Mike’s Thoughts on Regulations

Mike’s Thoughts on Regulations

I recently did this really awesome educational video for you on Bonds, but unfortunately I described the characteristics of bond mutual funds in layman terms without a bunch of disclosures, and approval from a higher up regulatory agency is required (come to find out).

So that got me thinking about rules and regulations.  Should we have more or less, are they a cure-all panacea, and most importantly, what are the unintended consequences?

Click on the video below to hear my crazy thoughts on regulations.  All right, they’re not really crazy, but I think the question of more or less is a hard one, and we shouldn’t “knee jerk” one way or another “just because”.

 

Hi there—Mike Brady with Generosity Wealth Management, a comprehensive, full-service wealth management headquartered right here in Boulder, Colorado.

Today, I want to talk about regulations—are they good, are they bad, should we have more, should we have less, and I’m going to tell you that I’m right in between. The most important thing is that it doesn’t solve everything. First off, before you think I’m some kind of a radical, you’ve got two extremes. This is 100% regulation, this is 0% regulation and I don’t think that anybody of sane mind is saying that we should have 100% regulation, that’s government ownership of everything, or is zero regulations. I don’t know what things were like before the 1929 crash, but I definitely know that, after that fact, there has always been some kind of regulation. It’s not necessarily a panacea. It doesn’t solve all your problems and I think that it’s good for us as investors, not to necessarily advocate for more or less, but just to understand that they have a place, but it just doesn’t solve everything and if you think it’s going to then I think you’re going to have a false sense of security, because something is probably going to happen in the future as well.

Let me tell you why I’m even bringing up today’s topic. I’ve probably done 100, maybe 150 of these particular videos over the last five years and the reason why I started doing the videos is I thought it was a great way, an additional way to communicate with clients and friends, maybe perspective clients. It’s a way for me to try to be as clear and concise as possible to share with you what I’m thinking and how I view things without having to pick up the phone and call every single person. That might be a very inefficient way to do it.

I also want it to be educational for you so if you’ve been watching a lot of my videos, you know that I talk about maybe a current topic, maybe a general topic, etcetera, because the way I view things is just because I do this all day, it’s not because I’m smarter than you, but maybe I’m on page five, maybe I’m on page six and because you don’t do this every day, maybe your education level in investments and financial planning is on a page two and so if I can help bring you up to page three or page four we can have a great conversation and I think you’re better off for it and I think I am as well.

Well, out of all those videos I recently did a video last week that was called All About those Bonds, and actually I don’t know if you ever that song, All About that Bass, all that Bass, well I called it All About those Bonds and I figured a couple people would get the joke, but it turned out to be a 16 to 17 minute video about bonds, so I talked about price, I talked about yield, I talked about what a bond is, how it works, premium, discount and in my opinion, it was a beautiful video. I was very proud of myself because I thought that I could refer back to it in coming months and coming years and say wow, you have a question about bonds. Just look at this particular video. Inside there, I talked about bond funds and I talked about the characteristics of bond funds, and so I was trying to talk, in layman’s terms, about the characteristics of them, whether they could lose money, make money and various situations like that and so for 30 seconds, I actually talked and warned about some things in bond funds, but because of that, I talked about the characteristics of bonds. A compliance department examiner doing absolutely her best job and that’s what she’s supposed to do, said Mike, this is actually you can’t talk about characteristics of bonds without FINRA approval. Now FINRA is one of the regulators. It’s a self-regulatory organization. It’s just one of the big regulators out there for broker-dealers. I’m like okay, how do I get FINRA approval. She’s like well you got to pay a certain amount of money. I think it was like $125 and it’s probably going to take five or six weeks and I’m like really, you got to be kidding me, so I just decided it wasn’t worth the hassle really, to go through all that delay and some of the requirements.

It’s not the $125, it’s actually the transcript, and it’s actually more involved than what I’ve led you to believe. So I basically decided it’s just not worth it for me to do it. Now the unintended consequence of that particular regulation is that what I feel is a great educational opportunity for clients is not going to be out there. A warning of some things that you should beware of as it relates to particular bonds, and I think that bonds have a place in a portfolio. I’m not going to lie to you, I think they’re a good place for most people in their portfolio and, of course, you have to personalize it to your individual situation.

