To Do List for Emergencies and End of Life

The most popular course I ever taught was called Finishing Well. I taught people how to get everything together so that their executor, or perhaps themselves as executor of a parent’s estate, would not find themselves in “executor hell.” The tasks also work well just preparing for emergencies like an accident or heart attack.

Probably no one other than someone that has been through it, knows how much time and work is involved in being the executor of an estate, especially if it is one of the vast majority that did not get things sufficiently organized beforehand. There are so many unclear things and the feeling that you have left something out is always there, especially when you consider that around $60 billion sits in unclaimed accounts in this country. Some time spent in cross-generational conversation and getting things organized is enormously helpful.

If you would like a copy of the to-do list, email me at DaveH@CornerstoneInvestment.com and I’ll send it to you.

This entry was posted on Wednesday, March 8th, 2017 at 12:15 pm

Pres. Trump’s Hold on the Fiduciary Rule

Well, there is a whirlwind in the oval office these days, and one of the recent actions was to put the new DOL fiduciary rule on hold as part of a review ordered on the reasonableness of provisions in the enormous Dodd-Frank bill passed in 2009.

The fiduciary rule was only finalized in 2016 and was only indirectly tied to Dodd-Frank. The bill had mandated that the S.E.C. look at conflicts of interest among financial institutions as they related to clients and come with up solutions. When the S.E.C. could not get it done due to internal conflicts, the Dept. of Labor stepped in and issued a fiduciary rule that affects retirement accounts, like different types of IRAs.

I am 100% in favor of the spirit of the rule and if I were king, I would have it take effect in April as scheduled. The fact that insurance companies, brokerage firms and banks fought it with everything they had says all you need to know about the trustworthiness of their business models.

I remember being shocked as a young broker at Merrill Lynch back in the 1980s and discovering that the firm tracked commissions by the hour but did not bother to track client account performance at all. That is precisely why I left the brokerage industry in 1995 to be an independent fee-only advisor working in the sole best interest of clients from day 1.

Having said, the rule’s requirements for documentation are as typical Washington – more difficult than they should be and creating unnecessary paperwork burdens that are difficult and expensive to comply with, especially for smaller firms. If the rule is held up and/or changed in some way, one hopes it will be to correct those issues.

The specter of the new rule has prompted a good deal of change for the better in the industry and much of that will stick one way or the other. One example is Merrill Lynch changing all accounts to fee-based accounts rather than commissions. Across the industry, firms have recently told advisors without experience or a reasonable number of retirement plans to work in partnership with those who do, though that doesn’t necessarily mean that the bigger advisors know what they ought in order to properly advise companies sponsoring retirement plans.

I continue to see much evidence to the contrary and I continue to see nearly everyone but me continue to charge plans a % of assets in plans under $25 million. That is a terrible thing for plan fiduciaries and participants because plan fees grow just as fast the plan does, often 7% to 10% per year, for the same flat level of service. That service provided is sadly low and inept in the vast majority of those smaller plans.

If fees are taken out of plan assets, which they typically are, it is a dereliction of duty for plan sponsors to allow fees to grow 7% to 10% per year for any static level of service. It is almost criminal to pay it for the level of service most small plans receive, which is a trustee meeting or two a year, usually no participant education, rarely a change to under-performing funds and no advice to plan sponsors on how to properly monitor vendors or plan investments and document it.

I just did a presentation to a very small plan, under a million dollars in assets, in which my flat fee was currently about $5,000 less than than their current fees. Since the plan was being charged a % of assets by the other company, the difference in money saved by participants over the next 10 years was projected to be over $50,000 and in 20 years over $200,000. That’s the power of a flat fee. And, the service I will provide is in a whole other league from what they had been getting.

That’s putting the client first. The other firm was more interested in an additional $200,000 in compensation from one small plan. That’s the problem, and unfortunately, the new fiduciary rule does not even address it. Still, it is time financial firms were required to act in the best interest of clients. We can then work on little issues like excessive compensation and poor service.

