Below, we offer the welcomed insights of former Georgetown professor and Wall Street veteran, John Montgomery, who offers his own balanced insights on the Fed, trade wars, portfolio construction and the state and role of today’s stock and bond markets.
Thoughts from the Sidelines
Back when I was working, I always tried to get the second quarter Investment Outlook out by April 1st. I felt that April Fools’ Day was really an appropriate date to “publish” economic and investment forecasts. Now that I’m “retired” and under current circumstances, it seems less important and far less humorous.
Here we go ̶ A salary out and a week behind
Now that it’s been almost a year since I “retired,” I thought that you might be wondering what I’ve been doing with my time. NO!?! Tough! I’m going to let you know, regardless.
The short, and most accurate, answer is “not much.” I sleep later. I read more. I play a little more (but certainly not any better) golf. I travel a lot more. Maryann and I went to France and Bulgaria in October. We went to Dublin for New Year’s Eve. I went to the Strategic Investment Conference in San Diego last month. We also visited our kids in New Mexico and Texas…a couple of times. I spend more time with my wife who explains her take on my “retirement” as “I married him for better or worse but not for lunch.” Her adjustment has been harder than mine since I’m used to hanging around me all the time. But, far and away, the most fun and rewarding thing that I’ve done is to teach a course in Personal Finance at Mount St. Mary’s University. (More on that later.)
I try to pay less attention to politics which is difficult to do. We (still) live in Washington,
D.C. and, given what’s going on these days, Maryann and I are spending more time in Blue Ridge Summit but it’s hard to ignore the political show. What is, IMHO, the most startling aspect of President Trump is that no one who supports him can understand why everyone doesn’t, while everyone who doesn’t can’t understand how anyone can. About the only thing everyone can agree on is that it’s the other guy who is wrong. The other baffling development is that having watched what the TEA Party did to the Republicans, the Liberal/Progressive wing of the Democrat Party is trying to duplicate the effort ̶ an Herbal Tea Party, if you will. This will do little to promote bi-partisanship. (You remember bi-partisanship, don’t you?) It will be hard to ignore the midterm elections but I’m going to try. Well, not really.
One of the things on my “to-do” list is to read Gregg Easterbrook’s new book, It’s Better Than It Looks! Reasons for Optimism in an Age of Fear. I want to try to better understand why, given the pessimistic bias of the world today is it that, by virtually every measurable standard, people’s lives are improving. We are living longer; are in better health; have higher incomes, greater wealth and more creature comforts than ever before; there is far less poverty; fewer major conflicts; better health care and educational opportunities and yet most feel that the world is “going to hell in a hand basket!” MY conclusion is simple. Bad news sells better than good and politicians stay in power by promising ever more goodies to their supporters, made even better if paid for by people their supporters don’t like.
My Take on the Economy
It’s been a long time since the last recession and, while there is not one immediately in sight, we are closer to the next recession that we are to the last. In spite of the recent mini spurt, economic growth since “The Great Recession” has been the slowest since WW II partially offset by it likely to become the longest since records have been kept. IF the U.S. economy continues to grow through the end of 2019, this will be the first decade without a recession since at least the 1850s. Recently, we’ve been told that the economy is showing more signs of (renewed) life than old age. I don’t see it. President Trump does seem to have fired up the economic “animal spirits.” Soft economic indicators, seen primarily through sentiment gauges, have been strong and have, at least periodically, spilled over into harder economic data. Until recently, stock market indicators were pointing toward economic strength. Stock indices rose to record highs while volatility declined to record lows. The bulls felt that this was an omen of better times ahead. The bears felt it was a bubble pumped by dangerously experimental monetary policies.
The Trump administration, with NO help from the Democrats, passed a major tax reduction of about $1.5 Trillion over the next decade and, with plenty of help from the Democrats, increased government spending by $300 Billion over the next two years. This, nine years into an economic recovery and with unemployment hovering around 4%. So much for fiscal responsibility…We’ll grow our way out of this! Many consider this to be a dangerous fiscal experimental while others dismiss it as more “voodoo economics.” Trump and his supporters label it as “GENIUS!” It seems that Donald Trump’s promises to balance the budget have gone the same way as Melania Trump’s anti-cyber-bullying campaign.
