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Tuesday, September 4, 2012
Welcome Back My Friends
Friday, August 24, 2012
City Pension Board Rejects Studying "Realistic" Returns
City Pension Board Rejects Studying "Realistic" Returns
I'm a morning person, especially on these beautiful summer morns. I love the quiet, the girls sleeping, my papers waiting for me in the driveway, and a day full of possibilities. Occasionally that tranquility is shattered by something stupid I read in the papers. Today was one of those days. On the front page of Section B in today's Post Gazette I see the following headline, City Pension Board Rejects Studying "Realistic" Returns. The link can be found here: http://www.post-gazette.com/stories/local/neighborhoods-city/city-pension-board-rejects-studying-realistic-returns-650328/
My blood starts to simmer before I even begin reading the article. The City of Pittsburgh's Pension Board rejects studying using realistic return assumptions. They didn't reject actually adopting realistic return assumptions, they rejected the absurd notion of even studying the use of realistic return assumptions!
Now pension accounting can be fairly absurd in and of itself, but in a nutshell here's how it works. A city or state has pension obligations that they have promised their employees. Over the years the employees contribute part of their earnings to the pension plan and the city (i.e. Taxpayers) kick in the rest. In the case of Pittsburgh the employees contribute about 6% and the taxpayers kick in the other 94%. Pension fund accounting allows the municipality to assume a rate of return on their investment in order to defray the annual amount that the taxpayers need to contribute. The higher the return assumption the less the taxpayers have to kick in. Of course if those return assumptions don't turn into return realities then the pension fund becomes woefully underfunded, and either the pensioners take a huge hit or the taxpayers take a huge hit, or most likely both. As of June 30, 2012 the plan was only 57% funded.
In the real world (where you and I live), if we are saving for college or retirement, we actually put real money based on real assumptions into our investment plans. We base our contributions on actual returns, not hoped for returns. Oh well, politicians don't live in the real world, and they don't like math.
I'll give Mayor Luke some credit though. He says that he doesn't want to study realistic return assumptions because he knows it will lead to higher contributions, which can only be funded with higher taxes. The Mayor states, "To me this is where this is going, and I'm not going to do it." He fully understands that reality bites, and he chooses to ignore it.
Since City Controller Michael Lamb was shot down by proposing a projected return study, I thought I would do my mornings allotment of community service by doing the study for him pro bono.
Over the years I've managed investments for numerous pension plans while at Mellon Bank, Federated Investors, and National City Bank, including our beloved City of Pittsburgh. I've sat in these board meetings, and have always tried to bring a modicum of reality to the presentations. So speaking in real terms for Controller Lamb here's his study:
According to the most recent Investment Policy posted on the City's web site dated March 2009 (they're not very good at providing current information), the city uses a fairly standard asset allocation of 65% Equity and 35% Fixed Income. The City uses a fairly static "buy and hold" asset allocation strategy, versus a more dynamic tactical asset allocation. Over the five year period ending December 2010 (again, the most recent numbers posted on their web site) the City's plan earned an annual return of 3.5%.
For the sake of our study lets assume that the plan is still invested 65% in equities and 35% in fixed income. What type of "realistic" returns can we expect?
Let's start with Fixed Income since it's the easiest. News Flash - Yields are low!
A two-year Treasury bond yields 0.25%, a ten-year Treasury bond yields 1.65%, and a 30-year Treasury bond yields 2.75%. Investment grade corporate bonds yield a few basis points more than treasuries. High-yield corporate bonds yield about 6%.
Using current interest rates and looking out over the next ten years, a diversified fixed income investor, willing to own some high-yield bonds, could expect a return in the 2.5% - 3% neighborhood. We'll say 3% since we're in a generous mood.
Projections for equity returns are a bit more complicated, but not too bad. Equity returns are a function of three items, 1) the current dividend yield, 2) the current earnings and projected growth rate of those earnings, and 3) the P/E ratio (price-to-earnings) that investors will be willing to pay for those earnings in say 10 years.
1) The current dividend yield is easy; the S&P 500 currently yields 1.95%.
2) For the S&P 500, current year GAAP earnings are projected to be $100. Earnings growth is a function of GDP growth and inflation. For the last 82 years earnings have grown at about 6% annually, and GDP has grown at 3.3%. Considering demographics, and the massive (and increasing) deficit the nation is burdened with, it is fair to assume that future GDP growth in the neighborhood of 2% is realistic.
