This blog is written weekly by Dock David Treece, a registered investment advisor with Treece Investment Advisory Corp. It is meant to share insight of investment professionals, including Dock David and his father, Dock, and brother, Ben, with the public at large. The hope is that the knowledge shared will help individuals to better navigate the investment world.

Tuesday, December 28, 2010

Year-End Financial Checklist

They say failure to plan is planning for failure. While many rely on a financial plan to outline their long term goals and strategies, each year it’s a good idea to take a little time to reassess what progress has been made and think further about long-term goals, as well as plans for achieving those goals.

Obviously we all have different financial needs and varying opinions on strategies for achieving our goals. There are many different ways to manage money, so while results are important, much more significant is what system is a comfortable fit for the client.

For example, diversification will, by design, tend to yield lower results than concentrated portfolios, the offset being, ideally, less volatility. Similarly, systems of actively managing money typically have higher fees, as well as better returns – or at least that’s the hope.

Consider for example that the Standard & Poor 500 Index is up roughly 12% for the year. Representing a wide array of stocks from varying sectors, the S&P500 essentially illustrates the direction of the broader stock market.

Given the results of the S&P this year, investors need to look at their own statements, and if returns aren’t in or at least near double digits, take some time to think about whether to stick with their current strategy.

For those using a diversified strategy, this is probably a good time to schedule an appointment with an advisor, if you have one. This is the time of year to look at the last year and do a little portfolio rebalancing. You might even consider “tilting” your portfolio in one direction or another, based either on your own research or on professional advice.

On the other hand, investors using active management systems like ours have more questions to ask themselves. First and foremost, they need to decide if they’re still comfortable with the system their money manager is using. While investors should obviously be pleased with their returns, these are hardly important if they aren’t comfortable with their advisor’s system.

Those attempting to actively manage themselves have quite a to-do list for the end of the year. They need to be doing research to come up with a forecast of what the market will likely do next year.

Then they need to decide whether they want to be invested. If so, what do they want to own? Are there particular asset classes that look more attractive than others? Do they want to make any moves immediately? Maybe they want to be patient and wait for opportunities to develop.

Few people realize how much work goes into money management. The number of people who think they can trade in their spare time and be profitable is astounding. And despite the odds stacked against them, people continue to try their luck in the markets – and make no mistake, the average investor managing money in their spare time without devoting any real time to research is basing their success on just that: Luck.

No matter the strategy, around this time each year it’s a good idea for all of us to spend a little time thinking about the upcoming year, what’s upcoming and what might develop. Make a list of any issues coming up this next year that might affect your financial life. If you have a child going to college, hopefully you’ve been putting money away for some time, but don’t forget about the costs of moving and/or travelling to visit.

Take an inventory of these kinds of issues, from travel expenses to health or medical expectations, kids’ school costs, and so on. While some of these require long-term preparation, others are good just to keep in the back of your mind. Ignoring them doesn’t solve the problem, but at least we can keep them from sneaking up on us.

Tuesday, December 21, 2010

The Next Motor City

Many of the issues currently causing worry among Americans, particularly among the working class, are based on several assumptions. Fortunately, many of these assumptions are flawed.

Of these worries, two stand out: First, that the national debt is growing too large and too fast, and that it will cause the US to go bust. Second, that employment in this country has undergone a substantial shift and that we must adjust to the “new normal.”

Oddly enough, these concerns are related, and both are based on the assumption that jobs which have been swept overseas during outsourcing wave of the past several decades are gone forever.

Since we at Treece Investments spend roughly 80% of our time trying to figure out where the economy is headed (so we can make profitable investments for clients) we feel fairly competent to address this topic, and qualified to comment. And given the set of economic circumstances that we see developing presently, we feel confident in saying that manufacturing must come back to the US.

As the economies of China, India and Russia have grown over the past several decades thanks to outsourcing and political shifts (Russia), each has begun developing a substantial middle-class that did not previously exist.

These growing middle classes are now getting to the point where they want access to many of the same luxuries that we have long enjoyed in this country.

For example, in Russia car sales have roughly doubled this year from last. In China, meanwhile, the average age of an owner of Mercedes’ luxury S-class sedan is a startling 26, all of 30 years less than it is in this country.

To date, as these countries have grown an increasing amount of their production has gone simply to meet demand within their own countries. Rather than building goods and shipping them to the Americas or Europe for sale, they are sold in India, Russia, or China without such high shipping costs.

Thankfully for the US, many of these countries are now getting to the point where they are having trouble simply producing enough to meet their internal demand, let alone those from other nations that had outsourced their production.

As the Asian nations have developed each has carved out a role in the manufacturing process, but in a strange twist of events it seems that they are missing a valuable link in the chain that few nations besides ours can fill: Russia has raw materials, India has technology, China does manufacturing, but none of them do engineering. The US, however, is one of if not THE world’s best country for engineering, and while other countries do have manufacturing sectors, few do it has efficiently as we do.

