%. For those of you that continued along investing in bonds, the Barclays Aggregate Bond Index was up 5% during the month of August but has a negative return for 2018 at -1.2%. For the one year period that index has generated a loss of 1.3%. As you can see any investor that has a significant allocation to bonds is not even coming close to generating a return as high as the underlying rate of inflation.
Due to the new highs being reached in the markets, a great deal has been said in the press lately regarding the potential for a huge decline in the stock market. I am not sure where the naysayers are finding their research on this subject since it is not supported by economic facts. Yes, it is true that the major market industries have hit all-time highs, but the market, by any measurable standard, is not overpriced. Due to the huge increase in earnings that U.S. corporations have realized over the last several years, the P/E ratio is still maintaining historically moderate levels.
If you look at the current earnings for the next 12 months, the P/E ratio for the Standard and Poor’s Index of 500 stocks is only at 17. If you evaluate the last 4 decades of investing you will find that, on average, 17 is the standard valuation represented by this index. So, when your neighbors or friends tell you the market is overvalued, ask them exactly what standards they are using to make this determination. In every decade since the 1920’s the average P/E ratio for the S&P Index has been 17, precisely where we are today!
About 90 days ago, there was much discussion in the press that the inverted bond yield would in fact push the economy into recession sooner rather than later. However, not many people have mentioned lately that the 10-year Treasury has actually declined, hovering around the 2.8% range over the last 90 days. There is actually an economic reason for this lack of movement, although the Federal Reserve continues to push short term rates higher. What we are seeing is a moderating inflation cycle that has not exceeded the 2% threshold as mandated by the Federal Reserve. But more importantly, there is a huge drag on interest rates by the 10-year Treasury rates in competing countries. If the Federal Reserve pushed up rates too high, money would flow out of foreign currencies into the U.S. dollar, hurting their economies and making their currencies less competitive. Trust me; I don’t think the Federal Reserve has any intention of creating that chaos and is likely to only make one more increase in 2018.
It is amazing to me that I have to explain to people how well the economy is doing. You do not have to look far to see all of the construction cranes in Atlanta; and good luck trying to get reservations at your favorite restaurant. Have you noticed that traffic is terrible everywhere you go, at all times of the day? I drive by the full parking lots of Lenox Square and wonder to myself why anyone would be inside a mall on a beautiful Saturday afternoon.
The department of labor has just announced that the unemployment rate continues to be below 4%. The economy added 201,000 jobs during the month of August, which by all historic standards is a very slow month for employment. As I have pointed out in these pages for many years, the more people you have working in America, the better the economy will be. With more jobs you will see the economy pick up in every respect and right now we are above full employment in America. If you want to know how strong the economy is you have to realize that U.S. employers have added to payrolls for 95 straight months. This is the longest extended job expansion in the history of the United States. Also, it was reported that manufacturing activity in August expanded at the strongest pace in more than 14 years and U.S. corporate profits boomed in the second quarter. I am not sure exactly what type of evidence that you would need to accept the reality of the strength of the economy, but those statistics are pretty compelling.
There is no question that there is economic uncertainty in the emerging markets and of course in the world’s smaller economies. Much of this uncertainty and the decline in value is a direct result of the issue with tariffs. However, from a true economic standpoint, the cheapest markets in the world today are Asia and the other emerging markets. They are however, not investable at the current time since the momentum traders continue to create economic chaos by forcing these stock markets down. The traders have neither the capital nor willpower to stay in these trades forever. Even though the emerging markets have incurred 5-6% losses over the last 90 days and are today trading down -7% while the S&P is up 10 %, it will be a quick rebound. Obviously, no one knows exactly what date this rebound will occur, and we are better off not investing in those markets until it does. I’ll bet that you will see the emerging markets rally late in 2018.
