February 17, 2012
Perhaps it’s the great recession and the gradual pace of the economy's recovery that has uncovered them, but the number of suspect and unethical undertakings revealed in the financial services arena over the past few years is greater than anytime I can remember in my career. While the dark shadow of these mischievous acts looms over my entire industry, I know that no level of regulation can guarantee that your money is being held by the ethical standards I believe it should. Ultimately, the responsibility of insuring such rests on the investor. Given my 19 years of experience, I offer some basic steps for investor protection.
Before I get too far, let me clarify the subject. These steps are intended to address the basic concept of custody and practical matters of ethics that anyone who has the responsibility of holding someone else's money should abide. This is not about a money manager's investment prowess, a subject I'll address in a future edition. Simply stated, the following will help you validate if your money is where you think it is:
1) Investigate and understand the institution that actually holds your money. Do you recognize the name? Did you or someone you trust read the disclosures on the account application? Is the term hypothecation in the agreement? What rights does the custodian have to borrow money from your account? If you don't know or can't find these then ask the institution you’re considering to explain and verify. If you don't understand their explanation, do business elsewhere.
2) Are your accounts covered by Securities Investor Protection Corporation (SIPC) or the Federal Deposit Insurance Corporation (FDIC)? SIPC deals specifically with investment accounts held at broker-dealers registered with the Securities and Exchange Commission. SIPC’s role is to return funds and securities to investors if a broker-dealer registered with the SEC holding these assets becomes insolvent and it covers the first $500,000 held within your account. The FDIC is an independent agency of the U.S. government and it protects depositors of insured banks. The standard deposit insurance amount is $250,000 per depositor, per insured bank, for each account ownership category.
3) What insurance coverage does your broker-dealer have beyond $500,000? Almost every large broker-dealer has coverage beyond SIPC and you should know the amount.
4) What investments do you actually own and are they being valued by the investment manager or a third party? This subject can be tricky because many invest via mutual funds or private investments companies and their underlying holdings aren't publicly disclosed at all times. Mutual funds are one of the most highly regulated investment vehicles, however. In all my years I don't remember a single mutual fund that was able to commit fraud. But to validate, take your fund symbol and type it into Yahoo Finance or Google. That should give a good idea of what was in it last time it filed its holdings and how it’s invested. If you don't get any results from the Web, call your broker and investigate. Private investment companies/funds are more difficult as they are often invested in more exotic instruments than stocks and bonds and valuation is done by the money manager, which is difficult. But private funds require accounting and are often audited. Seek out the accountant and auditor before investing. Be suspicious if the fund doesn't have either.
5) What underlying assets are in your money market? Many money market funds have the ability to invest in non-Treasury instruments. Funds often purchase commercial paper of financial institutions or sovereign debt of foreign countries. In 2008, the Primary Reserve Fund "broke the buck" because it held Lehman Brothers’ paper which plummeted in value when they declared bankruptcy. Many people consider money market the equivalent of cash. But there are underlying assets in money market and you should know the risk. For absolute safety, find a money market that can only invest in Treasuries.
6) Ask your broker or bank representative exactly what they personally are invested in or where their money is held. Our clients take comfort in the fact that we hold the same positions they do. If your broker isn't doing something fairly similar to what you're doing you should ask why.
Several cases have emerged of recent that demonstrate the greed and guile of those rotten few within our industry. Be it acts of Madoff, Rajaratnam or the insider trading network currently under SEC investigation, they all tarnish our image. But the motive for writing this article is the MF Global case. While details are still emerging, it seems as if MF Global utilized regulatory rulings that few knew existed and coerced its regulator into continuing to permit questionable borrowing.
As a commodities broker, MF Global was under the regulation of the U.S. Commodity Futures Trading Commission (CFTC). The Commodities and Exchange Act of 1936 set forth that customer’s assets were required to be segregated from firm’s assets. (Be certain that everyone in the securities industry and the futures business knows the line between customer funds and broker funds is sacrosanct!) However, firms could invest customer’s cash “in excess” but only in the safest assets, such as Treasuries. But unbeknownst to many customers, a ruling in 2000 allowed MF Global to invest in sovereign debt of other nations as well, like that of Greece, Italy and Spain. To top it off, a 2005 ruling allowed MF Global to lend themselves their customers’ cash in exchange for things like sovereign debt and it permitted them to do it without customers’ knowledge or consent. The trouble is that when the value of the sovereign debt falls MF Global has to post cash to cover its loans, which they didn’t have. If this is done by a broker that has SIPC coverage, then the aforementioned protection applies. But MF Global was a commodities broker and there was no such protection. Tragically, $1.6 billion of customer money is still unaccounted for some five months after its bankruptcy. This differs from Lehman Brothers, as to my knowledge, all customer securities and funds were returned to the customer or transferred to another broker. The ones who lost were people that invested in Lehman Brothers and its creditors, which all knew there was some level of risk.
To me this is the most egregious violation of the fundamental ethics of our business. What makes it even more disgusting is that it might just have been legal! While my legal opinion is not much better than my branzino recipe, there is a very real chance that no one will be prosecuted for this despicable act. Regardless, merely conceptualizing this act of circumvention reaches beyond the ethical standards of the financial services industry as it tears at the very fibers of morality. Imagine conjuring up a way to borrow money from the very clients that keep you in business while not properly informing them that you are borrowing or that what you are doing with the borrowed money is speculative and there is no backstop. The only solace I can find is that the executives that conducted this act will have to face themselves in the mirror, be it at their beach house or their penitentiary of jurisdiction, every day forward knowing that this conduct was simply wrong and that fact can't be contested.
