Investment Opportunity or High Risk Adventure?

The Dow Jones Industrial Average (The DOW) first crossed and closed above 10,000 back on March 29, 1999 more than ten years ago.  The DOW’s all time high (closing value) was set on October 18, 2007 at 14,146. Since then the markets have been very volatile posting enormous single day gains and losses.  On October 13^th, 2008 the DOW closed up more than 11% with a record point gain of more than 936.  In the past few weeks we have had a number of near record single day gains and losses.  Just what is the source of such record volatility and how do you maintain a rational investment portfolio in such an irrational setting?

The source is fear:

1. Banks fear Federal Reserve action/inaction and central government regulations that force banks to act outside their normal functions.
2. Small Business owners fear the HC law and its unintended consequences and are NOT hiring new employees and cannot borrow to expand/improve operations.
3. Debt: both private and public debt is rising and dramatically so.
4. Europe, specifically Greece, Portugal and Spain.  Greece is likely to default on billions in loans made by EU banks and American Banks.  What does that mean to the average American?

It all comes down to what is right for you and your objectives and how do we best address those fears and implement a plan to attain your individual goals.

There are a number of investment styles such as: Value, Growth, Income, Wealth Preservation, etc.  Large Cap companies, Mid-Cap and Small Cap, Cap referring to the market capitalization of a particular corporation (number of shares authorized times the price per share) as opposed to debt financing.

We have for the first time in decades the opportunity to invest, carefully, in large, multi-national companies (that do business in USA and overseas) that are traditionally viewed as a Growth style investment that are now paying very high dividend yields (% of dividend relative to the current price per share).  The combined opportunity to received 1.5% dividend yield up to 6% on DOW and other companies plus the opportunity to grow the price by more than 10% is highly unusual.  Most investments either offer stable or valued income with very modest growth, such as a phone company stock or public utility.

The danger of investing in or ‘chasing yield’ is that a corporation’s board of directors and management can reduce or eliminate their common stock dividend in times of cash shortages.  That is why we must analyze the balance sheet and income statements of each company that we may consider investing our hard earned money with.

What are the major investment styles?

1. Growth: Where investors seek companies and industries with a strong growth trend in sales and earnings.  Growth is defined as beating the growth of the economy or GDP.  These types of investments have typically much higher P/E ratios and pay little if any dividend.  These stocks generally have a much higher volatility relative to the market and have little tolerance for earnings ‘disappointments.’ 
2. Value Investing:  Is essentially bargain hunting.  Buy great performing stocks that have had significant sell-off of late and as a result major decreases in current prices.  The price of the stock is trading at a closer relation to its book value than normal.  Here one must buy into these positions early on in order to reap the benefits of price appreciation as the price returns to ‘normal’ price ranges. 
3. Income: Investing in stocks and bonds that pay higher dividends/interest than other investment alternatives.  The objective here is typically current income with no emphasis on growth or price appreciation. 
4. Wealth Preservation: The objective here is to maintain the accumulated wealth of one’s estate through a more conservative approach.  These types of portfolios tend to be weighted more towards fixes income with a percentage of equity stocks that have a low beta and even lower volatility.  Of course these equities have very low price appreciation.  Stocks in this category are typically public utilities, such as in the electric generation and phone company stocks. These stocks tend to distribute the majority of their earnings in excess of capital requirements in the form of higher dividend yields/interest rates.  These portfolios also have a higher weight of treasury bonds, etc. 
5. Momentum Investing: Investment managers in this style look for trends in companies that have a higher rate of earnings appreciation for a short period of time.  Timing is critical here and very hard to buy at the absolute low and sell at the absolute high. This style has a much higher risk to significant loss than other styles.
6. Contrarian:  Investment managers in this style usually are investing when the average investor is selling or staying away.  Here the time horizon is much longer, typically more than 10 years.  Essentially when the average investor is buying/selling these managers are selling/buying.
7. Blended or Balanced Approach: Is just that, a portfolio that has a mix of equity and fixed income and growth/income stocks.

Market Capitalization: Also known as Market Cap is a measure of the size of equity capitalization employed in the financing of the entity.  Market Cap is determined by the number of shares outstanding (common shares) times the current price.  Currently the largest market cap of any corporation publicly traded is Exxon-Mobile with a market cap exceeding $515 billion.  There are three categories of capitalization: Large, Mid and Small.  Large cap stocks typically have long histories of solid performance in both earnings and price appreciation.  Whereas Mid. and Small cap companies have a shorter track record of both earnings and price performance.  These two categories also are typically higher beta (risk) and more volatile than their large cap cousins.

