February 28, 2012
A Black Swan or the Goose That Laid the Golden Egg?
The Investment View from Prescott, Arizona
by Will Hepburn
The term "black swan" describes an event that no one even considers possible until it happens, as described in the 2007 book by Nassim Taleb entitled The Black Swan.
The idea stems from the European experience that all swans were white, until the 1697 discovery of black swans by explorers in Australia. Prior to the discovery, the existence of a swan that was not white was inconceivable. In finance, the term Black Swan refers to low-probability but highly-impactful events.
The goose that laid the golden egg, by contrast, is the fictional bird capable of producing eggs of pure gold providing perpetual wealth to the lucky owner. As the fable goes, the goose experienced its own version of a black swan event when the owner greedily demanded more golden eggs and then killed the goose in an attempt to get all the eggs at once.
In our sensitive economic state, we still face the specter of black swan events. A global debt default or Iranian nuclear crisis might not qualify as black swans because they are fairly visible possibilities. The unpredictable events like 9-11 or the Japanese tsunami are real black swans because they are so unexpected.
High levels of government handouts are like our citizens demanding more and more golden eggs. This trend has the potential to unleash a black swan by creating a dependence on the government that may doom many of the beneficiaries to unproductive lives. In my mind, there is not much difference between dependence and addiction.
The intentions behind the many demands are almost always good ones, but as writer G.K. Chesterton said, "It is not that they can't see the solution. It is that they cannot see the problem".
This demand for more government "help" reminds me of the story of a college economics professor whose class had insisted that socialism was preferable to capitalism because then no one would be poor and everything would be more fair.
The professor then said, "OK, substituting grades for dollars we will have an experiment in this class. All grades will be averaged and everyone will receive the same grade so it will be more "fair".
After the first test, the grades were averaged and everyone was given a B. The students who were used to getting A's because they studied hard were upset and the students who studied little were happy. As the second test rolled around, the students who studied little had studied even less and the ones who had studied hard were no longer motivated to put in the long hours as they had before.
The second test average was a D. No one was happy.
When the 3rd test rolled around, the average was an F.
As the tests proceeded, the scores never increased as bickering, blame and name-calling all resulted in hard feelings and no one would study for the benefit of anyone else.
To their great surprise, all failed and the professor told them that socialism would also ultimately fail because when the reward is great, the effort to succeed is great, but when there is no reward for hard work no one will put forth the effort to succeed.
This is the type of black swan consequence I worry about whenever the government announces more handouts, whether to corporations, individuals or other governments.
A Slice of Life
Beating Sciatic Pain
We aging athletes end up with more than our share of aches and pains, and an old back injury had me dealing with sciatic and related pains for a quite a while. Then about two years ago I discovered Pilates, which focuses on flexibility and strengthening core muscles.
Suzanne Fisher is a wonderful teacher and runs a class called Easy Matt Pilates which is all done sitting or lying down on a matt - no exercise machines in this class. The best thing about it is I have not had one bout of sciatic pain in the two years since I began Suzanne's class. I am a raving fan!
My 84 year old friend John, who began coming to class two years ago because of my mentioning it in this newsletter, just loves the class.
Monday and Wednesday from 9:00 - 10:00 a.m. we are in Suite 119 of the Safeway Center in Prescott - over toward the CAL Ranch store. Classes only cost $5. Come on down and check it out.
You know life is good when you can get your exercise lying down.
Pump up the volume by placing your iPhone & iPod in a bowl.
The concave shape amplifies the music.
How's the Market Doing?
Stocks continue their steady advance, climbing the proverbial "wall of worry" as they ignore problems in Europe, weak economic data and high unemployment.
This past week the news was centered on the inability of the Dow Jones Industrial Average**, the stocks of 30 large companies considered representative of the US Economy, to close above 13,000. It flirted with 13,000 last week, but didn't kiss it on the lips.
The 13,000 level really has no meaning, but the media thinks that round numbers make good headlines. The number with real meaning is 14,164, the closing high on August 8, 2007, because until that number is surpassed we are still below where we were 4-5 years ago, a down-trending market by many definitions.
Like a sumo wrestler, the government still sits on the bond market, depressing interest rates until the economy perks up due to "cheap money" being spent. As Dr. Phil would ask the people making those decisions, 'How's that been working for you?"
In the mean time, savers are relentlessly squeezed by low savings rates and forced to take more and more risk to maintain their income.
And while investors can easily see there is very little reward in government bonds, they need to remember there is a great risk of bonds losing value if interest rates rise. The government says they want to hold down bond rates into 2014. Do you believe they will? What if they are sincere, but just can't do it?