The vast majority of financial brokers and professionals exhibit the highest ethical standards and steward their clients’ funds to the best of their ability. Client investment goals, be it a second home, early retirement or helping a child leave college debt free, are met every day. But since these accomplishments garner no media attention, the positive things our industry produces are easily overshadowed. Tragically, a few rotten apples somehow nudge their way in and occasionally linger for too long. But the misdeeds of a few confirm the high code of ethics by which firms such as Warren Capital practice. Our clients trust we hold their interests above all else and they understand and appreciate our transparency and principles. My proof is the number of referrals we get. But as much as I think we should, I realize we don't hold every investment dollar out there and there are investors that choose to do business elsewhere. So, I author this as a field guide to everyone with assets as I consider part of my duty as a financial professional to help implement basic standards of investor protection.
As always, I appreciate your continued trust and confidence.
January 04, 2012
This is a natural time of year for reflection, and here at Warren Capital we've been looking back on lessons learned in order to improve our practice. Our challenge is that we can always find a competitor, or benchmark, or sector, or country, or asset, etc. that we'd like to have beaten but didn't. But is that really the nature of our race? If so, when does it end?
When I started Warren Capital in 2005 my goal was to build a complete wealth management practice that increased the likelihood of clients reaching their financial objectives. Whether it be monthly income, early retirement, a vacation home or saving for a child's education, our goal is to help our clients meet their aspirations. This requires much more than picking good investments because clients have to file taxes, get life and health insurance and provide a home to shelter their families at the same time. We know that helping our clients make good decisions on all these matters gets them to their goals. So, we've spent most of the last year enhancing and building those practice areas.
While we've worked with clients on their insurance needs in the past, we are actively building our insurance and annuity practice under the direction of John Norce and Paul Barbieri. Collectively, John and Paul have 45 years of insurance experience and are experts in their field. We've also brought on John Walsh, CPA, to help our clients with taxes. John has been a CPA for 33 years and handles personal and corporate filings as well as 401k administration for our clients. Finally, I acquired an interest in a mortgage broker and we are financing mortgages at very low interest rates. We are working with many clients in these new areas right now, but if we haven’t spoken to you about your needs, please give me a call.
So, how did we do in 2011? If you asked any of our clients that utilize our entire wealth management practice I believe they would say quite well. What makes me most proud is that we had a few clients retire earlier than they thought they would. This proves our process works, and we are doing our job. But I'm a perfectionist, and I'm always trying to find ways for us to do better. So, in addition to expanding our tax, mortgage and insurance business, we've added a new investment technique that is already producing sizable results —shorting stocks. In the past we've used our proprietary analysis to find companies we want to own but we didn't fully capitalize on the companies we believed were strategically disadvantaged or overvalued. We now are doing such and will be launching a product that allows us to short in retirement accounts.
It's easy to look at the S&P 500 which, after all the erratic headlines, ended the year unchanged and say very little was accomplished in 2011. But in reality there is more than just this benchmark. With our enhancements in the insurance, tax and mortgage arenas we've built an unparalleled wealth management practice that allows all financial matters our clients face to be handled in one place and to work in harmony. This all came together in 2011, but it has taken many years to put all these pieces together as much time and substantial effort was needed to find the right people. So, as you look back on your year and set goals for the upcoming one, I encourage you to look beyond the calendar as accomplishments aren’t necessarily tied to such. Whatever your goal, be it personal or financial, are you closer to meeting it? Because the race is long, but in the end it is only with yourself.
Happy New Year and I appreciate your continued trust and confidence.
November 22, 2011
The word amortization comes from the Latin word admortire, which means, “to kill.” Given the state of the housing and debt markets these days the derivation couldn’t be more fitting. Regardless of the origin, understanding how an amortization schedule is calculated and the influence of such a calculation on things like the housing market could not be timelier.
I’m not going to go through the entire amortization formula as it would take most of this piece. But know that the interest rate, the number of payment periods and the principal balance are the variables that calculate the monthly payment. (Visit our mortgage calculator at http://warcap.com/services/harmonyloans). Those variables also dictate the amount of interest vs. principal allocated within each payment: the amortization schedule. As you might deduce, the larger the number of payments (there are 360 monthly payments in a 30-year loan) the less principal allocated at the start of the loan. The nature of this formula and the fact that very few homeowners or mortgage brokers understand the formula is a primary reason for the current state of the housing market in this country.
Take a 30-year fixed loan for $500,000 initiated in November 2009 at 6%. The monthly principal and interest payment would be $2,997. While that is an important number, often mortgage brokers fail to properly explain that such a mortgage obligates the borrower to pay $579,190 in interest over the 30 years of that loan for a total repayment of $1,079,190. Today a qualified borrower could get a 30-year fixed mortgage for about 4.3%. While this is a significant rate difference, there is a dirty little secret hidden inside the option to refinance and most in the industry don’t want you to recognize it.
Two years of payments at $2,997 equals $71,928. But because of the magic of the bank’s amortization formula, the principal balance of this loan after two years is $482,922. Only $17,078 of $71,928 has gone to paying down the $500,000 borrowed. Moreover, refinancing into a new 30-year fixed mortgage immediately subjugates the borrower to another 360 monthly payments and a new amortization schedule. Under this scenario, after four years of payments totaling $129,480, the borrower would have a principal balance of $466,427. When you add back the $22,000 of closing costs the borrower would have to pay for both loans the total reduction of debt is de minimis. Here at Warren Capital, we believe this type of scenario should be avoided and we give our clients a much better solution.