This entry was posted on Friday, February 10th, 2017 at 9:41 am

Investing Strategy in Light of Trump’s Election

It’s been two weeks since the election and it is pretty clear what the stock and markets think will happen under President-elect Trump – faster economic growth from spending on infrastructure and significant cuts in the corporate income tax rate, as well as making it more attractive for companies to bring home the $2 trillion in cash they have parked overseas.

The bond market is also pricing in the broadly hinted at December increase in rates by the Fed, a growing indication that inflation is starting to increase slightly and that inflation will be given a significant boost if President-Elect Trump follows through on promises to raise tariffs significantly on some goods and to renegotiate the NAFTA and TPP trade accords. We can only hope that what he does is less than he promised on foreign trade, as it would be both inflationary and harm U.S. manufacturing growth as countries retaliate by raising tariffs and shop elsewhere for foreign-manufactured goods.

Of the bond market sectors, long treasury bonds, mortgages and municipal bonds have sold off the most, and it has been a very sharp move for a two-week period. High yield bonds have held up well, as they benefit from better economic growth. How much higher rates go largely depends on the changing market forecast for what Trump actually gets done.

The stock market moved up suddenly with the election results, up 4% the first week and 1% last week and is starting off the new week well. Thanksgiving week tends to be stock-market friendly.

One stock sector that jumped a great deal was financials. Bank of America jumped roughly 20% in a few days. That was is based on the hope that some of the enormous Dodd-Frank bill and attendant regulations will be negated and that higher rates will lead to higher spreads (profits) on lending. Near-zero rates have been killers for bank profits and the cost of complying with Dodd-Frank has been huge.

Out-of-favor, deeply cyclical companies like Caterpillar also had a great last two weeks, mainly on improved forecasts for world economic growth. Rolling back many Obama-era regulations as promised (a stroke of the Trump pen will wipe away a stroke of the Obama pen) would help businesses of all kinds. However, raising tariffs could really hurt some of these. Value-oriented funds, which often look for out-of-favor companies have done best, especially those investing in midsize and smaller companies.

So, the question is, will these trends persist? You will see what institutional investors think simply by watching the markets, both stock and bond.

The bond market is hard for most people to follow because there are so many sectors. The simplest broad proxies for most investors are large, broadly invested funds like PIMCO Total Return (PTTRX) and Metropolitan West Total Return (MWTRX). A falling share price normally means rising interest rates, or at least an increasingly confident forecast for that. Be aware that some funds may have a big one-day drop in price if they make a year-end tax distribution before year-end.

My personal opinion is that President-Elect Trump will get the cut in corporate taxes and reducing the penalty on bringing overseas cash home. Infrastructure spending will also likely get done. While that will take time to hash out, the Democrats are receptive to increased spending on infrastructure, although more conservative Republicans will push back based on the effect on the nation’s debt.

Tariffs are less predictable. We don’t know how much is pre-negotiation bluster, whether tariffs will actually rise, exactly which ones, how and when. It does appear that China is already seizing the opportunity generated by all the talk from Trump by moving on trade deals with Asian countries. China has considerable advantages in speed from a more authoritarian decision-making process and receptivity from not attaching required reforms as strings like the U.S. does.

The fly in the ointment is Trump’s insistence on spending so much early political capital on immigration issues. The more he concentrates on those, the less likely other things get done and the more likely that they get delayed. The next 3-4 months should continue to be very interesting.

This entry was posted on Monday, November 21st, 2016 at 12:57 pm

Jack Bogle, Vanguard Founder Agrees – Lower Stock Market Returns Ahead

For a while now, I’ve been using lower forecasts for stock and bond market returns over the next 10 years than the long-term historical averages. I think financial planners, advisors and brokers do their clients a disservice by using the Ibbottson average returns since 1929 when stocks are currently valued well above average, profits peaked a couple years ago and have been lower for the past six quarters in a row and the tailwinds that drove the increase in stock and bond prices since 1982 have one by one largely evaporated or become less of a factor.

I think 5%-7% on stocks is a more realistic assumption over the next 10 years and 2%-4% on bonds. That’s one reason you have heard me talk to clients more about alternatives, especially real estate. If you run a 401(k) it should have you considering some alternatives, though liquid alternative funds on the whole have been disappointing in their performance.