With 2% GDP growth we could realistically assume that corporate earnings will grow at about 4-5%, again lets be generous and say 5%.
3) Price-to-Earnings Ratios. The current P/E ratio for the S&P 500 is 14x. Over the last 82 years the average PE was 16x. PE's are a function of investor confidence, the more confident investors are that future return assumptions will play out, the more willing they are to pay for those returns. The less confidence they have in the future, the less they are willing to pay for those return assumptions. Today investors are faced with global macro risks that have rarely been faced in history. The very real specter of higher taxes on both dividends and capital gains also eats into returns. The greater the level of uncertainty, the lower the PE. A conservative/realistic investor would probably assume a future PE ratio of about 12-14x. With a few policy errors it would not be unusual for the PE to drop to 10 or lower.
Putting all of these variables together (a dividend yield of 1.95%, future earnings growth of 5%, and a terminal PE of 12-14x) we get an expected return on equities of 4-7%. Let's use 6% for arguments sake.
OK, so over the next ten years we can reasonably expect to earn 3% on our 35% fixed income allocation, and 6% on our 65% equity allocation, for a combined realistic return assumption of 4.95% ((.03*.35)+(.06*.65)). Again, being in a generous mood we'll just call it 5%.
So there it is Mayor Luke and Controller Lamb, your pro bono pension return assumption analysis says that if you hope to move your currently woefully underfunded pension closer to funded status you should use a return assumption of 5%. Of course this would require making tough decisions on raising taxes and cutting services, but isn't that what we pay you for?
Be careful out there, and keep the lights on,
Chris Wiles, CFA
412-260-7917
For prior Rockhaven Views visit:
This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
Sunday, August 19, 2012
Writer's Block
"Writers block is a fancy term made up by whiners so they can have an excuse to drink alcohol." - Steve Martin
Dear Friends and Readers, apologies for the relatively lengthy hiatus, but lately I have been distracted and humbled in the act of writing. Specifically, I have not been writing as frequently for a number of reasons, namely:
- Not having much of interest to say;
- Being exhausted and thoroughly frustrated with the partisan political wrangling and inane commentary on the financial markets;
- Enjoying the last days of summer with my family and a few good books;
- Forcing myself to focus on the big picture; life, happiness, and the pursuit of the perfect portfolio.
So with this post I have resorted to the last desperate act of a blocked writer...writing about writer's block.
Fortunately, for me at least, I have been bitten by my muse, and I have several subjects to write on. More importantly, over the next several months you'll be witness to a reenergizing of Rockhaven Capital Management. Hopefully you'll find it as exciting, and more importantly useful, as I believe it will be.
It is frustratingly hard to be an investor and saver in today's world. My overriding goal is to try and help as many people as possible, understand and hopefully prosper, in these chaotic times.
Please enjoy your final days of summer, the markets and all their craziness will still be there when you return.
Be careful out there, and keep the lights on,
Chris Wiles, CFA
412-260-7917
For prior Rockhaven Views visit:
This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
Tuesday, August 7, 2012
A Pox On Both Houses
A Pox On Both Houses
One of the things that I certainly didn't miss while in Europe was the constant lying during every commercial break, otherwise known as campaign season (which seems to last about 18 months of every year). It only took a few hours to snap me back to the reality of just how distasteful our political process is, it simply reeks.
Fortunately Congress is now in recess for five weeks. Yeah, yeah, I know they have a lot of work they should be doing, but honestly the world seems to revolve just fine when they're gone. Actually the world of stocks simply loves it when Congress is not in session. One of the most interesting stock market anomalies is called the "Congressional Effect", which is the tendency of stocks to fall when Congress is in session and to rally when they are on holiday. One academic study examined the Dow's performance from 1897 through 2004, and found that more than 90% of the market's capital gains occurred when Congress was not in session. The Dow returned 5.4% on an annualized basis when Congress was in recess, but only gained o.4% annually when they were in session.
Another more recent study looked at the 46 years from 1965 through 2011 and found that the S&P 500 gained 16.6% annualized during periods when Congress was adjourned versus a o.7% annual gain when Congress was in session. Of course this may just be some weird statistical fluke, but it also might be based in the reality that investors consider Congress to be more of a hindrance to the economy than a benefit. Either way, lets enjoy the next five weeks while we can.
