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.

Wednesday, September 29, 2010

Market Inefficiencies Prove Exploitable

One of the biggest debates within the investment world is whether markets are truly efficient. The business school explanation of the Efficient Market Hypothesis (EMH) states that a given stock’s price at any given time take into account all data, as well as opinions and interpretations of that data, relevant to a that stock.

While this argument may seem trivial to some, it does have far-reaching implications for investors and how they structure or manage their portfolios.

Investors who believe that markets truly are efficient tend to believe in passively portfolio management, as they find it statistically impossible for active money managers to beat the market over the long run. So, they purchase of a diverse set of securities across a range of asset classes. This portfolio is rarely altered, but may occasionally be rebalanced.

Conversely, there are many people believe that markets are inefficient for one reason or another. As an example, our own philosophy is that markets are inefficient because stocks prices only consider what has already happened, as well as current expectations. However, these expectations are likely to change as economic circumstances change.

Those of us who deny EMH tend to shy away from diversification, which Warren Buffett once characterized as “a hedge against ignorance,” in favor of actively managed portfolios of one type or another.

Passive investors and EMH subscribers frequently try to invalidate active money management theories using statistics. They contend that the average money manager is no better that picking investments than a monkey throwing darts at a dartboard.

Not that anyone asked us, but of course the average money manager can’t beat the market. After all, the market is the average, which would include both money managers who lost money, as well as those who significantly outperformed the market. It’s the same as saying that the average stock won’t beat the market’s average. Of course, there are always outliers. Some can beat the market; others will go broke.

For better understanding, consider that the average temperature in Washington, DC is between 48 and 66 degrees Fahrenheit. At those temperatures people would be pretty comfortable in a sweater. Of course, that doesn’t mean that if you were planning a trip to our nation’s capital, you would pack for average temperatures. You’d pack according to the season.

Similarly, while the average money manager won’t beat the market, it is possible to find those who dedicate their time and effort to studying the markets and can routinely outperform their peers as a result.

However, the only way to accomplish that goal is by looking forward and trying developing forecasts.

Unfortunately, the vast majority of the investing public has a faulty method of selecting investments. Most spend their time studying history. They look at old data, historical financial reports, charts, etc. The oldest trick in finance is to show a client a mountain chart and ask whether they would’ve liked to have been along for the ride.

The problem with looking at history is that is investors can’t make any money from what has already happened. The only way to make money investing is to develop a reasonable picture of how the future will unfold, and take positions in securities that will benefit as a result.

To accomplish this, investors don’t need a crystal ball, but they at least need to be forward-thinking. Obviously no one knows exactly how the future will unfold. Still, most investors are driving along and steering by what they see in their rear view mirror. This method works OK, until the road turns. It’s always better to look ahead, even if the view is hazy.

Sunday, September 26, 2010

Re-Industrializing America

Few realize it now, but despite its current political unrest, regulatory uncertainty, unemployment, monetary policy, tax rates, and general lack of international standing, the United States is well-poised to take back its long-held position as THE leading global industrial power.

There is no reason why business, particularly blue-collar manufacturing jobs, shouldn’t be flowing back to this country. Neither China nor Mexico has proved to be the panacea that businesses had hoped they would be. Companies with operations there are constantly dealing with problems of quality control and theft of intellectual property.

In fact, recent studies have shown that the costs of labor have declined to such an extent that production on a per unit basis is hardly more expensive here than in the global sweatshops of Southeast Asia. There’s also the added benefit of good PR and lowering shipping costs.

That’s right, my fellow Americans: We’ve got ‘em right where we want ‘em!

The only thing left is for this country to find some leadership who is willing to provide incentives for business and a little backbone in the international community. Instead, the current administration which frequently floods the markets with uncertainty and can be best be described as “apologetically American.” It might be said best in Proverbs, that “Where there is no vision, the people perish.”