Through our alliance with Mortgage Harmony Corp., we are able to offer our clients a unique type of loan that allows the borrower to reset their interest rate after they finance by simply clicking a button on their lender’s Web site. If interest rates change after the loan closes, which they always do, you now have the ability to take advantage of that new rate without refinancing. No credit check, no appraisal, no title work, no income or job verification and no new 30 year amortization schedule.
Our job at Warren Capital is to build and protect our clients’ wealth. Both asset and liability management are necessary to accomplish our job. There will be times when asset growth will be limited because of economic circumstances. During such times, you can be assured that we will use that opportunity to improve the other side of our clients’ ledgers and to make sure they don’t succumb to hidden financial pitfalls. While this is a unique approach for advisors in our industry, we know it’s the right way to help our clients build their net worth.
As always, I appreciate the continued trust and confidence.
September 08, 2011
This week marks the 10th anniversary of September 11th and given the economy, President Obama’s speech and the mantra of negativity gushing in the news, it’s easy to feel that the best days of the United States are behind us. Frankly, when I originally sat down to compose this edition, I checked various equity market valuations 10 years ago. But perhaps stock indices and unemployment rates are not the only measures to evaluate.
Most everyone has a vivid memory of what they experienced that morning in September 2001. I certainly do as I was a managing producer at the Washington office of Morgan Stanley at the time. What many forget is how fearful we were that another attack was inevitable. But we stand here 10 years later without any such attack, and I think it important we recognize some things that have occurred under a blanket of security.
Ten years ago, Google wasn’t the first source of information and Facebook wasn’t a measure of status. I find myself conducting a few searches a day, and such searches are an integral part of producing this newsletter. Furthermore, I can now wirelessly conduct those searches, check positions and share my views thanks to my Iphone from Apple, AT&T’s network and Facebook’s reach. This was just not possible in 2001. Had our country not taken such a forthright stance after 9/11 by declaring a war on terror, the secure environment that helped produce these innovations we now use daily would not have been fostered and our country as well as the rest of the world would be completely different.
It’s important to remember that 9/11 was an attack on individual liberties and on the democracy of the country that has served to advocate and protect such liberties around the world. By defending democracy within our borders and advocating it internationally, not only were these innovations nurtured but the simplicity of these innovations —free access to information and worldwide connectivity — provided a platform for democracy to prevail over authoritative regimes like those in Egypt, Libya, and Iraq. A decade that started with an attack on freedom ends with freedom more widespread than any time in history. So, while the United States faces daunting circumstances right now, take a moment to recognize how far we’ve come.
Moving Forward
As a Washington D.C. based investment advisory firm, we have a unique perspective on the inner workings of Washington. While we are not privy to any specific idea, we do have the opportunity to mingle with decision makers and their staff. Given our interactions, we are concerned that many in Washington have very few creative sparks remaining to stoke the economy. This in large part is due to federal budget constraints, but perhaps more significantly due to a lack of business experience among political leaders. Since neither will change anytime soon, here are some immediate suggestions to promote growth WITHOUT adding to the deficit:
■ Create an infrastructure bank initially funded by new dollars printed by the Fed. I’ve written about this many times, and it’s gathering some attention now. Rather than buying Treasuries, the Fed could grant new money to the various federal departments or provide new money directly to the states for schools, roads, bridges, and the electric grid.
■ Require more fuel efficient standards today. Most manufacturers currently have 40 mpg vehicles and the technology for even higher standards. Move all city buses to hybrid technology by 2015. Create a better natural gas distribution network for long haul use.
■ Open the Gulf of Mexico and Alaska to produce more energy. I realize this is a controversial issue but last year we sent $265 billion overseas via oil purchases. I’m a staunch supporter of alternative fuels but we are several years away from mass use. Until domestic alternatives replace overseas oil purchases I find it unreasonable for policy to restrict domestic production. Keep that $265 billion in the U.S. and the movement to alternatives will accelerate.
■ Promote tourism and streamline the visa process. The dollar has fallen over the last decade and travel to the U.S. by internationals is cheap. Furthermore, there is a direct correlation between population growth and economic growth. We should promote immigration and properly document immigrants as their work will add to the tax base.
As always, I appreciate the continued trust and confidence.
Joe Warren is CEO and founder of Warren Capital Group, an independent financial advising firm specializing in wealth management for high net worth individuals, institutions, foundations, and corporations. As a fee-based private wealth management firm, Warren Capital Group assists clients with asset allocation, risk management, estate planning and liability management via mortgage services and financial planning. Warren Capital Group and its independent financial advisors are based in Washington D.C. Email Joe at jrw@warcap.com
July 27, 2011
Right now the political rhetoric in Washington is thick as I’ve ever heard as the debate over the debt ceiling is coming to a crescendo. While I believe the majority of America would simply like some compromise between parties, the elected show no signs of that consideration as they are retracting further into their respective political burrows. This comes as no surprise, and I expect that even if an agreement is reached before August 2 it will have little impact on the indebtedness of the United States. Therefore, I take it upon myself to present reality.
We can all point fingers at Congress and its inability to enact legislation. But in theory, politicians are here to represent their constituents. Given such, the reality is that either citizens of this nation don’t have the civic fortitude to deal with the indebtedness for which we are all now responsible, or they haven’t made clear what policy they are willing to accept to correct this imbalance. Whatever the case, dealing with our imbalances can be done if handled practically.
It’s important to recognize that while the $14.3 trillion in treasuries is an obligation of the government, the ultimate responsible party is every American citizen. That means that because of previous policy and our lack of action every citizen of the country has become indebted by roughly $45,800 to treasury investors. In addition, government expenditures for the year will be approximately $3.55 trillion while incoming revenue will be $2.38 trillion. So, not only do you owe a huge sum but to simply prevent yourself from incurring another $3,751 in debt by year end you must take action! Here are some options:
1) Given that government receipts can only cover 67 percent of expenditures, take out a piece of paper and calculate the dollar value of every benefit you receive from the government. Once calculated, reduce that overall number by 33 percent and write down which of those benefits you are willing to reject.