Don't Fight The Fed - Fed President Calls for Open-Ended Bond Buying
Another bullish interview happened this week with Erik Rosengren, president of the Federal Reserve Bank of Boston (a non-voting member of the Fed), called on the Fed to launch an open-ended bond buying program that would continue until the economy grows and unemployment falls. Mr. Rosengren is part of a group of Fed officials who believe that even though the Feds stimulative efforts haven't led to economic growth or lower unemployment, the reason is simply because they haven't done enough. Of course there's another school of thought (one that I attend) that believes the reason the Fed's stimulative efforts have been ineffective is because economic participants realize that these efforts just lead to larger deficits and a more prolonged recession. Never-mind, the fact that the Fed is floating trial balloons about "open-ended" bond buying is seen by the market as another sugar fix. Don't fight the Fed, and don't fight the worlds central banks.
Also, Don't Fight The Tape
While volumes have been light, the markets have continued to subtly work their way higher. The S&P 500 is up 10.77% through July. Strangely, commodities and Treasuries were both up more than 5% in the month of July. This gradual move higher in risk assets has caused us to lower our cash holdings from 40% to 23%. We increased our weight in US Equities, International REITs, Commodities, High Yield Bonds, MLPs, and Emerging Market Debt.
Here's where we stand today in our Global Tactical Asset Allocation Portfolios:
US Equities -- 25% Bullish,
The US equity markets are still in a trading range, but sentiment has moved into bullish territory.
Int'l Equities -- 3% Bearish,
while improving, both developed and emerging equity markets are still in bearish territories. We remain at our minimal weight.
US REITs -- 6%
Bullish, we are still at our full US REIT target of 6%, but they are showing some early signs of weakness as investors get more aggressive.
Int'l REITs -- 4% Bullish, international REITs have moved decisively into bullish territory.
Gold -- 5% Bearish, Gold remains in bearish territory. Gold's trading range has been very narrow, but also fairly volatile.
Commodities -- 6% Neutral, Strength in grains and oil have led to an improvement in commodity indicators.
US Fixed Income -- 25% Bullish, US Treasuries continue to be near record low yields. High-yield bonds & MLP's have moved into bullish territory.
Int'l Fixed Income -- 3% Neutral, Emerging market bonds have improved along with other risk assets.
Cash Equivalents & Currencies -- 23%, cash levels have increased dramatically, and are divided between the US at 21%, and 2% in China.
Be careful out there, and keep the lights on,
Chris Wiles, CFA
412-260-7917
For prior Rockhaven Views visit:
This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
Sunday, August 5, 2012
Vacation, All I Ever Wanted
Vacation, all I ever wanted
Vacation, had to get away
Hola, and bonjour, I'm back from a couple of weeks vacation in Spain and France rested and ready to go. But go where? It seems that very little has really changed in the last two weeks, the markets have bounced a bit, because the fear of imminent economic collapse has receded. But none of the big picture issues facing investors have changed. Global economies are slowing, and the fiscal cliff still looms. If I were to base my investment allocation solely on macroeconomic data coming out of both US and foreign markets, I'd remain very cautious. However, based on the technical indicators I follow, the US equity markets have remained extremely resilient suggesting that we increase our weight to risk assets. The battle between fundamentals and technicals continues, and I'd expect a few changes to our allocations this week.
Anecdotal Observations from a European Vacation:
Fortunately I don't have to base investment decisions on anecdotal observations, we have a disciplined process, but it is always interesting to visit an area first hand. The flights to and from Europe were full, but not packed. Traffic in and around Paris was atrocious as usual, but the hotels had vacancies, and we never had any trouble getting a table, even without reservations. This was my first time to Spain's Costa Del Sol and the extent of the housing bubble was immediately evident. I've never seen so many vacant condo complexes, they put Las Vegas and Miami to shame. This was prime vacation time for southern Spain, but again we never had any problems getting tables for dinner, or chairs by the pool. While the yacht harbor in Marbella was full, it appeared that most of them were for rent or for sale. I was a little apprehensive heading to Spain because of the high 25% unemployment (50% of teenagers), but I never once felt uncomfortable. Everyone we met was friendly and helpful.
Southern Spain in August is a multicultural melting pot. The kids played beach volleyball with kids from Spain, England, Ireland, Italy, Jordan, and Lebanon. This being the social media generation, they exchanged email's and began Facebooking and Instagraming immediately.