Even as many of the world’s manufacturing jobs were shipped abroad in the “Flat World” Movement (so-called because it culminated in 2005 with the publishing of Thomas Friedman’s The World is Flat), those occupations that required the most thinking have predominantly stayed stateside. Most management jobs in US-based firms are still here. After all, this country has many of the world’s best business schools. Most of the Engineering jobs stayed as well – perhaps because our Engineering schools rank among the world’s best.

For the most part the jobs that left this country were in manufacturing, and not necessarily because they were cheaper abroad. Many Americans simply haven’t wanted to get their hands dirty. Having been convinced that the US is the most educated, developed nation in the world, many feel that a college degree entitles them to a $100,000 per year desk job.

In what has become one of the biggest farces of modern times, higher education has largely failed the people of this country. Starting in the 1970s, the academic community (or should we say: “colleges and universities who charge tuition and reap hefty profits based entirely on their reputations, whether earned or otherwise”) began pushing the idea that every American should have a college degree.

All this despite the fact that half or more of the careers in this country don’t inherently require a college degree, and would easily be learned with simple job training. Instead, over the past 40 years this country has trained a generation of sociologists, art historians, and liberal artists.

It’s about time this country shed its arrogance, put down the Xbox controller, goes out and rolls up its sleeves and gets back to work. We have been presented with an opportunity not seen in this country in a generation to regain our prominence as a global leader in business. With Europe and much of the world still floundering, the US could drastically improve its global standing, if it can find its footing.

Production isn’t just coming BACK to the US, it some cases it is coming to this country for the first time. Volkswagen, Hyundai, and Czech tire company CGS are just a few foreign firms that have been increasing their US-based production operations.

Recently Bloomberg Business Week ran an article profiling Foxconn, the Taiwanese manufacturing company that produces many electronics for the world’s consumers. This exhaustive story proved very insightful, none more discerning than a simple image portraying what appeared to be woven awnings extending roughly 20 feet from the sides over several buildings on Foxconn’s campus.

The caption underneath read simply: Suicide nets.

That’s not exactly something we routinely worry about in this country, is it? Certainly not enough to install nets on office buildings.

We have it pretty good in this country. Strike that: We have it VERY good in this country. But it’s just about time we all woke up and realized that we can maintain our role as a global industrial leader, but not without working to earn it.

Wednesday, September 22, 2010

The Great Recession: A Year Later

This week the all-seeing, all-knowing National Bureau of Economic Research announced that the Great Recession officially ended in June of 2009. If only they were a little quicker on the draw. In the same month that the recession officially ended, we penned an article entitled “United States on Clearance.” To quote from it directly:

We continue to believe that prices will be increasing in the near future due to both inflation and the recovery of the global economy. We see signs of these things emerging every day.
A little vindication certainly is nice every now and again.

Now, with the not-so-great recession officially behind us, fading into the annals of history, we’re ready to move on, both topically and economically.

The fact that more than a year has passed since the recession ended may prove to be the final nail in the coffin of the argument for a possible double-dip. As we have long-argued, this country was never poised for a double-dip, not since the Fed took steps in inject sufficient liquidity to keep markets solvent.

While obviously this hasn’t solved all our nations’ problems, it did turn what could have been a double-dip into more of an economic stagnation as recovery dollar spending ran dry. In that sense, as we’ve repeatedly argued, the economy has not declined since the initial recovery ran its course, but they certainly haven’t gotten much better either.

Before the real recovery can begin in this country – the one that will take this country back to its place as a prominent global economic power – some changes still need to be made.

Most notably, this country needs guidance and incentive from Washington, rather than uncertainty, burdensome regulation, and impotent foreign policy. Another hindrance the US could and likely will do without is another round of quantitative easing on top of already long-depressed interest rates. Judging by the Fed’s announcement on Tuesday, QE2 sounds less than likely.

And yet, the market seems continually worried about the “imminent” collapse of the US dollar. Every day seems to see more money piling into tradition inflation/calamity hedges ranging from gold and Treasury Inflation-Protected Securities (TIPS for short) to corporate and government debt.

Many major mutual fund companies continue to report substantial flows of retail investor assets into fixed income securities (Neil Anderson, Fixed Income Still Dominates Mutual Fund Flows…). Why investors have chosen to make such a move as interest rates hover at 30-year lows, we may never know.