Additionally, even though no one knows whether it‘s economic policy, political posturing or negotiating gambits, President Trump seems to have fired the opening shots in a trade war and, unsurprisingly, “they” are firing back. I’m not convinced that trade wars are all that easy to win. Some (probably many) will be caught in the crossfire.
The fiscal stimulus is likely to collide, possibly head-on, with less accommodative monetary policy. Since this President follows somewhat, to put it mildly, unconventional tactics, one might expect that he won’t pull many punches in telling the Fed how to run monetary policy. And, don’t forget, he’s a real estate developer who likes low cost debt. We’ll see if the Fed will be able to maintain even a scintilla of the political independence that it so highly values. Good luck, Jay Powell!
And, all this in yet another election year.
My Investment Implications
Being back in the classroom was great. Having never taught Personal Finance before and being more than a little rusty after a nearly two-decade sabbatical from my 20 years of teaching at Georgetown, I didn’t know what to expect. Lesson #1: Scheduling a class for Juniors and Seniors at 8:00 a.m. on Mondays and Fridays will hold down enrollment, and attendance. Next time, it will be a 2:00 p.m. on Tuesdays and Thursdays. Lesson #2: No matter that I had mostly finance
majors, focusing on the basics is important. Lesson #3: In spite of all the high-tech teaching tools now available, using the black board, encouraging questions and giving meaningful assignments are still helpful.
The kids were great. Attentive, bright and engaged, but not always at 8:00 a.m. As I proceeded through the basics of personal finance, I was struck by how much more complicated it seemed rather than it necessarily needed to be. Plan. Set goals and objectives. Learn what risk is and your tolerance for it. Budget. Live within your means. Use debt sparingly, Insure the big stuff. Invest for the long term. Don’t do stupid stuff.
After I finished college and graduate school, I learned more in the first six months of working on Wall Street than I had learned in 18 years in academia. Then after a career in the investment business, I think I unlearned more things back in academia than I had learned in my
43 years on Wall Street. My biggest “take-away” from teaching Personal Finance can be summarized by the old adage to “Keep It Simple, Stupid.” I fear that, as investment professionals, we often fell into the old “If you can’t blind them with your brilliance, baffle them with your b.s.” trap. Whether it’s teaching or investing, it’s probably better to K.I.S.S.!
What do we know? Well, stocks have historically provided superior returns to other investment vehicles albeit with greater risk and variability. However, the longer you stay invested in stocks, the more likely you are to be rewarded for taking the risks. There are very few examples of stocks not resulting in positive returns if you hold a widely diversified portfolio for five to ten years and virtually none if you hold for 20 or more years. Therefore, try to keep a lot of your assets invested in equities. However, 5, 10, 20 years are long periods of time, so make sure that you also hold some cash like assets for liquidity needs, emergencies, opportunities and for your peace of mind. Many “investors” have a propensity to buy high and to sell low. This is not an overly successful strategy. Try not to do that. The stock market has a good but far from perfect record of forecasting the economy. Try not to use the economy to forecast the stock market. Stock market risks rise and fall with stock prices not the other way around. So, try not to get caught up in the euphoria, or despair, of “the crowd.” Good luck with all this advice.
One of the things you always want to keep under consideration is the actions the Federal Reserve ̶ “Don’t fight the Fed!” Since retirement, I am even more convinced of the outsized role that monetary policy has played in this bull market not just in the U.S. but globally. “Printing” $15 Trillion (or so) out of thin air in a slowly growing economy means that there is a significant amount of liquidity that has to go somewhere. Since central banks bought a lot of high-quality assets with that $15 Trillion, investors had to redirect much of their investments into lower-quality assets, the prices of which became inflated. Some claim that a “bubble” in financial assets resulted from this even though the goal was to stimulate economic growth, somehow. The Fed has started to reduce this monetary largesse and, sooner or later, so will other central banks…maybe.
I often ask investors, “What happens when you play a country western song backward?” Answer: “You get back your truck. You get back your dog. You get back your wife.” Members of the FOMC have spoken about the possibility of a bubble in financial assets. Listen to them. They created that bubble. Draining even just some of this liquidity from the financial system could prove problematic, especially in light of an increasing supply of debt from the fiscal stimulus of lower taxes and higher spending. The Fed has left little doubt that it will continue to reduce monetary stimulus over the shorter term but their resolve in the face of possible unintended consequences is questionable, if not doubtful, over the longer term.