It should also make a difference in what you assume you’ll have for retirement and should prompt you to prudently consider upping your 401(k) and other retirement contributions.

So, when I read Morningstar’s Christine Benz interview Jack Bogle, the founder of Vanguard Group, I was interested to see that he agrees with me and is actually even a little more pessimistic. I have excerpted some comments from that interview below. You can read or watch the entire interview at http://news.morningstar.com/Cover/videoCenter.aspx?id=772785

Dave

Christine Benz: Hi, I’m Christine Benz for Morningstar.com. I recently had the opportunity to sit down with Vanguard founder Jack Bogle. We discussed his return forecasts for the major asset classes. Jack, thank you so much for being here.

Jack Bogle: Always good to be here, an annual occasion, Christine.

Benz: It’s an annual privilege for me. Let’s talk about your return expectations for stocks and bonds starting with equities. I think you have a really intuitive formula for forecasting equity market returns over the next decade. Let’s talk about how you get there and where you arrive.

Bogle: Sure. It’s very simple, easy to explain. Everybody knows this, but I don’t think anybody else has ever put it down in the way I have. I’ve been using it for 25 years and it’s worked beautifully for the full period. Every once in a while a decade is off by a good bit and then it’s made up in the next decade. But it places stock returns into two categories: investment return, that’s what you’re earning on the stock. That’s your dividend yield when you buy in–a crucial number–and the earnings growth that subsequently follows. And the other is speculative return, which is change in valuation of stocks generally, easily measured by the change in the price/earnings multiple. And for example, which happened in the ’80s and again in the ’90s, the price/earnings multiples roughly doubled twice from 10 to 20, and that doubling is a 7% per year increase in valuation, and it did the same thing the ’90s, that’s a 7%.

Benz: Sent us into bubble territory at that point.

Bogle: Yeah, it got us into bubble territory. So in those two decades the markets had returns of about 17% a year. But if you had even the most general idea that having gone from 10 to 20 to 40 times earnings, the next decade would have to go to 80 times earnings to continue those returns, you’d realize there was just a lot of air. That’s what valuations can get to in bubbles. So, putting all that together, we’re looking ahead–we’ll deal with stocks here first–we’re looking ahead to some challenges compared to what we’ve had in the past. So, today the dividend yield is 2%, the previous 50-year average or so is like 3.5% dividend yield, and that’s a dead-weight loss of 1.5% in return. You can make it up in other places, but you can’t make it up there.

Benz: Relative to past history.

Bogle: And the growth in earnings over the past 50 years has been about 6.5%. I don’t think it’s going to be that high. So I use 5% for earnings growth and that gives me roughly a 7% investment return on stocks. Those are pretty anchored, because we know the dividend yield, and earnings growth is such that you know we could have a 2% earnings growth and we could have a 10%, but we are highly unlikely to have zero and we’re highly unlikely have 20%. So there is a sort of centrality to earnings growth. So the problem is in the valuations. And today the stock market is selling at about 23 times earnings and the long-term norm is 17 times earnings, a little bit below that actually. And that would cost you 3% if the market ended this decade–I don’t do this for anything but decades; it doesn’t work at all year-by-year, but that would mean you’d lose 3% of that return.

This entry was posted on Monday, October 3rd, 2016 at 9:02 am

High Fees on Target Date Funds

Target date funds are wildly popular in 401(k) plans and are found in almost 80% of plans today. The little-known secret? They can be among the most expensive funds among the investment options. According to Morningstar, quoted in today’s Wall St. Journal article on target date funds, the average operating expense ratio (OER) of the 2,200 target date funds in existence is 0.903%.

Now, most sophisticated plan investment committees want expenses on funds to average below 0.65% if that includes actively managed funds and much less if the plan lineup is heavy on index funds. Yet target date funds on average are almost 50% higher than that.

Even worse, some fund families like American Funds, a very popular provider of 401(k) plans, have some target date funds with a higher expense ratio than the individual funds that make it up! Say what? The difference is pure gravy, more money in the pocket of fund companies and less money for plan participants, especially since target date funds are likely to be the most popular choices of plan participants.

