Charter Trust - Global Market Update

Has Japan turned around? During the ‘80s Japan’s market was booming. Their export-led economy was capitalizing on the growth in world trade, their stock market grew 10-fold from 1974 to 1989, and the market value of the imperial palace in Tokyo was supposedly greater than that of the State of California. Japan, Inc. was considered an economic juggernaut—a model of targeted subsidies and managerial expertise that could dominate any market it chose to. Then the bubble burst and things went into a tailspin. Even though their economy continue to grow, the stock market fell by half and went into a 20+ year bear market. Last November the Nikkei Average was 80% below the record high it set in December of 1989. Japan’s economy has become a byword for the perils of deflation and economic stagnation. But if inflation and deflation are primarily monetary phenomena, can monetary intervention cure them? That’s what we’re about to find out. Last Fall Prime Minister Shinzo Abe articulated his economic policy: a regime of monetary expansion and deficit spending dubbed Abenomics. The yen fell by over 25% and the stock market doubled. Japan’s new intervention is a grand experiment. We will soon see where the experiment leads. Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all! Follow me on Twitter @GlobalMarketUpd

So what does China need to do?The answer on everyone’s lips is growth: growth in output, growth in exports, growth in employment. If you have a growing economy, the additional economic output can cover a multitude of sins.But that’s actually been a problem in China. They’ve grown so strongly that they haven’t needed to be efficient. So issues of pollution, congestion, moving millions of people from the interior to the coastal manufacturing clusters, and quality control, overcapacity, and bad debts are catching up with them. Government controls on interest rates, foreign exchange, and energy prices mean China now has a bunch of debt-laden, energy-hungry exporters that are struggling to remain competitive.Prime Minister Li Keqiang noted in a recent speech, though, that the state is planning to reduce its role in economic matters in the hope of unleashing the nation’s creative energy. Whether this initiative moves from rhetoric to reality is an open question, but at least they’re talking about deregulation and reform.And it can’t come too quickly. With Europe still in recession and US growth stuck in second gear, China’s exports have sagged. But there won’t be another major government stimulus package, as there was in 2008. The central government is worried about mounting local government debt and more bad loans. China is at a crossroads: a return to cronyism or accelerating reform. The road to reform may be rocky, but at least it doesn’t end in a bureaucratic cul-de-sac.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd

Why has China grown so rapidly? There are lots of low-wage countries. In the ‘90s the “Asian Tigers” of Singapore, South Korea, Taiwan, and Hong Kong specialized in finance or high-tech manufacturing and developed rapidly. Now they are fixtures in the global economy, hosting some world-class businesses.China has become a manufacturing powerhouse not simply via low labor costs, but from its solid logistical performance. Companies only put facilities in places where they can be productive, and to be productive they need adequate infrastructure, efficient services, consistent border procedures, and reliable delivery performance. China has created manufacturing clusters in its coastal regions with eye towards these factors.Other low-wage countries would have to put decades of effort and pour billions of dollars into their trade infrastructure to put even a minor dent into China’s trade advantage. So as world trade has grown, China has been able to leverage this.China’s extraordinary growth has been a natural result of its focus on logistics. Its market pullback has come not from external competition, but from internal factors.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd

Has China lost its mojo? During the late ‘90s and early ‘00s the country became a manufacturing powerhouse, using inexpensive labor and managerial skill to surpass Japan, Germany, and the US in global exports. The value of its stock market soared, growing 5-fold between 1999 and 2007. China’s economy, and especially its coastal areas, have become boom-towns.But since the Financial Crisis that market has been in decline. Stocks have fallen 60%, led by Chinese oil companies and banks. While other indices have gone on to reach new highs, The best the Chinese composite did was come to regain about a third of what it lost—back in 2009. Since then, the market has been in a steady down-trend.Has China caught a Japanese flu? Back in the ‘80s Japan’s market was soaring, only to collapse under its own financial bubble. All their borrowing and spending couldn’t jump-start that economy, and their market has been on a 20-year slide.But China is not Japan. Their economy is still expanding at a dramatic rate because they are a developing economy still building tangible and intangible infrastructure. There’s no evidence that their share of global trade is falling, and their entrepreneurial culture is intact.China’s economy is still highly competitive. It’s market pullback will reverse, once they deal with some of the problems their growth has created. Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd

In spite of all you do, stuff happens.In spite of all your preparation, all your planning, all your experience, mountains and markets can and will surprise you. Mountains are chaotic systems: they disrupt the airflow around them, and so they can create extreme situations, where the turbulent winds and a lack of cover transform a beautiful clear day into a massive maelstrom where there’s no shelter.Markets are chaotic as well. That’s why the patterns we see, while perhaps reminiscent of previous market cycles, are always new. The most dangerous phrase in investing may be, “It’s different this time.” But in a very real sense, it’s always different. What makes that phrase so perilous is that it is often used to justify improper actions, that in “normal” times we would condemn as foolish.So how do we adapt to market and mountain chaos? First, don’t panic. The surge of emotion that comes when things go wrong is rarely helpful. Second, follow  the plan unless it’s obviously wrong. When the compass says to go one direction and your instincts say go the other way, follow the compass. Likewise, if the plan is to trim when a sector becomes 10% overweight, do it. It’s never easy to cut back on a winner. That’s why it’s a winner. Finally, don’t be afraid to turn back. Just because you’ve put money into a position doesn’t mean you should put more money there. Sunk costs are just that: sunk. We have to decide what to do based on current conditions, not based on what was done in the past.Knowing that the best laid plans will have to be adapted as conditions change is important. It means you’ll be ready when things go wrong.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd

It’s been said that the difference between danger and disaster is preparation. “Be prepared” is the motto of the Boy Scouts, and it’s good advice when you’re headed into the mountains. You need to be physically ready for challenge of the peaks—core body strength, cardio-vascular endurance, and mental energy. You need to have adequate clothing and emergency supplies, like a headlamp and compass. And you need to know the mountain and trails you’re going to. Maps, guides, and experienced friends help you understand where you are and what surprises might be around the next bend in the trail.  Investors need to be ready for what the markets might throw at them as well. Research, documentation, and mental preparation are critical to dealing with the surprises that markets inevitably send us. Researching investments can take time, but it’s worth it. If you understand what a business does and how it generates its cash, then the market’s gyrations are less likely to cause you to panic. Documenting your decisions is also a great defense against second-guessing yourself. Going back to your files to see why you bought or sold what you did when you did will help you learn about both the markets and your own mind. And understanding ourselves is the real key to investment success. Recognizing how much risk you can tolerate and your other limitations is an ongoing process—and the way we prepare mentally for the markets. With preparation, market volatility becomes opportunity. Without preparation, it can lead to permanent losses to a portfolio. Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all! Follow me on Twitter @GlobalMarketUpd

How does respect fit into risk management?When you’re in the mountains, the first thing you learn is respect for the mountain. No one ever “conquers” a peak. Hillary didn’t “conquer” Everest; Whymper didn’t “conquer” the Matterhorn. The men and women who made first ascents did something unprecedented, but the mountains are still there.And what we respect is the mountain’s weather, its terrain, its remoteness, its unpredictability. Mountains have a way of surprising you, and because you can be far from help, minor issues can turn into major emergencies.In the same way markets can be infinitely surprising. What should be an orderly process of buying and selling can break down, and you get a “flash crash” like what happened in May of 2010 or supposedly safe portfolio insurance can cause a market  meltdown like October 1987. Markets are always creating a new new thing, and new ideas engender new risks and opportunities.Respecting markets means working with them, not trying to outsmart them.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd

In the spring, skiers from around the world come to Mount Washington for its celebrated backcountry snow. Tuckerman’s Ravine is legendary—its 50-degree pitches and rugged beauty combine to give mountaineers some of the best spring skiing anywhere. And the only cost is the challenge of carrying your own equipment into the bowl and up its pitches.I’ve been going up to Tuck’s for over 15 years, but I’ve only skied there about 2/3rds of the time. The reason is risk. Mount Washington is a beautiful place, but it’s also a dangerous place. The same conditions that make it so attractive also make it risky. It’s home to some of the worst weather in the world.Managing risk is critical to enjoying the mountain. And managing risk is also crucial when you’re investing. Over the next several posts I will examine four aspects of risk management: respect, limits, preparation, and uncertainty. These four factors can help anyone get into the markets—and the mountains—safely.Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd

This is the way the Fed ends its easing. Not with a bang but with a whimper.With apologies to T.S. Eliot, the Fed doesn’t have to end its innovative asset-purchase program with grand announcements and immense bond sales. It could, of course. It could declare the end of quantitative easing tomorrow, and begin selling tens of billions of Treasuries every day to reduce rapidly its $3 trillion balance sheet. Such an approach would overwhelm the markets. There isn’t enough liquidity available to buy the Fed’s supply. Interest rates would spike and global markets would plunge.So such an approach would destroy the US and world economy. The only asset that might appreciate in such a scenario would be cash, as interest rates would zoom upwards. For obvious reasons, the Fed is unlike to adopt such an extreme approach—“going from wild-turkey to cold-turkey,” as one Fed President has put it.Instead, they are much more likely to simply reduce their asset purchases gradually, assessing the impact as the current $85-billion / month program goes to $60 billion and then $40 billion and so on. Most of the Fed’s debt matures in well under ten years.The first step would be to lay out an exit plan and float it publically, as they did recently in the Wall Street Journal. But it took years to adopt our current monetary-policy mix. It’s likely to take years to get out of it as well.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd

Why are pensions always underfunded? It’s easy to understand the underfunding of public pensions. Why tax today what you can put off until tomorrow? In New Hampshire the Concord politicians had a unique fix for the State’s underfunding problem: make the Towns pay. Property tax rates are going up to help fund the State pension system. But why are corporate and union pensions always in trouble? Yes, we had a couple of crashes in the last 13 years, but the markets are at record levels. My 401(k) recovered a while ago. Why can’t traditional pensions? Partly it’s the Fed, and partly it’s the IRS. Traditional pensions are measured by subtracting liabilities from assets. As long as interest rates are super-low, the present value of any future liabilities is going to be higher. And asset prices haven’t been able to keep up. But it’s also the IRS. Back in the heyday of defined benefit pensions, the IRS became concerned about small professional offices that would overfund a pension plan as a way to defer compensation and taxes—which was pretty desirable, with the top bracket at 70%. So the IRS got very strict about overfunding—any payments into a fully funded plan were no longer deductible. So when the market collapsed in 2001 and 2008, pensions were already underfunded. And few pension managers had the guts to immunize their plans like Boots Pharmacy did in 1999, by buying 7% government bonds. No mess, no fuss, but no fees. It’s worse for union plans—their contributions were fixed by contract. Their solution to overfunding was to increase benefits. Now those plans are saddled with generous benefits and underfunding. And union shops like Hostess can’t pay competitive wages because they have to pay $1 an hour toward towards their rat-hole pensions. It’s been said that a camel is a horse designed by a committee. These pension rules make camels look like Kentucky Derby winners. Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all! Follow me on Twitter @GlobalMarketUpd

What can we learn from college graduations?Around the country millions of students will finish college this year, and they and their families will endure interminable lectures by commencement speakers that are variations on the theme, “To thine own self be true.” (Of course, these Honorary Doctors don’t seem to realize that when Shakespeare coined that phrase, in Hamlet, he was mocking the old windbag who mouthed this truism. Hamlet’s quest to be true to himself resulted in his own death and the deaths of almost everyone around him.)But being true to yourself is easy. Find what you want to do and do it. It’s a little harder to find someone who will pay for it. “Follow your bliss” is stupid advice if no one wants to fund your bliss. Prosperity--and happiness--comes from understanding and serving the needs of others.What made Apple and Microsoft and Wal-Mart and other global innovators great was their ability to satisfy needs that most people didn’t even know they had. Far better advice for grads would be to create bliss for others: “So shines a good deed …”Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd

The market is hitting record levels. Should we be worried?Record levels on the S&P 500 remind people of October 2007 and August 2000. Folks get a gut-clenching sense of déjà vu that they’ve seen this movie before, and it isn’t a feel-good flic, it’s more like Halloween Part 3. They keep waiting for Jason to jump out from behind that tree in his hockey mask.But this isn’t a movie, even if there seems to be a laugh track around every corner. The Dow and the S&P are now in record territory, earnings are growing, margins are stable, and the economy has been growing steadily for four years. The market leads corporate earnings which lead the economy. Just because a market is at a new high doesn’t mean a pullback is imminent.Sure, there will be turbulence ahead—there always is, as industries and companies go in and out of favor. That’s part of the creative destruction of capitalism. But bull markets grow on skepticism. All that worry out there just helps the market get stronger.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd

Should Indian tribes be able to sell tax-free bonds to finance development?That’s what’s being pushed in Congress right now. They want the House Ways and Means Committee to allow them to sell bonds to finance golf courses, hotels, and other   enterprises. At present, tribes can only issue tax-free bonds to fund essential government functions, like roads and sewers. States can issue bonds to support businesses, so why not Indian tribes?One reason is bankruptcy. Municipalities and other government entities have a clear bankruptcy regime—it’s called Chapter 9. But tribal governments aren’t subject to US bankruptcy laws. When the Foxwoods mega-casino defaulted on its debt, it never went into bankruptcy, because the tribes are sovereign. That’s why they have their own traffic laws and police.Until Congress sorts out how bonds will be treated if a business fails, they’d better not treat them like States. Because one of the ways people succeed in investing is by knowing what will happen if they fail.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd

With the market hitting records, what could go right?This market has advanced against a lot of skepticism. China is slowing down, the payroll tax hike will slow consumer spending, the sequester will cut government employment, national politics are dysfunctional, the states are bankrupt—there has been plenty of gloom to go around.Topping it all has been our stuck-in-the-mud economy. Month in, month out employment has grown by around 170 thousand jobs per month. At this rate, employment will recover to its previous high in a year and a half, and unemployment will get below 6.5% in two and a half years. But our economy won’t get back to its potential for about five.The unemployed in our country need something. It’s not redistribution or extended benefits, and it’s not a good swift kick in the seat of the pants. It’s a job—something our slow-growth economy isn’t generating enough of. But the market, hitting record levels, somehow thinks we’ll get there. I sure hope it’s right.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd

So how can bond investors produce enough income?One of the most dangerous practices in bond market investing is “reaching for yield,” going outside of your normal parameters in order to produce the income that you need. But extraordinary times call for extraordinary measures, and when circumstances change people need to adapt.Certainly, the last 5 years have been extraordinary, with the Fed holding its target rate below the inflation rate. Most folks thought that rates would have returned to normal by now. But with the economy still weak and no prospect for higher rates in sight, what can bonds investors do?One approach is to extend maturities, but that leaves them more vulnerable to rising interest rates. If rates rise 1%, the price a 5-year bond falls about 5%, but a 20-year falls 15%--3 times as much. And these longer bonds only yield 2% more. We call that “return-free risk.”But by taking controlled credit risk—in a managed, diversified portfolio—investors improve their incomes while only marginally adding to the volatility of their portfolios, because if rates rise now, it will be because the economy is improving—helping lower-rated firms.Short, lower-rated bonds are a reasonable addition to an income-oriented portfolio. And they can help investors reach their goals.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpd