Category Archives: Economy and Investing

A Reasonable Request?

By Larry Luxenberg  

Last week a client told me that he believed a recession was imminent and he wanted to take investment actions capitalizing on that view.

At first blush, this seems to be a reasonable request. Many commentators foresee a recession as the result of the Federal Reserve’s aggressive interest rate tightening cycle.

However, this view reflects several beliefs about investing that are simply not true. One of the main suppositions is that the stock market acts in line with what is happening now. In fact, the stock market tends to take a collective view of the economy 6 to 12 months ahead and discount those future events.

In the case of this expected recession, if it’s visible now, stock market action should have discounted it last year.

Even more difficult is the idea that anyone can predict a recession ahead of time. To get an idea of how difficult it is to predict a recession consider this. Officially, recessions are designated by a group of nationally prominent economists at the National Bureau of Economic Research. One of the main indicators of a recession is two consecutive quarters of decline in Gross National Product. However, the economists look at many indicators of economic activity in determining when a recession began and when it ended.

But what’s most telling about this group of distinguished economists is that they determine the dates of a recession several years after the recession has ended and the subsequent recovery is well under way. In essence they struggle to call the recession afterwards and don’t even attempt to predict it ahead of time.

So what my client wants to do is something no economist would hazard and after he accomplishes this feat he then has to backtrack as much as a year to capitalize.

If you ask for the impossible, often you will be disappointed.

Instead, it makes more investment sense to take into account the regular occurrence of recessions and bear markets when you put together your investment portfolio. Being able to ride out these downturns without shifting positions has produced powerful long-term returns.

Over the last century, investors in the largest American companies (measured by the Dow Jones Industrial Average and the S&P 500) have doubled their returns on average every seven years. This doesn’t occur like clockwork but the longer you give it the closer you’ve gotten to these results.

When I began my investment career in 1982, the Dow hovered around 800 as it emerged from a two year double recession. Today, after a terrible period for the stock market, the Dow is almost 33,000.

That’s a great period for investors who shunned predictions and stuck with the market through thick and thin. Trying to save yourself some short-term pain is just as likely to sabotage your long-term performance as it is to help.

If there was a way to avoid the pain, I would be among the first to sign up. Instead, I do the next best thing. Put together a diversified portfolio that’s designed to prosper despite market swings and keep my investments intact as best I can.

No one knows whether this approach will work in the future but it makes more sense than trying to find a better crystal ball.

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Know-It-Alls

By Larry Luxenberg  

Beginning investors think they know more than they do. Experienced professionals accept uncertainty and are secure in the knowledge that they cannot predict the future.

It is not a harmless affectation to think that you can know the future. It is one of the costliest mistakes an investor can make. Only luck can save an investor who is overly confident in his foresight.

Often, investors spot a trend and think they can make money at it. They think they alone, among millions of investors globally, who spot this particular trend and have the sagacity to capitalize on it. Most dangerous are those who get lucky early in their investing efforts and conclude that they are investment geniuses.

Some investment geniuses exist and I’ve known several. But investment geniuses are much rarer than the number of people who claim that rank. A wise investor I know, compared investing in stocks to mining low grade ore. Picking up a little ore efficiently can make you money if you are patient and work hard. You won’t get rich quickly but over time, the rewards add up.

A common investment mistake is believing that the investment world is static when in fact it is highly dynamic. By way of illustration, consider a trend like the widespread legalization of marijuana. Without doubt, the industry will grow. More marijuana will be consumed, marijuana businesses will add many employees and revenues may skyrocket.

This trend may help investors but it does not guarantee that investors will profit. At the start, there may be no public companies in the industry. Small private companies may dominate. Over time, some of these companies may go public and grow large enough for investors to buy shares.

But if the industry grows fast, soon dozens and perhaps hundreds of companies will spring up to compete for the business. Each company will issue shares and some companies may issue shares repeatedly. As the number of shares of stock in the industry rises, the higher profits are divided among more and more shares. Shares often grow faster than profits. Even if the industry grows faster than the investor anticipates, the investor’s share price may not rise and he could even lose money.

Some version of this sequence has happened many times. In the late 19th century, there was only one automobile company, according to Wikipedia. At the peak, there were 1900 automobile companies. That number plummeted during the Great Depression and by the 1950s, the Big Three dominated U.S. production. Not all the early companies were flops. Some were acquired and their investors made money but many companies became worthless. This is a great example of a big and successful trend. At the start, only a handful of cars were produced. Eventually 17 million or more were sold annually. While the industry had nearly a century of growth, over much of that time, investors were left in the cold.

