Archive for Most Recent Stories

Were You Scammed by the “Biggest Scam in the History of the World”?

A little over a year ago this video went viral on the internet garnering almost 3 million page views.  I immediately came saying that the video was highly misleading and that people should be extremely skeptical of those selling gold and silver based on obvious misunderstandings about the monetary system.  Sadly, I’ve gotten a number of emails in recent weeks from people who were “duped” by this video and bought big positions in gold and silver based on the video’s misleading portrayal of the hyperinflationary impact of QE.  Well, QE is coming to a close and we know, definitively, that all of the high inflation and hyperinflation predictions about QE were wrong.  And as this has been realized gold and silver prices have entered a truly horrific bear market.

Since the video was posted last year gold is down 9.5% and silver is down 28%.  Since their peaks gold is down 40% and silver is down 70%.  Those are extraordinary figures.

Anyhow, if you bought into this nonsense about gold, silver, QE and inflation then please do me a favor and read my original debunking of that video and then go read my paper on how QE works and how the monetary system works.  It will provide you with the knowledge to avoid people who are trying to separate you from your hard earned money.

The 1970’s are not a Good Proxy for a Bond Bear Market

A reader kindly forwarded me this interview from Tony Robbins in which he defends his “All Weather” portfolio against some of the criticism laid out against it.  Several people, myself included, have criticized the recommendation of this portfolio given that the portfolio, which is bond heavy, is unlikely to perform well in a low and rising interest rate environment.  In countering this claim, Robbins cites the 70’s as proof that the All Weather portfolio can perform well in a rising interest rate environment.   That’s true, but the 1970’s are not a good proxy for a rising interest rate environment relative to today.

The reason for this is simple – in the 1970’s the Fed Funds Rate averaged 7.15% and actually started the decade at 9%.  There was never a period where the overnight interest rate was 0% (as it is today) or got even close to that level.  So the 1970’s were a HIGH AND RISING interest rate environment and not a LOW AND RISING interest rate environment like we might experience going forward.  So Tony’s not comparing apples to apples there when he cites the 1970s.  And let me be clear – I don’t mean to pick on Robbins because I see this all the time from other finance professionals who cite the 70’s as a good proxy for a rising interest rate environment relative to today.  It’s just not a good example.

Importantly, there is a historical period that gives us some good insight here.  In the 1940’s long-term interest rates fell just below 2%, remained low for a while and steadily increased until the early 80’s when they peaked.  The 10 year T-Note is currently at 2.25% so we’re looking at a pretty close starting point.  Therefore, this 40 year period from 1940-1980 actually provides us with a much better historical understanding of how bonds might perform in a LOW AND RISING interest rate environment.

Now, the Robbins All Weather portfolio advocated a 40% position in long-term govt bonds, 15% position in intermediate govt bonds, 30% position in stocks, 7.5% position in gold and a 7.5% position in commodities.  To better understand how this portfolio might respond in a LOW AND RISING interest rate environment let’s take the 40 year period from 1940-1980 when US T-Bonds troughed and peaked and then also apply longer-term historical returns to the other asset classes.  This will give us a very fair understanding of how this portfolio might perform in a LOW AND RISING interest rate environment.

Not surprisingly, when you start from a very low interest rate the bonds tend to generate a low nominal return.  Over this 40 year period T-Bonds generated an average annual return of just 2.65%.  A 40/15 bond portfolio of long and intermediate durations generated a 2.5% return over this period.  So there’s your bond return in the period where interest rates were LOW AND RISING – a whopping 2.5%.  This is less than half of the average return of T-Bonds in the 1970s (5.58%).  

