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|Essential Investment Partners: Safe Catch receives $5m to develop low-mercury fish linesSafe Catch has received $5 million in seed funding from Echo Capital, Essential Investments and Angels after it developed a method to test fish products for mercury contamination.The post Safe Catch receives $5m to develop low-mercury fish lines appeared first on FoodBev Media.FoodBev|
|Essential Investment Partners Blog Social Security -- The Perplexing Retirement AssetWith thousands of baby boomers reaching retirement age each day, tens of millions of people will be signing up to receive their Social Security benefits over the coming few years. Until President Reagan worked out a deal with Congress to raise the retirement age gradually, many of us expected that Social Security would be bankrupt long before we reached retirement age. The good news is that the system is solvent for at least another decade but it will need another, perhaps similar, fix to keep full benefits going through retirement for boomers and gen Xers.What many don't know, however, is that maximizing your Social Security benefits takes some planning. Most know that delaying benefits until age 66 (so called Full Retirement Age for most boomers) is good and delaying until age 70 is even better. While that is generally true, the situation can get quite complex and confusing for two earner couples, divorced individuals, couples with substantial age differences and even those couples who have uneven employment records. As more of our clients are approaching their full retirement age, we decided to dig deeper into this subject and, quite honestly, we were surprised by what we found. While the simple rules of thumb do apply, they may not maximize benefits, depending on the specific situation. And, not surprisingly, the helpful folks at the Social Security Administration may not be able to provide you the best answers. Perhaps more importantly, they likely won't know if you are asking the wrong questions for your situation. In addition to lots of reading on this topic, we have purchased software that allows us to help clients determine the optimal claiming strategy for their specific situations. You might think: how much difference can this make? The answer is: quite a lot. For example, one change to the simple "defer until 70" strategy for a two career couple could net them an incremental $50k in benefits!This is the type of service we provide to our wealth management clients as part of helping them live the best life possible with the resources they have available. Essential Investment Partners Blog|
|Essential Investment Partners Blog Big Change in the World's Third Largest Economy?We recently had the opportunity to spend 11 days in Japan, our first trip to a country that boasts the world's third largest economy. Honestly, we weren't sure what to expect because Japan has spent much of the last 20 years wrestling with recessions and deflation. And, if a two decade hangover from the 1980's party wasn't enough, the country is also recovering from a devastating tsunami that has shifted their entire energy policy away from nuclear energy.Viewed from this side of the Pacific, the launch of Abenomics 18 months ago is having a positive impact on economic growth and inflation. But the history of Japan's government stimulus programs over the past 20 years is littered with failures. So the question is: is it really different this time?Certainly, in structure, scale and scope, Abenomics is much greater than prior efforts. The three "arrows" -- fiscal stimulus (deficit spending), monetary stimulus (quantitative easing) and structural reforms to boost competitiveness -- are designed to be mutually reinforcing (a Japanese folk tale says that three arrows held together cannot be broken). The first two were readily implemented and are producing results. The third is very much a work in progress, requiring both legislative action and great deal of change to Japanese work life. So what did we observe in our brief trip? First, we were consistently struck by the great deal of pride each person we encountered took in their work. As we settled into our first taxi ride -- with an extraordinarily polite, uniformed driver and an immaculate vehicle -- we could only imagine the horror of a Tokyo native who hails a cab for the first time in New York or Chicago. This pride was evident everywhere we went and in every service provider we encountered. So refreshing and so different than the US!Second, we sensed real optimism about the direction of the economy. Having family in Michigan, we have seen the impact of pervasive economic devastation first hand. We sensed none of that in the three cities we visited. On the contrary, the people we encountered were upbeat, welcoming and focused on their work. Our visit came on the heals of the consumption tax increase from 5 to 8% that took effect on April 1. Japan's retail sales reports for March and April showed the impact (a big pull forward increase and then a large decrease). However, we found retailers to be sanguine about the changes, even if they were acutely aware of its short term impact. We came away thinking that Prime Minister Abe must have done an excellent job of communicating his policies. People understood and seemed to accept the tax increase