Charter Trust - Global Market Update

Execution is what most people think about when they think about investing, but it’s only part of the process. It’s important, though--as important as framing up a structure after you’ve made all your plans. When people say they’re building a structure, they usually mean they’re in the last stages—framing up the walls, or finishing out the interior. And that part of the process is really important. But it flows from the other steps. Again, there are always choices, choices, choices: joinings, fasteners—the nuts and bolts of building. When you execute a plan, there are all kinds of choices as well. What kind of brokerage to use—the cheapest one, or one that will take extra care with your order, and protect your order’s information? What kind of custody arrangements to use: a third-party custodian, or one of the manager’s choosing? And what kind of orders do you make—market orders, or do you specify a price, and run the risk of not being able to buy the stock or bond that you want? Execution can be everything. If you buy a hot stock that everyone else is jumping into at the time, there’s a pretty good chance that you’ll be disappointed, because what the wise do in the beginning, the fool does at the end. Hot securities are usually priced for perfection, and rarely deliver. But buying a falling stock or market can be like catching a falling knife: the harder you try, the worse you get hurt. But the entry price frequently turns out to be the difference between a truly profitable investment idea and a mediocre one. How you put an investment plan into action matters as much as any other step. Investing is a detail business—close-enough usually isn’t good enough. Because it’s your money, and what people do with it is always your business. Douglas R. Tengdin, CFA Chief Investment Officer Follow me on Twitter @GlobalMarketUpd

Once you have blueprints and a foundation, what do you do? The next issue builders face is choosing materials—balancing cost and quality. And the next choice for structuring a portfolio is asset allocation. Asset allocation balances risk and return. Different investment vehicles represent different forms of ownership, stand in different places in the capital structure, and so bear different levels of risk. In general, the more junior the claim your asset has on the cash flow of an entity, the more the risk that you don’t get paid, but the more upside you have if things work out, or if the business grows. For example, bonds represent a senior claim on operating cash flow. For a business not to pay its bonds, it has to go through bankruptcy—a laborious and disruptive process, in which managers often lose their jobs. So people usually avoid this, and bonds usually get paid. Stocks, on the other hand, represent the most junior claim, and dividends get cut all the time. Shareholders can face losses for all sorts of reasons. But they also benefit the most if the business grows. Other assets represent different sorts of claims. Short-term treasury bonds are the least risky asset out there. It’s almost inconceivable that a government won’t pay its debts in its own currency. After all, it can always print more! This could lead to inflation, but short-term bonds can be reinvested at the higher rates, so they’re less risky than long-term bonds, which bear inflation risk. Government bonds from states and municipalities—that don’t issue their own currency, but that do collect taxes—are a little more risky, but if the economy is growing and the local government is credible, they’re safer than almost everything else. And then there are other sorts of securities—real estate trusts and master-limited partnerships. These instruments use various legal structures to reduce taxes. They’re not appropriate for all investors, though, so you need to do your homework! Asset allocation is a critical step—but it flows from having a plan and policy specific to your needs. It balances the risk/return trade-off, and helps keep your portfolio on-track. Douglas R. Tengdin, CFA Chief Investment Officer Follow me on Twitter @GlobalMarketUpd

What’s the foundation for good investing. It’s a good question. Because foundations are—well—foundational. They support everything else. If a building’s foundation isn’t sound, the structure itself won’t be stable. Joinings will fail, and eventually the entire building will come down. A good foundation goes below any disruptive influences—like frost—and keeps things true. It allows you to build a much more interesting structure.In the same way, an investment portfolio needs to have a sound foundation. And the foundation of any portfolio is the investment policy—the document that specifies the required return, the risk tolerance, and various constraints: time-horizon, liquidity needs, tax considerations, the legal and regulatory framework, and any other considerations.The required return is simple: money needed divided by money available over time. Yes, compound interest makes the required return smaller, but only over long periods—ten years or more. So, if you have $50,000 and need it to double over 20 years, that implies a 5% return. But the actual required return is 4% due to compounding. A simple spreadsheet can calculate thisOnce you have your needed return, you should determine how much risk you can deal with. Risk is on most people’s mind these days. Stocks underwent a 50% decline in 2008, just as they did in 2001 and in 1974. If you can’t live with this sort of volatility, you need to pare it down by owning a proportional amount of bonds and cash.Other constraints need to be specified as well. These things don’t change with the investing climate, and can serve as touchstones when market conditions become unsettling. The policy isn’t disrupted, because it doesn’t depend on market conditions.A good foundation makes for a good structure. And a well though-out investment policy is more likely to lead to investment success than all the bull markets in the world.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

