Wednesday, August 10, 2022

Banana Republic

Banana Republic

The United States officially became a banana republic (and I don't mean the cargo-pant slinging clothier) on Monday August 8th, 2022. Couple the Trump Raid with the looming passage of the "Inflation Reduction Act" adding 87,000 armed "tax police" and we are there dear readers. As my good friend Jackie Chiles would say "Outrageous, Egregious, Preposterous!"

Under the auspices of non-compliance with an Archives Act violation (what is that anyway?) the FBI raided former President Donald Trump's Mar-a-lago home Monday August 8th, 2022 in the most brazen political hit job this country has ever witnessed. On the heels of this raid, Democrats have voted 51-50 to send arguably the most freedom destroying legislation to the House. The impact of creating an armed partisan tax police with 87,000 new recruits boggles the mind. This country is in trouble.

When justice is no longer blind to political affiliation or religious beliefs or the Bill of Rights truly storm clouds brew. Such is the case now as the country will undoubtedly become more polarized along political lines as the Constitution becomes a notion rather than an ideal.

What is a financial farmer to do? Oddly, the market continues to rally into the better-than-expected horrible inflation number (8.5% vs. 9.1% previously) so a crest in inflation may sling-shot us out of a Bear Market. But to a larger extent, the market is always forward-looking. How far forward is a matter of debate, but something along the lines of 6-9 months is a reasonable assumption. And based on inbound data from recent macro events it *appears* that with inflation peaking the Fed may only have to raise another couple points. 

"Only have to raise another couple points" is a tricky proposition nonetheless, as mortgage rate increases tied to the 10-year Treasury Note dictate the housing market. Expect purchasing to slow, inventory to rise, mortgage payments to be missed, and a general malaise to hit the housing market. It is hard to believe housing will continue to rally into a near-doubling of rates. The one savior (economically speaking) of this economy is the unemployment rate.

With historically low unemployment and steady to higher wages, the consumer has some semblance of protection from inflation, protection in the sense that they can now get less for more; "grin and bear it" has become the signature economic policy of the Biden Administration.

That's where we're at now as a country, trying to shoulder the burdens of inflation without breaking our backs all the while watching the rule of law disintegrate. But keep faith dear readers, as so plainly spoken in "Unbroken": "If you can take it, you can make it."

Thursday, August 4, 2022

Heat Waves

Heat Waves

It is said that farmers live and die by the weather, so too with financial farmers. Particular amongst weather events are heat waves. These heat inductions outside nominal weather conditions typically have rapid onsets. We know they're coming, but not necessarily the time or place. So too with Bear Markets. A confluence of events result in both; for farmers a heat wave can lay waste to their crops and livestock; for those of us farming for profits and cash flow, a Bear Market can do the same to our portfolios.

World War Z has one of my favorite lines: "First to know, first to act." It relates to the measures North Korea took to prevent the spread of the Solanum virus. It is application to both farmers and financial farmers is immense. In terms of farmers and ranchers, knowing weather patterns allows them to prepare (somewhat) for conditions on their farms and ranches. Sadly, most are held hostage to the weather they get. There is a limit to the actions that can be taken; increase the watering, provide shade perhaps, and maybe move the herd. The investor, however, has multiple choices when a heat wave is imminent. 

As discussed in a previous post, financial farmers have the ability to pursue an Absolute Alpha approach. This strategy harnesses early warnings systems to alert an investor to changing economic conditions. But just like heat waves and meteorology, the time and place of a Bear Market aren't precisely known to economists. Say hello to our old friend Pareto.

Pareto's Principle states that 80% of most results are directly proportional to 20% of the inputs. For our purposes we are keen to know where we are in an economic cycle and the corresponding stock market rotation (Bull/Bear). Why? Unlike farmers and ranchers beholden to heat waves, investors have the opportunity to take drastic, immediate action to protect their portfolios. 