Now let’s apply the other components.  Stocks have averaged about a 11.75% annual nominal return, gold has generated a 11% return since 1971 (when it was unpegged) and commodities have generated returns in-line with the rate of inflation (roughly 3.5%).  When we allocate this portfolio according to the Robbins weightings you get a 5.95% average annual return when applying the LOW AND RISING rate environment.  That’s not terrible, but it’s nowhere close to the 10% figure that Robbins cites in the book.  More importantly, you took a decent amount of risk to generate that return.  The average standard deviation over this period was 14.55 for the Robbins portfolio.  Historically, the S&P 500 generates an annual standard deviation of about 20.  So, in a LOW AND RISING interest rate environment the Robbins All Weather portfolio takes 72% of the risk of the S&P 500 and generates about half of the return.  Robbins focuses on asymmetric returns in the book, but failed to put together a realistic analysis of the types of risk adjusted returns this portfolio might generate in a LOW AND RISING interest rate environment.  So the portfolio he provides for readers isn’t asymmetric and is likely to generate a much lower nominal return than he cites.

This is an important exercise to think about going forward.  Not only will bonds fail to generate the necessary nominal return to substantially contribute to a balanced portfolio, but they will also fail to significantly boost the risk adjusted returns of portfolios to the same degree that they did during the period from 1980-2014 when rates were a one way bet on a historic bull market.

BNN Interview: Trouble Ahead?

Good morning Canada!  I did a quick hit with BNN in Canada this morning touching on some macro points:

  • I argue, as I did in this research note, that future market returns are likely to be lower than we’ve become accustomed to due to the low interest rate environment and slow growth in developed markets.  A balanaced portfolio simply can’t generate the types of returns that investors have become accustomed to.
  • This is going to force investors out of their comfort zone and into instruments that are inherently higher risk instruments such as emerging market equities or other higher return instruments.
  • I update my recession index which shows that the US economy continues in a healthy expansion.  At a macro level this is useful for understanding whether there is high probability of a tail risk event in the future knowing that the largest annual declines in the stock market have tended to occur inside of recessions.
  • I discuss the biggest myth in investing – the idea that you have to “beat the market”.  I touch on the concept of the Savings Portfolio and why I think most investors should avoid strategies that claim to be able to “beat the market”.
  • Lastly, I touch on some alternative ideas and why I think the low return environment is going to force investors to be more dynamic in their approaches.  60/40 and 50/50 isn’t going to cut it in the future.  You likely need to diversify into other instruments and a more dynamic asset allocation approach going forward.

You can watch the full segment here:


The NY Fed Declares the end of the Deleveraging

The latest NY Fed quarterly on US household debt trends won’t come as much of a surprise to regular readers here.  I don’t even want to think about how many posts I wrote about the household debt crisis and the balance sheet recession over the last 5 years.  Luckily, it looks like we’re closing the book on that chapter (for now at least).  The NY Fed officially declared the end of the deleveraging at the US household level:

“Outstanding household debt, led by increases in auto loans, student loans and credit card balances, has steadily trended upward in recent quarters,” said Wilbert van der Klaauw, senior vice president and economist at the New York Fed. “In light of these data, it appears that the deleveraging period has come to an end and households are borrowing more.”

Well, they were about a year later than I was to make this declaration, but better late than never, right?

More importantly, I think it’s important to note that while the deleveraging is over the releveraging is still very weak.  As you can see below US households are releveraging, but they’re releveraging at a pace that is very low by historical standards.  So yes, we’re making progress, but we shouldn’t all get too excited just yet.  In my view, the weak borrowing is still a sign that household balance sheets are too weak to be burdened by substantially more debt.  And that’s a big problem for aggregate demand and the US economy which is operating well below capacity despite some decent economic news in recent years.



7 Simple Things Most Investors Don’t Do

By Ben Carlson, A Wealth of Common Sense

Tadas Viskanta from Abnormal Returns made a great point in a recent post:

In the financial blogosphere and financial media we are often confronted with debates about issues that really are important only the margin. Of late discussions about active vs. passive, smart beta vs. dumb beta and alternative assets have been at the front and center. The problem is that issues like these are really peripheral to the big problems facing most average investors.

Most investors can safely ignore the debates investment professionals have amongst themselves.