The biggest comfort about worries of the dollar collapsing, though, comes from outside this country; from our neighbors across the pond. Some may remember that earlier this summer the fear permeating the world’s financial markets was the prospective failure of the EU, a notion which even we did not dismiss.

Admittedly, Europe is still a long way from having worked through its fiscal and economic woes, which are numerous and substantial, but the fear of the EU’s failure seems to have mostly subsided. So too will fears surrounding the dollar or the breakdown of the US economy, but certainly at a higher cost to investors.

Thursday, September 16, 2010

The Small Investors Discrimination Act of 2010

Leave it to a Democratic-controlled Congress and a Democratic White House to enact policies to hurt the working man. Thanks to the “Law of Unintended Consequences” recent shifts in public policy have resulted in some surprising consequences for small investors.

Due to increased regulation and added bureaucracy, the costs of doing business (for investment firms especially) have been rising of late. One result is that many firms have taken steps to avoid small investors. Firms simply can’t create sufficient revenue from such small accounts to justify the increased costs of catering to that market segment.

According to a recent Bloomberg article, Meredith Whitney predicts that Wall Street firms will likely cut approximately 80,000 jobs over the next year and a half. This comes on top of the fact that banks have shed more than 300,000 jobs worldwide since 2008 (Yalman Onaran, Wall Street Firms to Cut 80,000 Jobs in 18 Months, Whitney Says). While the statistics for potential layoffs aren’t yet public, it’s generally safe to say that a good number will come from customer service departments.

A 2009 article from the Wall Street Journal went even further, revealing several changes in Wall Street ritual that encourage the desertion of small accounts. Apparently the standard practice at Merrill Lynch these days is not to pay brokers for accounts less than $100,000 (Evelyn Juan, Firms Push Call Centers).

Meanwhile, the same article also presents small examples of changes in firm policy that aren’t particularly friendly to the less affluent. Case in point: Bank of America used to assign personal bankers to clients with more than $100,000 in assets with the bank; that minimum has since been raised to $500,000.

The irony, of course, is that the entire reason (read: justification, not logic) for added regulation was to protect small investors. Instead, it seems, these folks will be pushed out of the markets altogether. And it’s all thanks to the Democratic powers-that-be, supposed advocates of the working man.

Don’t think that the Democrat Congress and the Obama White House don’t know what they’re doing. They do; it’s standard operating procedure. One the one hand they sing the praises of the American working man, going so far as to pass a wildly unpopular Healthcare Bill as a blue collar pick-me-up. On the other they are trying, directly and indirectly, to evict small investors from the world’s financial markets.

In the mind of the Democrat politician small investors obviously lack the education or expertise to handle their own healthcare, much less operate motor vehicles at a safe speed. If so, they must also be simply too stupid to make decisions about investments, too easily tricked or fooled. Like defenseless snail darters, they must be protected.

But all the D.C. Democrats, it seems, forgot about one small, under-represented group: financial firms. In an industry so saturated with regulation that even small firms typically employ a small platoon of compliance consultants and attorneys, the success of any new policy is predicated entirely on the consent of the governed – namely investment firms and their associated persons.

Just as the regulatory body for brokerage firms (FINRA) has been recently reaching beyond its jurisdiction to scold firms over outside operations, the government seems to have forgotten who pays the bills. Take the case of FINRA, which is funded entirely by securities firms, acting almost like a union.

As is the case of any new tax, the immediate reaction of the taxed is to look for methods of avoidance. When new regulations are enacted and firms are placed under increased scrutiny, their initial reaction is rarely full compliance, as regulators intend. Instead, it is to seek out cost-effective solutions; a balance of cost and compliance.

In the same way, the US government ought to know by now that policy enacted without the support of those affected will be met with resistance or subterfuge. Maybe one day politicians might finally learn not to bite the hand that feeds them.

Wednesday, September 15, 2010

No One Rings a Bell…

In the markets, there’s an old saying: “No one rings a bell at the top.” Or, we might add, at the bottom.