Types of Investors:

1. Conservative: These investors typically cannot tolerate volatility in their portfolio.  They will be weighted more towards fixed income with very low risk equity positions: Utilities, etc.
2. Moderate: They like higher returns than pure fixed income but are not very adventurous.  Most investors fall into this category.  Normal weighting here would be 40% fixed 50% equity and the remainder in cash/money markets.  These portfolios will be well balanced with more than 30 individual positions.
3. Aggressive: These investors seek to beat the market averages, have a shorter time frame and definitely have the ability (psychologically and financially) to absorb deep losses in their portfolios. These portfolios typically have a high concentration of in one or two sectors with very few individual security positions. Much higher rate of gains and losses.Example of a growth/value investment:  Cisco Systems (NYSE:CSCO) is a DJIA component and normally pays a very low dividend as a percent of its common share price.  CSCO also has a P/E ratio (Prices/Earnings per Share) much higher than a value or income oriented investment.  As of 09/02/2011 CSCO’s PE was 10 based upon 2012 EPS estimates.  The current yield is 1.6% which is unheard of for a growth company.  The ten year US Treasury is yielding barely 2% with zero growth potential and a substantial risk to rising interest rates which would erode the current bond price.  Additionally, there is virtually no risk of CSCO abandoning or reducing its dividend as they are currently holding more than $44 BILLION in cash.

The only way to determine which style of investing that is appropriate for you is to know these few basics:

1. What is your risk tolerance?  Many small business owners when asked to assess their risk tolerance related to investing in the stock market they often describe themselves as being conservative.  However, in reality the small business owner has a high percentage of their total wealth is concentrated in only one sector and one company – their own.  That makes them very aggressive investors.  A wise adviser will point this fact out rather bluntly.  The overwhelming majority of advisers and investors NEVER discuss this very important aspect of investing.  An adviser/investor MUST measure their return relative ro the exposed risk of loss.  Risk adjusted returns are normally substantially lower than the pure math of gain/loss typically measured.
2. What is your Time Horizon?:   Time horizon refers to the actual time you have to invest before you retire or make regular (monthly) demands on these funds.  Short time horizon you should be heavily invested in fixed income and near cash assets as you do NOT have the necessary time to rebuild these funds should a market correction wreck your plans for retirement.
3. Maturity Risk?: Is similar to time horizon but relates directly to fixed income.  A bond that has a longer maturity date(time where the bond is fully paid off by borrower) has a higher risk of non-payment of interest or of default.
4. Objectives/Goals?: Why are you investing these funds?  Retirement, vacation planning, education, etc.  This question is almost never asked and is very important.

Before we can recommend any investment no matter how attractive WE believe it to be we must have a serious and lengthy conversation.  We can be reached at www.thomascapitalmgt.com, tom@thomascapitalmgt.com or by calling 928-282-5731.

Yours Truly,

Thomas J. Zaleski EA RIA

President

Thomas Capital Management.

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European Banking Crisis

We now know that the banking and debt crisis in the European Union is here to stay and it has placed a black cloud over the world-wide market!  The cause is simple and one that the American Left refuses to acknowledge: decades of socialism that has created massive entitlement programs for their peoples, especially amongst their immigration classes that have virtually no credible job skills other than manual labor.  Yes, they too have a significant legal/illegal immigration problem and these people demand even more.

After decades of entrenched socialism that permeates their entire economy coupled with the highest tax rates in the world, the EU[1] is created a massive underground economy.  Proponents of the Fair Tax in USA believe the underground economy can be taxed with their approach of taxing all consumption.  The EU’s massive underground economy proves that theorem wrong, again. The underground economy throughout the over taxed EU rivals the legitimate economy and pays virtually no income tax.  The heavy burden of the central authority has created significant incentives to break the law and simply violates the Laffer Curve.

The underlying financial problem is simple: European banks are heavily exposed to bad debt of Greece and Portugal, and Italy to a lesser extent.  These major banks such as Societe General, Credit Agricole SA and BNP Paribas have more than $55 billion (USD) exposure to Greece alone.  These banks are going to need significant cash infusion from the ECB.[2]  Will Germany, France and the UK be willing to go along with more bailouts?