Any money you may need during the next year should be held in cash and equivalents. Any funds you need for the next one to five years should be held in high-quality debt instruments of short duration. The rest of your investable assets should be equities with many caveats and qualifiers.
My Take on Bonds
I continue to be a bondgnostic both longer term and, especially, shorter term. Over the long term, bonds have usually returned around half of what equities have and more recently less. With high- quality bonds yielding 3%-6% and since bonds normally return about the level of their yield, a return of 3%-6% is about what you should expect. IF that works for you, you might consider owning bonds. Also, if you are pessimistic and believe that the “Killer Ds” (debt, deflation and demographics) could lead to recession, you might want to own longer-maturity bonds as a hedge. (This is what Lacy Hunt of Hoisington Management continues to predict as he did at this year’s Strategic Investment Conference.) In the shorter term, the Fed is likely to continue to push rates higher which should drive down the value of shorter-maturity bonds. Cash now at least yields something so waiting IS an option IF you believe rates are headed higher.
Ironically, the possible trade war looming on the not-so-distant horizon could further roil the interest rate outlook. Any decrease in the U.S. trade deficit, especially with China, could reduce demand for U.S. treasuries just as the supply increases. That old supply/demand bugaboo.
Tightening monetary policy, inflation fears, growing deficits and never ending political risks in a still very low interest rate environment provide headwinds in an overvalued asset environment. However, those “Killer Ds” (debt, deflation and demographics) severely limit the likelihood of interest rates rising a lot. That and the fact the, IMHO, sooner or later the Fed will blink.
My Take on Stocks
The stock market went up so much and for so long that many felt left out. The Fear Of Missing Out (FOMO) turned into greed and many decided that buying high was all right…again…since this time was different. But, as is often the case, the fully invested bear is turning out to be the most dangerous animal in the Wall Street jungle. As mentioned before, we are now likely to see how well “Mo”mentum works on the downside.
It increasingly looks like it’s time to focus more on RISK than on return. Since retiring, I’ve grown even more aware of how great the risks are in trying to time the market. After winning his $1,000,000 bet that the S&P 500 Index would outperform a selected number of
hedge funds, Warren Buffett wrote in the Berkshire Hathaway 2017 Annual Report that “I want to quickly acknowledge that in any upcoming day, week or even year, that stocks will be riskier ̶ far riskier ̶ than short-term U.S. bonds.” (This is about as close to Warren Buffett sounding a warning as you are likely to read.) He continues, “As an investor’s investment horizon lengthens, however, a diversified portfolio of U.S. equities becomes progressively less risky than bonds, assuming the stocks are purchased at a sensible multiple of earnings relative to then-prevailing interest rates.” This IS a call to “buy-and-hold.” I do, however, point out that Berkshire Hathaway is sitting on a record amount of cash while Buffett often remarks how difficult it currently is to buy reasonably valued stocks. U.S. equity P/E’s are near all-time highs while yields remain near all-time lows. Does recognizing that such things are indicative of risk and acting accordingly equate to “market timing?” At the Strategic Investment Conference that I recently attended, bearishness was the order of the day. Like the “Killer Ds” in the bond market, I’ve been warning that the “Killer Vs” (volatility, valuation and volume) may return to spook the stock market. While volatility has returned, valuations remain high and volume remains low. When, rather than if, the bear market comes the press and pundits will revel in crying “wolf” and telling us that they told us so. Every correction has the possibility of turning into a bear market and we are way overdue. When it happens the “buy and hold” chorus will morph once again into born again bears. This is how it works. Always has and, probably, always will. At least until human nature changes which it doesn’t.
What to do? Here’s what I’ve already done. I raised cash-Heresy! -to about 15% of my investable assets. I reduced my exposure to large cap blue-chip equities, especially technology stocks. I’ve raised my exposure internationally, especially to emerging markets. (I still consider emerging market equities to have greater growth potential and are priced more cheaply than developed country stocks.) I’ve increased hedged positions, especially to gold. I’m considering a short-only fund but, importantly, I’ve started a shopping list of stocks and funds to buy on weakness_̶ whatever that means!
Please keep in mind that one of the most valuable things I’ve learned since I “retired” is to NOT pay too much attention to the bulls or the bears. I still have almost 70% of my assets invested in stocks, which is pretty high even for a stock-loving retired guy like me.
April 1, make that April 11, 2018, John E. Montgomery
Happy Belated April Fool’s Day