In August there was growing concern that the market would fall apart after technical traders documented what they refer to as the “Hindenburg Omen,” which had “never been wrong.” Fortunately for us all they were wrong, and the Hindenburg proved slightly less than foolproof.

Before the Hindenburg Omen there was major uproar over the “Death Cross” back in midsummer. The Death Cross is a technical indicator where a particular moving average crosses another. Once again, the technicians got it wrong, and the markets staved off “impending” disaster.

The fact is that as the market’s post-crash rally has continued, investors have grown increasingly skittish on fear that stocks will fall a second time.

So strong is this fear that the many stock prices are becoming irrationally depressed. In fact, right now approximately one-third of stocks in Standard and Poor’s 500 Index have dividend yields that are higher than the interest rate on 10-year US Treasury bonds. (This means that investors in those stocks are effectively being paid higher interest than the 10-year Treasury, plus they have the potential for growth if stock prices rise – though they also have increased risk in the event of a decline.)

Lately many investors have been allowing their heightened concern to impact their investment decisions in ways that will ultimately prove detrimental to their financial well-being. As just explained, one example is the manner in which funds have been flowing away from yield.

Despite the fact that so many stocks have higher yields than Treasury bonds, assets continue to pile into government debt. However, even more concerning is the amount of money being invested in gold and precious metals, which produce absolutely no yield whatsoever.

Admittedly many of these commodities have their advantages, primarily as insurance in the event of economic calamity or political upheaval. However, neither of these is altogether likely to occur in this country in the near future.

Lately gold is being paid a particularly large amount of attention, largely because it recent reached a new all-time high. While obviously we can’t say whether gold has reached its top, neither can anyone else.

Investors can rest assured, though, that when the metals market finally reaches its apex, there will still be people forecasting that it will continue climbing higher, that “this is only the beginning.” This was true of real estate several years ago, and tech stocks before that.

It is safe to say that lately precious metals, especially gold, have begun to exhibit classic topping signs. It’s almost impossible today to pick up a newspaper or magazine without finding an ad for gold; and you can forget trying to watch TV without seeing G. Gordon Liddy or that guy from Law & Order pushing the stuff.

[As a quick side note, the fact that people are willing to take investment advice from an actor and a guy who went to prison over the Watergate scandal is simply mind-boggling.]

In fact, in the process of writing this very article our office received a call from a solicitor trying to get us to buy silver. Now, when an investment firm that has been in and out of metals for more than twenty years, and is constantly studying the intricacies of these specialized markets, starts getting calls from telemarketers with little more than a script to go from, something is just not quite right.

Unbeknownst to many fearful investors, over the past several months the economy seems to have begun staging a fairly well-founded recovery. Currently automotive acquisitions (supplies buying one-another) have been occurring at the fastest pace in nearly a decade. Many more companies, which have been sitting on substantial cash, have been putting their reserves to work in expansion products and stock buybacks.

Sooner or later investors will become aware of the recovery that’s underway, and market prices will certainly reflect this realization. The only question is whether investors will be benefiting from prices changes or reacting to them.

Wednesday, September 8, 2010

Making Cents of Savings

Quite often we are asked by readers and clients how we recommend investors develop a long-term financial plan, and what kind of investment strategies we recommend. Though these are topics we typically try to work into our normal pieces, from time to time it’s necessary to dedicate an entire space to exploring ideas about saving, financial planning, investing, and so on.

First and foremost, let us say that financial planning is one of the most misunderstood and overcomplicated concepts in modern finance.

Obviously all investors need to build some sort of loose financial plan in order to help them save and invest money for the future. It’s also nice to find ways to avoid (NOTE: not evade) taxes when possible. However, most people are under the impression that this process is way more complicated than it truly is, thanks mostly to people in the financial services industry.

Most financial planners try to sell financial plans by the pound; because that’s the only way they’re profitable. Most people simple don’t need one. Most have issues that they need to deal with as they arise (e.g. kids that will be going to college, elderly parents who need care, etc), but very few have so many issues to consider at once that a full-blown financial plan is warranted.

