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Get Comfortable, It’s Going to Remain Bumpy

“If you can’t explain it simply, you don’t understand it well enough.” - Albert Einstein

In 1984, the hip-hop artist Kurtis Blow released a hit single “8 Million Stories” which featured Run DMC. The song goes through various accounts of surviving the tough life in New York City and what that meantfor them at the time. Frankly, the lyrics come off poetic when compared to the needless explicit nature of the genre today, but that is a topic for another discussion. To those either interested in reminiscing or hearing the track for the first time, I’ve inserted the link here. Anyway, during my commute back home a couple weeks ago, I was listening to a flashback session on Apple’s Beats 1 Radio and the song came up, which brought me around to thinking about stories I have been hearing lately, from the people I come across in my life. Some of these people would be considered well to do having achieved impressive professional accomplishments over the years, while many others, I will add are just as talented, but have yet to find their groove for one reason or another. What they all seem to have in common is the perception that maintaining their particular living standards, whatever that may be, had become increasingly more difficult over recent years.

Not enough can be said for rolling up one’s sleeves and diving into the data first hand. With that in mind, I pulled up a couple of graphs from the Bureau of Labor Statistics for further investigation on the topic of living standards. From the below charts we can see that Nominal Wages has been averaging approximately 2.0% (Figure 1) while Core CPI (Consumer Price Index – Less Food and Energy) has also been

averaging around 2.0% (Figure 2). The difference between these two variables equates to roughly zero inflation adjusted, otherwise known as real wage growth over the past few years. When we couple the fact of virtually zero real household wage growth, with the idea that the price growth of big ticket items which eat up much of our income, such as the cost of real estate (including one’s monthly mortgage or rental payment), health insurance premiums, and education expenses, it becomes apparent that disposable incomes for a large segment of the population would certainly be under a considerable amount of pressure. Coincidently, I’d also like to highlight that all of the above prices (real estate, health insurance, and education) have been affected by government intervention either directly or indirectly. Housing is an obvious case in point and at the top of the list for many San Francisco Bay Area residents.

For that reason, I have included a table (Figure 3) from the Financial Times, which shows that four out of ten or 40% of the ten most unaffordable cities in the entire world are located in the state of California.

Much ink has been spilt recently about the Presidential primaries and the shocking rise of both Donald Trump and Bernie Sanders. The former is a populist while the latter is a self-described socialist. I believe their popularity is a reflection of the economic anxiety many voters are feeling across the nation, which may be a consequence of both global capitalism and technological progress.

Many of these people, I believe, have done what was expected but have yet to realize the promised payoff. This has left the “folks” generally resentful of both big business and career politicians, particularly nervous about losing further economic ground. Monocle Radio, the online radio station of the business, culture and design magazine Monocle, did a segment at the 2016 World Economic Forum in Davos with the investment bank UBS, addressing what some in attendance have described as the “Fourth Industrial Revolution.” I have included an audio link to the show here for those that are interested, as I believe much of what was discussed has relevance to the overall mood of our nation, and how this is playing out in both politics and the financial markets.

Moving on to the current state of the financial markets, we see that the reality of lackluster global economic growth has finally seeped it’s way into risk asset prices. These price signals, I believe are capturing the mood of the populace better than any political speech or Op-Ed newspaper piece ever could. Prices, we are led to believe reflect value, but value is something that is perceived, and perceptions of the crowd have been known to swing wildly at times. This is the case today with a very high level of realized volatility occurring daily in the markets. This may be good for both algorithmic and investment bank market makers, who buy on the bid and sell at the offer, but is generally detrimental for most investors and tends to be a major factor behind the mistakes made by those that buy high and sell low. Kristen Scholer, in the Wall Street Journal’s MoneyBeat column recently wrote, “The average daily spread between the S&P 500’s intraday high and intraday low was 2.3% in January, the highest for a month since September 2011 when it was 2.6%, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. For the year, though we are only a month into 2016, the spread is tracking to be the greatest on an annual basis since 2008 when it averaged 2.8% across all 12 months.” Later in the column she changed her tone and identified a bit of light at the end of the tunnel.“Volatility jumped in January amid tumbling oil prices and concerns about growth in the U.S. and abroad. The S&P 500 booked its worst start to the year since January 2009, just before the market bottomed... While spikes in volatility can coincide with steep market drops, the last time intraday spreads were so large, the S&P 500 recovered shortly thereafter and marched higher nearly unimpeded for three years.”

On a purely quantitative basis, I believe the time to sell or de-risk has probably passed for many investors who had not done so, as the bulk of the declines could very well be behind us. However for investors who are less comfortable with their portfolio values swinging about as they have been, it may make sense to pull in the reins from a risk tolerance perspective. In other words, know yourself. To put the markets in perspective, J.P. Morgan Asset Management in their Weekly Market Recap shows the three-year cumulative return on the MSCI Emerging Markets Index down approximately -25% as of February 1, 2016 while Consuelo Mack of WealthTrack wrote in her recent newsletter, “...the majority of stocks in the S&P 500 are already in a bear market, having declined more than 20% from their recent highs. Were it not for large market cap stocks like McDonalds, AT&T and Google parent, Alphabet, Inc. the damage in the index itself would be far greater. It already is in many overseas markets. According to a recent count by Bank of America Merrill Lynch, at least 33 out of 45 major country stock indexes are in bear territory.”

The best direction one can take at moments like these is to get comfortable with your overall risk exposure. This means structuring a portfolio around realistic return objectives rather than trying to make the most or lose the least amount of money. This type of strategy and form of guidance should help the investor ignore inevitable market volatility and portfolio drawdowns. Russell Napier, who wrote “Anatomy of the Bear: Lessons From Wall Street’s Four Great Bottoms” is a well regarded market historian while the book is considered a cult classic among many of the “smart” money traders and investors I have met over the years. He gave a recent interview to ValueWalk an investing website and rather than summarize, I’ll close this month’s note with the interview’s concluding Q&A.

Interviewer: You must have built up quite a broad understanding of bear markets while researching the book. So, if you had to give just one piece of advice to a novice investor, to help them prepare for the next great bear market, what would it be?

Russell Napier: Invest your funds with a multi-asset fund manager and not an equity fund manager. Finding when equities represent good or bad value relative to other asset classes is very, very difficult and best left to a professional manager. An equity fund manager is simply not mandated to provide that advice so you need to find a multi-asset fund manager who does.


Justin Kobe, CFA Founder & Portfolio Manager


Securities and Advisory Services offered by Protected Investors of America, an SEC Registered Investment Advisor. Member FINRA/SIPC. The views expressed in this commentary are the personal views of Justin Kobe of Pacificus Capital Management and do not necessarily reflect the views of Protected Investors of America. There is no assurance that the investment process will consistently lead to successful investing. This commentary does not constitute an offer to sell any securities or the solicitation of an offer to purchase any securities. Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

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