Our Investment Perspective — Stay Calm and Carry On

Last night was very unsettling to many Americans. There are many issues in this election, but as your Chief Investment Officer, I am focused on your money and your investments:

1. We do well when we separate our emotional reactions from our investment process. A first rule is to not make any immediate, knee-jerk moves in response to the election outcome. The US stock market is incredibly resilient, and a recent example is the market’s reaction to Brexit in June. After an initial, sharp drop, the market recovered within the month.

Construction heavy equipment; caterpillar of excavator

Post-Election Investment Perspective

2. After the initial shock of Trump’s victory, I believe the market is digesting Trump’s three top fiscal policy priorities:

  • There will be corporate and personal tax reform. This is long overdue and has been stalled by gridlock in Washington. It is likely that Republicans who now control the three branches of government will be able to fix the policy that keeps $2 trillion trapped overseas in our large multi-national companies. Tim Cook of Apple said that as CEO he could not justify repatriating Apple’s foreign profits because the taxes due would be 40%. This will now change, and it will be good for the US economy and stock market.
  • Trump will spend significantly on infrastructure; Caterpillar is up 7% so far today.
  • The Republicans will roll back regulations. Not everyone will like how they do this, but it will benefit business in the near term.

3. Our whole team of analysts and advisors are watching investment results with utmost concentration. We work diligently with you to make sure you have the appropriate investment strategy for your long-term future. Please call your advisor if you care to discuss your investment strategy and how it is responding to post-election developments.

Yours truly,

Jim Bell, CFP®
Chief Investment Officer
President and Founder

Money Market Fund Reform

Driven by the 2008 financial crisis, the U.S. Security and Exchange Commission (SEC)SEC bldg has, in the last few years, implemented multiple rounds of reform regarding money market funds. These changes have been developed in an effort to increase fund liquidity and protect investors.

Financial institutions offering money market funds are required to implement the latest of these reforms by October 2016. The reforms involve:
1. A possible imposition of a liquidity fee of up to 2% and/or a redemption gate,
(which is a temporary suspension of redemptions for up to 10 business days)
2. The possibility of the share price dropping below $1
The rules vary somewhat among the three newly-established categories of funds:

Retail Prime and Retail Municipal Money Market Funds
Investors deemed to be “natural persons”, certain types of trusts, participant-directed retirement accounts, etc.
1. Funds are subject to a liquidity fee and/or a redemption gate.
2. Accounts are eligible for the constant price of $1 per share.
(Schwab will continue to seek to maintain a constant price of $1 per share).

Institutional Prime and Institutional Municipal Money Market Funds
Corporate accounts, certain types of trusts, non-participant-directed retirement accounts
1. Funds are subject to a liquidity fee and/or a redemption gate.
2. Price fluctuates and could drop below $1 or could be priced above $1.

Government Money Market Funds
For both retail and institutional accounts
1. Schwab does not plan to implement redemption fees and gates at this time.
2. Accounts are eligible for the constant price of $1 per share.

Charles Schwab, the custodian of Bell Investment Advisors’ client funds, began implementing the changes required by the SEC on June 1, 2016. No action is required by Bell or by our clients. If you have any questions, please contact us at 510.433.1066 or go to:


When Your Portfolio Isn’t Making Money

While preparing for our next gathering of The Women’s Roundtable later this month, “Keep Calm & Invest On: Taking the Emotion Out of Your Money”, where we plan to discuss investor behaviors and risk evaluations, we began to wonder what inherent reaction investors have in a market environment like the one we are experiencing  now — a highly volatile, low return environment. Let’s explain further.

Image of young businesswoman looks stressful with red stock exchange background

Safe or in Danger
As humans, we are built to perceive ourselves as either safe or in danger, and this concept can be applied to the markets. In years when the market is moving higher, investors perceive themselves to be safe and perhaps make poor decisions such as moving to a more aggressive strategy than his or her risk tolerance allows. When the market is moving lower, like it did to start this year with a correction of more than 10%, investors perceive themselves to be in danger and perhaps make poor decisions such as selling positions low.

The Question
This begs the question — how do investors perceive themselves when the market is rather flat and aimless?

The markets have done little since the beginning of 2015, with the MSCI All Country World Index declining -2.36% in 2015 and returning +2.30% YTD 2016 through June 3. Frustration with this lack of trajectory appears to be a common feeling among investors and advisors alike. Jeffrey Saut, Chief Investment Strategist at St. Petersburg, Florida-based Raymond James Financial Inc., which oversees $500 billion, was quoted in the Washington Post on May 23, 2016: “The past 19 months have been the most difficult stock market I have ever experienced in more than 50 years of investing,” In bear markets, “at least we knew stocks were going to go down. However, over the past 19 months the up one session, and down the next, has been extraordinarily frustrating.”

Frustration vs. Patience
This frustration may lead some investors to make poor decisions, just as the perception of being safe or in danger can. As maddening as slightly negative to slightly positive returns can be, years like these are not rare and can be expected about 10% of the time, according to the CNBC article “S&P 500 is Having a Dull Year, and That’s Good for Investors”, dated August 2015: “Going back to 1918, there are 11 instances of calendar years in which the S&P 500 was up or down by 3 percent or less, according to S&P Capital IQ.” Moreover, “In the subsequent calendar year, the market rose an average 13.3 percent and gained in price 82 percent of the time (nine of 11 instances), according to data from Sam Stovall, chief investment strategist at S&P Equity Research Services.”

We of course cannot know if solid positive returns are just around the corner or the opposite, but what we do know is that investing in the stock market has been the best way to grow wealth over time. The market is a resilient thing. If you have a long-term strategy that abides your risk tolerance and the patience to fight the urge for drastic action when you feel safe, in danger, or just down-right frustrated, we believe you will benefit from staying the course.

The Women’s Roundtable
If you’d like to hear more about investor behavior and how to limit emotional reactions during market movements, please join us for The Women’s Roundtable wine and cheese gathering on June 29 at our office in downtown Oakland.

More on Investor Behavior
You can also access more on the topic from our website resource center and from this blog:

“Mind Over Money Matters: How Our Psychology Reduces Investment Returns”
Bell webinar, September 2015

“Why Momentum Exists: A Perspective on Investor Behavior”
Bell white paper, October 2012

“The Endowment Effect”
Bell blog post, October 2014

“Stress is Good”
Bell newsletter article from The Opening Bell, July 2014

“Building a Better Bunker Portfolio”
Bell newsletter article from The Opening Bell, April 2012

“Momentum Investing: How to Gauge the Market’s Opinion of the Future”
Bell white paper, September 2011

Is There an Opportunity in
Energy Stocks?

In our investment management experience, investors fall into one of two camps when looking at an investment that has dropped in price significantly. Investors in the first group steer clear, not wanting to “catch a falling knife” as the old Wall Street adage warns. They can be described as trend-following investors. However, the second group of investors sees opportunity in a depressed price. These are the value investors.

With the S&P Energy Sector off over -20% from its all-time high set just about a year ago, how should you view beaten-down energy stocks? Should you take the value approach and look for opportunity? Or should you stay away, expecting the sector to continue to underperform?

If you rely on history, you should expect the latter. According to Ned Davis Research, after major bottoms in the price of oil (which we believe occurred in March), oil prices tend to recover and continue upward, but energy stocks tend to outperform the broad stock market for a couple of months before starting to underperform again.

This time around, energy stocks have followed the historical pattern almost identically. After oil’s bottom in March, energy stocks outperformed the stock market for  one and a half months before underperforming again. As a result, we continue to recommend avoiding energy stocks despite the recovery in the price of oil.

Consequences of a Strong Dollar

The value of the U.S. dollar relative to other world currencies has grown by approximately 22% in the past year. That means if the average investor outside the United States bought a U.S. stock in dollars one year ago and the stock purchased stayed flat (did not go up or down), that foreign investor would show a gain of 22% on average just because the U.S. dollar appreciated 22%. This demonstrates the principle that investors want to invest where the local currency is strong.

This dollar strength is helping exporters in weaker economies like Europe because the dollar goes a long way in purchasing goods and services denominated in Euros as the Euro gets weaker. It is common to hear people on Wall Street say that this is the time to book your vacation in Europe because the U.S. dollar will convert into many more Euros than it did a year ago.

