Investing in the Land of or During the Time of OZ

March 8, 2017

Yes, I know this is a long title and I will try to explain. What can I really tell you?

I have been in the investment advisory field for 47 years. Not only have I never witnessed an investment environment like this, not a person currently alive has ever witnessed what we are living through.  A good friend of mine once warned: “Never say never and always avoid always.”

As you can see, I did not pay attention to him. Strike One!  Having made such a bold statement, how do I substantiate it?  Yes, we have had markets which may be overvalued.  (I recently read that over all investment periods, 95% of them were at valuations that are lower than we are currently witnessing.)

Can stocks become more expensive? Of course!  Bob Farrell, former Chief Technical Strategist at Merrill Lynch, and one of the industry’s most respected analysts, once wrote of Ten Market Rules to Remember that every investor should know.  His Rule #4: Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.  Translation:  Even though a hot group of markets will ultimately revert back to the mean (i.e. average valuation) a strong trend can last for a long time.  Once this trend ends, however, the correction tends to be sharp.

Ok. So, maybe the market can go up, and perhaps by a lot.  Since we are in the upper 5th percentile, is it a risk you are willing, or can afford, to take?

Then why is the market so high, and why are so many investors increasingly allocating more resources to it? Answer: TINA (i.e. There Is No Alternative.)  Let’s examine the other alternatives.  Ordinarily one might consider savings accounts, money market accounts, etc.  REALLY?  How excited have you been with your .5% (that is ½ of 1%) in a money market account, bank account, or brokerage account for the past five years?  Yes, if you searched hard and took some “risk,” perhaps you might have “eeked out” 1 – 1 ¼% return over that time period. I bet that really helped!  The Fed indicated that it IS going to be raising short-term interest rates, and may do so three more times this year.  How much have you noticed with that gargantuan increase of ¼ of 1% recently.  By the way, that represented an almost 100% increase from where it had been previously.  Sure, they may do so three more times this year.  But, an investor would really need a lot of money before those increases amount to a recognizable sum.

Math Class: If you have $100,000 invested, a ¼% increase will provide you with an extra $250 per year.  $1,000,000 will provide you with an additional $2,500.  $5,000,000 will translate to $12,500.  Now we are talking!  However, I must ask, if you have $5 or $10 million, why are you getting excited about an additional $12,500 or $25,000 per year?

Of course, I have yet to cover another obvious alternative: bonds. Oops!  I should point out that we are currently at a 5000 year low in interest rates.  That is NOT a misprint.  There are many places in the world where interest rates are below zero.  (Not nada, but negative!)  Investors in those countries are willing to invest their money and get back less than they invested…in some case out to ten years.

Math class again! As interest rates rise, bond prices go down.  And, the longer time period in which you have invested, the greater the prices of the investments will fall.

What else should (could) we look at? Yes – forgot about that.  Real Estate prices never fall, do they?  Well, maybe in 2007, 2008, 2009, 2010, 2011, etc.  But, that probably can’t happen again.  Can it?

If you want to be more exotic, there are currencies, commodities, hedge funds and such. In fact, many investors use all of these vehicles for diversification purposes.  You know, diversifying means to spread the risk over many different areas so if one goes down, perhaps the other will go up by more and you will come out just fine.

Here’s that OOPS again. In 2000-2003 and 2007-2009 when those stock markets collapsed, guess what?  Currencies, commodities and hedge funds all went down as well.  Not as much perhaps, but meaningfully, nonetheless.  The principle behind diversification is based on the concept of non-correlation.  What investors discovered to their dismay was that in those periods, all of a sudden everything correlated – rather than non-correlated.

So, let’s get back to the title: Investing in the Land of or During the Time of Oz.

Our Federal Reserve (The Fed), the European Central Bank, and the Bank of Japan, just to name a few, have all been engaged in trying to stimulate their respective economies by flooding them with liquidity. (Flooding the economies with money!) Their hope was that by driving interest rates down, money would become so cheap (i.e. easily available) that rather than saving it and get nothing in return, investors would spend it!  Or, because it was so inexpensive (cheap!) these investors would borrow it (this is cheap money) and spend it, thus creating economic activity.

Does anyone see a potential flaw in this? Spend instead of save.  Hypothetically, one will be a good soldier and spend one’s savings.  If one does, what will they rely upon when they choose or need to retire?  Strike two?

What if we chose to borrow and spend? Where does one develop the resources to pay off the loans that have been incurred?  Strike three?

Finally, remember TINA? What if those savings are not spent, but invested.  If OZ has encouraged the saver to invest during a time period when market valuations are in the top 5th percentile, what happens if something goes wrong and the markets sell off a lot?  Game over!

Unfortunately, have you heard about the “best laid plans of mice and men?”  It just has not worked out.  Example:  The US Economy has not had a single year of 3% GDP growth during the last ten years.  In fact, most of those years were below 2 ½%.  Fact: Real GDP has only been above 2 ½% in one year, 2010, at 2.73%.  In seven of those years, it has been below 2% and in two of those years it has been negative.

Allow me to summarize:

Equities are at high valuation.

Money market and savings account returns are non-existent.

The Bond Market is at a 5000 year low.

In addition:

The “Wizards behind the Curtain” (i.e. Oz) are involved in an experiment that may or may not be successful.  Hope is rarely an effective investment strategy.

Toto, I’ve a feeling we’re not in Kansas anymore.

In closing, for your information, I also have an adviser. That would be my wife of 49 years.  I asked for her feedback on this article and she asked, “Aren’t you going to finish it?”

Apologetically, I thought I had! Thus, I will leave you with two more of Bob Farrell’s rules: #2) Excesses in one direction will lead to an opposite excess in the other direction.  #3) There are no new eras – excesses are never permanent.  In 1929, and most recently 2000, when market valuation also reached excesses, the excuse was: “This time it is different.”  Uh, it wasn’t.

I hope this helps!   This does not mean as investors we should be hopeless.  I believe we are in a challenging, non-traditional environment that requires other than what are the traditional solutions, formulas and expectations.

By HERMAN RIJ Special for Lehigh Valley Business, March 6, 2017

Herman Rij , Founding Partner of Quadrant Private Wealth, Private Wealth Advisor, in 2014 and has over 46 years of industry experience   He holds the Certified Investment Management Analyst ® (CIMA®) designation  .  He has been named as one of Barron’s “Top 1000 Financial Advisors in America” in 2009, 2010, 2011, 2012, 2013 and 2014 and in Registered Rep.’s “Top 100 Wirehouse Advisors in America” in 2009.   He earned an MBA in Finance from Lehigh University and a Bachelor’s degree from Albright College.    


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