The month of August was an excellent month financially, but the more new clients I began to see coming in, the more I questioned why anyone would entrust their hard-earned money to an advisor with no fiduciary responsibility. I see so many cases of new clients who have been taken advantage of by previous advisors, and yet people out there continue to invest with non-fiduciary advisors. Many of these large brokerage houses and banks do not have your best interest at heart; they invest your money in investments that benefit them more than you. It just baffles me that anyone would take that risk, and I intend to cover that matter later in this posting.
Ava at the beach, age 7
Carly Kramschuster at the Braves game
Let me give you a couple examples of what I have seen over the last few years with new potential clients. I had a lady come in recently who was 72 years old. She had absolutely no knowledge of the financial markets and no real understanding of what was going on with her money. However, at 72 years old she was fully retired and expected to live off of her retirement money. She, like many others, was scared to death of investing in the stock market and was therefore drawn in by an advertisement from an insurance company that guaranteed her 6% for the remainder of her lifetime.
She had no idea exactly how this annuity worked and gave me the actual document to read, which ran close to 100 pages. This lady was 72 years old, but the annuity provided that for the very first 10 years of the annuity she was not allowed to touch it. Therefore, her money was tied up from age 72 to age 82, during a time where she desperately needed the cash flow for her monthly needs. This is an example of how insurance agents take advantage of retired people. When you think about it, after the money has sat for 10 years, the commitment to pay 6% over time is hardly a stretch for even the worst investors. The lady decided to cancel the annuity so she could have ready access to the money and transferred it to another form of investing, incurring a penalty of roughly $60,000.
We had an unfortunate situation where a husband died tragically early, but fortunately for his wife and family he had roughly $1.5 million in life insurance. Six months after making this transaction, with annuities from the insurance company, the widow realized she had no opportunity to spend the funds that were to be her livelihood after his death. After a while, she determined that the annuity was impossible to live on based on her cash flow and agreed to take a $150,000 penalty for canceling the policy. Another example of why these types of deals should be illegal... Did the agent really have the widow’s best interests at heart?
We had two clients in recent weeks that had very large government pension plans. If you think about it, a government pension is much like a fixed income portfolio since it pays out for life at a reasonable rate of return with no volatility. It also goes up annually with inflation so it is a wonderful hedge against future expenses. In addition to their wonderful government pension, they had $500,000 or so in fixed rate investments. If you put that on paper, you would quickly see that virtually 100% of their money was in fixed income, with their investments earning next to nothing over the past few years. This is a classic case of an investment advisor who did not understand a client’s entire finances and recommended investments that benefitted him more than the client. Once again, a prime example of why there should be a regulation to keep advisors from taking fees from products they sell to clients.
Recently, I had a very distinguished couple come into my office who lived entirely off of their investments and social security. They had roughly $500,000 invested with their local bank manager. I asked if I could see their investments and found that every dollar was invested in tax-free municipal bonds. Of course, over the last few years as the interest rates have been rising, they have made no money whatsoever on their tax-free bonds. This led me to wonder whether they had a substantial tax problem and thus the need for the bonds. When I looked at their tax return they had zero taxable income and had not paid any income taxes over the last decade. This type of poor advising of the clients is the reason we put so much emphasis on taxation in our investment plans.
Shortly after I started my business in 1980, I would get up every morning, get fully dressed, and sit down at my desk. I only had a few clients and not much to do, so the highlight of my day was when the Wall Street Journal arrived in the mail. By that time it was 2 days old, but it was still news to me. There was no internet and obviously no financial news programs on television. You had to get your financial news the old fashioned way: the newspaper. I would study the Wall Street Journal from cover to cover, reading virtually every article regarding investing and tax matters. It would literally take up the majority of my day, right up until 4 o’clock when M*A*S*H would come on the TV. So, my day would be occupied by reading the financial news and enjoying the Korean War again for basically 10 hours a day. Needless to say, I have seen every M*A*S*H episode that was ever made.
One day, I received a phone call from my “friend” at Merrill Lynch. He indicated they had a unique opportunity that he thought I should invest in. Basically, it was an orange juice manufacturer near Tampa with its own groves that processed orange juice for wholesale. Since my “friend” had recommended it, I elected to buy 1,000 shares at $6.50 per share, which was a world of money to me at that time. Since I was new to investing, I had no knowledge of the conflicts of interest that major brokers legally practiced. With great anticipation, I was sent the confirmation of my purchase and watched it daily in the coming weeks and months.
After about two months, the stock began to fall. I called my broker to find out if there was some negative news I should be aware of, and he indicated no, everything was fine. On the 90-day anniversary, my outstanding stock was now down to $3 per share, losing more than 50% of its value. At that time, I decided it was time for me to find out exactly what was going on. It was not like I had anything else to do, so I booked a flight to Tampa to attend their annual meeting and see exactly what the company was all about. Clearly, I should have done this prior to investing, but again, I was a novice and learning as I went along.
At the annual meeting, the president of the company strolled in; I vividly remember that he was wearing a yellow seersucker suit and was smoking a cigar. To this day, he is still the most obnoxious host I have ever been around in a public setting. He refused to answer questions from the audience, dodging any inquiries into the company’s financial standing. After the meeting, I did an analysis of the financial statements. I found that while the orange groves were on the balance sheet of this public company, they were actually purchased by him personally and he was draining off most of the company’s profits through rent of the actual groves themselves. This was a clear conflict of interest with the business and even I, the proud owner of a mere 1,000 shares, could see it.
I mention this story, not to explain how I lost money since I eventually sold the stock for about $1 per share, but rather to point out the conflicts of interest that play a major part in non-fiduciary brokers’ and bankers’ income stream. I found out later that Merrill Lynch was the underwriter of this particular security, meaning they billed large sums for providing this service. At that point, they turned over the security to their retail brokers and instructed them to call on their best clients and sell out the inventory of the underwriting. By virtue of ten thousand brokers calling their clients across the United States, there was an immediate demand as Merrill Lynch sold off the shares from their inventory. As you would expect, after the entire inventory was sold there was little demand for the stock. The volume collapsed since Merrill Lynch was no longer selling or buying the stock and it ultimately failed, dropping to an almost worthless value.
If you have ever wondered why your broker calls and asks for your permission to buy or sell a particular security, there is a specific reason. Unless they are operating as a fiduciary, as we are, they need your permission to do so. And because they receive commissions on these trades, they clearly need your consent. In addition, they have the authority to lend your shares to short sellers and basically treat your shares as their own while it is held in their accounts. This brings me back full circle as to why you would ever make an investment with any broker or advisor that did not have a fiduciary responsibility to you. My “friend” at Merrill Lynch was never my friend again.
You would think that this concept is so basic in nature that I would not even have to ask that question. It really all comes down to “Do you trust your advisor,” and “Who is truly benefitting from your invested dollars?” If you buy an annuity or life insurance policy with a huge upfront commission, you need to understand that the product you purchased paid a large fee to the person who sold it to you. You should never have to question whether a recommendation from your advisor is better for you or for them. If you are dealing with an advisor that is a fiduciary, you will never have to worry about this matter since no commissions are ever paid to them on investments made.
One of the basic concepts of our practice when I set it up in the late 1980s was that I wanted everyone to know that we would never take a fee of any kind from anyone but our clients. We have no financial relationships with the custodians, the mutual funds, etc. The only payment our firm receives is from our clients - never a third party. A concept as simple as this should be established by any major advisor. Unfortunately, people on a daily basis entrust their hard-earned retirement money with advisors that benefit directly from the investments themselves and not from their clients. The lesson to be learned here is, never invest your money with any advisor that is not a fiduciary.
We encourage you to come in and visit with us and discuss your goals and financial plans. If you are interested in discussing your specific financial situation, please feel free to call or email.
As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.
Best Regards,
Joe Rollins