I can build a custom target date fund from index funds and come in at 0.25% or less, depending on the mix.

You may not think saving 0.65%/year on expenses using custom target date funds amounts to much. Well, over 30 years, for a person starting with a $10,000 balance and contributing $5,000/year including the employer match, the difference is nearly $80,000 more at retirement (assumes 7.65% vs. 7.00% return). If that’s the average experience, multiply that by all the people participating in the plan and you are soon talking about millions of additional dollars for your workforce at retirement. That’s the tremendous value of lower fund expenses translated into better performance.

Don’t even get me started on the fact that many plan participants are pretty far off on what they think the allocations are in the target date funds near the target date. When they think they know what they have and are wrong, that’s a potential disaster in another big market downturn.

Consider having me replace your target date funds with custom target date funds using the best funds of each category rather than settling for off-the-shelf target date funds with high expenses. It can make a tremendous difference in how well your employees retire, including you.

Dave Hoshour AIF, MBA, MA
President
Cornerstone Investment Services
A Fee-Only Investment Advisor Specializing
in Company Retirement Plans
10800 Sikes Place Suite 300
Charlotte, NC 28277
704-698-1040 Phone
DaveH@CornerstoneInvestment.com

Note: This is part of my series on the biggest problems facing 401(k) plans today.

 

This entry was posted on Monday, October 3rd, 2016 at 8:51 am

High Fees in 401(k)s – Avoiding a Lawsuit

I recently covered what I thought was the biggest problem in 401(k)s today – advisors who don’t specialize in qualified retirement plans. This is the first of several parts addressing other problems in 401(k) plans.

High fees are a risk to both employer and employees – employees because they reduce the growth of their investments and harm their retirement readiness, assuming fees are deducted from participant accounts, which is the norm.

High fees are a risk to the employer because they invite lawsuits and Dept. of Labor (DOL) civil actions. In both cases, the company will have to pay tens of thousands in attorney fees. If found liable, which is usually the case, it will have to pay back 5 years of what was deemed to be the excess fees, plus interest, and if it is the DOL, probably excise taxes as well. There is also the tax on employee morale as they see management forced to pay back money to the retirement plan from mismanagement or _____ you fill in the blank with what employees are likely to think. Hint: it’s not good.

That would never happen in your plan, right? First, let’s see if you have a good handle on what your fees actually are. Big problem if you don’t think you’re paying any fees. You are. Always.

Have you had a consultant like me look to find both disclosed and hidden fees? By “consultant,” I don’t mean the hordes of junior smile-and-dial “advisors” that harass your HR Dept. with endless calls. I mean an experienced retirement plan specialist.

Do you have a copy of your required annual fee disclosure document (408(b)(2) from your plan provider(s)? Have you compared it to the ones from the last two years? If you do, and your plan is under $25 million in assets, your are probably in the 90% whose fees went up 5% – 10% each year. That’s because 90% of plans are charged an asset-based fee, and as the plan grows with investment growth, contributions and matches, the fee grows just as fast – exactly as fast. A dollar to a doughnut says you don’t let your other expenses grow at that rate in these low inflation times. Plus, it’s only partly your money. Fees typically come out of participant accounts based on what percentage of plan assets their account makes up. So, if you are a CEO, CFO or HR director and you have 10% of plan assets, 10% of the plan fees come out of your account and 90% from your coworkers.

The DOL says plan fees must be reasonable in light of services performed. How can service stay the same and fees grow 5%-10%/year and still be reasonable? The only way is if the service you are getting is at such a high level that you were underpaying before. If you have typical 401(k) service, which amounts to a meeting or two each year and not much else, and you are paying, say 0.5% in costs not related to the fund choices, you are paying $5,000/year per million in plan size. For what?

Do you know exactly what you’re paying? Not if you don’t know all the fees and whether the fund expenses are as low as possible. Many times I’ve seen fund options that are not in the lowest cost share class. WalMart paid many millions because their funds weren’t and quite a few other household names have too.

Are your fund expenses as low as they should be? Probably not. But you won’t know for sure unless I look at it carefully with you.

