Greetings. I sure hope that you and your loved ones are recovering emotionally from what has been an unbelievable 2020, and I hope that you're feeling clear-headed, strong and energetic. And if not, I hope that you're on your way to that place. Seriously - could you write a script that would ever be so jagged and dramatic as the series of events we've all been through in 2020?!?
As I reflect on where we've been this year (certainly only a partial list), I am thinking of:
... the yo-yo of the economy and the capital markets, shouting-match-politics, the pandemic, the promise of a vaccine, mask efficacy debates, social unrest, 'everyone's a virologist', the financial and emotional pain so many folks have had to endure, the irony of the parabolic growth of certain 'stay at home' companies, sky-high valuations of stocks and almost any financial asset, product shortages, inflation, deflation, the challenges to our democracy, the challenges to so many people's way of life, claims of breaking the law (both real and only claimed), murder, the horrific disrespect and treatment of fellow humans, the degradation of the environment due to to intentional harm and unintended consequence: like, too many people trying to visit national parks and the mountains of trash left behind, the inequality and wealth gap widening like a giant chasm, the exhaustion of those in the healthcare field, teachers and students struggling to learn without direct human to human interaction (only online), the inability of citizens to travel and congregate as they wish, personal rights and liberties being infringed upon, the increase in power of the media and the government...the list goes on and on and on...
Well, I can only do what I can do and that is to help you organize your finances and help you make wise decisions.
So with that, let's get started as we approach the close to 2020, and move towards 2021
As we've discussed in the past, we entered 2020 with LOADS of debt on all balance sheets: government, corporate and in many cases personal. And we've of course had an ultra-accommodative Federal Reserve, that, like it or not, is creating asset bubbles everywhere there's a financial asset and a liability off of that asset. This over-indebtedness and over-leverage applies to all asset classes and all sectors. There are a few exceptions, but very, very few. The flip side is that the latest personal savings rate report showed 14%! I can't remember a time other than just after 9/11 that we saw a rate that high.
An effective therapy already? YES...
Now that we appear to have some acuity into a Covid-19 solve, (some effective therapeutics/vaccines (only time, science and logistics will tell)), THAT IS a gamechanger of sorts. This means that the potential for really, really severe outcomes will likely be less severe and/or the severity won't be with us for as long. But this will take time to materialize assuming there are no setbacks. I pray there are no setbacks, obviously. It's just that we probably shouldn't uncork ALL the bottles of champagne yet. There will be time for that. And with the Fed being every risk-taker's friend, for now, the asset bubbles mentioned above may not pop for a while. But like every good party, at some point, there is a time when it ends.
By way of approach and performance review: as you know, as I've preached interest rate disinflation for years and years, we've been loading up on corporate and municipal bonds and investments with stated coupons and select duration in the neighborhood of 6%+ with corporate bond yields and 3%+ municipal bond yields. For example, we own XPO Logistics (you've probably seen their tractor trailer trucks on the road), senior corporate bonds with a 10% per year yield maturing in 14 years. That'll might just beat what the stock does over the same period. It may not, but it might. They'd have to execute one heck of a CAGR (Compounded Annual Growth Rate), over the next 14 years to top that...
Please note, many of our bond yields are lower than 6% and like XPO, some are higher than 6% (it just depends on when you became a client and when we put money to work). We've been doing this not to be anti-stock or anti-anything; we've been doing this due to a severe scarcity of higher-yielding, safe, secure investments that are higher up the capital structure than stocks. Our value stocks (managed both actively and passively), have, I think, performed handsomely, not subjected clients to cliff-drops as we're very careful to pay attention to metrics like price-to-sales, price to free cash flow, dividend payout ratios, competitive position in the marketplace, and reasonable debt profiles. Also these companies need solid access to capital markets, sustainable business models that don't have to be reliant upon a government bailout if times get tough, corporate leadership integrity, stability, and sustainable, dividend payouts.
Lastly, when the market was down -37% earlier in the year, nearly all clients were off by anywhere from 2%-10%. That's mission accomplished; and here's to limiting the downside the next time the other shoe drops. Our strong bond approach helps ballast our portfolios. I cannot emphasize enough that if you're close to retirement or in retirement, digging your way out of a -35% or more hole is brutal; the stark reality of the math makes that a serious setback. In addition, it makes our principal protected private pensions with good math income solves that provide lifetime income all the more attractive.