This is something that’s easy to forget when you deal with this stuff on a daily basis. It’s interesting to us that work in the world of finance, but it’s fairly trivial to the average investor. In the spirit of focusing on the big picture, here are seven simple things most average investors don’t do that can make a big difference:

(1) Look at everything from an overall portfolio perspective. While it can make sense to think about a bucket approach for certain future liabilities, you still have to consider everything within the context of an overall portfolio. This means aggregating all retirement funds, brokerage accounts and emergency savings vehicles into one place. This helps determine how liquid you are, what your true performance numbers look like, how diversified your portfolio is and what your entire asset allocation is.

It’s very difficult to make informed decisions if you’re not thinking about your next move in terms of your overall portfolio.

(2) Understand the importance of asset allocation. Asset allocation is the nerve center of the portfolio. Everything — risk tolerance, performance, expected gains and losses, volatility — really comes down to selecting the correct mix of asset classes. Get this one decision right and it gives you a pretty good margin of safety in other areas of portfolio construction as you look to find your way as an investor.

Stock picking is sexier, but asset allocation is far more important for 95% of investors.

(3) Calculate investment performance. This one seems obvious, but it’s something that most investors don’t do. One study showed that investors overestimate both their absolute and relative performance to the market by an average of 5% a year, so it’s a good way to keep your ego in check. Calculating performance numbers allows you to see how much of your change in market value is driven by investment performance versus how much is due to the money you save.

Comparing your portfolio performance to some very simple benchmarks (such as total market or balanced funds) in relation to your asset allocation over longer time frames can also help make sure the work you’re putting in is worth the time and effort.

Once a year should suffice.

(4) Define a time horizon when making a purchase. Buying an investment is easy. Managing risk after the fact is where things get difficult for most investors. Without an upfront definition of your expected holding period or when you will sell/rebalance an investment, it’s impossible to make rational decisions.

We only become more irrational after making a purchase, so taking the emotions out of your sell decisions by making systematic if/then rules helps a great deal.

(5) Save more every year. Tweaking your portfolio between asset classes or finding cheaper or better funds might make you feel like your doing something to increase your performance, but these are usually marginal improvements at best. The easiest way to grow your wealth will always be to save more money.

Saving just 1% more a year can have a large impact on your ending balance over many decades of compounding. Every 1% you increase your savings rate could translate into the equivalent of 0.4% in annual investment gains. So a 5% increase in your savings rate could add up to 1.5-2.0% a year to your bottom line.

(6) Focus only on what you control. Investors are constantly stressing about where the market is going to go next. Not only does no one really know which way the market is heading, but it’s something that’s completely out of anyone’s control. The factors that most often stress people out about the markets are the things that they have absolutely no control over.

(7) Delay gratification. The entire process of investing is about delaying current consumption for future consumption. A solid investment strategy should do the same. To make money you have to be willing trade comfort now for comfort later.

Here’s one of my favorite Buffett quotes from Guy Spier’s Education of a Value Investor when Spier sat down with Buffett for a charity lunch:

“Charlie [Munger] and I always knew we would become very wealthy,” he told us, “but we weren’t in a hurry.” After all, he said, “If you’re even a slightly above average investor who spends less than you earn, over a lifetime you cannot help but get very wealthy — if you’re patient.”

The starting is the hardest part: the case for robo-advisors (Abnormal Returns)

The Great Volatility Unwind

By Ben Carlson, A Wealth of Common Sense

One of the reasons the past couple of years have frustrated so many professional investors is because of the lack of volatility. For most investors, volatility is a four letter word that should be avoided at all costs. But for others, volatility acts as a form of opportunity.

If you rely exclusively on volatility to find opportunities it’s probably been a tough stretch for your strategy. Here’s the rolling two year standard deviation for a 60/40 portfolio made up of the S&P 500 and Barclays Aggregate Bond Index going back to the mid-1970s:


We’re not quite back to the lows seen in the 2005-2007 cycle, but it’s getting close.

It’s easy to blame the Fed’s low interest rate policies for these subdued numbers, but it’s also worth noting that volatility isn’t the be-all, end-all of statistics. The 80s and 90s had fantastic returns, but volatility was still elevated from current levels. There were periods of unrest during that bull market, but volatility isn’t a one way street. It can be seen on both the upside and the downside.