Well, because of this particular regulation, that message isn’t getting out there. Look at prospectuses. Prospectuses—once again, I wasn’t around in the 1930’s and the 1940’s but the prospectus were probably very small. I’ve been doing this for 24 years. I started working with clients in 1991 and, at that point, the prospectuses were pretty fat. Over the years, my perception has been they get fatter and fatter and fatter because more and more either regulation or disclosure gets in there and to a certain degree, unfortunately, most people don’t read the prospectus. I highly encourage you to read the prospectus, okay, and I give out prospectuses to every client prior, or concurrent with an investment. However, the unintended consequence of some regulations has been to a certain point where it has now done, possibly, it just has not achieved its ultimate goal which is to inform the client. They’ve overinformed with so much information that you get nothing okay.

Back in 2008, there was a big discussion about too big to fail, that there were some various banks and institutions that were so big, that we shouldn’t have that. We shouldn’t have—people would say wait a second, we shouldn’t have to bail these things out and you shouldn’t be allowed to be too big to fail. Well, unfortunately, many of the regulations that come out work against the decentralization because every regulation has some kind of a cost associated with it and sometimes it’s hard to say what that actual cost is, but if it’s an extra sheet of paper that’s required, it’s an extra piece of documentation. I mean I have to tell you, I’ve gone through in the last 24 years, you have periodic audits and if I don’t have a folder with a label on it, even though it’s empty, I have to have that label and that folder, but if I don’t they’ll ding me.

So there’s a lot of bureaucratic type of things that add to the cost of doing business and the unintended consequence of some regulations are that it causes smaller operations, smaller businesses to just not be able to survive and be profitable and so they have to merge with larger ones and pretty soon you have, instead of five small ones, you might have two or three or maybe have one because they have to group together for the economy of scale. Now, I’m being very broad here and very general, but the most important thing is that regulations are not a cure-all for everything. Do I think we should have some regulations—absolutely, and I certainly hope you’re not getting from me that we should have no regulations, but I like to think of it as, even the prison system, I mean I think that there are some people who are a danger to society, they just are and it’s for the good of the community that they are put away and shielded from us and from harming us, but it’s very easy to say, well, I’m tough on crime so, therefore, the easy is let’s more people in prison. After decades of saying that, pretty soon we have a lot of people in prison and we have a huge amount of money going towards prison, because the easy answer was well, let’s just put him in prison. That’s the answer for everything.

Every time some kind of a crime happens, we need to be tougher on crime. Well, it’s the same way when something bad happens in the financial world. It’s like, well let’s throw more regulations on there because that’s kind of a kneejerk answer and in my response is, just so that you know where I stand is usually, well, let’s look at what we currently have and do they need to be modified? Are there some regulations that maybe need to be cut, that actually were an unintended consequence that led to that bad action and so it’s really more piling on, piling on, piling on.

That’s my video today. Really, the most important thing I want you to take away from this is that I think regulations are good and I’m glad that we have regulators. I truly believe that, but it is not an answer to everything and one of the unintended consequences at times of some regulations are unforeseen. That’s why they’re unintended, okay, they weren’t intended to begin with, but also sometimes the end investor is actually hurt and, in my case, I think the video that I did was wonderful and beautiful and, unfortunately, you’re never going to see it, but it was a good education I think for all my clients who see this particular video. If you want to know more about bonds, give me a call, because I’ll be able to do that for you in person and I think that over this next year, I’m going to make a commitment to at every meeting, really educating you on what’s the difference between price and yield, why is a 10-year Treasury important. Why has this been in the news all this time and where, in my portfolio speaking as you, where in a client’s portfolio, do bonds have a place? Do they have a big place, a little place, what is for you, so I’m going to now do it for you individually since doing it en masse didn’t work out for me. I’m looking forward to doing another video for you in a couple of weeks. I’m doing this on a Thursday afternoon so, hopefully, you’re getting it Thursday night, maybe Friday morning, because a consideration is oh, Mike, we’ll look at your stuff right away, so you can get your newsletter so anyway, I hope you have a great day. I hope you have a great weekend and you have a wonderful day. Thanks, bye bye.

Current Market Conditions

Current Market Conditions

As volatility has increased in the past 3 weeks, I want to keep you well informed of my thoughts.

Are the past weeks normal, have the fundamentals changed, or is this the canary in the coal mine we’ve been waiting for?

These questions are answered in my video.