Unfortunately for the emerging economies of the world, they are being hurt by dollar strength. The March 21 issue of The Economist reports that emerging market countries have borrowed $4.5 trillion in dollar-denominated debt. As the dollar gains in strength, emerging market currencies are growing weaker, and the debt in dollars becomes more and more expensive to service. This creates economic drag and uncertainty for emerging market countries.

The March 25 issue of The Wall Street Journal reports that African nations are being hit especially hard by the strengthening dollar and the decline in commodity prices. Shopkeepers throughout Africa cannot afford to import goods to stock their shelves.

The relative strength of America is highlighted by Europe and Japan being stuck in neutral or first gear and China, along with other emerging markets, slowing. The International Monetary Fund predicts that the U.S. economy will grow by 3.6% in 2015. With our Federal Reserve preparing to raise interest rates as other central banks are going the opposite direction, this all leads to the consequence that investors make higher returns in dollar-denominated assets.

25% of profits earned by S&P 500 firms are earned in foreign currencies. A stronger dollar causes these goods and services to be more expensive and less competitive. The stronger dollar will hurt foreign earnings by U.S. companies. Ironically, dollar strength mutes inflation because foreign goods and services are less expensive in dollar terms. Inflation is driven by goods and services becoming more expensive. Inflation in the U.S. year-over-year is -0.1%, while core inflation (excluding food and energy) is +1.6%. This is still well below the Federal Reserve target of 2% inflation as a cause for raising interest rates. The Fed may continue to talk about raising interest rates, but they may not act, because inflation under 2% does not call for higher rates.

Conclusion: Invest in the relative strength of the USA. Invest where the currency
is strong.

Why We Don’t Like Bond Indexes

Most investors know that most stock indexes like the S&P 500 are weighted by size or market capitalization as it is known in investment parlance. That means that the larger companies—in terms of value—comprise a larger proportion of the index. Apple is the largest company in terms of market cap, so it is the largest company in the
S&P 500 Index.

However, most investors don’t realize that bond indexes are weighted in the same manner—by size. The more debt a country, company, or county issues the larger the weight it holds within the index. Within the United States, the U.S. government is by far the largest issuer of debt, so it holds the largest weight in the Vanguard Total Bond Market Index Fund (58.6%).

This weighting methodology is why we recommend that our clients avoid investing in bond indexes. Automatically allocating funds to the most indebted countries, companies, and counties runs counter to prudent credit risk analysis. And the more debt these issuers take on, the larger their representation in the index becomes.

As a result, we advise steering clear of passively-managed bond index funds. Instead find an actively-managed bond fund, where the portfolio manager can decide which countries, companies, and counties deserve to borrow your hard-earned dollars. After all, to paraphrase the famous quote, bond investing is less about the return on your capital than the return of your capital.

Gifts That Give Back

‘Tis the season. The holidays are a great time to experience the joy of giving to friends and family. It is also the time of the year when people opt for gifts that benefit the greater good.

For philanthropic and aspirational shoppers, there are plenty of gift options from companies that produce “sustainable products” (conservation of natural resources, sustainable farming) or products designed for “social good” (handmade products that support women and children in the developing world).

It used to be that values-based investing was exclusive to large private foundations and very affluent individuals. But our world is changing in dramatic ways, and there is a heightened global awareness. Investors and companies recognize that doing good and doing well financially should go hand-in-hand. People want to invest in companies with values and business practices that are congruent with their own. With a values-based objective, investors are willing to exchange financial benefits for the greater good.

In 2015, we will introduce a series on values-based investing. Our objective is to leverage our practice by seeking options for our clients who desire to align their personal values with their investment portfolio. We invite you to be part of this conversation.


Don’t Believe Everything You Read About Investing

A client of ours forwarded us an email she received from a financial news organization to which she subscribes. It reads as follows:

A handful of billionaires are quietly dumping their American stocks . . . and fast.

Warren Buffett, who has been a cheerleader for U.S. stocks for quite some time, is dumping shares at an alarming rate. He recently complained of “disappointing performance” in dyed-in-the-wool American companies like Johnson & Johnson, Procter & Gamble, and Kraft Foods.

Buffett’s holding company, Berkshire Hathaway, has been drastically reducing his exposure to stocks that depend on consumer purchasing habits. Berkshire sold roughly 19 million shares of Johnson & Johnson, and reduced its overall stake in “consumer product stocks” by 21%. Berkshire Hathaway also sold its entire stake in California-based computer parts supplier Intel.