How do you craft a portfolio?Assembling a financial portfolio is a lot like building a house. Everyone has a basic need for shelter, but once you get beyond the basics there are all kinds of decisions to make—where to locate, how big to make it, what kind of materials to use, and so on. Building a home can be stressful—but it can be exhilarating, too.In the same way, putting an investment portfolio together can be stressful but also can be exciting. The projects are similar, especially because they both start with the owner’s needs, desires, and resources. By taking stock of yourself, you end up with a much more satisfying product. The first question to ask is what do you want your portfolio to accomplish. Some people are looking for supplemental income, others are saving for their children’s college tuition, and other people have other goals. Whatever the objective is, write it down. Then try to make a rough estimate as to what this will cost. For example, many private colleges cost about $200,000 over four years. If you can only set aside $400 / month, that will accumulate $72 thousand over fifteen years. If you want to have half the cost of college saved up, this goal implies that you will need about a 5% return over this period. If you can save more, your required return is lower.Your required return will indicate what kinds of assets you need to invest in. Everyone wants safety—but most people also need growth. By specifying your objectives, you can sketch out a plan that is more likely to meet your needs, without keeping you up at night.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

In many ways, assembling an investment portfolio is like building a house.Both tasks are public and intensely personal. Both require diligence and expertise. And both have general principles that everyone needs to follow, if they want to be satisfied with the result.In both building a house and a portfolio you don’t begin by buying nails, you start by going over a set of plans—the blueprints. These make it clear how your home will be sited, what the layout will be, and the general framework. In the same way, an investment plan will tell you what your money is supposed to accomplish—whether it’s supplementing your income, saving for retirement, or establishing a personal rainy-day fund. In both cases the plan starts with your desires and limitations.From planning, you move on to laying a foundation. And the foundation of any successful investment process is the investment policy. The policy will specify what the required return is, how much risk you can handle, and other restrictions, such as tax considerations, liquidity needs, your time-horizon, and so on. In any building project, the foundation is what supports the structure. When you’re investing, the investment policy supports every subsequent decision.From the foundation, we go on to choosing materials. In investing, that’s your asset-allocation decision. When you build, you have to decide between quality and price; with investing, the trade-off is between risk and return. Assets with higher return potential have greater risk to them—it’s inherent to the asset. This is because what allows them to grow—either faster or slower—makes them more risky. It’s usually their position in the legal or economic capital structure that creates the risk.Framing up the structure is like purchasing the stocks, bonds, and other instruments. And like putting up a frame, execution is everything. A great plan poorly executed won’t make anyone happy. Finishing out the home is akin to setting up proper reporting and access rules. You may have a superior structure, but if the details bother you, you won’t be happy. And home maintenance is like portfolio maintenance: evaluating and adjusting as time goes on.The parallels are striking—and encouraging. Because building a home isn’t a mystery, it’s a rational process that takes discipline and planning. And everyone has one sort of home or another. It’s just a question of what kind of home we want.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

What does it take to build wealth?Like many in my generation, I grew up watching Gilligan’s Island. My idea of a rich person was shaped by the behavior of Thurston Howell III and his wife “Lovey.” Week after week, they washed and dried their green-backs and did other silly things. What they wanted the currency for while stranded on a desert island was never clear.But the world is full of lots of non-fictional millionaires. Their lifestyles can be instructive. In his book The Millionaire Next Door Thomas Stanley examined how they live and, more importantly, what their attitude is about money. What he learned is instructive.First, they tend to live modest lifestyles. The average home price of someone with $2-5 million was about $350 thousand—comfortable, but not opulent. They rarely buy new, late model cars, preferring older models or even used cars. And they rarely financed their purchases, preferring to avoid the interest expense.On the other hand, they were willing to borrow—for business opportunities. When the situation presented itself, they weren’t afraid to borrow to invest in their business. For the most part, they love what they do, and are usually more interested in building a business than in making a bundle.Above all, they lived within their means, spending less than they made. Sometimes that meant detailed budgets; other times it was a savings plan that set aside the money before they saw it. In most cases they understood that the best things in life aren’t things, and that what really counts in life can’t be counted.What’s really striking about this study is the fact that if people focus on status and what they can buy, they usually can’t afford it. But it’s the patient saver who maxes out his 401(k) and re-soles his shoes who often ends up owning the business. Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