Being on the right side of a trade is vital; stay too long on the wrong side of a trade and you risk serious financial pain that may not be recoverable in the short term (or long term.) Also, being on the wrong side of a trade naturally implies you are NOT on the right side of the trade...hence the opportunity cost of a being on the upside. Farmers, ranchers, and investors all know time is a valuable commodity. Maybe the most valuable. And generally speaking, being wrong for extended periods of time is bad for business.

Friday, July 29, 2022

Tax & Spend

Tax & Spend

If you really want to destroy a society, debase its money. With the M2 money supply currently at some $21T (that's correct, trillion) from a previous level of $14T, the country is flush with cash. This is causing lots of problems and weird things to happen. 

In terms of problems, too many people have too much money chasing too few goods. Hence, inflation is rampant. Of the two ways to combat this, either increasing supply of goods or killing demand, the Fed has chosen the latter. But even that action will be of little consequence if spending increases at a similar clip to the supply of money.

Money needs to come from somewhere, and the Treasury has been happy to keep the printing presses going night and day. This has led to an environment of stagflation and the government choosing winners and losers; the winners are the pork barrel recipients such as healthcare, (the) climate Solyndras, and "infrastructure." You can count on your taxes going on up, way up, especially if you're a small business owner. The pitch is always "pay your fair share" or "just a nibble" and when you take a look in the kitchen are your cookies are gone.

What is an investor to do? You need some good strategery. Assuming the omnipartisan "Inflation Reduction Act" agreed upon by Democrat members of the Senate gets approval in the House we can expect the "Tax & Spend" moniker to ring truer than ever. Investors need to adjust their portfolios accordingly.

Consider where and how the wealth redistribution is occurring, determine who the net losers and winners are, and allocate accordingly. Fighting the Fed is hard enough, fighting both the Fed and Congress is nearly impossible, especially when the IRS is being weaponized. Like the Indians of old, look for the gravy train and attack. Mark Twain put it best when he said "No man's liberty or property is safe while Congress is in session."

Saturday, July 23, 2022

ACA Gravy Train

ACA Gravy Train

In the annuals of history, there has naught been a bigger Gravy Train than the passing of the "Affordable Care Act" on March 23rd, 2010. It is a day that will live in infamy.  Imbued with the power of nation-states by the Sun King Barrack Hussein Obama, health insurers were granted pass-through monopolies.

Consider the charts above of the four largest remaining publicly traded health insurance companies. Almost to the day of ACA passage there has been a meteoric rise in their respective share prices. How is this possible? Amazing care? Deft management? Sweeping reform? Oh no dear readers, these companies have the implicit power to charge whatever the market will bear...and if you can't afford it, the government will pay your premium, but if you can afford it and DO NOT pay, then you can go to jail (the government of course determines "affordability.") Got that? 

So while Chicago burns this summer (both figuratively and literally), its most famous son, who vowed that "the South Side of Chicago is my Martha's Vineyard," is inking yet another lucrative media deal at his estate in...Martha's Vineyard.

The hypocrisy is as thick as our vast oil reserves that can't be pumped. In terms of corruption and maleficence perpetrated on the American people, the ACA ranks high. Consider the fallacy of mandating purchases, at any price, from private companies with geographic monopolies, of a product you may or may not use, but you are required to buy less face the loss of your freedom. Preposterous.

If there's one thing we've learned at ILAF though, crazy pays. Consider all the innovation in the tech space over the past decade. Or in EVs. Or in just about EVERY industry. The only thing healthcare seems to have innovated is consolidation, increased premiums, and higher share prices. Now that dear readers is true innovation! 

Friday, July 22, 2022

Reverse Engineering

Reverse Engineering

Generally speaking, stock prices increase with increased earnings. When a company makes more money, in general, their shares are worth more because investors put value in growth and reward it by bidding up the share prices of companies that increase their earnings. Naturally, the opposite is also true. Granted, there are always exceptions to the rule, but for the most part earnings drive the market higher.