as part of a bigger plan. So what was negative? You have to look beneath the surface to find it. First, unemployment is very low and many people are employed in ways we would not conceive of here. At department store elevators, we encountered three elevator ushers, assisting shoppers to the next available car, when we wouldn't even have one here. In our eleven days, I can't remember ever having to wait to be assisted - there was always some one ready, willing and able to help. (Mind you, we scrupulously avoided the queues at the most popular outlets - the first "street" queue we encountered was for Garrett's Popcorn. Those of you from Chicago will instantly remember the Garrett's lines on Michigan Avenue - the same situation exists at Garrett's near Harajuku in Tokyo.)Second, the lack of immigration is painfully obvious. The elevator ushers, the hotel bell persons (many female) and the cab drivers were all Japanese. The corollary is that the workforce is not growing, either by birth rate or by immigration, and this will work to limit the growth in the economy. It also implies that while unemployment is low, many workers are performing far below their potential. As part of his structural reforms, Mr. Abe wants to encourage greater female participation in the labor force. However, that would at best provide a one time boost to the work force, likely in the service sector. Finally, with the first two arrows of Abenomics firmly in place, the government is showing some success in creating economic growth and inflation. However, the third arrow - labor market reform is critical for several reasons. First, with little slack in the current labor force, even modest raises in wages could easily ignite a labor cost-driven inflation cycle that would be difficult to contain. Worst case, Abenomics could give rise to a stagflation situation - high inflation and low growth. Second, for the labor market to be more productive, employers need to be free to hire and fire. Third, to have sustained growth in the labor market (and, by extension, the overall economy), some immigration will be required, as the domestic population simply isn't growing on its own. And boosting it with female participation won't be sufficient.With difficult structural reforms ahead, Mr. Abe has his work cut out for him to establish a long term platform for growth. Our observation was that people are optimistic about positive change. Whether Mr. Abe will have the will to propose sweeping labor and immigration reforms is an open question. Assuming he does, then we will see whether the people will continue to be supportive of him and his policies. Only time will tell. Essential Investment Partners Blog|
|Essential Investment Partners Blog Thoughts on the Current OutlookThree Key Thoughts: A bear hug for oil Collision of the economic and political in China Higher risk, lower return prospects call for cautionEnergy prices remain firmly in the grip of a major bear market. In the near term, production is expected to stay elevated with OPEC not budging and Iran output expected to add to the glut. Meanwhile, demand is relatively stable as the world remains in slow growth mode. If US production begins to fall off in 2016, forced by the financial realities of low oil prices, then we could see some stabilization in the supply/demand imbalance. Expectations of defaults on energy-related high yield bonds caused ripples across the entire high yield bond market late in 2015. This is certainly a warning sign that actual energy defaults could create problems across the credit markets.Two other energy related matters are surprising. First, we have not seen much of an energy savings "dividend" in consumer spending. This usually takes some time to play out but we would have thought we would be seeing more of it by now. Second, rising tensions in the Middle East (Russia joining the Syrian fighting, open feuding between Iran and Saudi Arabia) should lead to stable or higher oil prices. That has simply not been the case as investors believe the supply/demand imbalance will continue despite these developments. Apparently, it will take an event that actually changes the supply situation to jolt the markets. In China, the year started with a big drop in the A share market as concerns about currency devaluation and expirations of selling bans came front and center. Imposition of a poorly designed circuit breaker deepened the uncertainties and contributed to selling pressures in stocks around the globe. It's important to remember that the A share market is primarily for locals and does not represent a major portion of Chinese wealth. The Chinese authorities are trying very hard to balance four things: (1) a long term transition to a service oriented economy which means substantially lower, but more sustainable, growth; (2) a gradual transition to a freely floating currency, when the market is expecting a dramatic devaluation; (3) developing open stock and bond markets that can support a market based economy; and (4) cracking down on dissension and perceived corruption on the part of those who don't fully support the government's policies. Any one of these initiatives would be incredibly difficult in an economy the size of China's. But trying to do all four invites policy mistakes. We have seen several missteps already and will likely see