Sometimes it feels like the wheels are coming off. The pope resigns. The North Koreans detonate a nuke. A $100 billion cut in Federal spending is on track to take effect in a month. And the stock market is flirting with record high levels. What’s wrong with this picture?What’s going right for the market is the Fed throwing money at the economy through quantitative easing. But stocks climb a wall of worry, and the world is obliging. First the Pope: the pontiff’s resignation was prompted by his health—he’s just not physically strong enough to deal with the 24/7 demands of being a modern leader in the 21st century, so he set a humble precedent: step down voluntarily. Don’t wait for your health to cripple the papacy, possibly for months. This is actually a good thing.With North Korea, their motivation is simple: get as much attention as possible for as long as possible. It’s hard not to see this as timed to get play at the State of the Union speech. The way to address it is equally clear: quiet diplomacy, with as little prominence as possible. Unless they attack someone or sell their bombs to terrorists, this is old news, and fairly neutral.But it’s the sequester that has the real potential to hurt the market. $100 billion is only 0.5% of the economy, but if it comes from the wrong places it can ripple through and be magnified. We’ve just raised Social Security taxes by 2%; that will cut spending. Hit people hard enough and often enough in their pocketbooks and they’ll scale back enough to contract the economy. In a global balance sheet recession like this one, that would be bad.Yesterday’s news was alarming, but it’s the devil we’ve known—Congressional gridlock and government dysfunction—that’s the biggest risk today. Keep your eyes on Washington.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

Does a dip in the economy mean we’re headed into a recession?Normally the answer would be: maybe. The popular definition of a recession is two successive quarters of negative economic growth. Having one negative quarter—even if only by a measly -0.1%--means the chances of a second negative quarter are that much higher. After all, if you’re dealt an ace as in your first card in blackjack, your chances of getting twenty one are a lot better.But the economy isn’t a card game. While it’s true that unexpectedly low growth usually increases the chances of recession, the composition of economic growth matters. While investment, which constitutes roughly 10% of the economy, declined last quarter, personal consumption actually went up—especially of durable goods, like cars, or washing machines. Also, the decline in investment was led by a $40 billion decline in inventories, a volatile component that often reverses itself. For example, a 1.1% decline in inventories in the summer of 2011 was followed by a 2½% gain the next quarter.Moreover, net exports were also an economic drag in the latest report, estimated to have fallen by some $30 billion. But that item is a rough estimate, initially. The Commerce Department has to guess what the final month’s data will be. Up until now the trend in trade had not been good. But December’s numbers turned that trend around. Based on that report, GDP is likely to be revised higher, possibly turning a slight negative number into a small positive. The economy hasn’t been strong, and we face some real headwinds: anemic bank lending, weak employment growth, and structural deficits. But like the guy in the Monty Python skit, it’s not dead yet.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

This just in: S&P mis-rated some Mortgage Backed Securities. Who knew? The cynic might say that the government’s suit against S&P for its role in the housing boom and bust is payback for the credit downgrade S&P gave the US government. After all, Justice didn’t accuse Moody’s or Fitch, and they missed the downturn, too. In fact, almost everyone did. But it’s probably the case that Moody’s and Fitch are still negotiating a settlement. That’s why they haven’t been sued yet. And it’s hardly new news that S&P (and Moody’s, and Fitch) blew some calls. In fact, the Financial Crisis Inquiry Commission explored all of this. In their report (issued two years ago) they stated: “The three credit rating agencies were key enablers of the financial meltdown. The securities at the heart of the crisis could not have been sold without their seal of approval.” But there’s a big difference between errors of judgment and fraud. To err is human. And to willfully misunderstand something happens all the time, when self-interest gets in the way. Upton Sinclair famously stated, “It’s difficult to get a man to understand something when his job depends on not understanding it.” As long as rating agencies are paid by the parties that they rate, they will be conflicted, and will misunderstand things. Is the answer an open-source credit rating system, where everyone knows the rules and thresholds ahead of time--Google-ratings? Seems to me that sort of system is liable to be “gamed,” with deals structured to just get by. The Justice Department may claim they’re pursuing fraud, but to many observers this just looks like scapegoating. And everyone loses credibility in the process. Douglas R. Tengdin, CFA Chief Investment Officer Follow me on Twitter @GlobalMarketUpd