Along those lines, investors should be able to reverse engineer a portfolio based on their spend habits, or even consider the spend habits of a typical cohort. So for example, if you have a breakdown of your monthly expenses you can also typically trace that spending to broad sectors, and specially individual brands. This provided a good backdrop to the Chinatown adage of "follow the money."

A classic Maslow's hierarchy of needs also works well in this example. For the "average" American, the top three expenses on a recurring monthly basis are housing, medical, and food. Now for people who are NOT self-employed, that medical cost might not be too high because your employer is picking up the tab. Consider their cost in our example as yours.

So right from the start we can see from a percentage basis how much of our monthly income feeds the banks for mortgages or the landlord, the medical plan operator, and the food prodders. Depending on your situation, there most likely will be energy costs (fuel and/electric), clothing, entertainment, and many others. List them out and I suspect you'll start to see the brands behind the sectors popping up. Take note of the specific brands you utilize both as a function of your purchase, but also your time. You might only buy a smartphone once a every couple years, but you most likely are using it frequently. Same for a computer. TV. Internet.

All of these purchases and time uses trickle down to brand utilization. The brands with the most utilization should be ones you pay attention to from a portfolio perspective. You are probably not alone in your brand utility. And generally speaking, yet again, the fewer brands choices you have for a good or service or time usage the more of the total market that brand is capturing.

This reverse engineering exercise should reveal some very powerful, some would say monopolistic, brands in your life. Maybe you should consider owning them?

Tuesday, July 19, 2022

One-Two Punch

One-Two Punch

Americans have been economically knocked out by their elected leaders. The Wayfair decision and American Recovery Act language stipulating a Form 1099-K for transactions totaling $600 or more effectively acts as a one-two punch. When did we vote to join a Fight Club?

In the words of noted U.S. attorney Jackie Chiles, it is "outrageous, egregious, preposterous" to pay elected members of Congress to knock us to the mat. Enough is enough. This author believes Wayfair was the single most harmful Supreme Court decision in a generation. Consider the rationale.

When basic freedoms are destroyed or restricted, it leads to the rise of juggernauts that monopolize the respective industries; whether they are natural resources, air travel, or in this case internet commerce. And internet commerce is huge...literally hundreds of billions of dollars of goods and services flow through those fiber optic cables on a daily basis. Every. Single. Day.

They say people get the government they deserve, but we don't deserve this...the problem arises that there are two (possibly three) sets of standards; one is the citizen taxpayer who is treated like dirt. Then there is the elected officials. They treat themselves well. The third is the true constituency. Now a rationale person would ask "Isn't that the citizen taxpayer?" Theoretically, yes. In reality, the true constituency is corporate America (think S&P 500 constituents) and pandering to special interest voting blocks.

Sadly what arises is the decay of the foundational Constitutional values AND rights. Citizen taxpayers get a watered down Slushie while the political machine feasts. The solution? One is to vote them out. That is very, very difficult in states like California with a majority rule impervious to reason or accountability. Another idea is to vote with your feet. That option is not available to everyone, but most people who can, do. Finally there is the "moat" strategy. This idea involves creating an economic and social moat by capturing enough value in your life to protect your family from your very government.

Saturday, July 9, 2022

Ghosting Pareto

Ghosting Pareto

Ghosting Pareto is like avoiding gravity. Yet, this is exactly what investors should do. Why suffer the proverbial "slings and arrows of outrageous fortune" shot by Big Finance when alternative strategies exist

Vilfredo Pareto is best remembered as an economist of the namesake "Pareto Principle" which is a economic, social, and mathematical rule of thumb commonly referred to as the "80/20 Principle" or the "80/20 Rule." It is the recognition and codification of a naturally occurring phenomenon in life which he learned occurred in nearly every facet of life; whether it be income distribution, height, or even touchdowns thrown.

Investors should be concerned with Pareto because he helps us, indeed reveals, that the market for the most part is bullish over time. There are, however, vicious downturns that roll through the economy like sneaker waves every 4-5 years aptly termed Bear Markets.