I did have a couple of conversations with locals, and some other vacationing europeans, and what we are reading regarding their respective economies is all basically true. Politicians promised whatever would get them elected, and now no one wants to give up what has been promised. The adoption of the euro allowed countries like Spain and Italy to borrow at nearly identical rates as Germany, which led to massive overbuilding. In summary, it's a mess.
One of the best conversations I had was with a 30 something Parisian on my flight to Malaga. She works in consulting and spent five years in Chicago going to school. While she has a job her prospects for advancement are extremely limited. She said that her generation has very little hope for the future, they don't see any way out of their fiscal situation that doesn't lead to them enjoying a lower standard of living. On the bright side, she said, that instead of worrying about the future most of her friends just live for the day and try and enjoy life one day at a time. It's sad to see an entire generation resigned to the fact their standard of living is going to decline and there's nothing they can do about it. Education isn't the ticket out, they're all educated, there just isn't any growth.
Overall it was a great trip, the weather, food, and wine couldn't be beat.
Be careful out there, and keep the lights on,
Chris Wiles, CFA
412-260-7917
For prior Rockhaven Views visit:
This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
Saturday, July 14, 2012
I Could Change My Life To Better Suit Your Mood
"And if you said this life ain't good enough
I would give my world to lift you up
I could change my life to better suit your mood
'Cause you're so smooth"
What mood is Mrs. Market in? Is she bullish or bearish? Is she ambivalent or certain, apathetic or concerned?
She's a fickle mistress, but who could blame her. After all, she is made up of the collective intelligence and collective emotions of all of her participants. Some times her emotions run to the ebullient, while at other times she is deeply morose. Maybe I could change my life to better suit her mood!
Lately her mood has been more ambivalent, almost apathetic, and who could blame her. It's hard to be upbeat and cheerful when your returns for the last five years have been negative (S&P 500 -0.50% annualized), when 10-year bonds yield 1.50%, and your cash generates negative real returns. It hardly makes it worth getting out of bed.
The other problem is she's smart, wicked smart. She knows our problems, and she knows how to fix them. She knows that you don't fix a debt and entitlement problem with more debt and entitlements. She's watched our elected and unelected officials repeat the same mistakes over and over again hoping for a different outcome. Borrow more money to "stimulate" the economy. Bail out banks so they can keep lending to over-leveraged consumers. Lower interest rates to zero, and print money to buy your own debt, in the hope that it will instill confidence in the markets. She laughs at the political elites belief that we can all grow wealthy by borrowing and consuming, instead of producing and saving. She shakes her head every-time she hears them state, that a government, which produces nothing, can grow our economy.
She's hopeful that we can still come to our senses. She understands that businessmen love to grow; it is their inherent nature to grow their businesses, their profits, and their net worth. They find ways to overcome obstacles, they're creative, and optimistic. Politicians, on the other hand, believe that they have a superior ability to spend other peoples money, they focus on how to divide up the pie, not on how to grow it.
We've always had this tug-of-war between growing the pie, and slicing it up, and more times than not, as a nation, we've chosen to grow the pie. But she worries that this time the pie slicers may have the upper hand. It scares her to think that for over a generation both parties have been telling our citizens these lies. We've set up a system that rewards those who go into debt with tax incentives and bailouts, while we punish those who save and invest with taxes and inflation. The incentives are all wrong and they've been wrong for some time now. The facts aren't pretty. In 2010, 48.5% of Americans lived in a household that received some form of government assistance. That's up from 30% in 1982, and will be greater than 50% (if it already isn't) when ObamaCare takes effect. In the meantime, 49.5% of Americans paid no federal income tax in 2009, up from 34.1% in 2001.
Mrs. Market is powerful too. She knows that if she pouts, and sends prices lower elected officials tend to pay attention. Historically, they'd rush to change their evil ways. They'd enact reforms to slash taxes that discourage the investment of capital, and they'd abolish the red-tape that is stifling growth. But times have changed. Politicians hate the thought of anyone being more powerful then themselves. They've silenced her friend, Bond Vigilante, by allowing the Fed to print unlimited dollars to buy back their own debt. And now they're trying to silence her by making over 50% of the population beholden to the government, not the markets.
"Man it's a hot one, like seven inches from the midday sun..." This battle is shaping up to be a real doozy. While she may appear apathetic at the moment, Mrs. Market is eagerly watching the continued spectacle in Europe, the rapidly approaching November election, and the looming Fiscal Cliff. I have a feeling that she won't sit idly by over the next several months as our politicians continue to drag us over the cliff. She still matters, and she still has a voice, unfortunately she may have to shake us to our core before we actually wake up. "Well I'll tell you one thing, if you would leave it'd be a crying shame."