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The Law of the Jungle

By Larry Luxenberg  

The way humans have evolved over millions of years is spectacularly unsuited for investing (Think Ramapithecus and similar forebears). The events and the results of the last year demonstrate that as well as anything could.

In most environments, survival is based on quickly recognizing threats and reacting. In the stock market, the best results come from putting some thought into investments ahead of time and then ignoring threats and being patient.

In mid-March last year, in the early stages of the pandemic, the stock market had a historic two-week swoon. In that period, the stock market had three of the 20 biggest single day drops in the more than 100 years of modern stock market history.

A global disease closed economies around the world with unprecedented speed and thoroughness. In time, the pandemic turned out to be much worse in many ways than most experts predicted. Still, the economy, while not fully back, has recovered more quickly than most forecasters anticipated.

Any prudent investor could be excused for taking money off the table last spring and sitting on the sidelines until the devastation was behind us.

And that was the exact wrong thing to do.

Looking back over the last year, we have had a historic stock market rally with stocks increasing more than 60 percent in the U.S. to all-time record levels.

Within the market, we have had an equally dramatic turn of events.

As the pandemic raged, giant technology stocks, which benefited from the economic activity of shut-ins, soared. A huge percentage of the gains from spring to early fall were concentrated in a handful of stocks such as Apple, Facebook, Microsoft, Google, Netflix and Amazon. Tesla became the most valuable automobile stock in history.

And then quietly, it all changed in undramatic fashion. The big tech stocks continued to drift upwards but stocks that had under performed for a decade, the small cap value stocks, the energy stocks, real estate stocks, cruise ships and airlines surged.

These unloved, even hated stocks had one of their half dozen biggest periods of out performance in the last century and for the full year dramatically outperformed the tech darlings.

In the spring of 2020, any investor who was paying attention was ready to panic. There was no plausible explanation for sticking with the program. No story made sense. In practice, on March 23, 2020, the Federal Reserve launched the most aggressive rescue program in modern history and it worked beyond anyone’s expectations. In a shocking display of unity, the Congress passed dramatic legislation that also played a key part in reviving the economy. Into 2021, the Fed and Congress continue to do their parts to keep the economy climbing.

Despite this volatile period that no market analyst could possibly have predicted, individual investors faith in their ability to foresee stock market gloom is still undiminished. People who badly misread the landscape a year ago to their own detriment, are convinced that they see the pratfalls ahead. Surely after the stock market has risen so far so fast, it cannot keep going.

Of course, no one knows. That is the big lesson of the last year. No one knows and anyone who thinks differently is an ill-informed fool.

What we do know is that over time, if the economy does well, the broad stock market should too. Over the last 95 years, since good data became available in 1926, the broad U.S. stock market, as measured by the Dow Jones Industrial Average and the S&P 500 have increased by 10 percent a year on average. Rarely has the market gone up close to 10 percent in a year but most years it has produced positive returns and only a quarter of the time has it produced significantly negative returns.

At a 10 percent annual return, the market doubles every seven years and quadruples in 14. My stock market career began in the summer of 1982 when the Dow was at 800. Today it is above 33,000. There has never been a time in those nearly 40 years when I could not have made a case that the stock market faced significant challenges and it was prudent to be wary. And yet, the prudent thing actually was to stay invested.

If you stay invested through thick and thin, you are highly likely to be the beneficiary of powerful returns. If you go in and out of the market, your returns are likely to suffer greatly. Big gains on a handful of days power portfolios and these rare big days are impossible to foresee.  The effect has been well documented.

For several decades consulting firm Dalbar has looked at investor returns compared to the performance of the mutual funds they invest in. Generally, investors get 1/3 to ½ of the returns their mutual funds generate because they move in and out at the wrong times.

In 1996, Fed Chairman Alan Greenspan made his historic warning that the market had risen too much because of “irrational exuberance.” At the time, the Dow was at 6437.

Surely, after a period of big increases the stock market is bound to cool off. After a spell of hot temperatures, we often have a cold wave.

However, every day logic does not factor into the stock market.

Stock market researchers have crunched the numbers. After periods of strong stock market returns, the stock market has produced average returns. After periods of weak stock market returns, the market has produced average returns. After periods of average returns, a similar result.

The lesson? Don’t guess. Don’t expect that your common sense will work on the stock market. Don’t expect that you are smarter or better informed than the millions of other people focused on the stock market and paid to do so.

What should you do? Understand your situation. Figure out how much risk of a difficult period can you sustain. Understand why you are investing and when you will be spending the money. Craft a diversified portfolio. Keep your plan flexible. Above all, don’t react to events and be patient. Don’t let your adrenalin and emotions guide your investments. Understand that investing is a long game and short- term movements are noise.

