February 17, 2012
Commentary by Joseph Warren
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
Commentary by Joseph Warren
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.
December 30, 2011
Commentary by Stuart Brown
For this week only…All is quiet
All is quiet the week before the New Year celebration. Could it be Europe has stumbled into a solution of their debt crisis with the circularity of the European Central Bank (ECB) lending billions to the banks, which in turn deposit the funds with the ECB (rather than face counterparty risk by lending to each other or businesses)? Or have the hedge funds, like Congress, simply taken the last week off?
The ECB, still at work, is quietly buying billions of Italian sovereign debt and that has helped keep rates tame. (If paying seven percent marks the end of the world, the debt problem can’t truly be solved.)
In the US, for all the brinksmanship and bluster of the year, the budget has barely been trimmed by a few billion. Bruised by the payroll tax debate, Congress went home leaving the President to quietly ask for another trillion dollar hike to the debt ceiling this week.
(In the spirit of getting something for nothing, who will ever want to see a thousand dollars less in their paycheck? Like the unfunded prescription drug add-on to Medicare, the payroll tax holiday is another Trojan horse bringing forward the day of insolvency.)
But next week, with the Iowa Caucuses, the volume of the political discourse will be turned up again. Congress reconvenes and Wall St. will get us back in the swing of things. There is a trillion dollars of European debt to refinance in 2012, along with another trillion of junk bonds and some hefty Treasury borrowings.
Everyone knows all the woes. Seems to me, that must then, be already priced into the market. It is what is not priced in the market that will prove important as the new year unfolds.
Stocks began the year with a P/E of 17 and ended at 14, or an Earnings Yield of over 7%, historically a tremendous value in light of the thirty-year treasury paying under 3%. Over the next few weeks companies will report their fourth quarter earnings, which are expected to be generally pretty good.
For all its gyrations 2011 was a lot of nothing. The New Year may still be volatile, but is starting from a better valuation and so may very well be more profitable.
I want to thank you for your continued confidence. I hope 2012 comes with great happiness and health and the joy of loving family and friends.
September 12, 2011
Commentary by Stuart Brown
Since 1900, the stock market has averaged six percent growth per year, excluding
dividends. Seldom have stocks been priced as inexpensively as today. When at this valuation in the past, a year later, on average, the market was up over twice the historic average.
Most recently, in June 2009, a dollar invested in the S&P represented 1.7 times the yield on the thirty-year Treasury bond. A year later, the market had risen 28%.
Today, with reported earnings of $85.18 and the S&P at 1169 (an earnings yield of 7.3%) the market is priced at over twice the 3.5% yield of Treasuries.
The stock market has been similarly valued 46 times over the past century. Each following year, the market had rebounded sharply (with the exception of the early years of WWII). There are no assurances as to what the future might bring. But if things unfold the way they have in the past, this could be a very profitable time to own stocks.
There are ways, other than higher prices, for stocks to appear expensive, e.g. if interest rates soared above 9%, the market would no longer look as cheap in comparison. Or if a soft patch turns into full blown recession and earnings decline. There are three moving parts to this model: earnings are reported quarter by quarter, interest rates and the price of the market change moment by moment.
Most recently earnings have been reported for the second quarter and have generally been good. For the Dow Jones Industrial Average, earnings rose on average 14% on 10.5% higher sales. Not bad, but the market, concerned about where earnings might be next year in a slower economy, sold off some 15%. Money moved to bonds, driving the yield on the Treasury down from 4.7% to under 3.5%.
Irene blew her way up the east coast. While hurricanes aren’t known for doing much good, there may be one nice thing about a market decline; once again stocks are offered at a compelling price. Stocks are as cheap as they were in early 2009—at the recent market bottom.
July 27, 2011
Commentary by Joseph Warren
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.
March 01, 2011
Commentary by Joseph Warren
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 10, 2010
Commentary by Stuart Brown
Interest rates have risen as much as three quarters of a point across the yield curve. Barron’s estimates these higher rates will add $800 billion to the cost of financing our deficit. How much higher would rates now be were it not for $600 billion in QE2?
Is the economy stronger than it appears? Recent reports are encouraging. Third quarter earnings were the best ever. Retail sales look decent. GDP was better than first reported.
Are investors returning to risk-taking? Rates rise as sellers overwhelm buyers of bonds. As this occurred, the stock market rose. If banks don’t pay enough on savings, people look for alternatives. Foreclosures dampen enthusiasm for real estate. But a second year of double digit returns for equities and an improving economy encourage stock investors.
Continue reading this commentary »
October 26, 2010
Commentary by Stuart Brown
Once a quarter we get meaningful information. So far the news has been fine. Just over half of the thirty stocks that comprise the DJIA (Dow Jones Industrial Average) have reported third quarter earnings. As I wrote in my August comment, The Only Thing Not Priced into this Market, it does not look like the end of the world. On average earnings are up 57% compared to the same quarter a year ago.
No one expects that rate to continue. However, there may yet be more good news. Estimates, which have been overly bearish, now call for earnings to rise on average 26% this year and 11% next.
The world is looking less and less gloomy. Since my August commentary, 2010 earnings estimates have been revised higher for over three quarters of the DJIA stocks. All but five of the 2011 estimates are now substantially higher than just a few months ago.
Continue reading this commentary »
September 13, 2010
Commentary by Stuart Brown
There are not many examples of a market as cheap as today’s. Other than early 2009, the last time the market was this cheap was 1941, when a dollar in the S&P; represented, in earnings, over twice the interest paid by Treasuries. 1949 and 1977 got close to this valuation.
1941. Earnings had almost recovered their 1937 highs, just as today earnings have almost returned to 2007 levels.
Continue reading this commentary »
August 05, 2010
Commentary by Stuart Brown
Despite a crummy decade in the stock market, the market has been a good place to invest. Since 1900 there have been 1193 months at the onset of a completed decade. At the end of those decades the market had risen on average 87% though 225 times the market was down.
As a friend in the real estate industry observed, all the money is made on the price paid at acquisition. How expensive the market is at the start of the decade has a lot to do with the investment experience. When more earnings can be got from the stock market than interest from bonds, investors should overweight equities.
The greater the earnings yield vs. Treasury yield, the better the market experience.
Continue reading this commentary »