more. Our greatest concerns are at the point of intersections of the initiatives, particularly when "corruption" could be defined to include market-based selling of stocks, bonds or currencies at a time when the government wants them bought. This is a sure way to delay the development of the markets. We should expect continued bouts of volatility as authorities work through this learning process. Halfway across the globe, we continue to be concerned about the impact of the refugee crisis on Europe. These concerns are heightened now that weakness in the immigration system has been linked with terrorism. All this adds to uncertainty against a weak economic backdrop. The European central bank is trying hard to stimulate growth and inflation but so far they have met with limited success. Finally, here at home, our economy continues to muddle along at an expectedly slow rate. The employment picture remains pretty strong and so far inflation has been quite limited. At some point, we may see a pickup in wage inflation as employers are forced to pay more to hire a dwindling supply of available workers. That assumes the economy doesn't stall before then. The Fed is certainly counting on this return of inflation as it plans further rate hikes over the course of this year. But the Fed's track record is mostly on the "too optimistic" side of things. Recognizing this, the markets don't believe the Fed will raise rates sharply, as short term rates have moved up modestly and long term rates have stayed stable after the Fed's first hike. Slow growth and low inflation leave us with low nominal growth, which means low growth in earnings for companies. And if inflation picks up because of wage pressures, that could hurt corporate profitability further. Bottom line, we expect corporate profits to be weak generally, particularly absent a bounce in oil. One possible bright spot could be a stable dollar, which would eliminate the large drag on revenues and profits that last year's strong dollar had. So where does all of this leave us? Quite honestly, it leaves us with lots of potential sources of volatility and not many sources of great prospective returns. The combination of low returns and high risk is not a hospitable environment for investors. Among individual stocks, we are focused on companies that can continue to grow revenue and profits at healthy rates even in a relatively weak environment. We continue to add to investments in the "alternative strategy" space, mostly in long short equity or debt strategies, seeking moderate returns with moderate risk. Finally, we are far underweight US small cap stocks as we view that category as high risk with quite uncertain rewards in the period ahead. January 13, 2016 © Essential Investment Partners, LLC All Rights ReservedEssential Investment Partners Blog|
|Essential Investment Partners Blog Thoughts on the Current Outlook -- April, 2015The US economy grew by 2.3% in 2012, 2.2% in 2013 and 2.4% in 2014, despite a number of volatile quarterly reports. We expect a similar result in 2015. In fact, 2015 is shaping up in some ways very much like 2014: an unexpectedly poor first quarter, resulting from temporary factors, followed by a bounce back to somewhat stronger growth. The net result is slow but surprisingly consistent growth. This time, the special factors have been the east coast weather (again!), the west coast port labor dispute and a sharp reduction in energy projects. In the last few weeks, we have seen expectations for first quarter growth get marked down quickly. Optimism for a second half rebound remains high, however. The Federal Reserve seems to have become cheerleader-in-chief for the economy. Perhaps it isn't too surprising that they would "talk their book," hoping their optimism becomes contagious, allowing a move off of zero interest rates. Unfortunately, their track record in the last several years is consistent: too much optimism, which must be tempered significantly as reality sets in. Bond investors now believe the Fed will be slower to raise rates than the Fed members themselves believe. We agree. While the economy will likely do better later this year, three factors will likely keep inflation low and growth slow: (1) the large decline in oil prices will keep headline inflation low and producer prices stable, offsetting modest wage pressures; (2) gains in the value of the dollar relative to almost all other major currencies make imports cheaper and exports more expensive, leading to lower domestic growth; (3) reduced capital expenditures and losses in high paying employment in the energy sector will be reflected in economic reports over the balance of 2015. Over the longer term, we believe that very slow growth in the labor force, combined with small productivity gains, will constrain our growth to less than 3%. Over the next few weeks, we will get another read on the magnitude of the impact of the stronger dollar and lower oil prices on corporate earnings. In aggregate, earnings are likely to decline modestly. For now, investors are giving companies a pass on the earnings hit from the stronger dollar and are expecting that oil prices will gradually recover. And so far, consumers haven't been spending their oil bonuses - they have been saving them instead. Put all these factors together and US stock valuations remain disturbingly