This is something you really need to be on top of. It doesn’t cost anything for me to look at your plan costs. You owe it to your employees and to protect yourself. The average award in a DOL civil action last year was well over $200,000, not counting attorney fees and the hit to employee morale. Protect yourself and your retirement as well as your employees’.

This entry was posted on Wednesday, August 17th, 2016 at 11:10 am

The Biggest Problem with 401(k) Plans Today

What’s the #1 problem with 401(k) plans today? I can think of several strong contenders for that title, mainly in the small plan market, which I define as under $25 million in assets. The biggest issues include high fees, lack of good participant education, poor participation,  poor retirement readiness, too few and too similar fixed income choices, the absence of funds not strongly correlated to stocks and bonds, the difficulty adding a true real estate option (not a REIT fund), the maintenance of low performing funds in fund lineups and inertia in addressing the retirement plan.

But, the easy winner as the #1 problem is unqualified plan investment advisors.

The vast majority of smaller plans are advised by financial planners, brokers, insurance agents and bankers for whom a plan is just a tiny sideline to their core business. They often have just 1 or 2 plans they fell into because they knew the owner or senior executive. They have no training specific to retirement plans other than enough to pass a securities or insurance exam, they get no or almost no continuing education specific to qualified plans, they have little familiarity with Dept. of Labor regulations, ERISA and other legislation, recent significant court cases or best practices in plan processes, compliance and documentation.

These advisors typically take thousands of dollars each year from participant retirement balances for little to no time, service or expertise. This is especially true for bundled (single provider) plans from insurance companies and banks.

Why in the world would you hire them? More to the point, why would you keep them?

It is dangerous for plan sponsors to keep them, but alas, inertia and/or inattentiveness on the part of decision-makers  is overwhelming in the small plan market. And, it’s not just costs, the issues extend to legal liabilities and compliance issues since compliance with DOL regulations and fiduciary issues is primarily the province of the investment advisor. But, as I just pointed out, most advisors don’t know it themselves.

It is hard to overstate how widespread and serious this problem is.  To entrust the retirement of your employees to companies with increasingly expensive turnkey plans and little service or informed advice is not a good idea, no matter how many others do it. More than that, it opens you to very expensive lawsuits and civil actions.

That’s why you absolutely need an experienced advisor with strong ethics who specializes in retirement plans. That is what I do, and I would welcome a call or email from you.

If you’re one of these advisors, agents or financial planners, talk to me about me buying your plans so you can concentrate on what you do well and reduce your liability in a time of increasing specialization, lawsuits and regulatory scrutiny.

Dave Hoshour

This entry was posted on Wednesday, August 10th, 2016 at 2:38 pm

The Coming Crisis in 401(k) Fund Choices

Think about the choices in your 401(k). You probably have a long list of stock funds, maybe two general purpose bond funds and a list of target date funds that combine stocks and bonds. Essentially, all you can invest in is a combination of stocks and bonds. That’s it. Sure, you have a stable value fund or money market, but what is it paying? – probably less than the rate of inflation. Your only growth choice is some combination of stocks and bonds.

In this crazy post-2008, post-Brexit world, that’s likely to be a big problem, because bonds are getting pushed to nosebleed-level prices. About 1/3 of all debt issued by high quality sovereign nations is now selling for prices that result in negative yields. In other words, investors are paying so much for bonds that when they get back the face value of the bonds at maturity the extra price they paid to buy the bond is more than all the interest they get. Institutional investors are chasing high quality bonds so hard that they are willing to lose money to own them if held to maturity.

Why on earth would any investor be willing lose money buying bonds? The only reasons I can think of are (1) that they need to own bonds (insurance companies, banks and those with fixed allocation to bonds like pension plans), (2) they are so afraid of what’s next that they will only buy government bonds or (3) as prices have gone even higher, they are seeing capital gains on the bonds.

When this extreme situation stops, those general bond funds in your 401(k) lineup may be worthless as investment choices, or worse. When rates finally do rise, many if not most bond funds may lose money for awhile. Their only significant income will likely come from junk bonds and international bonds. That is, if they are allowed to invest in them and if they are not falling in price as well. If you have a bond index fund, it cannot adjust because it has the least flexibility – zero.