After the crash from 2007-2009 the biggest risk on every investor’s mind was tail risk and downside protection. What many failed to recognize is that there are two tails on a probability distribution. The tail risk for a crash is ever present, but so is the tail risk for a melt-up.

Some might look at these numbers and assume that holding a portfolio of stocks and bonds has been easy over the past few years, but investors that actually did hold on know that it’s never easy. We’ve been bombarded with crash calls and double-dip recession predictions the entire way up. Not only is volatility seen as a huge risk, but a lack of volatility leads to warnings as well.

Like everything else in the markets, volatility is cyclical. Those patiently waiting for opportunities will see them eventually, but these things can always overshoot in either direction. Eventually things will go wrong. They always do. Something will cause volatility to flare up once again. Successful investors understand that it’s not the volatility itself that matters, but how you react to it.

Further Reading:
Volatility is not your enemy

When Gurus Say Strange Things

John Bogle famously said that the most important lesson we can learn about Wall Street is that “nobody knows nothin!”  I have to admit that that quote has always bothered me.  Now, there’s a good chance that I don’t know nothin because I am one of the few people on Wall Street who is stupid enough to criticize the saintly John Bogle.  And yes, he is a saint in the financial world.  There are few people who I respect more.  But I also believe wholeheartedly in the idea that we can learn operational facts about the financial world, the economy and the monetary system and thereby vastly improve our likelihood of making good decisions within that system.  I think better understandings lead to a better decision making process.  The financial world isn’t just a big random walk that is entirely unpredictable and incomprehensible.  There are deterministic factors driving results and understanding the operational realities of the system will substantially increase the odds that you understand what can and cannot happen.

The reason I bring this up is because of a quote I read in the Tony Robbins book during the Bogle interview section.  Bogle is asked about the likelihood of another crisis and he says:

“We still have to deleverage.  There’s too much borrowing in the country.  There’s not really too much leverage on the corporate side.  Corporate balance sheets are in pretty good shape.  But the government balance sheets, including federal, state and local, are all overextended.  And we’ve got to do something about that.

One of the big risks – one of the big questions, really-is the Federal Reserve now has in round numbers$4 trillion in reserves.  That’s $3 trillion more than usual, with about $3 trillion having been acquired in the last five, six years.  And that has to be unwound.  And it’s not clear to anybody exactly how that’s going to happen.  But everybody knows it has to happen sooner or later.”

The second point is operationally incorrect.  The Fed most certainly does not “have to” unwind their balance sheet.  With the Fed paying interest on reserves they can easily raise interest rates if they want.  In addition, they can simply let the balance sheet mature and unwind naturally over time if they so desire.  There is absolutely no need to unwind the portfolio.  So this isn’t a market risk at all.  See this piece which explains this point in more detail.

Also, why does he say the government is “overextended”?  Is there proof that the government’s debt level poses some solvency risk?  Is it causing inflation?  Is it hurting growth?  How so?  What’s the rationale for such a position?  We know, for a fact, that the US government, whose debt is denominated in a currency it can print, isn’t going to run out of money.  That should just be common sense.  And we also know that the government’s debt hasn’t caused high levels of inflation.  So what’s the rationale for this comment?

It seems to me that Bogle is pushing for some form of austerity despite the fact that we know that austerity hurts growth during a deleveraging.  Europe’s peripheral countries have made this abundantly clear in recent years.  So, at an operational level, I don’t know why Bogle makes such a bold statement.  It just doesn’t appear to be consistent with a sound understanding of the monetary system.  To me, he seems to be pushing a common political theme that really isn’t grounded in any empirical evidence.  See this piece for a more detailed explanation here.

If you accept the idea that none of us understands these concepts then we become increasingly susceptible to myths and misunderstandings about potential risks in the financial system.  This can lead to all sorts of bad decisions and biased thinking.  Personally, I prefer to try to understand the rules of the system and operational realities as best I can so that I can improve the odds of making high probability decisions.   It’s just not true that we don’t know nothing.

In Energy Revolution, Bond Investors Must Keep Their Heads

By Ivan Rudolph-Shabinsky and Petter Stensland, AllianceBernstein

A surge in capital expenditures and leverage in the energy industry could end badly for some companies and their creditors. While select opportunities exist, we think bond investors should think carefully before they blindly bankroll today’s North American energy revolution.

Energy-sector high-yield bonds have been at the epicenter of recent volatility in the global high-yield market. Between late August and mid-November, the US high-yield energy sector is down 6.2%, compared to a 1.7% decline for the broader US high-yield corporate-bond market.

So does this volatility represent a buying opportunity? Or is it an indicator of problems to come?

In our view, it might be trouble—at least for many small, highly-leveraged companies involved in oil exploration and production—and that’s reason for investors to tread carefully.

Since 2000, energy companies have invested some $1.5 trillion into operations—mostly exploration and production—and they’ve taken on a hefty share of debt to do it. Debt issued by energy firms today comprises more than 15% of the Barclays US High Yield Index, compared to less than 5% a decade ago (Display).


It’s hard to find a historical example of so much money chasing an opportunity that ended well. Typically, such ambitious investment leads to bubbles, and the bubbles eventually burst. Consider the US telecom industry, which saw its share of debt as a percentage of the overall market increase by a similar margin in the years leading up to the early 2000s, when the sector ran into trouble.

Energy Boom Does Not Guarantee Profits

There’s no doubt technological advances and shale-gas discovery in the US and Canada have reshaped North American oil and gas markets. US natural gas production hit a record high in 2013 and oil production has reversed a prolonged decline. This progress is thanks largely to horizontal drilling and hydraulic fracturing—or fracking.

But not every segment of the energy industry stands to benefit. Oil prices are now below $80 a barrel—in part a result of the supply glut caused by the North American production boom. Small companies that have levered up to fund exploration and production will see their margins squeezed—with bankruptcy a distinct possibility in some cases. As a result, many firms no longer have access to capital markets. But we think investors should think carefully before deciding to snap up their existing debt at a discount.

Companies involved in exploration and production—known as “upstream operations”—are vulnerable simply because they’ve earmarked too much capital for production. While fracking has helped increase capacity, the cost of developing production capabilities isn’t likely to be fully recovered.

The Struggle to Recoup Investment
To understand why, let’s again turn to telecoms at the turn of the century. The investments many companies made to lay high-speed network cables proved a boon for internet users. But investors suffered sizable losses because they miscalculated the true cost of those investments.

Like telecoms in the early 2000s, the money being spent on oil and gas field development in recent years may prove poor investments in the long run—even as the lower cost of energy benefits consumers. And the lower the price of oil goes, the more likely it is that companies will struggle to recover their costs.

Onshore service firms that support the energy sector will suffer from any resulting reduction in fracking activity. Meanwhile, an oversupply of drilling rigs that’s already squeezing offshore service providers could get worse.

Opportunities Exist, But Selectivity Is Key
None of this means the energy sector is devoid of opportunities. But the most promising ones, in our view, are likely to be focused on other segments of the industry. Companies that maintain pipelines and oil-storage providers, for instance, typically have less exposure to oil prices because they enjoy long-term contracts. For them, a decline in prices would be a good thing, boosting demand for oil and likely increasing the amount of oil moving through the system.

Likewise, downstream firms—particularly North American refiners—are living in a golden age. Cheaper oil prices reduce their cost of business, allowing them to maintain or even increase margins even as cheaper energy prices boost demand.

Even in the upstream segment, some firms that control attractive oil and gas fields will emerge as winners. But finding these gems won’t be easy, particularly if overall industry turmoil increases. In our view, significant losses for creditors of the least profitable exploration and production companies are a real risk.

When it comes to the high-yield energy sector, investors should proceed with caution.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

Ivan Rudolph-Shabinsky is a Portfolio Manager of Credit and Petter Stensland is a Research Analyst, Credit, both at AllianceBernstein, L.P. (NYSE:AB).