Investing while the Fed is overbidding the public in the struggle
The Federal Reserve's Primary and Secondary Corporate and Municipal Credit Market Facilities (two of the Fed's current programs), is officially RATIONING higher yielding corporate and municipal bonds. That's why we've been 'fighting the Fed', for so many years, if that is what you want to call it. Most of our pre-retired and retired clients own both stocks and bonds, but with one part principal preservation and three parts scarcity, we've been hoarding bonds for years now. That's because of what economist Ludwig Von Mises says about government price fixing in his treatise, "Human Action: A Treatise on Economics - The Scholar's Edition":
- "If the government fixes prices at a height different from what the market would have fixed if left alone, this equilibrium of demand and supply is disturbed. Then there are - with maximum prices - potential buyers who cannot buy although they are ready to pay the price fixed by the authority, or even a higher price. The price can no longer segregate those potential buyers and sellers who can buy or sell from those who cannot. A different principle for the allocation of the goods and services concerned and available necessarily comes into operation. It must resort to rationing. But rationing does not affect the core of the issue. The government's interference is that production of these commodities drops or stops altogether. It is a complete failure." - Ludwig Von Mises
Please note that he wrote that about 'interference with the structure of prices', and most folks apply those principles to the production of commodities and services, but I submit, that as a buyer of income investments, and one who knows a lot about price discovery in the capital markets, these principles apply to the production of income investments available to investors as well.
Today, the 'word on the street', is that solvency and potential default issues are no longer an issue for corporations. That's simply not true. In 2021 and 2022 we will see how the markets deal with the expiration of programs like eviction moratoriums and forbearance of rent and other situations where debtors are not paying their bills on time or in some cases at all.
"Maintaining interest rates at extraordinarily low levels for years on end has contributed to the rise in asset prices and the increase in debt. Debt has now reached a level where it is a drag on the willingness to spend and likely to be the trigger for a future crisis. Short-term stimulus reinforces the misallocation of investment between sectors of the economy, and its impact on spending peters out when households and businesses come to realize that the pattern of spending is unsustainable." Mervyn King - former governor of the Bank of England
The chart below illustrates how effective the Federal Reserve's Facilities have been at mashing down borrowing costs for corporate borrowers even in the very speculative parts of the debt market. I won't bore you with the nerdy details here, but suffice it to say, that these facilities are eliminating normal market pricing dynamics and it's not clear what the implications will be longer term as there is an artificialization of both lower than appropriate borrowing levels, and a low default rate environment. The prices of individual bonds are literally determined by the Federal Reserve rather than the markets. In simple terms, it's QE for corporate bonds and municipal bonds. And I contend that in the near future, they'll be buying individual commercial real estate loans along with equity ETFs. That's a story for another day.
Always trying to recognize VALUE
Many of our value stocks have been strong of late and I have to attribute most, not all, of those moves as a rotation out of tech growth names and into value names. I'd like to tell you it is some sort of investing magic, but it's just not paying too much for your investments and understanding what a reasonable price range is based on their earnings and not getting caught up in the hype of the stocks du'jour. But this means that there are time periods when we don't make as much money as many managers who take on much more risk.
Walgreen's is a great example: WBA is priced at 0.2 price to sales, pays a 4.5% common dividend, is right-sizing their store footprint emphasizing same store sales and profitability and stand to frankly make maybe more than a billion dollars dispensing vaccines over the next 18 months or so (a guess).
Have a bias towards selling more so than buying (even with a 'vaccine')...EVEN THOUGH, as I mentioned above, the positive therapeutics/vaccines development IS a gamechanger (and bullish for the economy), that's for sure. It doesn't mean you don't invest in things, it just means, have more of a sell risk assets at present rather than a buy risk assets mindset. This may seem to fly in the face of what folks on CNBC are saying but remember 2000 and 2007?