high, relative to earnings. Despite all of this talk about slow US growth, we are still doing much better than Europe and Japan. Looking back, the dollar strength compared to the Euro and the Yen makes perfect sense. Higher rates, stronger growth, low inflation: what's not to like? The question is: where do we head from here? We believe that as the European and Japanese economies recover, the gap between the respective growth rates will decline and the currencies will be more stable. However, fixed income investors will continue to be drawn to US bonds as our rates are still more attractive than those available in Europe and Japan. We expect this will keep a lid on US longer term rates and the dollar in a positive trend. Europe finally seems to be turning a corner, even while dealing with the Greek challenge and uncertainty in Ukraine. With the European Central Bank's quantitative easing program well underway, we expect interest rates there to stay low until the major economies show sustained growth and some inflation is evident. These green shoots have been welcomed by the equity markets, which have rallied sharply. Unfortunately for US dollar investors, a portion of those gains have been erased by currency losses. In Japan, the third arrow of Abenomics - important economic and labor reforms - are beginning to take hold. Corporate governance reform, increased equity investments by pension plans, greater employer/employee flexibility and growing wages are a few of the more visible signs that genuine change is afoot. Serious problems remain, however, including a very rapidly aging workforce, an aversion to immigration and low productivity growth, all of which work to limit the potential growth of the Japanese economy. Finally, China continues on its unique path toward greater free market reform, broader social safety nets and crackdowns on political dissent and "corruption." In the west, we have a hard time understanding how capitalism can flourish in the absence of political and personal freedom. Meanwhile, given the miraculous growth of the Chinese economy over the last 30 years, the Chinese wonder why we don't think their model is better than ours! We expect China to continue its move toward a sustainable 4-5% growth rate, suitable for a mature but healthy economy. And they have accelerated the pace of capital market reforms, including a more freely traded currency, more flexible exchange rate and relaxed constraints on trading in the domestic equity (A share) and Hong Kong equity markets. Longer term, this greater economic openness is quite positive for the entire region.In client portfolios, we remain overweight stocks in a diversified set of strategies, including a high allocation to international stock markets where growth is emerging. In addition, we are under-weighted in fixed income as yields generally are not attractive. We continue to add to carefully selected hedged strategies as we believe valuations of US stocks and bonds are high. April 15, 2015© Essential Investment Partners, LLC All Rights Reserved Essential Investment Partners Blog|
|Essential Investment Partners Blog Thoughts on the Current Outlook -- October, 2014A few comments about risk...At a point in time when many people think US stocks are very overvalued and even more believe that bond prices are in a bubble, we thought it made sense to talk a bit about risks we see. But first a little background. Howard Marks, Chairman of Oaktree, a highly-regarded investment firm, has written eloquently and extensively on the subject of risk. He sets the stage this way: "Here's the essential conundrum: investing requires us to decide how to position a portfolio for future developments, but the future isn't knowable."But even though we can't know the future, we can still develop a plan to deal with possible outcomes in a logical way. Indeed, we, like most investors, view the investing world as a series of possible outcomes each with its own probability of occurring. Because each outcome only has a probability, we have no way of knowing in advance what will actually occur. Back to Mr. Marks: "Risk means more things can happen than will happen...Many things would have happened in each case in the past, and the fact that only one did understates the variability that existed...Even though many things can happen, only one will."Rather than trying to predict the exact course of events, it is our job to try to tip the scales in our favor, i.e., make informed judgments about investments that are likely to succeed based on the events we believe are most likely to occur. Of course, we will almost always be wrong about the specific events (unless we are just lucky) but if we correctly choose those investments with more upside than downside, we and our clients should fare well over time. Mr. Marks refers to this process as finding "asymmetries" - where the upside far exceeds the downside. Are bonds now riskier than stocks?Applying this thinking to the current environment, we can readily see good and bad asymmetries in the bond world. The very low yields on sovereign debt throughout the developed world can't fall much further but those rates could certainly rise dramatically, if growth and inflation were to be ignited. This is particularly true in continental Europe and Japan where we believe the downside risk to bond