This is far from ideal for your participants. Plan sponsors really need to wake up and smell the coffee. One decent growth investment class (stocks) is not enough, especially in this nearly stagnant, low-growth world where stocks sell above their historical averages and corporate profits are declining. There are numerous alternative funds and sponsors need to start considering adding these to the 401(k) lineup.

If you have a say in the management of your plan, it is time to get busy taking a hard look at plan investment choices. The stakes are about to get much higher. The time to just go along with the list your bundled plan provider gives you is over. It is time to look at alternative funds and custom target date funds that can use them.It takes time to do the research and come to a prudent decision.

It also takes a plan investment advisor that is savvy on these issues, not just a financial planner or insurance agent that has lucked into a couple retirement plans as a sideline. If that is who you have now (do you even know how many plans your advisor manages, whether he is bonded for retirement plans, how much continuing ed he does that is specific to qualified retirement plans, how much he charged the plan last year, etc.?) you should think hard about replacing him with an advisor that is a retirement plan specialist that can help you significantly improve your investment lineup for the good of your participants and for your protection as the one with liability for prudent plan management.

 

 

This entry was posted on Monday, July 11th, 2016 at 12:30 pm

Putting Brexit Vote in Perspective – Part 2

Let me follow up to Saturday’s note about putting the Brexit in perspective.  Much of the following comes from the “Up & Down Wall Street” column in the June 27, 2016 issue of Barron’s.

Positives for Britain

Economic Strength – Britain is the 2nd largest economy in Europe, 5th largest in the world and one of the two healthiest major European economies. London, not New York, is the largest financial center in the world.

Reduced Contribution to EU Budget – Britain had been paying 13 billion pounds annually into the European Union budget and received 4.5 billion of spending in Britain in return. That 8.5 billion outflow will disappear.

Less Regulatory Burden – Britain also frees itself of the regulatory burdens Brussels imposed. The size of that benefit of that is uncertain but what is certain is that the European Union’s (EU) regulation is very large and growing and hinders business profitability in Britain.

Vulnerability to New EU Tariffs – Concerning the potential for tariffs being imposed on British exports to the EU, the World Trade Organization (WTO) forbids unfair or punitive tariffs among members, an organization to which Britain the EU belong.

While new trade deals will have to struck between Britain and other countries since Britain will over the next 2+ years be withdrawing from the EU, Britain’s size and location a few miles from continental Europe and it’s excellent relationship with the US, make it a priority for the US and other countries outside Europe. For the EU, Britain is a very close trading partner with whom they are used to doing business.

This point about it taking 2+ years is important. Britain did not leave the EU last week – it voted to start the process and that will take a maximum of 2 years after the prime minister. Cameron has said he will not invoke Article 50 of the Lisbon Treaty but will let the new PM do that, and elections are currently scheduled for October. The British Parliament can call for earlier new elections but it takes a 2/3 majority.

But, realize that any tariff at all gives a disincentive for companies to ship products to Britain that are intended for the EU, reducing that trade in favor of shipping to another European port.

Negatives for Britain

Uncertainty – When businesses are uncertain about the future they tend to hold off on investing. Thus business activity is likely to slow, both local businesses and continental businesses considering investments in the UK. So, an economic slowdown is likely, with estimates of 0.5- 1% over the next year.

The EU Making an Example of Britain – Populist parties in Denmark, Sweden and Italy also favor Brexit-type votes and Rome just elected a young, anti-establishment mayor. Marie Le Pen, head of the French National Front party and who has been gaining in popularity, called for a similar vote there. The EU will recognize that this vote may embolden those efforts to split up the EU and may try to demonstrate that doing so will lead to sizeable negative consequences, for example, tariffs by the EU on goods imported from countries that leave.

Trade between all EU member countries is tariff-free and about 50% of Britain’s trade is with the EU. Tariffs would make those imported goods more expensive. More than that, imports might decline if worldwide shipping to Europe via Britain means tariffs are slapped on those goods. World exporters might then ship things directly to the EU rather than to Britain as they often do now.

