I attended the 67th CFA Institute Annual Conference in Seattle earlier this month. It brings together CFA (Chartered Financial Analyst) charterholders from all over the world to hear what some of the industry’s most brilliant minds have to say. Last year’s conference was held in Singapore, and next year it will be in Frankfurt (Germany, not Kentucky).
To me, speakers seemed more interesting at previous conferences. Apparently, there’s much more to discuss in times of economic turmoil. A five-year bull market combined with reduced geo-political tensions does not offer much financial fodder. While I feel that previous conferences offered more and better information, I still walked away with a few “nuggets.”
One of the more notable presentations concerned global demographics and how future investment decisions will be affected. It was interesting to learn that 65% of all global consumer spending comes from North America, Western Europe and “Affluent Asia” and 25% from China, South America and Eastern Europe. That means 90% of all global consumer spending originates from countries/regions that most people can identity fairly easily on a globe.
Over the next decade, these economies will experience a substantial increase in the percentage of “Working Age Empty Nesters” (WAEN, which is not a very good acronym at all). By 2024, two thirds of all household decision makers in these economies will be over 40 years old.
This is significant because consumers UNDER 40 years tend to be purchasers of “things” (homes, cars, TVs, diapers, etc.) Consumers OVER 40 tend to be purchasers of “experiences” (cruises, entertainment, trips, etc.) And, of course, as the over-40 group ages, health care and assisted living expenses will become more popular.
We are not rushing out today to re-shape our portfolios to accommodate this trend, which will evolve over the next decade. But we will remember these “nuggets” as we invest throughout the next decade.
At every conference, there is a behavioral finance presentation where we’re told things we already know (or should know), but it’s always good to hear them again. This year’s CFA Institute Annual Conference was no exception.
Behavioral finance, which takes into account that investors act irrationally sometimes and attempts to scientifically explain why, is relatively new in the investment world. Up until 20 years ago or so, most market theories were based on the premise that all market participants are rational and that all company information at any given time is fully reflected in the price of its stock. Clearly all market participants are NOT rational and many of them are just idiots.
To explain why people depart from rationality, the speaker discussed three ideas of belief formation:
- Representativeness (a.k.a.: Belief in the Law of Small Numbers) – Investors use samples that are too small from which to extrapolate trends. If the stock market has gone up (down) in the past year or two, many investors think it will continue going (up) down. This is particularly true with mutual funds in that investors are excessively drawn to funds with good past performance. One barometer that investors like to use when selecting a mutual fund is the 10-year performance record. The assumption is that if it was the best performing fund for the past 10 years, it will likely be very good for the next decade. People think of 10 years as being a long enough period to draw a reliable conclusion. But the reality is that a decade of out-performance does not ensure a good investment experience for the next 10 years.
- Overconfidence – People have overly rosy views of their investment abilities relative to other people. And (I hate to admit this) studies have shown that men are more overconfident than women. Men trade more often than women with worse results. Fortunately, the BCWM Portfolio Management team has both the male and female perspective.
- Prospect Theory – People think in terms of potential gains and losses and are much more sensitive to potential losses. Investors always like to have large gains, but they will forgo the opportunity for large gains if it means there is a possibility for a large loss. In addition, they can tend to put more emphasis on the possibility of large gains and large losses. Even when the vast majority of returns are small (normal events), investors think about stock market returns in terms of large gains or large losses (unusual events). In other words, investors’ emotions (primarily fear and greed) drive most investment decisions.
At Boyer & Corporon Wealth Management, we remain mindful of the potential for emotional flaws in our security selection. Realizing, understanding and admitting inadequacies is half the battle in overcoming them.
A recent headline from the Wall Street Journal read “U.S. Backs Off Tight Mortgage Rules.” Because the housing market is not recovering fast enough, regulators have decided that mortgage lending standards should be loosened. The article said that not only is the Federal Housing Finance Agency (FHFA) going to outline new “looser” guidelines for Fannie Mae and Freddie Mac, but also they are going to peg executive compensation to the achievement of these guidelines. This is proof positive that it doesn’t take very long to forget economic pain.
I think the reason for this decision is that the housing sector appeared to suddenly stop growing in the past few months. Everyone is in a panic that the economic recovery is over, and we are going back into a recession. I don’t think this is the case. I think they are overreacting and that housing will pick up again… albeit slowly.
Of course housing is going to have problems from time to time. Let’s face it. A lot of future homebuyers are saddled with massive student loan debt that might take 10 years or more to pay off, if it can EVER be paid off. And if Baby Boomers are buying new homes, it’s because they are downsizing from the current monstrosities in which they are now living. So the housing sector might take a long time to return to a robust period of new home building. Looser lending standards don’t solve those problems.
Maybe lending standards were tightened too much after the housing bubble. Maybe regulators overreacted to the mortgage crisis of 2006-2008. But I hope they don’t forget that relaxed lending standards are what precipitated the worst economic crisis in 80 years. The notion that everyone needs to own a home is misguided. Everyone needs to have shelter, but they don’t necessarily need to own. There’s nothing wrong with renting.
A recent “jobs report” stated 288,000 new jobs were created in April and that the unemployment rate declined from 6.7% to 6.3%. 288,000 is an impressive number and exceeds most estimates. However, it is not large enough to reduce unemployment from 6.7% to 6.3%. The 800,000 workers who left the labor force caused the unemployment rate to decline. These people are no longer looking for employment for whatever reason. This is a trend that will continue for years as Baby Boomers reach retirement age.
The U.S. stock markets increased just shy of 1% during April. Foreign stock markets were only slightly better. Year-to-date, U.S. markets are up about 2.5% and foreign markets just under 1%.
Meanwhile the bond market remains resilient. The 10-year U.S. Treasury Bond is trading with a yield of 2.5%. In spite of pundits calling for a spike in interest rates (they have now been declaring that the sky is falling for over five years), interest rates remain historically low. We think they will remain low, although we wouldn’t be surprised to see the 10-year Treasury Bond hit 3% this year. The slow economy combined with the recent drop off in home building will keep interest rates low for a long time.
At Boyer & Corporon Wealth Management, we continue to have an unusually large allocation to long duration zero coupon municipal bonds combined with shorter duration corporate bonds. Although we slightly reduced our equity allocation last year, we see no reason to reduce it further. With almost non-existent headline risk, we are moderately positive on the stock market. We see no reason to “sell in May and go away.”
This information is provided for general information purposes only and should not be construed as investment, tax, or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.