The last round of bailouts to Greece with the massive IMF[3] intervention cost more than $145 Billion USD.  The USA owns about 17.09% of the IMF; therefore, the American tax payer was forced to pay out more than $24.7805 billion to bailout Greece due to its failed socialist policies.  Remember, much of the EU lambastes America for our economic problems and ALWAYS blames our greedy system of capitalism as the root cause of THEIR problems.  The real objective of Greece bailouts is not the saving of the nation itself but the private banks that lent so much money to Greece that is the target of the bailouts.  If Greece defaults these banks will be decimated and this failure will effect America and our banks directly as we have lent billions and guaranteed countless billions more from the Federal Reserve.

What are the EU citizens’ reactions to the current wave of austerity programs launched by the UK, Germany, France and elsewhere?  Riots: yes, the entitled class of citizens and non-citizens burn cars and kills policemen, and burn down whole city blocks doing billions in property damages.  Who pays that tab? the EU taxpayer.

Where did this all begin, with European and American banks being forced, by government regulations and policy, to make loans to entities and individuals that did not qualify under normal lending practices?  Iceland whose major driving force of their GDP is fishing was invaded by bankers from the UK and Netherlands who were flush with cash due to the Federal Reserves super low interest rates. Soon Iceland’s banking sector’s input as percentage of GDP more than doubled in short order. These banks began lending money to anyone in Iceland that had a pulse creating a huge boom in real estate, both commercial and residential.  Alas, 2006 came and the ponzi scheme was revealed, devastating Iceland’s economy.

Iceland’s three largest banks, Kaupting bank, Glitnin Bank and Landsbanki had total debt exceeding $160 billion more than 10 times their national GDP.  Iceland’s solution was to NOT guarantee the bonds of those and other banks.  However, the UK and made a deal with Iceland’s government to provide them aid providing that the loans were guaranteed by each citizen of Iceland.  UK and the Dutch banks brought hard currency aid to Iceland but they received guarantees directly from each citizen, essentially.  There are 320,000 citizens and they will be paying $135 per month per person for 8 years.  So Iceland allowed its major banks to fail and then received direct aid from the UK and Dutch banks/taxpayers.  Can this be Greece’s answer? If, so how will it affect the global financial markets and will that outline the end of the EU and the Euro?  Most likely the effects on the markets will be sharp and painful, but not long lasting.

Since Estonia adopted the flat tax in 1994 (22%) 13 nations have followed suit, including many former Soviet Bloc nations, including Russia herself.  Since then these nations have experience solid economic growth and reduced overall public debt.  For example, Russia’s debt to GDP is a mere 9.5% while USA is 95% debt to GDP.  Is the Flat tax the cure all?  Perhaps not but it must be seriously studied as a method to replace the Internal Revenue Code.[4] The IRC has more than 9,833 sections and is more than 90,000 pages.  What America needs and the EU members need is a well defined central government that is both limited in size and scope of power so the private sector can perform its function of wealth creation, production, and jobs which will generate sufficient and stable revenue for the government to perform its duties.

[1] European Union

[2] European Central Bank

[3] International Monetary Fund.

[4] IRC is Title 26 United States Code

My first blog

Hello everyone! My name is Thomas Zaleski and this is my first attempt at blogging. I am an economist and experienced money manager and will be sharing my thoughts with everyone. I welcome feedback and can be reached on the web at http://www.Thomascapitalmgt.com or via email Tom@Thomascapitalmgt.com

PLEASE SHARE YOUR THOUGHTS WITH ME!

About Me
At Thomas Capital Management, LLC we provide our clients with individual, customized portfolios of equities and fixed income securities. From retirement funding and planning to college savings, we handle 100% of our client’s money. Shift away from risky high-tech portfolios to a properly diversified portfolio based upon Modern Portfolio Theory.

In the investment marketplace, the difference between a customer and a client is dramatic. Customers receive little, if any, “added value” services from the financial vendors, and are left to fend for themselves in an investment world full of pitfalls. No one truly qualified is available to help them understand their investment goals, evaluate their portfolio structure and risk attributes, track their investment performance, or help them avoid making critical mistakes. TCM’s clients have a significant relationship with their adviser that understands their dreams and objectives, their risk tolerance, and their overall financial situation.

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Our objective is to provide you with quality service and sound advice. Planning begins when we meet to discuss your goals and resources, and continues throughout our relationship. Keep in mind that, most importantly, this is a process during which the steps may be taken more than once as your plans, goals, dreams, and circumstances change.

Thomas Capital Management, LLC was formed in 1999 encompassing the above philosophy and values. We are independent investment advisors with our only bias being the attainment of our clients stated objectives. Please contact us if you are interested in a comprehensive review with no obligation with the intent of determining if joining our distinctive family will meet your goals.

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