Remember the old adage, "Buy low and sell high"? Of course you do. Well, as of this moment, there are very, very, very few things that are priced low versus the level of both uncertainty and extreme valuation we face today. So, pick something you own that is a financial asset, if you don't use it or don't need it, (or maybe because it's up 387% from where you bought it (just an example)), and sell it. Seriously. Pick something and sell it. You'll capture a gain and you won't have to worry about finding a buyer in the future and unloading it for an above-market price. The truth of investment cycles has not miraculously gone away. We've not entered a new nirvana (despite what you'll see/hear in the financial media).
I found a lake house in the mountains where a person paid $342k three short years ago, according to the county records had done no structural improvements (admittedly, may have done cosmetic improvements), and has it on the market listed for $650k. That's a person who isn't necessarily timing tops and bottoms perfectly, but by listing it to sell it, they are at least recognizing value.
I won't disagree in the obvious rotation out of uber-expensive tech names that have run like crazy into more normal value names, but as Dave Rosenberg said recently, this current, value-phenomena is more of a 'trade than a trend'. There are reasons why we invested in Raytheon shortly after they were kicked out of the Dow Jones Industrial Average, which I won't go into here, but suffice it to say, there is value there long term and yet, the company is maybe going to continue the layoff announcements for a little while longer, the hit to revenue will likely continue, and it's not a perfect situation there. But, there is value there long term for sure.
We're not anti-FedEx (in fact, I'm a big fan), we'll just take the packaged gift ahead of Christmas, and move on, that's all.
We sold all of our shares of FedEx and will look for a better re-entry point primarily because it's trading in a high range (using historic price metrics), and also because of the parabolic move of the stock price off of its March low (corporate profits in the USA overall peaked in 2018), also because it was that far above it's 200 day moving average, and lastly because out of the last 27 insider trades on the stock, 25 were sells. So if the officers are selling, why shouldn't we consider it?
Here are the twelve things high net worth investors should consider as we approach 2021:
1) Asset Allocation - Do you own sound bonds and bond-like investments where the companies and/or municipalities can't just refinance their way out of having to pay you above-market yields on your bonds? Are you in the driver's seat? Do you own reasonably priced investments with an emphasis on Value and GARP: (GARP (Growth At a Reasonable Price)), and are you exposed to areas of Asia where growth and management of the virus are both more positive than in the US and Europe and they didn't blow their fiscal balance sheets to bits? Do you have enough bonds? I know, they're currently a hated asset class. I've been through this before, like approximately 10 years ago when the 10 year UST yielded around 4% and lots of folks were saying 'sell those boring bonds', and now, with the 10 year UST less than 1%, well, they're much more likely to advise folks to outright sell their bonds (eye-roll). Also, as commercial real estate undergoes a transformational shift (as companies rethink their commercial real estate needs), one granular example of how to carefully invest safely for yield in commercial real estate is in the preferred stock of Digital Realty Trust which currently yields 6.38% per year. Digital Realty is a well-operated data center REIT experiencing robust demand.
As Scott Minerd of Guggenheim recently said, "I wouldn't want to be underweight bonds in the next correction, that's for sure."
2) Your estate planning docs need to take into consideration things like Covid-19 (the idea that hospital access may be impaired due to unforeseen events, like pandemics). If you have elderly parents, or other loved ones who you assist, are the documents so old that banks might be concerned about their validity? Does the agent have authority to change beneficiary designations to deal with decision-making post-Secure Act? Also, many powers of attorney are "springing" powers that become effective only if a person becomes incapacitated and cannot manage their affairs. In other words, IF the document says your agent cannot act until the principal is incapacitated, you may want to consider with your loves ones and an attorney changing that immediately to a new power of attorney that lets the agent act immediately (i.e., not contingent on the principal being disabled, so that the agent can help you today. * Note: Florida is a state that doesn't allow a springing power.
- Sample clause for Health Care Proxies and HIPAA Releases: 'I expressly authorize my Agent to communicate decisions to any medical provider verbally, in person, by telephone, via email, via web conference including but not limited to such services as Skype, Zoom, FaceTime or in any other manner appropriate to the circumstances. Further, I expressly hold harmless any medical provider for relying on such communications of decisions and directions by my Agent.'...