prices is much greater than the upside - the bad kind of asymmetry. Further amplifying this risk, the Japanese and European central banks are firmly in stimulus mode. Japan is much further along and the jury is still out on whether they will be able to jumpstart the economy. So far they have succeeded in weakening the yen dramatically and spurring sporadic growth. While a weaker yen might boost reported inflation, it could be counterproductive if rising import prices dampen economic growth. In Europe, the central bank is just beginning its quantitative easing program and the only result so far is a significant drop in the common currency. Due to limitations unique to the Eurozone situation, this program will have a tougher time succeeding. In addition, it has a big near term challenge in overcoming the negative effects of the sanctions against Russia on the Eurozone economy. Bottom line, both central banks are working hard to boost their economies and, if they are successful, rates will rise significantly. For these economies, we believe the answer is yes, bonds are much riskier than stocks. Here in the US, the Federal Reserve is near the end of its bond purchase program and will likely begin raising short term rates sometime next year. Unless we get some spark of inflation, however, we expect those rate increases to be relatively modest. With energy prices recently declining and wage pressures non-existent, reported inflation is likely to be benign. So we think a large increase in US rates is unlikely but a modestly higher range of rates, particularly for short and medium term debt, seems like a quite reasonable outcome. However, we can buy fixed income closed end funds at very high discounts to net asset values (reflecting investors' belief that a large increase in rates or spreads is around the corner) which we believe provides our clients a good asymmetry. In addition, high yield and floating rate loans provide good yields relative to inflation and higher quality bonds. For the US market, we don't think carefully selected bond investments are riskier than stocks. Stocks aren't cheap eitherAmong US stocks, we have thought small caps were overvalued for a long time. We were wrong in 2013 but have been proven correct so far in 2014 as small caps have drastically underperformed large caps. However, even among large cap companies, we are finding it difficult to find high quality companies trading at reasonable values. One particular concern of ours is that many very good, but slow-growing, companies are trading at very high multiples on earnings. Typically, these stocks would be safe havens in difficult markets - that may not prove to be true if the market decides to mark these multiples down to more reasonable levels. To some extent, stocks are levitating based on a lack of alternatives (many perceive a higher risk in bonds) and a general skepticism that the bull market cannot last much longer. How long this will go on and how it will be resolved only time will tell. For now, we are paying very close attention to individual stock values, relative to the earnings growth expected. Outside the US, valuations are much less challenged so we added significantly to international stock fund positions earlier this year. This proved premature this quarter as the dollar strengthened dramatically and international stocks, with the exception of a few markets, slumped. However, leaving China aside, prospects for better economic growth are good in the coming year and this should provide a positive environment for stocks. In China, the gradual growth slowdown continues, making it hard for investors to handicap the stock market. As a result, valuations remain low. We believe China is heading for mid-single digit GDP growth with a greater share of its economy comprised of consumer spending. What we find hard to discern is how the dichotomy between the government's more market-oriented economic policies and crack down on political freedoms will play out. Finally, we continue to increase positions in hedged investments which provide some exposure to equity and debt markets but with lower market exposure. Fortunately, more successful hedge fund managers are bringing their strategies to mutual fund form, providing us access to a much broader array of managers and strategies than ever before.October 8, 2014 © Essential Investment Partners, LLC All Rights ReservedEssential Investment Partners Blog|
|Essential Investment Partners Blog Thoughts on the Current Outlook -- July, 2015Three Key Thoughts:Fed dials back its optimism about US economy; 2+% is the new normChina's stock market volatility complicates market reformers' jobGreece is the word Last quarter, we talked about our expectation that the US economy would grow in the 2-2.5% range for 2015, a result very similar to the previous three years. Now that we have seen much more data on the first quarter and some preliminary figures for the second quarter, the Federal Reserve has dialed its consensus forecasts down into this range as well. And the discussions about interest rate hikes are more about the Fed wanting to get off of zero so that it has room to maneuver if the economy weakens. This is a very different viewpoint than one which had been concerned about strong growth and inflation. You might wonder why we spend any time thinking about