In fact, thanks to many of our contacts in various businesses, most notably automotive manufacturing, we have personal knowledge that the Chinese are actually looking at outsourcing a good deal of their engineering to the US.

We’ve also caught wind of several Chinese companies that are considering purchasing manufacturing facilities in the United States. Ironically, they’ve apparently grown tired of having a government that owns everything, and though the US has been looking increasingly socialist, it’s still not caught up to Red China.

Wednesday, December 15, 2010

Keep It Simple, Stupid

According to a recent USA Today article there is a new fad on the rise in the world of finance. Termed “mirrored investing,” this new concept being offered by several websites including Ditto Trade and Covestor allow investors to “mirror” the strategies of other, presumably more knowledgeable or successful traders.

Under this system, “master traders” place trades which are simultaneously executed for any investors following their strategy. Some traders that investors can choose to track charge a fee for their “guidance,” on top of the trading charges assessed by the brokerage site processing the trades.

This new strategy is incredibly inventive and actually follows many of the psychological trends that have brought success to websites like Facebook, Myspace and Twitter. Unfortunately, while mirrored trading might be the “latest and greatest,” if has some serious pitfalls from an investing perspective.

First and foremost, mirrored investing opens investors up to exploitation by traders, though not necessarily in the Bernie Madoff sense.

Given that this business model exists entirely in the virtual realm, how much oversight do you think sites like Ditto Trade or Covestor have of a “master trader’s” activities? What’s to stop them from having an account at a trading account at a different site and engaging in what is called “front-running,” which is illegal for money managers?

In front-running, advisors make trades for their own accounts ahead of client accounts in order to take advantage of the market moves created by their clients’ activity. A trader with clients mirroring their strategy on Ditto Trade could, for example, log onto E-trade to buy 100 shares of XYZ for their own account, and then enter the same trade on Ditto, which would be mirrored by anyone following their strategy. That trader could then sell the shares from the E-trade account after the share price has risen on buying among their Ditto followers.

Of course this obviously isn’t the only risk run by clients who used mirrored investing. Clients have little knowledge of the background of a “master trader,” other than what they are told. They may be entrusting their money to someone who has never been registered with the Financial Industry Regulatory Authority (FINRA) and knows little of securities law, or somebody who exaggerates their own experience and expertise. They could have just been laid off from a job in an unrelated field and decide to give trading a try.

Oddly enough, mirrored investing is not a completely new concept; though the delivery – being entirely only and taking on the feel of social networking – is original. There are many firms, often with far more brick and mortar, who have been letting clients mirror their trading for years. Our own firm has been using such a strategy since 1979. The difference is that we are registered with FINRA and the Securities Exchange Commission. Our companies and our employees are very highly regulated, so our system provides clients with increased safety and transparency.

Over the course of 30 years, we’ve seen dozens of fads come and go. From portfolio insurance to credit default swaps, we’ve outlasted them all. The problem is that most while innovative ideas can be profitable for their architects, they are often fundamentally unsound for one reason or another. Unfortunately, many people usually end up having to pay for the mistakes or gimmicks engineered by others.
Sadly, most people never look beyond the pitch. The same is true of investors buying annuities, life insurance, hedge funds or ETFs: salespeople use complicated language to describe complex products and systems, but they don’t know how they really work. Salespeople only know the sales brochure. Their job is to sell, not to understand how the products work.

Still, one would hope that clients might be skeptical of buying products from someone who can’t explain how a product works in simple terms.

In general, people would be better off sticking to the basics; quite often, the best solution isn’t the most complicated. Some people are inherently turned off by strategies that aren’t new and shiny with tons of moving parts that only a NASA engineer can imagine, but tried and true strategies can still do the trick. Slow and steady wins this race.

Thursday, December 9, 2010

Innovation: Death by Regulation

The theory of Diffusion of Innovations states that innovation begets further innovation; that when one person makes progress in some way, they spark or allow for various further innovations. So, theoretically, innovation ought to occur at an ever-increasing pace.

The truth, however, is quite different. As physicists Jonathan Huebner and Theodore Modis have noted in modern studies, it appears that global innovation isn’t occurring nearly as quick as it should be, and may actually be slowing down.

Many separate theorists including John Smart, founder of the Acceleration Studies Foundation, criticize elements of arguments made by Huebner and Modis. For example, Hueber argues that the number of patents issued per person peaked in 1873; while Smart notes that the vast population growth since then would seriously impact this calculation. Huebner also forgets to take into account innovations for which patents are not filed, including the development of existing “technologies.”

There is, however, a different theory – one most free market capitalists would probably find much more appealing. This argument looks past the scientific calculations and cuts down to solid fundamentals.