What is it with email? Whether it’s talking about the Talking Heads or comparing clients to Muppets, there’s something about the immediacy and intimacy of email that releases the inner locker-room of the most sophisticated professional.  Banks like Barclays, Standard Chartered, UBS, and Royal Bank of Scotland have paid billions in fines because—apart from trash talk trading-floor profanity—their traders exclaimed, “it’s amazing how fixing can make you so much money.” How could they put that in writing? Email is forever. Asking someone not to forward a joke, song, or comment is worthless. Once you send off an email, it gets stored on someone’s server somewhere. And because it’s digital, it can be discovered with a simple search algorithm. If you write it, they will find it. And in large organizations, if something sketchy is going on, it’s a near certainty that there will be at least one stupid, profane email, IM, or voice-mail admitting to the crime. The authorities don’t have to be bloodhounds. All they need is access to the company’s servers. Remember: email and instant messages are documents. Even if they’re deleted, they can be recovered. Email is great for communicating facts. But if you have an opinion on a sensitive issue, keep it to yourself. Or pick up the phone. Remember the New York Times rule: assume any email you send could appear tomorrow in a little box in the front page of the times. So remember what your grandma said: if you can’t say something nice, don’t say anything at all. Douglas R. Tengdin, CFA Chief Investment Officer Follow me on Twitter @GlobalMarketUpd

What’s a baseline budget?Baseline budgeting is when you start with this year’s budget, add a cost-of-living adjustment, and voila, you have next year’s budget. It’s a quick way to get a bottom-line number, and it helps organizations plan what they can spend for repairs, maintenance, and upgrades. It differs from zero-based budgeting, where the organization has to justify each program every year. Baseline budgeting is better for planning, zero-based budgeting is better for cost-cutting.But something pernicious happens when politicians get their hands on this process. Any downward deviation from the baseline becomes a cut, even if spending actually rises. In the current debate over the defense budget, it is rarely noted that the sequestered budget actually rises about 2% per year. Spending, adjusted for inflation, is constant.But bureaucrats play games with zero-based budgets, too. One of the oldest is to put the important programs at the bottom of the page, and the smallest items at the top. Thus, most of the budget gets approved before you get to the hard decisions--those considered too crucial. So your eye moves back up to the middle of the list, where there are a couple of sacrificial lambs.But that’s not the world we’re in—normal budgetary horse-trading. We’ve traveled through the looking glass to a land where budget increases get spun as program cuts, and where less spending on scientists and engineers at defense contractors is going to put us into the path of an incoming North Korean missile and double the unemployment rate at the same time. I don’t think so.Baseline budgeting is another way that the “supper club” tab just keeps getting bigger. And the sequester approved at year-end may be the only way to deal with it.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

When everyone thinks alike, everyone is likely to be wrong. These ten words embody the essence of contrary investing. Bubbles and panics have been a part of the financial landscape ever since people have been buying and selling. The South Sea bubble, Tulipmania, the Roaring Twenties, the commodities boom of the ‘70s, the dot-com boom, and the recent housing bubble all have this in common: excess leverage creates excess demand for and production of some particular good. After the bubble deflates, the excess capacity needs to be re-absorbed into the economy. A recession or depression inevitably follows.Marx saw these booms and busts during the 19th century as proof that capitalism is self-defeating and must inevitably be replaced by a centrally planned economy, not realizing that the central planners could be just as susceptible to group-think, booms, and busts.But people like to fit in. They are quick to conform and slow to differ. And because our minds are so adaptable, just repeating the conventional wisdom a dozen or so times a day will make you come to believe it.Three years ago all anyone wanted to talk about was China, China, China. A five-year plan and leadership change later, their market has contracted 20%, and no one wants to talk about China, with its billion increasingly sophisticated consumers. Last year it was Apple, Apple, Apple. Now, a moderate earnings report and product launch behind it, the stock is down 35% and no one wants to touch it.The crowd is most enthusiastic when it should be cautious, and is most cautious when it should be enthusiastic. Contrary thinking can be lonely and require great patience. But good returns are the best revenge. If you’re thinking of going against the crowd, you’ll have to think hard.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