the aggregate growth of the US economy. After all, gyrations in that growth rate show very little correlation to stock market returns. We care because stock prices are tied quite closely to corporate earnings and aggregate corporate earnings growth is tied to the nominal growth (not adjusted for inflation) in the economy. Stock prices can rise for either of two reasons: (1) growth in corporate earnings; or (2) an expansion in the multiple (the price/earnings ratio) that investors are willing to pay for future earnings. At this point in the market cycle, those multiples have already expanded significantly so further gains are very dependent on earnings growth.There are other underlying reasons why we expect the economy to grow slowly over the next several years. In aggregate, the economy can only produce more by a combination of increases in the labor force and increases in productivity. The Bureau of Labor Statistics projects that the US labor force will grow by about 0.5% over the next 7 years. With the exception of a short period in the early 2000s, productivity has increased about 1.5% annually over the long term. Adding these together, we get about 2% real (after inflation) growth as the new benchmark. If we add 2% inflation, then we can expect about 4% in corporate profit growth, certainly not a very exciting number. With the US stock market trading at a price/earnings ratio of about 17, investors are paying a relatively high price for pretty slow growth. So what is a good corporate executive to do? Predictably, corporations have been raising dividends and buying back stock. While stock buybacks boost reported earnings per share (because the share count is lower), they do nothing to grow the underlying business. Bottom line: we expect modest returns on US stocks.Outside the US, we are more optimistic about stocks as earnings growth is picking up in many places and prices are much more reasonable. However, the major non US economies all have their issues. In China, financial regulators are getting a lesson in what can go wrong when markets are opened up without all of the proper regulatory controls in place. The China A share market soared for more than a year and now is suffering a severe correction. Day to day volatility is through the roof and regulators are scrambling to put in place proper margin account controls and other initiatives to stabilize the markets. Ironically, this stock market volatility was caused by the rush of domestic investors speculating on A shares, betting that prices would go higher once non US investors are fully allowed in. This game was bound to end poorly and it is a distraction from the government's long term efforts to open China's capital markets to the outside world. We view these developments as growing pains and, as in the past, China will learn, adapt and move forward. Japan continues to make progress, albeit slowly, in creating sustainable economic growth and a moderate level of inflation. If we look at Japan with the same lens we examined US growth potential above, it is easy to see how difficult their challenge is. Japan's demographics are poor (rapidly aging and low birth rate) and they do not encourage immigration so their labor force is not growing. Addressing these issues is one part of Prime Minister Abe's "third arrow" of comprehensive labor and corporate governance reforms. In Europe, Greece is the word, for now anyway. Having stolen the limelight from the rest of Europe (which seemed on the road to a respectable recovery), Greece now seems to be playing the part of your erratic drunk uncle at the family party. His behavior gets increasingly bizarre up to the point at which he is ushered out the door by the largest family members. It seems to us that the only reasons the Europeans continue to negotiate are: (1) to prevent other weak members (Portugal, Spain, Italy and France) from trying to renegotiate their own debts; and (2) to prevent Greece from leaving the Eurozone and providing an opening for a competing rescue with geopolitical implications (think Russia). If the Europeans could dispatch Greece in isolation, they would have long since done so. It is just not that simple and the entire episode raises questions about the wisdom of the currency union for weaker members. So we must be mindful of the broader risks and how they are managed. In client portfolios, we remain overweight stocks in a diversified set of strategies, including a high allocation to international stock markets where growth is emerging. In addition, we are under-weighted in fixed income as yields generally are not attractive except in closed end funds where discounts to net asset value have widened to very attractive levels. We continue to add to carefully selected hedged strategies as a way of controlling portfolio risk. July 8, 2015 © Essential Investment Partners, LLC All Rights ReservedEssential Investment Partners Blog|