Effect on London as a Financial Center – In the same way, the EU could make it tough on Britain to remain the biggest center for financial trading in the EU. That would cost a lot of high-paying jobs in what is one Britain’s fastest growing and important economic sectors and reverse the momentum London now enjoys in that area.

Capital Flow – Another effect of a reversal of growth in London’s financial industry is on the flow of money for the UK. The UK currently imports 7.4% more than it exports, leading to an outflow of money, what economists call a deficit in the country’s current account. That means that the UK must significantly rely on the world to fund a portion of UK economic growth. The US does too, but its current account deficit is 2% of the economy. The decrease in a flow of money into London as a financial center obviously makes this problem worse and could lead to higher British interest rates, which are a drag on the economy and could lead to higher taxes.

An EU Breakup?

Whether this is the first step in the breakup of the EU is the biggest issue in all this discussion of the Brexit and the reason other world stock and bond markets have sold off. Most think it unlikely, but those who think it will include a person I think is the savviest commentator on world markets that I know of.

His name is Felix Zulauf, a Swiss investor and over the years, the most prescient of the highly esteemed Barron’s Roundtable members. Barron’s is the best financial periodical and I never miss the writeup of the semiannual roundtable. Zulauf is neither a perma-bull nor perma-bear and he has correctly made some big calls, some of which seemed unlikely at the time, such as his 2007 prediction of a 30% drop in US housing prices. The drop ended up being 33%, according to the Case-Schiller Home Price Index.

Over the better part of the last year, Zulauf has said that 2016 would be a down year for world stock markets. Halfway through the year, he is certainly correct about international markets and the US market is now negative for the year as well.

Zulauf thinks the Brexit is the start of the European Union slowly disintegrating. He cites the rising anti-immigrant and antiestablishment wave across Europe I mentioned before and has long felt that the very sizeable differences in culture and economic management between European countries, especially between northern and southern Europe, was too great. Just contrast Germany with Italy. Italy is the world’s 7th most indebted nation and its economy has grown a total of 5.4% since it joined the EU in 1999, 17 years ago. Germany enjoys the largest capital surplus in the world and its economy has grown 67% since 1999, or about 4%/year, even with the huge 2008-09 recession.

Investments

What does this have to do with investments? Markets dislike uncertainty and there will be a lot of that in Europe, especially for the next few months. If Zulauf and others are correct about the slow disintegration of the EU that would likely mean a long downtrend in European markets.

The US market has fared much better than most European and other world markets, although the last three years have been poor here too. The Wilshire 5000 Equally Weighted Total Return Index, which treats all US stocks the same, has had the following returns – 2014 4.9%, 2015 -4.6%, 2016 -0.3% (estimate), giving a net return of 0% for 2014-16.

You may find worldwide allocations to European stocks declining for a while, and to avoid that, I plan to further reduce client positions in international funds that focus on Europe, which most do, though I would like to see a bounce to sell on. While I don’t favor in and out market timing, I do shift allocations within an asset class from time to time. This summer is a time to be cautious and that’s the plan.

This entry was posted on Monday, June 27th, 2016 at 3:09 pm

Some Clarity on Effects of the Brexit Vote Yesterday

There are news stories galore on the effects of the United Kingdom leaving the European Union after Brits voted to leave the European Union, the so-called Brexit. However, there is almost nothing of substance in these articles and quick videos, just people wanting to go on the record and talk about the increase in market volatility (Thank you, Captain Obvious!), uncertainty, a fall in the British currency – the pound and a rise in U.S. Treasury prices and tell us “it’s too soon to tell.” Not exactly a lot of clarity. Let me see if I can do better.

Because most polls this week had a lead for the Remain vote, markets in Europe and the U.S. were up close to new highs with optimism. Part of the fall today, which ranged from 3% to 13% in Europe, with the weak, southern countries down the most and roughly 3% in the U.S., is simply giving back these gains. Part of the selling here in the States is from Europeans and global hedge funds selling what is easiest to sell.

Diversification – While oil and stocks are down, U.S. bond prices and gold went up nicely today. Real estate in the U.S. was unaffected, so diversification shows its value once again.

US. Interest rates – Janet Yellen will probably have a very hard time raising rates more this year because the Brexit vote has people thinking about recession in Europe.