With 70% of the U.S. economy dependent on consumer spending, Buffett’s apparent lack of faith in these companies’ future prospects is worrisome.

She was scared, and who wouldn’t be after reading that? Warren Buffett is a legendary investor, and if he is worried about stocks perhaps you should be too.

The only problem is that Mr. Buffett is not selling Intel or cutting back on Johnson & Johnson now. He already did that—in the summer of 2012. Although the email was dated November 3, 2014, it contained “news” from 2½ years ago.

If you want to know what Mr. Buffett thinks about stocks today, all you have to do is run a quick internet search. During last month’s stock market pullback, he told CNBC he was buying stock in “names you’d recognize.”

Whatever the author’s motivation, the content is misleading. But don’t let it be damaging to your portfolio by blindly following it. Do a bit of research to check out the author’s claims. Or do what our client wisely did: forward it to your investment advisor for his or her opinion before you act on an impulse.

Ben Bernanke Makes a Bold Forecast About Inflation

Former Federal Reserve Bank Chairman, Dr. Ben Bernanke, is not worried about inflation. Before an audience of over 3,000 Registered Investment Advisors, Financial Planners and Investment Managers at the Schwab Institutional IMPACT Conference in Denver on November 5, 2014, Dr. Bernanke was remarkably confident about the future of tame inflation in the USA for years to come.

He has been widely criticized for executing the Quantitative Easing (QE) programs at the Fed which allows the U.S. central bank to buy longer term bonds in the open market thereby raising their market price and lowering their yield. Many fear that the QE programs already executed will lead to rampant inflation, but after five years since the beginning of QE, inflation is still very tame at 2% or less. Dr. Bernanke speculated that it could be another five years before inflation becomes a problem, and when it does appear, he believes the expanded toolkit now available to the Fed will make future inflation easier to control.

Dr. Bernanke also asserted that the Troubled Asset Relief Program (TARP) invented during the 2008 financial crisis was one of the most successful government programs in the history of the United States while simultaneously being one of the least popular. The TARP loans and asset purchases have been repaid at a significant profit to the U.S. government.

Another controversy is that the Fed allowed Lehman Brothers to fail in 2008 and chose to bail out American International Group, Inc. (AIG). Dr. Bernanke explained that AIG had capital so that it could be rescued while Lehman Brothers had no capital.

Dr. Bernanke is simultaneously proud and humble regarding his legacy as Fed Chairman. He is humble by nature. He is proud that the U.S. economy has the strongest recovery in the world from the 2008/2009 financial crisis, and he is proud that all of his hard work and the hard work of the Federal Reserve Bank staff contributed to this result.

The Endowment Effect

Deciding when to sell a stock or a mutual fund can be difficult, especially when that unwanted stock or mutual fund resides in a taxable account. To be sure, there are a number of strategic reasons to hold positions you want to sell. This is the time of year, for example, when many investors resist the urge to sell because they would prefer to push the capital gains into the next tax year. But many of the reasons that investors hold onto positions are not so strategic in nature.

In their book, Why Smart People Make Big Money Mistakes, Gary Belsky and Thomas Gilovich examine a host of psychological mental tendencies that make selling any investment, even a bad one, so challenging. Research demonstrates, for example, that most investors tend to overvalue whatever it is that they already own. This is described, according to behavioral finance, as the “endowment effect,” and its influence is very powerful.

To illustrate the power of the endowment effect, Richard Thaler divided a Cornell economics class in two. Half the class received school coffee mugs as a gift; the other half received nothing. Then Thaler held a coffee mug auction. The students who did not own a coffee mug already, on average, were willing to pay only around $2.75 to acquire a mug. The students who already owned a coffee mug, however, had much greater sense of the value of their mug. On average, these students needed to be offered around $5.25 to sell their mug. This study and others like it, demonstrate that one of the primary side-effects of already owning an asset is the owner values that owned asset as much as twice as much as it is actually worth.

With the endowment effect in mind, it is easy to understand why so many portfolios are littered with positions that should be sold but are not. The psychology behind the impulse to hang onto what you already have is understandable, but it should be kept in mind because it is not always helpful or strategic.