Simply put, innovation isn’t occurring at a quickening pace because governments, through their endless rules and regulations, are killing it.

Consider, for example, the incredible rate of progress seen in Russia directly following its conversation to capitalism less than 20 years ago. The amount of wealth created in the former Soviet stronghold has been incredible, and already the country is gaining prominence around the world, this time as an economic rather than military power.

Why, in just last year alone we saw the number of Russian billionaires more than double. That’s certainly nothing to shake a stick at.

To our point, though, the progress made in Russia is not by happenstance. The Russians and their trading partners can thank the lack of regulation in the region that resulted from the final collapse of the socialist government that previously controlled the region.

For more evidence, look at China. Though still technically a communist country, the Reds certainly got a few things right – but don’t tell that to Google. The Chinese may like to have a say in the crazy theories that infect the minds of their people, but the government still leaves its people mostly free to innovate. And thanks to cheap power produced from burning mountains of coal, the Chinese have left their role as trinket-supplier to the world and is now innovating, designing, and engineering right alongside the largest American enterprises.

Still not convinced? Consider the histories of two separate industries right here in America, perhaps the two that impacted people’s lives more than anything that had come before them: cars and computers.

Pop quiz: When did either of these industries experience their most rapid rates of innovation?

Answer: In their infancy, before the government started regulating them “for the public good.”

Now for a test of wits: Name one meaningful innovation that has come out of Cuba in the past 50 years.

[Crickets]

It seems so simple, and yet some people just don’t get it. Unfortunately they’re called politicians. But mark my words, the more rules and regulations the government makes, the further they will slow innovation and the further people’s standard of living will fall.

For the better part of this country’s history it’s been headed down a path of increased government regulation. We’ve seen this progression with other societies before, and we’ve seen this movie ends. It’s our choice; this country can keep going the way it’s been headed, or it can choose a new path. If we keep going, we will see standards of living decline as innovation slows to a snail’s pace. But it’s not too late.

Wednesday, December 8, 2010

Obama Caught Between a Tax Cut and a Hard Place

The big news this week is Obama’s recent 180-degree turn on cutting taxes to help bolster the US economy. There has been talk of extending the tax cuts passed during George W. Bush’s first term; or possible structuring a new piece of legislation that would provide some variant of tax relief.

Unfortunately for President Obama, he seems to be caught in a catch-22 on this important issue. Since the midterm elections in November it has become obvious that he will need to cooperate with Republicans, who will control the House come January, despite what he’s been saying in recent speeches.

If Obama refuses to acquiesce, the US economy will see very little progress going forward and he’ll be headed back to Chicago after his first term. If, on the other hand, he DOES cooperate with Republicans in Congress to provide some form of tax relief to the American people, he will do so at the cost of losing his voting base. What’s more, if the tax cuts do encourage business and help the economy, Obama won’t be given the credit that will likely go to Republicans. Either way, he’ll probably be headed back to Chicago.

Surely by this time White House advisors are telling Obama not only that tax cuts are desired by the American people, but that they are necessary for the US economy to continue its recovery.

The theory among many [leftists] is that during hard economic times, people need to buckle down and sacrifice more for the greater good. The proposed sacrifice is primarily in the form of increased taxes that hopefully allow the government to ramp up spending, keeping business afloat through rough seas.

In reality it’s the GOVERNMENT that ought to be making the sacrifice by LOWERING taxes with the hopes of encouraging businesses, which will put people back to work. Lower unemployment should, in turn, support consumer spending, further helping the economy.

Much of the debate lately has centered on the Bush-era tax cuts, and whether they ought to be extended. Readers would do well to think deeply about the circumstances of those tax cuts for a moment.

The “Bush tax cuts” were passed in the early 2000’s (2001 and 2003 respectively) very early in Bush’s first term. And just what was happening in this country during that time? It was still reeling from the burst of the tech bubble. In fact, the country was struggling to gain footing to pull itself out of the recession caused by the market crash.

Perhaps the most important facet of the Bush tax cuts, given the circumstances under which they were enacted, is that they WORKED. In just five years both the economy recovered tremendously, as did financial markets. In fact, stocks soared to new highs that surpassed even those of the tech boom. This recovery was halted only by the financial crisis that ultimately led to the market crash of 2008 and the ensuing recession.

Given this history, some will undoubtedly feel that the blame for the financial crisis and the current recession from which we are trying to emerge ultimately lie with President Bush (II). However, the reality is that we are really talking about two separate and distinct things.

The financial crisis, it is widely known, was the result not of lower taxes, but of excess debt. As debt was the cause of this mess, it will not likely be the solution as Federal Reserve Chairman Bernanke has suggested with renewed lending.

Rather, fiscal policy dictated by the United States government CAN and SHOULD serve to foster economic growth by encouraging businesses. The all-important question still remains, though, what policies will come out of Washington.