Hi, Mike Brady here with Generosity Wealth Management, a comprehensive, full service wealth management firm, headquartered right here in Boulder, Colorado.

I last spoke to you a couple of weeks ago and at that time, I talked about the third quarter. I said it’s been a tough quarter, very volatile and it was down.   We’ve taken some steps back as it relates to the unmanaged stock market indexes. So far this quarter in the last couple of weeks, that has continued on the downside. Nobody ever minds volatility on the upside. One thing that’s interesting is over the last 25 years the daily average of volatility has been 0.77%, about eight-tenths of 1% on a daily basis. So far this year for the first half of this year, it was a half of 1%. It was kind of the average volatility on a daily basis. One of the reasons why the last two to three weeks seems so alarming is because the volatility has been over 1% so it’s two to three times what we’ve been kind of lulled into feeling the first half of this year and also what is normal when we look back over a 25-year timeframe. Two weeks ago, I mentioned that the smart money looks at the data and what’s happening now and says okay, so how far out an outlier is this? Is this something that actually happens quite often or periodically and that it’s a part of the game investing, part of what we should expect or is this is a precursor to something much more deadly? Are the fundamentals telling us that this is an early canary in the coal mine of some bad that’s going to happen? My answer is the first, not the latter, in that this is actually normal even if it is painful, a part of the process. When we look at a longer time horizon which is what sort of the smart money should do is looking at it from where does this fit in one year, five year, 10 year and even longer than that.

I’m going to throw up on the graph there up on your screen there, looking back over a 17-year time horizon for the S&P 500 which is an unmanaged stock market index and this is as of September 30. I’m going to put a little red mark where we are right now just to give it some perspective. I’m doing this Tuesday night so I know exactly what our closing number was and hopefully you’re getting this on Wednesday or Thursday. You can kind of see that in the whole scheme of things we could have said at that other line that I just put in there, yeah, you can see it’s a pop. It’s not going to go any higher and then we could have done it all the way from that bottom arrow all the way to where we are today. We could have said, oh my gosh, this is a high, it can never go any higher.

I’m going to put on the screen now a second graph which is looking back 114 years. You can see that there are consolidation periods and then there are times of advance, consolidation periods of times of advance. You can see there and I’ve just circled it where I believe that we are. I actually believe that we are on a longer-term advanced than we are in consolidation or a decline. Other people can make an argument to the downside; that’s okay. We always joke that economists have predicted 17 of the last the last three recessions so that’s an easy thing to do. The hard thing is for me to try to be as straightforward with you and say this is a part of that long-term process. As a matter of fact, our emotions have a tendency want to react in the wrong way. I’m going to throw a chart up on the screen there. You can see that in the late 90s, consumer confidence was at an absolute high, but that was the worst time to buy. Okay? Now you’re going to see back in the beginning of ’09 which was the beginning of that huge upswing that I showed you in the first graph that consumer confidence was a low. Then two years ago right before last year’s really strong stock market gain, consumer confidence was once again at a low. It’s almost contrary of what you would think. Like oh, people are feeling all negative so the market must go down negative. No, it’s quite the opposite. In fact, kind of what we call a lagging indicator where people actually do the wrong thing at the wrong time.

The next graph that I want to show you is up on that screen there. I think this absolutely essential. What you are going to see is those red numbers at the bottom are the intra-year decline. What that means is if the market was up 10% and then it drops 7% and at the end of the year at 3% or maybe it even ended at a different number, the high to the low throughout that year is normally a seven, eight, nine, 10, sometimes double digits so it is normal for there to be corrections within the year. It does not mean the year will end that way. I think that’s absolutely essential for us to keep in mind because we do take five steps forward at times and four steps back. If we believe that in the future that the market will be higher than where it is today, that’s why we have investments. If we didn’t believe that, why would we have investments? Keep it in your mattress, keep it in the bank. That makes no sense if you believe that long term the market is going to be lower than it is today over long term. I think that’s not a very wise bet.

I’m going to throw another chart on the screen; it’s a table. The reason why I throw this up there is because there is a well, you know, it’s just like the 1990s or it’s ‘07. Let me just tell you, look at the price to earnings ratio of about 15%. It was double that back in the late ‘90s. I mean from a valuation point of view, we’re nowhere near where we were in previous times when we’ve had a huge decline. We have lots of cash, a huge profitability, leveraging is down so this is a very good thing and the fundamentals I feel are still strong.

This last graph I want to show you I think is very, very important and that it shows historical returns by holding period. What you’re going to see is that on a yearly basis, that’s the one on the far left-hand side, there is a huge variance. The left one is 100% stock, unmanaged stock market index. The next one is 100% bond index and then there is a mix of the two together. With the one year, there is a huge variance. That’s just the way things work. Once we look out five years, 10 years, even 20 years that variance, that kind of expected return or that highs and lows have a tendency to kind of, the highs go lower and the lows go higher. For a 50/50 split historically, of course it could be different in the future, there actually has never been a five-year timeframe when the worst you’ve done is make 1% a year. Moving out to cash, thinking that you’re going to try to outsmart everyone else, that you are reading the headlines and you have some supposition of about what’s going to happen in the future I think is not very wise.

The very last thing I want to show before I cut this video is the benefits of having a stock and a bond mixed together. You’ve seen me do this before even with my hand. Up on the screen there is the 10-year Treasury note yield. It’s declined which is a good thing. The yield goes down when the price goes up. You can see that there is actually huge volatility in the last year. Those arrows there are in the last kind of year-to-date. This has been a great year to have bonds. In hindsight, having 100% of your portfolio in bonds would’ve been a fine thing to do. We don’t know hindsight so that’s why we have a mix of stocks and bonds and of course that mixture depends on the client what’s appropriate. Of course, having a well-diversified portfolio does not guarantee against declines in a general declining market, but I do believe that it is the wise way to go going forward. You can see that in the last month or so as the stock market has rarely gone down that the bonds have actually gone up. Once again, we know that because the graph went down which is counter-intuitive, but it actually meant that bonds went up so this is a good thing for bonds when the graph looks on the downside from left to right like that.

That’s what I have for right now today. I’m going to continue with these updates to you, my clients and to my friends and prospects, prospective clients. I’m here if there are any concerns that you have, 303-747-6455. Investments are a part of the big picture of getting you to where you want to go with your goals, etc., but I’m not overly freaked out about where things are at this point. Hey, would I wish that things were higher? Of course, of course, but do I over react and scrap my plan based on some weeks and months of data? Absolutely not and you shouldn’t either.

Mike Brady, Generosity Wealth Management, 303-747-6455. You have a great day, see you, bye-bye.

Pimco Founder Bill Gross

Pimco Founder Bill Gross

Pimco is a mutual and ETF firm with a huge bond fund that has been the player in that space for the past 40 years.  Bill Gross founded the firm in 1971, and it is now around $2 trillion dollars under management. Bill Bross

Last week Bill Gross decided to leave the fund and move to Janus.  This is important because of the disruption to the bond market as huge sums could (and I say could) move from one firm to another.

The bond market doesn’t get as much coverage as the stock markets, but this is a pretty big change, equal to the Denver Offensive team picking up and going to Oakland.  Heaven forbid.

 

Bill Bross from Pimco 

Definition:  Leveraged Buyout LBO

Definition: Leveraged Buyout LBO

LBO

Defined:

The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. Often, the assets of the company being acquired are used as collateral for the loans in addition to the assets of the acquiring company. The purpose of leveraged buyouts is to allow companies to make large acquisitions without having to commit a lot of capital.

 

Definition:  High Yield

Definition: High Yield

2013 12 13 high yield

Defined:

A high paying bond with a lower credit rating than investment-grade corporate bonds, Treasury bonds and municipal bonds. Because of the higher risk of default, these bonds pay a higher yield than investment grade bonds.

Based on the two main credit rating agencies, high-yield bonds carry a rating below ‘BBB’ from S&P, and below ‘Baa’ from Moody’s. Bonds with ratings at or above these levels are considered investment grade. Credit ratings can be as low as ‘D’ (currently in default), and most bonds with ‘C’ ratings or lower carry a high risk of default; to compensate for this risk, yields will typically be very high.

Also known as “junk bonds”.

 

Definition:  Eurodollar

Definition: Eurodollar

 

 

definition- euro dollar

Defined: U.S.-dollar denominated deposits at foreign banks or foreign branches of American banks. By locating outside of the United States, Eeurodollars escape regulation by the Federal Reserve Board.

Despite the name, Eurodollars do not have to be in Europe, and they are priced in U.S. dollars.