2) Look back on your tax return for 2010 and examine what deductions you took. Remove a third of those deduction going forward so your tax obligation is increased by 33 percent.
3) Prepare a check written to the U.S. Treasury for $3,751.
4) If you have treasuries in your investment or retirement accounts repudiate your ownership in four of those securities thereby alleviating the U.S. Treasury of $4,000 worth of its obligations.
While none of these options are very appealing, this only gets us through year end. Your next priority is to figure out how to pay off the $45,800 you already owe. We can all whine and moan about how we got here, but that doesn’t change the reality that you owe it and are paying interest on it. The good news is that you have more time to pay off that debt. The bad news is that it’s going to take a much more drastic combination of the aforementioned options to get whole. While these actions are necessary, communicating what you’re willing to do is just as vital.
I’ve been searching the net for records on the volume of phone calls, emails and letters that have been made to Congress in the last few weeks and the data is sparse. The best that I can tell is approximately 3 percent of the U.S. population has made contact with his or her representative of late. I live in the District and politics supersedes any other topic including the weather in this town. So, I’m not sure how much this subject stirs the blood of the general public. But I do believe that remaining 97 percent would care that they are on the edge of incurring nearly $50,000 in debt at the behest of ill-directed policy if they actually recognized their looming obligation.
I also know that most Americans truly care about this country and are willing to endure some personal sacrifice for the benefit of the nation. The question is how much do you care? If there can be such a thing as a call to action in this day and age than this is it. (To find your representative visit http://www.congress.org/congressional_staff). It is no longer acceptable to simply point fingers and dodge the issue. If you decide not to participate, realize that those of us who do take action will determine the fate of your responsibility.
Short Term Consequences
Because of our reputation and what we deliver, we bring on many new clients each year. What we often hear during the initial consultation with a prospective client is that they can’t afford to take a loss like they have experienced in the past. The alarming thing is that even though much time has passed since they took such losses, they have done nothing to protect themselves against that experience going forward. That’s usually the time we explain our process as independent financial advisors and how we differ from all other money managers. While we’re not predicting it, the next few weeks could prove why we invest the way we do.
Even if my call to action sweeps the nation and it starts tomorrow, the effects will not take hold for some time. Therefore, investors might face some unique circumstances for the next few weeks related to the debt ceiling debate and the potential effects on the financial markets of a treasury default. We always look to the markets to measure the amount of trouble looming, and right now indicators remain stable. But we are keenly aware of how quickly things can change.
Whatever happens, you must have a plan in place to deal with unprecedented circumstances, like a treasury default. Our clients take solace in the fact that we do have a plan and the ability to act quickly if needed. If you’re not a client and you don’t have your plan in place, consider this your wakeup call and see our phone number is below. As always, I appreciate the continued trust and confidence.
May 01, 2011
Given the close relationship we have with our clients and the amount of time we get to spend with each of them we often hear their worries about various economic issues. Having clients in the real world expressing their economic concerns to us holds immeasurable value as they are the true barometer of the level of fear in the markets. But often times the fearful topic du jour is not the issue to worry about as a more silent, less media-friendly matter emerges as a sure way to lose. Right now the looming debt vote in Congress serves as the former and inflation the latter.
For those not aware, the U.S. Treasury’s borrowing spree has a limit and it’s called the debt ceiling. The debt ceiling is a cap set by Congress on the total amount of indebtedness the Treasury may incur, currently $14.29 trillion. According to the Treasury, the cap will be met in the next 60 days. Two things can happen once reached: The debt ceiling can be raised like it has been done almost every year for the past five decades or the government can stop paying some of its bills.
I’ve written extensively in past editions about the inevitable path to insolvency the country is on with this deficit spending and the media has covered it ad nauseam. In reality there is no political benefit to the politicians balancing the federal budget as each representative gets elected by and is responsible to their own individual constituents. (I imagine allocating federal dollars to benefit the voters in the districts that elected you helps at re-election time.) As such, I doubt there will ever be a political consensus on government outlays vs. spending. So I can understand why clients are concerned about the pending ceiling vote on the Hill. But according to the markets, they should not be.
The most recent headline to spook investors regarding federal debt was Moody’s release that it was considering downgrading the credit quality of Treasuries. Losing its gold-plated AAA status would be a huge blow to Treasuries. But contrary to logic, the Treasury market has rallied since Moody’s release in mid-March as the yield on the 10-year Treasury has declined from 3.34% to 3.17%. While it’s not a big move, the mere decline in yield, or rally in price, proves the point. Treasuries are the world’s safe haven investment and even a threat of a downgrade to the ratings of Treasuries themselves doesn’t replace that notion. Furthermore, the paltry yield of 3.17% suggests that investors have no concern whatsoever about the government’s ability to meet its obligations. In comparison, 10-year yields on Greek and Portugal debt are 15.1% and 9.63%, respectively. Now I’m not saying it’s right, but the markets are telling you not to worry about the government defaulting. What is a concern and what we work to mitigate every day is inflation.
Inflation is a complicated matter as the cost of goods affects people differently depending on their direct use of those goods. That is why the consumer price index (CPI) may increase by only 2.7% in the past year while you are paying 28% more for gas. Whatever the measure, inflation is far more onerous than the government’s creditworthiness.
First, it is important to understand that the ultimate agent of stability, the Federal Reserve, faces consequences each time it eases. The Fed has absorbed $2 trillion of new assets since the financial disaster of 2008. In order to buy these assets, the Fed had to create new money. Increasing the amount of dollars in existence by 20% will eventually cause the value of each dollar to fall. We measure the value of a dollar on an index basis as it must be measured against a basket of currencies. At 73 it stands just two points away from its all time low!
Second, the value of the dollar has an inverse relationship to the cost of anything that is priced in those dollars. Hence, the recent sticker shock at the pump and the grocery store. The ultimate threat to any central bank is falling prices or deflation. One way to counteract the deflation we faced in 2008 is to add new dollars to the total amount of dollars in existence. This is guaranteed to lower the value of the dollar and will likely raise the price of anything denominated in that currency over time. What makes a falling currency so burdensome is the inflation it produces and the effect that inflation has on “real return.”
Many investors who manage their own money often cite the return they are receiving on their investments. While it’s a useful measure, it has less meaning than real return, a measure followed at Warren Capital. Real return accounts for inflation as it subtracts the inflation rate from the net return. From our perspective there is no point in evaluating how many dollars can be made on an investment without considering what those dollars will be worth when earned. Furthermore, measuring real return will continue to hold more creed going forward as Fed policy is poised to keep the value of the dollar low for some time.
Currently the Federal Reserve’s federal funds rate is targeted at zero percent. It’s pretty difficult to lower a rate beyond zero and, therefore, the Fed has no other stimulus available other than printing and buying, as noted by their recent QE2 effort. Given the anemic growth of the economy and comments from recent minutes released by the Fed, it’s hard to foresee any eminent policy designed to increase the value of the dollar or slow inflation. With CPI at 2.7% an investor would have to go out eight years on the Treasury yield curve to find debt that would break. By not considering this and owning investments with less than an equivalent yield you find a sure way to lose.
As always, I appreciate the continued trust and confidence.
Warren Capital Group is a registered investment advisor specializing in private wealth management and protection and growth for high net worth individuals, institutions, foundations, and corporations. Warren Capital Group wealth managers use their collective expertise to invest in stocks, bonds, real estate, money markets and other alternative assets on behalf of clients and advise them on mortgages, insurance and other aspects of their net worth. As a fee-based personal wealth management firm, Warren Capital Group assists clients with asset allocation, risk management, estate planning and liability management via mortgage services.
March 01, 2011
Sometimes I wonder if the founders of the Internet understood the full implications of what they were producing. While there’s some debate about who started the Internet, it is my understanding that the Department of Defense (DOD) created it in 1969 as a way to connect internal computers. Of course this is woefully ironic given the geopolitical turmoil now erupting across the Middle East all because of the Internet.
For those who don’t know, it was the death of 28-year-old Khaled Said — who was beaten to death last June after being dragged from an Internet café in Alexandria, Egypt — that galvanized Egyptians into a social movement that led to the resignation of the 30-year dictator Hosni Mubarak. Not only did access to the Internet assist in this movement, the movement took shape via Facebook and when the dictatorship blocked access, the cyber movement transformed into massive protest. The reality is that the Internet is a form of freedom and authoritative regimes may crumple in its path.
I’m taking a few things for granted when I say this, but it’s not surprising that the Internet was created in the United States. While our reputation is suffering in various parts of the world, it’s generally still accepted that America represents a free nation. And in this age what better way to demonstrate our unalienable rights than via the Internet? Of course life, liberty and the pursuit of happiness are rights that fundamentally contradict the oppressive nature of authoritative regimes.
The list of countries with oppressive governments is vast. But according to a popular human rights index, both Egypt and Libya are in the top 20 in the list of worst rights offenders. So it shouldn’t be surprising to see Mubarak ousted and Muammar Gaddafi, the controversial leader of Libya, losing his grip. What’s interesting is how the dictators react to insurrection.
With the Egyptian experience the protestors were blessed with a government that didn’t have a clue how to deal with an uprising via the Internet, as demonstrated by their fraught attempt to shut the Internet down. In Libya the reaction has been much more violent as the military fired upon protestors. This led to a massive defection of army colonels who are now attacking Col. Gaddafi’s remaining forces. What’s shocking is that these multi-decade tyrants didn’t learn more about handling Internet insurgencies from governments like China, which has more documented cases of human rights violations than both.
Last year a 24-year-old peasant was arrested in China for “illegal blogging.” The peasant mysteriously died in prison and the incident generated 100,000 comments on a Chinese blog. But the Chinese government reacted differently by reaching out to irritated bloggers and inviting them to join an investigative committee on the incident. Nothing came of the investigation as it was extremely limited, but the social unrest subsided. To me the results of these vastly different strategies have investment implications.
The seven largest companies by market capitalization are Exxon, Apple, GE, Microsoft, Berkshire Hathaway, IBM and Google. (Facebook is not included, as it remains private.) It is not coincidental that four of the seven all provide technology, software and hardware focused around the Internet. Those that further the ease of use and help push greater access worldwide stand to change both the economic and political landscape. As it becomes the tool that both democratic governments (President Obama’s online campaign was a vital tool for his overwhelming victory) use to further their reach and the force of liberty that oppressive governments must face, we will be on the lookout for the next game changer. Because not only can tyrants be toppled, but vast wealth can be created by the freedom of the Internet.
Warren Capital News
For those who read my November 2010 letter to Fed Chairman Ben Bernanke, you'll remember that I questioned effectiveness of the $600 billion treasury bond purchase the Fed was about to embark. I was concerned that the second part of their dual mandate — to promote a high level of employment — would not be reasonably influenced by such a bond purchase. Rather, I proposed, start an infrastructure fund with said funds, which would certainly create jobs. Well to my pleasant surprise, I received a reply from a Fed director in late January.