What’s more, very few investors realize that the second a new unexpected issue arises, the costly plan they just paid for is probably obsolete.

This is because all financial plans are built on assumptions. In order to make any kind of forecasts, certain variables need to be taken out of the equation. Interest rates, average annual returns, taxes, even the rate of inflation needs to be “approximated” (read: guessed). If any of these “approximations” become inaccurate, so is any financial plan based on the incorrect assumptions.

The single greatest aspect of any sound plan for saving or investing is this: flexibility. As circumstances change, it is of the utmost importance that they be able to react to those changes. However, these circumstances aren’t limited to lifestyle issues, they also include economic developments.

As economic circumstances change, it is critical that investors be able to react. Follow the old Marine Corp mantra to “improvise, adapt, and overcome” to changing market conditions.

Unfortunately, the vast majority of people believe that they can construct a portfolio to buy and hold, regardless of changes in the investment world, based on their individual characteristics.

Typically they consider age, income, net worth, tax bracket, risk tolerance, etc. I’m sorry to say that this strategy absolutely doesn’t work. The fact is that the investment world simply doesn’t care about investors, much less their age, average annual income, or “risk tolerance.” Nor does it care about height, eye color, pre-existing medical conditions, or any number of useless factors.

The investment world reacts to economic developments, political climate, monetary policy, and a host of broad factors that are ever-changing.

In our opinion, the three criteria required of any successful savings and investment plan are:

1. A savings plan that is disciplined and consistent,
2. A financial plan that is adaptive to lifestyle changes, and
3. An investment strategy that is flexible and reactive to changing market conditions


In order to achieve financial independence, it is critical that investors employ these three factors with at least moderate success over a long term. The three can be prioritized, but never neglected.

Wednesday, September 1, 2010

Investor Sentiment Follows Party Lines

Though many try, in our business it’s extremely hard to ignore politics. Aside from being difficult, it can also be expensive. After all, government policy has a tremendous impact on economics, which in turn influences the global financial markets.

As we’ve written before, generally speaking we try to remove ourselves from our own political opinions while analyzing investments. Unfortunately, we can’t ignore them completely. To do so would be to ignore one of the biggest factors impacting the investment world.

However, while we have our own opinions, we also recognize that when analyzing the current political or economic atmosphere, our opinions simply don’t make a difference. This has nothing to do with whether our views align with current party in power. It is simply necessary that we understand that our own opinions are of no consequence, and we need to take an objective view of the world.

Each and every day market prices are determined by consensus. Though the market continues to reach this consensus, we have been seeing markets become increasingly divided – just like the current political situation in this country. As in Washington, people on Wall Street are tending towards extremes.

Today some argue that we are in the midst of the most severe depression since the 1930s, while others argue that we are on the verge of one of the fiercest bull markets in a generation.

It might seem strange, but these forecasts are strongly influenced by political beliefs. Beliefs, not in what politicians in Washington SHOULD do, but how circumstances will likely play out because of what’s already been done.

Across history, the vast majority of the time this country is relatively centrist, politically speaking. At different times in history, though, the US can become torn between extremes. This seems to be one of those times. Further, the extreme opinions on politics are also impacting people’s view of the economy and markets.

For an example of the division currently facing our country, look no further than Glenn Beck’s recent rally at the Lincoln Memorial. Just as importantly, explore the differing reactions people have to that event.

It’s important to understand the factors weighing on the world today, but just as important is where we go from here. Some say revolution or a second civil war. These are so unlikely that they’re hardly worth considering.

Through history, while extreme opinions sometime come to dominate political or business climates, they trend always back to the center. This theory of mean reversion applies across a great deal of disciplines, from meteorology and chemistry to sociology and philosophy.

Thankfully, it also applies to economics, politics, and finance. Each of these subjects is the study of either people or the world around us, both of which have natural equilibriums that exist. Despite the occasionally extreme conditions that occur, these equilibriums tend to be sought out.