Again, we continue to be very defensively positioned with 40% cash, 25% fixed income, 5% gold, and only 30% in risk assets like equities, commodities, and REITs.
"When you see that trading is done, not by consent, but by compulsion - when you see that in order to produce, you need to obtain permission from men who produce nothing - when you see that money is flowing to those who deal, not in goods, but in favors - when you see that men get richer by graft and by pull than by work, and your laws don't protect you against them, but protect them against you - when you see corruption being rewarded and honesty becoming a self-sacrifice - you may know that your society is doomed."
--Ayn Rand
Be careful out there, and keep the lights on,
Chris Wiles, CFA
412-260-7917
For prior Rockhaven Views visit:
This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
Sunday, July 8, 2012
"Money, it's a gas
Grab that cash with both hands
and make a stash"
I'll admit it, I've always been a fan of cash. Cold, hard cash. Not that I carry huge wads around, but I want to know that I can get my hands on it at a moments notice.
Back in 1970, after Warren Buffett's grandfather passed, Warren found an envelope in his safety deposit box along with $1,000 in cash. The letter extolled the virtues of ready cash, explaining, "Over a period of a good many years I have known a great many people who at some time or another have suffered in various ways simply because they did not have ready cash. I have known people who have had to sacrifice some of their holdings in order to have money that was necessary at the time. Thus I feel that everyone should have a reserve. It is my wish that you keep this envelope in your safety deposit box, and keep it for the purpose it was created for."
Ever the vigilant student, Warren Buffett listened to Ernest Buffett's advice, and has kept substantial reserves in cash. He likes to keep at least $20 billion of Berkshire Hathaway's assets in liquid cash equivalents. Cash plays three vital roles in an individuals portfolio; 1) as a risk management tool, it helps mitigate the downside, 2) as an opportunistic tool, it's nice to have ready cash when an opportunity presents itself, and 3) as a liquidity management tool, having cash available for distribution needs.
Remember back in 2008 when the financial markets were in a death spiral, Warren Buffett was able to sit back and choose who he wanted to bail out and set the terms. He was able to extract a sweetheart deal from Goldman Sachs whereby Berkshire purchased $5 billion of preferred shares in Goldman paying a 10% dividend, and also received warrants to buy $5 billion in common stock at $115 per share. Berkshires portfolio was protected on the downside, and was subsequently able to take advantage of opportunities when they presented themselves.
Warren's Berkshire Hathaway is not alone in its fondness for cash. Even with cash holdings generating negative real returns, US Industrial companies have increased their cash reserves from $600 billion in 2007 to more than $1 trillion today. What 2008, and the ongoing financial turmoil, has taught corporate America is that you can't rely on the capital markets to be there when you need them. Companies, and individuals, need to be ready to fund themselves.
How much cash is enough? Clearly $1,000 tucked away in a safety deposit box won't get you very far in today's dollars. A safe starting point is to have at least one years worth of expenses covered. This is more than most pundits tell you to put away, but that's generally because they're trying to sell you something. Once you've set aside a years worth of expenses you can then begin thinking of how to use cash in your asset allocation process.
At Rockhaven, cash in our global tactical asset allocation model will vary between 0% and 60%. This percentage will vary based on our global macro-risk outlook. The cash allocation is determined by how attractive every other asset class looks on a technical and fundamental basis. We're not making an active cash call, cash is a default asset. Lets take US Equities as an example. Our allocation to US stocks can vary between 7% and 25%, we are currently at a neutral 15%. As our allocation to stocks increases or decreases, our allocation to cash moves in the opposite direction.
Our current allocation to cash is at 40%.
The Feds zero interest rate policy (ZIRP), makes holding cash a bit painful at times, but it also has its advantages. As stated above, holding cash helps protect us on the downside (we sleep better), and it allows us to be ready to move whenever an asset becomes extremely oversold. Of course cash isn't risk-less, everything carries risk. We have to worry about inflation risk, credit risk, and liquidity risk, but these are all risks we'd deal with no matter what. However, cash can be a great asset, or as Roger Waters said, "Money it's a hit. Don't give me that do goody good bullshit."
Be careful out there, and keep the lights on,
Chris Wiles, CFA
412-260-7917
For prior Rockhaven Views visit:
This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management. The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
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