Part of the beauty of the Fed is the unique manner in which they communicate. When you control monetary policy and are the lender of last resort, you better have an ability to mask your intentions or the markets will manipulate them. The Fed is truly the master of the obscure and their reply to me served proof. The general nature of the reply was neither to dismiss nor fully address my suggestion, but rather point out the merits of their quantitative easing (QE2). After reading it multiple times I came to the exact conclusion they wanted me to: That the Federal Reserve’s treasury purchases “should help keep interest rates lower than they would otherwise have been”. While this was not the revelation I'd hoped, I did learn two things.
First, the interest on the treasuries that the Fed purchases is returned to the treasury; thereby, saving the government $110 billion in interest payments. So through this bizarre tactic, not only are the interest payments the treasury must make on their bonds lower “than they than would otherwise have been," the Fed also massively reduces the treasury's expenses. (If I was running the treasury I'd have to send a thank you note to Chairman Bernanke.) Second, and potentially more important to me over the long run, I now know that there is a decent chance that some of my opinions are reaching powerful ears. So if you ever decide to employ such a brash tactic as composing a letter to arguably the most powerful individual in the world, I advise you to make your point direct and your language precise. Your message might just reach intended recipient. As always, I appreciate the continued trust and confidence.
Warren Capital Group is a registered investment advisor specializing in wealth protection and growth for high net worth individuals, institutions, foundations, and corporations. As a fee-based private wealth management firm, Warren Capital Group's independent financial advisors based in Washington D.C. assist clients with asset allocation, risk management, estate planning and liability management via mortgage services. Warren Capital Group wealth managers use their collective expertise to invest in stocks, bonds, real estate, money markets and other alternative assets on behalf of clients and advise them on mortgages, insurance and other aspects of their net worth.
December 01, 2010
The Federal Reserve Bank
Attn: Federal Reserve Chairman Ben Bernanke
20th St. and Constitution Ave, NW
Washington, DC 20551
November 16, 2010
Regarding: The Fed’s New Economic Highway
Dear Chairman Bernanke,
After reviewing the recent quantitative easing (QE) announcement and your opinion piece in the Washington Post on Nov. 4, 2010, it dawned on me that there is a much better way for the Fed to reach its dual mandates of high employment and low, stable inflation. While I understand the intent of the Fed’s $600,000,000,000 longer term treasury buying program, I’m not certain it should be conducted. Nevertheless, the decision to print has been made and I propose a more effective use for this money. Instead create an “infrastructure fund” with that money dedicated solely for building and improving schools, roads, water systems and the electric grid across America.
While the net effects of Fed action over the last two years is highly contested, even you state you can “hardly be satisfied” with the current economic situation. I assume the majority of the dissatisfaction is because the unemployment rate remains stubbornly high. But as a private business owner I can wholeheartedly say that if longer-term treasury rates drop by a few more basis it will have absolutely NO influence on my decision to hire more people. The only circumstance that dictates hiring is demand. A sure way to increase employment demand is to print money and dedicate it to rebuilding infrastructure.
To put this into perspective, let’s consider the country’s needs. Just try to leave the District at rush hour and to get a picture of the need to expand road capacity. It’s also difficult to find any city in the country that couldn’t use a few more qualified teachers to educate our children. These are very basic, immediate needs that will drastically improve the entire country fundamentally and financially. Instead a large portion of newly printed money by the Fed to date has gone directly to bail out those that caused economic strife through their over-indebtedness. At this stage, this might be ill-aimed policy. Spending money to build things does work and there is data to prove it.
According to a 2005 report from the U.S. Bureau of Labor Statistics, every $1 billion spent creates about 17,500 jobs in education or 21,000 jobs in mass transit. Imagine what $600,000,000,000 would do? Furthermore, spending on infrastructure increases inflation as the commodities used in development will rise in price.
Naysayers might point out that this type of Fed funding is completely outside the realm of the Fed. But this is no more outside the intent of the central banking system than bailing out AIG or buying Lehman’s Maiden Lane mortgage portfolio. The government is already in the market of helping states and municipalities with their infrastructure needs through the Build America Bond program. Furthermore, this cannot be derailed by an incapable Congress as the Fed can actually create these new dollars and this plan does not add to the deficit. So, why isn’t this being considered?
There are two reasonable arguments I can surmise. First, such action might create a precedent for dealing with future economic debacles. Wouldn’t it be better to have the Fed actually inject money into building things that improve the country rather than bailing out those who made bad decisions? Second, this would devalue the dollar. This is unlikely as the money created increases the infrastructure value of the country. In comparison, much of the Fed support to date has simply gone to heal the balance sheets of over-leveraged corporations.
If implemented the Fed should receive no real or tangible assets in return for the money deployed, which has been part of the problem with past Fed aid. In order for newly printed money to reach real pockets the Fed must buy some assets from the private markets in return. For the past two years, the Fed traded some of that new cash for questionable mortgage bonds and rights to insolvent corporations. I applaud the Fed for some of the support provided as I’ve been managing money through this entire process. However, such backing simply rewards the bad decisions and behavior of a few at the expense of the remainder of the country. Given the authority that you have, I probably would have done many of the same things to avert economic disaster despite this reality. But today the economy is not on the edge and we certainly don’t need to be furthering this inappropriate rewarding by bailing the ultimate debtor, the U.S. Treasury, through this massive bond purchase.