Big Finance (kinda like Big Tobacco, but more dangerous) continually pitches "buy-and-hold," "weather it out,' and "dollar cost average." Are these bad strategies? Not necessarily, but investors rarely, if ever, hear about methods to avoid Pareto; ie selling covered calls, buying puts, or selling short when markets turn.

Nobel Laureate Paul A. Samuelson made a profound comment when he said: "The longer you own stocks, the greater risk of a devastating loss." Think about that for a moment. As investors gradually build a portfolio over time it generally goes up in total value. Meaning, just at the point of retirement a portfolio is the most susceptible to a sneaker wave. Take a look at the historical performance of the S&P 500:

For those visual learners out there like me, it is apparent that enough sneaker waves roll in often enough to really put the hurt on a long-term portillo and potentially destroy decades of wealth. How often are these sneaker waves rolling in? You guested it, about 20% of the time. Meaning you can be cruising along on your yacht 80% of the time with the wind at your back, sun shining, and boom! A sneaker wave strikes.

How do investors avoid Pareto? First, investors need to accept that sneaker waves exist. For some reason Big Finance is obsessed with telling investors that they should only buy, buy, buy. I wonder why that is? Hmmm. Second, investors should build an "all-weather" strategy. This might be as simple as selling when the tide turns. Or it might be an aggressive approach like riding the wave, see Absolute Alpha. Third, investors should codify their strategy and monitor it. 

Blindly dumping money into Index Funds and ETFs has been the hallmark pitch of Big Finance now for decades. Low cost! Low cost! chimes the jingle over and over like Chinese water torture. And as the billionaire heirs and executives of these juggernauts motor by in their cash-burning steamboats, who's advising investors to avoid Pareto? ILAF, that's who! 

Wednesday, July 6, 2022

The Bear Necessities

The Bear Necessities

If every policy maker is against you, who is for you? ILAF, that is who! As investors recover from a long weekend it is important to focus on The Bear Necessities to avoid indigestion. To date, this Bear Market (using the S&P 500 as our benchmark) is off approximately 20% from its highs. Crunching almost 100 years of data (because that's what we like to do at ILAF) the average Bear Market sells of approximately 36% from its high. Meaning? We are in the eye of the hurricane now, with plenty of pain left!

Another useful metric is the "time in a Bear Market" which averages 289 days or roughly 10 months from start to finish. We have been in the current Bear Market since highs were reached on January 3rd, so a little over 180 days. So that is the top-level data. Maybe more important, however, is economic policy. 

Current economic policy is focused on increased regulation, increased taxation, increased spending and the Federal Reserve poised to raise interested rates on guess what? Yes, increased inflation! Expect a 75- basis point hike again in 3 weeks to fight inflation. Sadly, consumers have largely burnt through their Covid savings and are now dipping into grubstakes squirreled away for retirement, house down payments, or starting families. Love hurts, and so does inflation.

What possible Bullish metric remains? Ahhh...the old "We have bottomed" theory. There has been a significant demand shock in oil over the past month as consumers have changed behavior. Most commodities are now significantly off their recent highs. Just about the time the full force of government intervention begins, consumers have already changed their spending habits. Combined with the Fed's sudden desire to "break the back" of inflation, this will almost certainly exacerbate the situation and result in a hard landing.

What is a hard landing? Imagine that the economy has self-corrected and oil prices have fallen 20% in 60 days while mortgage rates have nearly doubled. The supply/demand dynamic is already self-correcting. Yet, the most powerful unelected force in the world (sorry China), the Federal Reserve, now puts their heavy hand on the scales by raising rates. Ouch! Who's running this country?

The bottom line? Focus on the bare necessities; structure your portfolio and lifestyle accordingly. It is the belief of ILAF that the lows are not yet in, we are currently in a recession, and no meaningful economic recovery will happen until we get economic policy changes. As the Middle Class goes, so goes the country. Ben Franklin said it well: "If you want to double your money, fold it in half and put it back in your pocket."