Travel costs to England, Wales, Scotland and Wales just went on sale by 10% because of the fall in the pound sterling, the British currency. Remember that the UK never adopted the Euro currency.

European economic growth – This may dampen UK and to a lesser extent, the Eurozone’s economic growth, which has been anemic, but this effect should take years to play out. The biggest reason for it is that it will be harder for Eurozone laborers to get jobs in the UK because it will mean getting a visa and at the same time makes it harder for British businesses to hire from the continent. Plus the flow of goods will be more difficult.

But, the negotiations over issues like this will take at least two years according to the Lisbon Treaty. I am hearing that some details may take 10 years to get worked out. For the UK, the currency drop means their exported good just got 10% cheaper and imports 10% more expensive. In one day. That’s a boost both to export growth and to local inflation.

US economic growth – Europe is our largest trading partner, so any weakness there affects our export business to some degree. The 2% rise in the US dollar against the Euro makes our goods a little more expensive overseas. That is especially so against Japan, whose currency also dropped roughly 10% today for this and other reasons. On the other hand, cheaper oil saves consumers and businesses money.

US corporate profits – A slightly stronger dollar means that currency translation will work against profits for multinational companies based in the US. US profits are already weakening some the last couple years.

Immigration – Without Britons worrying about their jobs in the face of the unstoppable flood of immigrants from Europe and worrying whether the many Muslim immigrants have terrorists among them, there would have been no Brexit, not even a vote over it. This is really the heart of the matter, though some will cite Brussels having too much control over Britain. What they really mean is that Brussels mandates the free flow of people from one European Union country to another and Brits have had no say in that, though there are other less contentious issues as well.

US election – Donald Trump really rides the same wave of voter discontent and fear of immigration and terrorism that the British Leave party did. Predictably, the Donald applauded the Leave vote as a validation of his antiestablishment campaign. It is largely the same demographic – working class whites who worry about a link between terrorism and immigration, who have lost all respect for leadership from a capital far removed in many ways from them, who worry about their jobs and who have seen no progress in their wages for quite some time while they see the rich get richer. Don’t underestimate the class warfare element of either campaign.

Fear – Sudden, unexpected news make people nervous, as do sudden drops in stock prices. Realize that the media loves to feed that fear, as do politicians (think of the rush to immediately pass widespread gun control legislation after an Islamic terrorist killed dozens of people in a nightclub). You may disagree about the 2nd Amendment but no one can argue that the media and politicians don’t jump on crises. “Never waste a crisis,” Saul Alinsky wrote. Calm down and take the time to think things through. As I said above, the economic consequences people are worried about will take years to work out, not days, and many other factors will come into play.

Media hyperbole – Don’t let the media’s breathless hyperbole rattle you and make you rush into panicked decisions. This is nothing like the 2008 financial crisis in which people legitimately worried about whether companies like Merrill Lynch and Prudential and large banks were going out of business. Sometimes the media gets so focused on one thing that it seems like which way it goes will immediately plunge the world into chaos. That is far overstating the case here.

The continuation of the European Union – Britain held a unique position in being an EU member but not fully so because they never adopted the Euro as their currency. Britain is not part of the continent, as the French will tell you, and always felt a bit apart. There is no reason to believe that this the start of a waterfall in which countries begin to peel off the EU. Greece should go for its own good, but is generally opposed to that.

Stocks – You will likely see some more selling in European stocks. You could see some more short term selling in U.S. stocks. Part of that is giving back the recent gains and part of it is that selling begets selling. The market is also at the top of its recent trading range. Stick to your long term allocations. Market timing based on world events usually ends up being a losing proposition.

I hope that helps put things in perspective a little better. Please let me know if you have questions or concerns.

Dave Hoshour AIF, MBA, MA
President
Cornerstone Investment Services
A Fee-Only Investment Advisor
10800 Sikes Place Suite 300
Charlotte, NC 28277
704-698-1040 Phone
855-557-5474 Fax
DaveH@CornerstoneInvestment.com
www.CornerstoneInvestment.com

This entry was posted on Friday, June 24th, 2016 at 4:16 pm