At this economic stage, I hope you and the powers at the Fed simply reconsider or at least match whatever treasury purchases you embark upon with infrastructure funding. Quite frankly, it’s surprising that additional rate reductions are even a consideration given the fact that the 1.5% decrease in rates over the last two years was accompanied by a 2.5% uptick in unemployment. That’s enough validity to say that it might be time to try something else. Two good examples of the potential benefit are China and India, whose economies continue to flourish because of their infrastructure funding. Besides, what’s the worst that can happen by allocating new money to infrastructure? At a bare minimum you’ll be the founder of the Fed’s new economic highway.
Sincerely,
Joseph Warren CEO and Founder
Warren Capital Group is a registered investment advisor specializing in private wealth management and protection and growth for high net worth individuals, institutions, foundations, and corporations. Warren Capital Group wealth managers use their collective expertise to invest in stocks, bonds, real estate, money markets and other alternative assets on behalf of clients and advise them on mortgages, insurance and other aspects of their net worth. As a fee-based personal wealth management firm, Warren Capital Group assists clients with asset allocation, risk management, estate planning and liability management via mortgage services.
November 01, 2010
As I stand here today, I can’t help but acknowledge how far things have come and how much has improved since this time last year. About this time in 2008, we were on the edge of an economic abyss and looking into it. But as I suggested in my commentary last November, investors underestimate the ability of the U.S. to self correct and the 39% year‐to‐date return on the NASDAQ is proof. Regardless of this rebound, I believe it my prudent duty to consider what could be different next time.
Here’s the reality: Every time we face a true correction in markets, it is more severe, frightening and painful than the last one.It has to be. Otherwise, prices really won’t correct. This was certainly the case this past fall as fear ran rampant. Nearly every asset went down in value and the Treasury was immersed in a daily game of financial whack‐a‐mole. As it turns out, the world did not collapse and the apocalyptic prognosticators proved incorrect. But I remember how easy it was to understand their arguments as I, along with just about everyone privy, actually examined what was over the ledge for the first time. (Luckily, our headquarters is located on a low floor). No one predicted nor understood the interconnectivity of financial markets, and we’ve seen the consequences of such. Given this fact and the said reality, it may prove futile to spend much time predicting the next financial calamity. Nevertheless, here’s my educated guess on a more frightening scenario that could unfold.
Our recession narrowly avoided becoming the second great depression only by the aid and backing of assets by the U.S. Government. Everything from money markets to car manufacturers was guaranteed. Intrinsic in the ability of the government to stabilize the markets with its guarantees is the assumption that it has the capability to meet these guarantees. If called, the money the government can use to meet these obligations comes from sales of treasury bonds and the printing of dollars, both methods of which the government relied heavily upon during this last crisis. But in my mind, there is a very real possibility these options might not be available next time.
Whether the Treasury likes to admit it or not, there is such a thing as the debt ceiling, and Congress does have to vote on it. More importantly is the fact that there has to be an appetite for treasuries — whetted by interest rates — for them to be acquired. At today’s paltry rates, I’m baffled as to who would really want to buy treasuries. Long‐term critics of this stance argue that treasury auctions continue to run smoothly and foreigners continue to buy our bonds. But closer inspection reveals an interesting trend.
It’s true that holdings of treasuries by foreigners are up throughout this crisis. But so is the total amount of treasury debt and the 29 percent of this total that foreigners hold is about the same percentage it was in August 2008. What’salarming is that of the approximately $1 trillionincrease in treasury debt over the pastyear, half of that came in the form of Treasury Bills (short term debt) and foreigners purchased the vast majority of these bills. To me that indicates that very few were interested in buying long‐term treasuries. The majority of the government’s ability to guarantee and stabilize the economy came from foreign purchases of very liquid and easily redirected money in the form of Treasury Bills. What happens when the interest on those bills, which is paid in dollars and currently averages 0.17 percent, turns into an actual loss for foreign holders because of exchange rates? This leads to my secondconcern: money supply and the ability to print currency.
For the past decade, the government has basically burned the buck by printing dollars. It’s a rather stealthy maneuver as the layman rarely follows the value of the dollar. But the fact is that the total amount of money in the system (the money supply) has doubled in the past decade. The net effect of this policy, a decrease in the value of the dollar, has finally started to make headlines. But in reality, the dollar has been declining in value since 2002 (the change in the value of the dollar is noted in red and the change in money supply in blue in the chart below) and whether we like it or not this has major consequences.
Most tangible assets, like gold and oil, are priced in dollars. If you check their charts you’ll see the effect of a falling dollar. They have skyrocketed in price in recent times primarily because the countries that produce these assets are getting paid in dollars that are going down in value. If this continues, it is my belief that these most vital assets will no longer be priced in dollars and our currency will lose its dominant role. This, of course, becomes self fulfilling: The value of the dollar will plummet if this happens to the extent that our ability to buy goods from other countries is seriously compromised and permanently diminished.
If you want to set the stage for a truly precarious and frightening scenario for the United States, take away its ability to borrow and print money. That’s the type of thing that destroys empires. I’m not necessarily making that prediction as I know predictions have the half life of an open cup of Activia in this business. But I do believe these possibilities need to be recognized and understood by policy makers.
In the end, I have to admit that I don’t know what will cause the next calamity or exactly when it will occur. (If I knew such, I’d probably install a T1 line into the house, link up a few more trading terminals and rarely leave my desk). So, this could be somewhat of a futile exercise. Nevertheless, this is not the first time I’ve run such an analysis. But no matter the accuracy of these thoughts, what I do know is that next time it will be different.
As always, I appreciate your continued trust and confidence.