Over the long term, over decades, the stock market has the potential to be rewarding if you can keep your own behaviors in check. The stock market is inherently risky but the biggest risk is you, not the market. Here is the true law of the jungle for investors. Stick in the market and hear your returns roar.

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A Pig in A Poke

By Larry Luxenberg  

Every so often, complacency sets in on Wall Street. You never know how long afterwards bad stuff will start to happen but it’s a time to be vigilant.

For me, one of the warning signs is when people start to cut big blank checks. A few weeks ago billionaire investor Bill Ackman attempted to raise $3 billion dollars to buy something. Instead, investors threw money at him and he raised $4 billion.

Ackman gave investors vague clues about what he’d do with the money but only in time will they actually find out where the money will indeed go. He would like to buy a company or two and he’ll let you know when he does.

The actual investment vehicle is titled the Pershing Square Tontine Holdings. It’s a blank check company or more properly a SPAC, a Special Purpose Acquisitions Company.

Ackman has compiled an enviable investment record and there are checks built into the SPAC structure. Still, these vehicles normally appear during bull markets and disappear in bad times when investors are more reluctant to part with their money and fund speculative vehicles.

Sometimes it can be years before there is a reckoning. Sometimes, it’s only parts of the market that suffer. Still, every time there is a global pandemic and deep recession and yet investors are eager to buy a pig in a poke, I get nervous as a cat.

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Less is More Sometimes

By Larry Luxenberg  

As a result of the pandemic and economic downturn, there are now two kinds of Americans: those who are spending less because they have less money and those who are spending less because they don’t have anywhere to spend their money.

For an economy that is two-thirds driven by consumer spending, that doesn’t bode well for a quick recovery and overall statistics. But despite the crude economic measures we employ, the true purposes of an economy are to satisfy people’s needs and wants. If we possessed better statistics, those measures might paint a different picture.

For the first group, suffering will be epic — high joblessness lasted 6 to 8 years after the Great Recession and food insecurity remained high even longer —  and the bleak statistics will adequately measure their distress.

But for the other 75 to 90 percent of Americans, the picture could be quite different. Economists assume that every dollar spent is for something a consumer wanted and if they can’t have it or have to substitute something else, their satisfaction is diminished. That, of course, is a good shorthand and adequate in normal times.

What we are living through is anything but normal and normal statistics don’t capture our current experience. As half or more of the population lives through an enforced idleness, satisfaction has to come through different means. A leisurely trip to the mall is out. A free zoom call with distant friends and relatives is in. People are reaching out more and spending less on leisure pursuits, apparel, fixing up homes and myriad other things.

Many people remind us that “if you have your health, you have everything.” For the million or more people who have contracted the virus and for the 80,000 or so who have died, their health is compromised or they have succumbed. Stress has soared and with it crabbiness, abuse, substance overuse and mental illness.

For others, who retain their health, many have regained an appreciation for the simple pleasures of life that do not carry dollar signs. For large segments of the population, such as the vulnerable elderly, their first impulse after a murky loosening or even an all clear signal will not be to shop until they drop. Their first, second and third impulse may be caution and to keep the purse strings tightly clamped.

The result could be continued high unemployment, the failure of many already shaky businesses, and continued weakness in measured Gross Domestic Product and other key traditional economic measures.

But what of true happiness? That’s a harder thing to measure. Many people hanker for a simpler time. Now that it has been delivered to their doorstop, they may find that they don’t like that imaginary simpler time. But others may find that spending and happiness are not the same and while traditional measurements of economic activity continue to look dreadful, they are fulfilled and much happier than the economists believe that they should be.

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Out Like a Lion

By Larry Luxenberg  

March is typically an odd month, the transition from the harshness of winter to the promise of spring. This year it’s been the reverse in the worst way in modern memory.

The month began in New York as a normal time with mild weather, the stock market near record levels and unemployment at a half century low.

March ended in a totally unprecedented way with two-thirds of the country confined to their homes, an explosion of illness and death across the U.S., the biggest jump in unemployment on record by a factor of five and $8 trillion of stock market value wiped out.

Congress had just approved a record bailout of everyone, adding $2 trillion of debt to plug massive holes in an economy at a self-imposed standstill. Coronavirus cases had gone from a handful to more than 100,000, making the U.S. suddenly the world leader.

Muddled mixed messages proliferated and fear was rampant. While glimmers of hope popped up here and there like the regular appearance of forsythia, cherry blossoms and daffodils, the gathering storm overshadowed everything as the world braced for the mysterious plaque to strike and dissipate.