So what did the Super Bowl mean?No, not the game last night, although a few comments are necessary. First, it was a great game. Both teams played magnificently in a high-pressure situation. Second, the New Orleans economy will benefit from all the activity—hotel rooms, restaurants, rental cars, and generators. Super Bowl week is an economic boon to any town. And third, the vaunted “Super Bowl Indicator” is meaningless. The indicator is supposedly a way to predict whether the market will go up or down in a given year. If the NFC wins, it’s supposed to be a bull market; if the AFC wins, expect a bear market. The indicator has been correct about 80% of the time. So what’s the problem? This is a classic case or correlation not implying causation. There is no reasonable mechanism whereby an NFC victory would affect the economy and the market. The Super Bowl Indicator is super-foolishness. But what I’m talking about is the statistical super bowl that came out on Friday: we got the employment report, benchmark revisions, the purchasing manager’s index, and January auto sales.They all look like an economy that’s muddling along—not in recession and not booming, either. It’s certainly not growing fast enough to reduce unemployment much, or to get the Fed to change. We’ll likely get more of what we’ve had for the past four years: zero-percent short-term interest rates, continued asset purchases by the Fed, and a fire hose of liquidity aimed at the asset markets, which has been pushing them higher.This may not be healthy in the long-run, but it’s my job to invest based on what’s happening. I don’t have to like it.Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

Most people will be looking to watch the Super Bowl on Sunday. But for economics mavens, the Super Bowl is today. At 8:30 am the Bureau of Labor Statistics releases its annual benchmark revision, along with the monthly employment report. At the same time, manufacturing data, consumer sentiment data, and car sales numbers are coming out. It’s a statistical feast! The benchmark revisions are the most interesting, however. Preliminary numbers last September indicated that the economy had been creating some 30 thousand more jobs per month than previously thought. That’s good, but it hardly makes up for the fact that the economy still currently employs about  4 million fewer workers now than it did at the end of 2007.Just as a review, the monthly employment report is actually two reports: an employer survey, and a household survey. Like any survey, it’s subject to errors: response rates, estimation, processing issues, and so on. So every year the BLS reconciles its data with State unemployment insurance forms and Census Bureau data. The revisions can reach back up to 5 years. Because the monthly survey takes such a large sample size, revisions are typically small—averaging 0.3%. But because the economy since 2008 has been so volatile, this set of revisions should be especially interesting.So while the Ravens / 49ers Harbowl clash will likely be one for the record books, my money is on the BLS. Not only do they tell us where the economy has been and where it is, but they do it with a minimum of drama and no commercial breaks. So break out the wings and hot sauce, the revisions are coming to town!Douglas R. Tengdin, CFA Chief Investment OfficerFollow me on Twitter @GlobalMarketUpd

Has Apple’s shine come off? Shares of Apple tumbled after their earnings release. While they met sales and earnings expectations, their margins narrowed, and they didn’t so much trim their guidance on future earnings so much as “shade” it—telling analysts that management’s expectations for future earnings were realistic rather than conservative: code for “We’ll beat this, but not by a lot.” It was the profit margin that had investors worried, though. Their gross margin declined to 39% from 45% a year ago. The concern is that as Apple moves to lower-priced items in its product list, there just isn’t as much room for their fat margins. So in spite of 40% annual sales growth and 60% annual earnings growth over the past 5 years, the stock is now valued at 7.5 times earnings, adjusting for Apple’s massive cash hoard—35% below its high price last September. Up until now, Apple could do no wrong. It was one of the four major asset classes: stocks, bonds, cash, and Apple. It grew to over 3% of the entire US market, and its soaring performance has been a big reason why so many portfolios have trailed their bogies—any decision other than to buy Apple has subtracted value. The company and its shares have been a victim of their own success—growing to the point where the law of large numbers makes exponential growth increasingly hard. But even if the company moves to a more modest growth track, the stock is exceptionally cheap—valued more like a slow-growing utility than a world-changing technology innovator. The recent swoon in the share price reminds everyone that trees don’t grow straight to heaven and don’t put all your eggs in one basket. Rational portfolio management demands diversification, no matter how hot one company’s prospects may be. Douglas R. Tengdin, CFA Chief Investment Officer Follow me on Twitter @GlobalMarketUpd