Warren Capital Group is a registered investment advisor specializing in wealth protection and growth for high net worth individuals, institutions, foundations, and corporations. As a fee-based private wealth management firm, Warren Capital Group assists clients with asset allocation, risk management, estate planning and liability management via mortgage services. Warren Capital Group wealth managers use their collective expertise to invest in stocks, bonds, real estate, money markets and other alternative assets on behalf of clients and advise them on mortgages, insurance and other aspects of their net worth.
While we manage numerous types of clients here at Warren Capital, occasionally there are times in the investment cycles when clients express similar concerns about the Market's value, and their interests culminate in a resounding crescendo. Today that crescendo can be summed up in a simple question: Where do I put my money to generate a conservative 8% annual return? While it's a very practical request, the answer is you can't in this current environment unless you establish reasonable expectations. So, what are your options?
Any tenured money manager will likely admit that a good portion of their time is spent evaluating risk vs. return. To us, the starting point for this type of analysis is to determine what a "risk-free" asset is and what it yields. Our risk-free asset is a 10-year treasury bond. (To define the 10-year as "risk free" we assume that it will be held to maturity; therefore, principal will be returned as long as the government has the ability to continue to print dollars.) Today the yield on a 10-year is 2.4%, which grants us a starting point.
The one commonality among all our clients is that all have a goal for the money we manage. Whether it be early retirement, children's education, a second home, funding philanthropic interests or meeting pension distribution needs, every account we run has an overall objective and our job is to help meet that objective.So, when we begin a new relationship we talk about whether a risk-free return will allow them to meet their goal. Right now a 2.4% annual yield doesn't provide enough return for much of anyone to meet their objectives. So, what should be done?
In my mind there are three options you can entertain, either individually or combined. First, you can expand your time horizon allowing for more compounding before withdrawals. Second, you can contribute more money annually in conjunction with the 2.4% payment. Third, you can exit the risk-free investment in search of higher return. While the first and second options are very helpful, they are self explanatory. It's the third option that requires analysis.
As I've noted in previous commentaries, there are four general types of asset classes available to invest idle cash: stocks, bonds, real estate and commodities. For comparison purposes, I'll disregard commodities at this point because the market within each individual commodity has to be measured to calculate yield. In order to determine if and when to seek exposure to the other three, a measure of current yield for each must be established. We spend a good deal of time evaluating those yields as it betters our odds of adding portfolio alpha.
For stocks there is a pretty simple way to measure yield. By inverting the price to earnings ratio of the S&P 500 you calculate its earnings yield, which today stands at 5.78%. Earnings yield is simply a measure of how much an investor would get paid at the end of the year - after expenses - if he bought the entire company (or the entire S&P 500, in this example). For comparison sake, 5.78% is a lot juicier than 2.4%.
While I covered the treasury market, I believe it's important to further dissect the bond market as treasuries are almost always going to offer the lowest bond yield. The index we use to reflect the broader bond market is the aggregate bond index, which currently yields 2.92%. Real estate yield can be measured by the real estate investment trust index, which is 3.39%. From my perspective, this is essential information.
If you just used these rates to make a decision without knowing the respective markets they represent, this would be pretty simple process. The problem is that by selecting the glaring 5.78% yield you head into the stock market, and anyone that invested and held their position in the S&P 500 over the last decade knows that result. So what has to be done, and what we do consistently, is monitor these yields knowing that markets are not static. Failure to do so can result in the types of losses some stock market investors experienced this past decade.
As noted in the accompanying spreadsheet, by simply recognizing and acting to avoid stocks in periods when the earnings yield was dramatically less than the 10-year treasury, the abysmal losses suffered from 2000-2002 were avoided. It's also important to recognize that in periods of much higher earnings yield, like early 2009, investors were handsomely rewarded if they added stocks to their portfolio. Now I will admit that in the years when the two yields have been within 1% the data is not conclusive. But in four of the last 11 years where the variance was stark the year-end result can't be ignored. This, of course, makes perfect sense as money will always flow to the asset offering the highest yield with the lowest risk at some point. But this is only half the story.
I've always felt that bond investing can be just as complex as stock investing. Not only do you need to be concerned that the entity that you are lending to will be around at the time of maturity of the bond, but you also must take into consideration where interest rates will be over the life of the bond. We have been in a 30-year bull market in bonds as interest rates have fallen precipitously over that time. (1n 1984, you could buy long term treasury bonds and get paid 18% per year!) Because of the duration of this bull market, many bond investors have forgotten the other side of the inverse relationship between bond prices and interest rates. And when rates are as low as they are today, a relatively small rise in rates equates a very large drop in the price of longer dated bonds. For those seeking "safety" in treasuries I remind you that your bond account value can drop 16% over the next year if rates simply rise back where they were 14 months ago.
Let me be frank and state that we'd all like to generate 8% annually forever without ever having a down month. But the reality is that we all live in the same general world of available investments. The potential of those options always hinges on the current return of the risk-free asset, which is 2.4% today. To be blunt, that's almost an insulting yield and reiterates the reality that the markets don't care about what you are trying to achieve. But at Warren Capital, we do care about what you are trying to achieve! We also know that eventually money will always flow to the highest yielding, lowest risk asset. So, if you accept this reality you can use these types of metrics on your own. Or you can do as our clients and employ us to work on your behalf. Because as long as you have reasonable expectations, we represent another option. As always, I appreciate the continued trust and confidence.
Warren Capital Group is a fee-based registered investment advisor specializing in wealth protection and growth. Warren Capital Group wealth managers use their collective expertise to invest in stocks, bonds, real estate, money markets and other alternative assets on behalf of the firm’s clients -- high net worth individuals, institutions, foundations, and corporations -- and advise them on mortgages, insurance and other aspects of their net worth. Warren Capital Group assists clients with asset allocation, risk management, estate planning and liability management via mortgage services.