Investors need to know what to do if the government does not make good on this latest promise. We know what we will do at HCM. Do you know what you will do?
Gold is at a price from which it has declined three times before, and is also facing a cyclical decline due in March. So, I expect gold to have a tough time for a while.
With 2 foot tall numbers in your face every day it is hard to miss the fact that gasoline prices are at record highs. But high gas prices are more than just an ordinary irritation, they really threaten our economy.
At a time when the President proposes to raise income taxes, gasoline prices are already acting like a tax, taking an extra $10 or $20 out of our pockets at each fill-up. That is money that you could spend on productive economic pursuits . . . or you can buy gasoline and send your money to the Middle East instead.
High gas prices also have a remarkable way of leading to recession. The recessions of 1990, 2001 and 2008 come to mind - all were foretold by rising gas prices. And who can forget the rolling recessions of the 1970s as gas prices went tenfold.
Gas prices also have a remarkable way of affecting Presidential approval ratings, so I would expect a shift in the presidential race as energy policy replaces health care and taxes as the hot topic.
On top of oil prices reflecting drilling restrictions here in the US and new delivery pipelines that are needed, refining capacity is now an issue driving gas prices up. Since there has not been a new refinery built in the US since the 1970s, the government's energy policy is being called into question.
So don't believe all you hear about good economic performance. This is an election year, so there will be a lot of misinformation floating about. But gas prices this high are a huge dark cloud over our economy.
We Are Waiting For Your Call
We have over 500 subscribers to this newsletter, and less than 100 families as clients. I know that there are around 50 professional financial advisers and a number of journalists who also follow my writing, and this next item is not meant for them.
If you are not already one of the Hepburn Capital family of clients, I have to ask: If you appreciate the insights Bryan and I provide here enough to keep reading, why haven't you called for an appointment?
The most common answer I get to that question is that you are comfortable with the way your investments are for you right now. The thinking is that you are planning to call when the next market decline is underway - when you get uncomfortable. If you think about that decision, by the time you get uncomfortable enough to call us you may already have taken uncomfortably large losses.
In years that have big stock market declines we have saved some clients 10 times our fees, but only if they were our clients going into the decline. Waiting until you are already in trouble is a false economy. You need to plan now for what will come next.
The second most common answer I get to the question is that if something happens to you, your spouse has instructions to call us to take over managing your money. The problem is that your spouse really doesn't know us like you do. If you keep at least some money with Hepburn Capital your spouse will have the opportunity to become comfortable with us before "that" happens.
Talking about our strategies is like talking about our kids. We really like to do it. And we would appreciate the opportunity to show you what our strategies that Adapt to Changing Markets® can do for you.
So don't put it off. Call us for an appointment to see if we might be able to help. 778-4000.
What's Going On In Your Portfolio?
We offer two main strategies, Flexible Income* and Shock Absorber Growth*, and we blend those two strategies together into Adaptive Balance* and Careful Growth*.
There has been no change in the Flexible Income* side of things over the past few weeks. We are fully invested in a broad mix of bond funds of adjustable rate bonds, both high quality and high yield corporate and municipals, all of which just keep perking right along.
We have a small amount of gold also, which has posted modest gains, but we are not adding to that position until the gold market gets past this questionable period over the next month or two.
Shock Absorber Growth* is carrying a smaller inverse position these days since the market has been performing nicely. But we will not be reducing the shock absorber any further due to storm clouds gathering on the horizon and have begun to raise cash with which to buy a larger shock absorber.
As of this writing on February 26, 2012, our traditional (long) investments are well diversified and include stocks of pharmaceutical and biotech companies, retail, auto makers, Brazil, and semi-conductor manufacturers.
Our Spotlight Strategy
Adaptive Balance* is a blend of our Flexible Income* and Shock Absorber Growth* strategies weighted to always have more income holdings than growth. We adjust the amount of growth strategy up and down between 10% and 50% of the portfolio depending upon market conditions.
You can see the details here: Adaptive Balance
* The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. Activity in client accounts may be different from that in the model in amount of each investment, specific timing of trades, and actual security used, which may vary from account to account. Not all trades are profitable. It should not be assumed that current or future holdings will be profitable. A list of all trades in these accounts for the past 12 months will be provided upon written request.
** The S&P 500 and Nasdaq Indexes are unmanaged lists of stocks considered representative of the broad stock market. Investors cannot invest directly in the S&P 500 Index.
This newsletter may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Information in this newsletter may be derived from sources deemed to be reliable, however we cannot guarantee its accuracy. Please discuss any legal or tax matters with your advisors in those areas. Neither the information presented nor any opinions expressed herein constitute a solicitation for the purchase or sale of any security.