Putting the pieces together...

A Low Cost High Quality Portfolio Manager

We who manage our own investment portfolios, no matter our age, often hope wistfully for a low cost but quality portfolio manager. We investigate many mutual funds, or closed funds, or ETF/ETN's or hedge funds looking for that perfect solution of positive return and safety of principle. Most professional money managers of all types seem too expensive for a low return "new normal" era.

In a recent interview in Index Universe, long term financial guru, Burton Malkiel mentions WealthFront as a maximizer of positive risk/return by keeping costs extremely low on their investments AND management fee as well as offering very scientific management of tax "harvesting" and re-balancing, which can add 1-2% to returns per year over long periods of time.

I have spent about five hours looking at the program on their website, thinking about it, and asking others about it. I have not spoken to the firm nor exchanged emails with them, so I am relying entirely upon their presentation which seems very forthright and attractive. Their model, which one can use without any contact with them, is quite an eye-opener and tailored to YOUR input. I have received NO emails or other unwanted contact with them since visiting their site.

Any and all comments on this subject will be gratefully received and answered.

 

Zero Hedge and Liaquat Ahamed

Yesterday Zero Hedge published "Charting US Debt and Deficit Since Inception", meaning since the first year of such US government statistics in 1792. The chart and comments speak quite well for themselves on both current US Government budget debt as a percent of GDP and total government debt as a percent of GDP.

Neither current huge tax increases nor current huge budgetary cuts can reduce the projected trillion dollar per year budget deficits projections of the Congressional Budget Office for EACH of the next four years. Only the Federal Reserve can do that and only by "buying" any and all new debt offered by the government, and in in return creating money out of thin air for the Treasury, as Zero Hedge tells us J P Morgan has predicted for 2013.

This milestone is much like what faced Germany in the early 1920's when a weakened economy collided with massive increases in social welfare government obligations (pensions, health care, disability payments, etc.) and potential war reparations.

As Max Warburg, Hamburg banker (and a signature founder of the Fed) and Reichsbank director, said in 1922, "the dilemma was whether one wished to stop the inflation and trigger the revolution, or continue to print money. Reichsbank head, Rudolf Havenstein, loyal servant of the state that he was, had no wish to destroy the last vestiges of the old order. If he had forced the government to raise taxes or cut expenditures he would have been accused of doing the work of the foreign collectors of war reparations OR of the recipients of government transfer payment .... [As it was]... von Havenstein elected to play for time, supplying the government with whatever money it needed. Contrary to popular myth, he was perfectly aware that printing money to finance the government deficit would bring on inflation, but he hoped it would be modest.... "

(from Lords of Finance: The Bankers Who Broke The World, Liaquat Ahamed, eISBN: 9781101403228, 2009; gently edited here by TED.) Not for the first time I recommend reading and re-reading many times this superb, very balanced book.

Are Stocks an Inflation Hedge?

In the past decade and a half since 1998, central banks have nearly continously manipulated markets and economies. Trailing price/earnings ratios have remained historically high even after frequent bear market crashes, and stocks are now seen primarily as speculative short term holdings rather than long term investments.

Traditionally, stocks were regarded as the basis of long term wealth building since corporate earnings rose inexorably in tandem with nominal GDP growth. The inherent belief was, and largely still is amongst credit lovers and gold haters, that stock prices rise more than inflation and are therefore inflation hedges. All an investor need do is to start buying stocks by age 25 and keep buying to make a pot of wealth which is safe from inflation. Stocks adjusted for inflation have nonetheless lost value since 1998-2000 (sector dependent), but that is dismissed with remarks that a bad decade is to be expected once in a while. It is indisputable, however, that commodities and gold and much real estate have greatly outperformed inflation and stocks in the same environment.

Stephane Deo of Union Bank of Switzerland has analyzed inflationary regime switches and whether and how much equities hedge inflation as it waxes or wanes. Deo found that equities hedge inflation quite well from just over 2% inflation periods up to nearly 5% inflation periods, but as inflation increases further, the inflation hedging power of equities falls off greatly, disappearing at about 6.5%. By 9.5% there is no longer any price increase even in nominal terms.

If one believes that inflation will increase over the next few years, this would be a good time to be exposed to stocks to hedge that inflation. Note, however, that if inflation falls below 2% (currently ~2.2%), prices of stocks would likely fall under very mild inflation and go negative at about +1.7% and below.This was true on a trend basis from about 1929-1942 in the US and since 1990 in Japan

The relationship of earnings and inflation is at the heart of Kondratieff Wave analysis. Under my wave analysis, stocks go up in mild deflation when interest rates are falling gradually from high levels (1982-2000), and stocks go up in mild inflation when interest rates are stable or rising slowly (1949-1965/72). But at "some point", which historically I personally judged to be ~6%, rates become "too high", and stocks stall out. Deo's 6.5% maximum hedge cutoff is pretty close to my own guess level, although the cutoff could happen earlier (at a lower rate) if velocity (or acceleration!) of inflation is "too high".

Bear in mind that another risk is that at very high levels of inflation stocks may not keep up with inflation but can still rise and attract money which is fleeing the economy and local currency in any way it can.