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Survival Mode

By Larry Luxenberg  

With the economy in free fall, for most businesses it’s a sudden shift to survival mode.

Most businesses spend most of their time trying hard to grow, to innovate, to take on new markets and better serve old ones. Few people with a choice go into business just to survive. But that’s where we find ourselves today.

You can’t grow if you don’t survive. Businesses that worked hard for decades to flourish, now find themselves facing excruciating choices. Capabilities and staff that were nurtured for many years, long established relationships, beautiful facilities — all are now on the chopping block.

President Eisenhower, the wartime U.S. commander of the European theater said that in war everything and everyone is expendable. With an imploding economy, that same attitude and urgency must be applied to businesses.

With a brutal recession on the near horizon, thousands of businesses will not survive. Those that hunker down and go into self-preservation mode quickly have a good chance to not only survive but to thrive after many of their competitors depart the scene.

Austrian economist Joseph Schumpeter called this the “creative destruction” of capitalism. After every painful recession, there is a flowering of innovation. It’s easy to see the destruction. Much harder to spot the bright new industries and new ways of doing business that are coming along.

After the 90-91 recession that shook America to its core, the Netscape browser appeared in 1995, ushering in the Internet and a towering wave of innovation.

Out of the current difficult period, good things will develop but only to those who survive and are sufficiently nimble to spot the emerging opportunities.

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A Bad Week

By Larry Luxenberg  

You know it’s been a bad week for the stock market when: The market has rallied from down 1,000 on the day to down 600 and you feel relieved that it’s only down 600 points.

But 600 points isn’t bad considering the Dow Jones Industrial Average is down 4,000 points on the week. That’s a record point total but more important, the percentage decline from the peak, about 14 percent in a little over a week, is close to a record decline.

The new Coronavirus is scary and many people have already died and many more certainly will. Beyond that, commerce and tourism have been disrupted around the world and that, too, will get worse before it gets better.

Even worse, no one can even hazard a good guess as to how bad things will get. A worst case scenario is truly frightening and there is good reason why that prospect has spooked investors.

But should the worst case not take place, the markets may have already discounted the economic damage from the virus. In that case, and if the virus doesn’t trigger a recession, the economy may begin recovering some time this year.

For long-term investors (and there is no other kind. Short-termers are speculators, not investors), this panic likely will just be a blip in the performance of the market over their investing careers. Decisions made in panic rarely serve investors well. It’s no guarantee, but the odds favor staying the course, not pulling the plug.

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What You Keep

By Larry Luxenberg  

The easy thing to do when you are investing is to look at how much your portfolio is going up or down.

But that’s not what’s really important. What’s important is how much of your investment portfolio, you get to keep and how much goes to Federal, state and local taxing authorities.

For example, an IRA defers taxes until you take the money out. Under current law, once an investor turns 70 1/2, he has to start taking money out of the IRA. This is called a required minimum distribution.

When an investor takes money out of the IRA, he has to pay ordinary income taxes on the withdrawal. This can be a third in combined taxes or even more.

If he has a Roth IRA and is over $59 1/2 and the Roth has been open five years, he probably won’t owe any taxes.

If he has a regular taxable account — no retirement savings vehicles — and owns mutual funds, he may owe taxes even if he doesn’t do any trading himself for the year. Mutual funds must distribute most of their income each year to avoid saddling their shareholders with double taxation.

In a strong stock market, like the market this year, gains accumulate in actively managed mutual funds and taxable distributions can be quite high.

Investors need to be aware not just of their investment returns but of how much of those gains they will keep. That makes a huge difference in long-term financial well being.

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Nothing to Fear

By Larry Luxenberg  

In the midst of the Great Depression, Franklin Roosevelt  addressed the fear that was paralyzing America. In his first inaugural address, Roosevelt said that “We have nothing to fear but fear itself.”

There actually was a lot to fear. The economy was in terrible shape, people were dying and lives were ruined. But action was needed and fear got in the way of taking steps to improve people’s prospects.

Often, in less dramatic ways, I find investors’ fears preventing them from taking prudent risks that would improve the lives of themselves and their families.

The fear of a small loss prevents them from seeking a big gain. Even the near certainty of a large loss over several decades prevents them from taking action that has the high probability of generating at least some gain and most likely a big gain.

People have been so programmed about what is “conservative” investing that they aren’t open to taking a rational look at the data and adjusting their investments accordingly.

While Roosevelt has long since been consigned to the history books, the shadow of the Great Depression and the subsequent stock market crash still looms large in investors’ psyches.

We will regularly see large drops in the stock market and inevitably a crash from time to time but that is something to plan for, not something to relegate us to the sidelines forever.

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