3) Wealth taxes will change some time between 2021-2026 (either on an intentional, govt regime change and legislative basis, or simply by way of expiration in 2026). It appears that Biden is the President elect, but at this moment in time, that is not fully decided. Also, the Senate is not determined. There could still be massive tax increases on the wealthy, including estate taxes.
Many folks may have incorrectly jumped to the conclusion that:
- Trump's allegations of fraud won't go anywhere;
- There was no blue wave, so big tax increases are off the table;
- Divided government will keep the tax increases from happening;
- The 'no big-taxes' in the next several years may be premature: Back in 2001, the Tax Act was passed by VP Dick Cheney when there was a 50/50 Senate, and if the Ga run-off goes Democratic, and Biden-Harris are in power, VP Kamala Harris could theoretically break any tie vote on tax legislation.
- Exemption-reduction isn't a problem. In 2026 (that'll be here before you know it), the exemption is set to automatically decline by half regardless.
- The elimination of the step-up in basis at death won't happen (I think this could easily happen and may be a mistake to assume it won't).
* I DO think that divided government will limit the Biden administration's stated goals of raising taxes; and we've actually had a divided government 62% of the time since the end of World War II, BUT I just think that folks are jumping to too many conclusions as of now. Come mid-December and certainly mid-January, we'll have MUCH better acuity into government policy projections.
4) Access to money (huge). 2021 could be the year to consider SLATs (Spousal Lifetime Access Trusts): you may want to create each SLAT in a different state, and, as an aside, a SLAT could own an interest in a vacation home. 2021 could also be the year to consider DAPTs (Domestic Asset Protection Trusts), that permit access by naming the grantor as a beneficiary. You want your spouse/loved ones to have access to money in the next several years, period. In simple, country-boy terms, the government could be coming for your stuff. And also, there may be interruptions to normal activity so have a cash buffer (emergency savings). Don't assume the government is not increasing taxes on the wealthy. They've got huge deficits and bills to pay, and the wealthy are wearing a target on their backs if you ask me.
5) Important to review the types of trusts you're using (I'll leave it at that and not delve into that point);
6) Lower for longer real interest rates despite periods of both disinflation, inflation and even product and service shortages
7) Income tax bracket management
- If you have any flexibility / control on the amounts and timing of your realized income, just be keenly aware of income tax brackets more so in coming years than in the past.
8) Are the companies/municipalities linked to your investments solvent/able to pay without future government bailouts? Do you know exactly what you own? And why?
9) Are you changing your passwords on your financial accounts a few times a year?
10) Have you communicated your estate plans and wishes with your heirs enough? Have you involved them in the process enough?
11) Do you have enough cash/liquidity?
12) Are you taking a periodic fast from news media and getting enough exercise, sleep and water?
As I close, I'll leave you with one of my favorite quotes from Coach Tony Bennett (UVA Men's Basketball Coach):
- "When we talk to our young men about what humility means, it's twofold. Don't think too highly of yourself...don't think too lowly of yourself."
Here's to a 2021 filled with more humility to benefit humanity.
As always, I thank you for your business. I have a great job and people like you make it possible.
Please enjoy your Veteran's Day by thanking a Veteran, enjoy your Thanksgiving with your friends and family, and have a very, Merry Christmas or Happy Hanukah and Happy New Year 2021 !
Jack Parsons CTFA, AEP
President & Chief Investment Officer
Vickery Creek Capital Mgmt., LLC
Sources: Bloomberg, CNBC, Fidelity Institutional Wealth Services, Rosenberg Research, "The End of Alchemy-Money, Banking, & the Future of the Global Economy"-Mervyn King-former governor Bank of England, XPO Logistics (ir- inv ppt-11-2020), Walgreen's (ir-inv ppt-11-2020), Scott Minerd-Guggenheim Partners, National Association of Estate Planners & Councils (annual conference - November 2020), Marty Shenkman, JD, AEP, Natalie Choate, JD, AEP, Jeff Gundlach, Doubleline Capital, Gary Shilling, Ludwig Von Mises "Human Action" - A Treatise on Economics - The Scholar's Edition, Office of Financial Research (Financial Stress Index), Wells Fargo loan surveys, NY Federal Reserve, San Francisco Federal Reserve, Bureau of Labor & Statistics, Vickery Creek Capital Mgmt., LLC, iR Research