|Essential Investment Partners Blog Thoughts on the Current Outlook -- July, 2014Volatility in Surprising PlacesWith two major bear markets in stocks within the last 15 years seared into investors' memories, we have come to expect high volatility in stock prices. Conversely, we tend to view the US economy as a lumbering giant, moving slowly but constantly forward, with only something as large as the Great Recession able to throw off its trajectory. Lately, we have seen volatility in the stock market decline rather dramatically. Actually, this is pretty typical of a sustained run of positive returns like we have had since the middle of 2011 and we also saw in the mid 2000s. However, we have seen the opposite in reported GDP over the past year. The quarterly numbers have bounced around a lot (+4.1%, +2.6%, -2.9% and +3% estimated for the last four quarters). If we just look at the year over year increase though, we find that GDP has grown at less than 2%. This raises a couple of questions. Is 2% as good as it gets, now that the economy seems to be hitting its stride in this long recovery? Does 2% growth really support the kind of rally we have had in stocks?We believe there are a number of structural reasons why this 2% level of growth may be closer to the economy's new growth potential, down roughly a third from the 3% we became accustomed to for several decades. Productivity growth has slowed for at least two reasons: (1) chronic underinvestment in business capital equipment in the post-Great Recession period and (2) changes to the size and composition of the labor force occasioned by demographic shifts. While productivity will be boosted somewhat by advances in mobile technology, these other factors will likely offset that boost, holding our growth back.There is both good news and bad associated with lower potential GDP growth. The good news is that we need fewer new jobs to sustain employment at a relatively high level (we are seeing this play out in the rather quick drop in the unemployment rate over the last 18 months). The bad news is that we could be much closer to triggering a bout of renewed inflation from wage pressures than the Federal Reserve currently believes. And, on a cyclical basis, we are getting close to a point on capacity utilization that typically results in inflation pressures. From an investment perspective, this result is by no means terrible. Growth at this new potential with renewed wage inflation will mean higher nominal GDP growth. Corporate profits and stocks can likely grow at that nominal rate. Interest rates on bonds will drift up to at a more normal spread to long term inflation expectations (elimination of Fed buying will let rates seek this natural level). Overall, we should expect returns to be lower than those of the last three years, when both stocks and bonds did quite well. Returning to the second question of stock prices relative to growth prospects, we view US small cap stock valuations as very stretched and US large cap stocks as fully valued. As we look at individual companies, we often see valuations that reflect a great deal of optimism about earnings growth when the reality is that earnings will likely grow slowly. It takes a great deal of searching to find growing companies at reasonable prices. We are much more positive about the prospects for non US stocks as growth is beginning to accelerate and prices are lower.Global Growth Takes a Positive TurnGlobally, we see economic growth trending more positively with renewed contributions from Japan and Europe offsetting lower growth in China and many other emerging markets. In Japan, the long-awaited, third and critical arrow of Abenomics will soon be announced. It will be interesting to see how bold Mr. Abe will be in his proposals for labor market reform and, if he is bold, whether the Japanese people will continue to support him. Please see the previous blog post on this website to read our publication about Japan entitled Big Change in the World's Third Largest Economy? Continental Europe is still struggling to emerge from recession. The process is slow and central bank stimulus continues to expand. Without a strong central force for fiscal stimulus, the European Central Bank's monetary stimulus is the only game in town. The ECB is still fighting off the effects of fiscal austerity plans put in place across southern Europe several years ago. Those economies are now bouncing back after severe recessions. On the other hand, the UK, which retained control of its own currency and fiscal matters, has recovered well from recession and is now looking at monetary restraint to make sure inflation doesn't become an issue. China continues to forge ahead on its economic and market reforms at the same time it seems to be going in reverse politically. Numerous incremental changes have been made in the financial markets that all point to a more market-oriented approach to economic policy. A series of important domestic policy initiatives have been announced that will allow more individual economic freedom. However, censorship is as strong as ever and China is flexing its military and political muscle on regional territory issues, including most surprisingly Hong Kong. Cautiously Overweight US Stocks, Aggressively Overweight Non US StocksIn most portfolios, we hold the maximum weight permitted in international stocks, particularly smaller company stocks, as we believe valuations are more compelling and better growth lies ahead. We have increased our weightings in hedged equity and continue to be underweight in fixed income, with a relatively defensive stance within those holdings. July 9, 2014 © Essential Investment Partners, LLCAll Rights ReservedEssential Investment Partners Blog|
|Essential Investment Partners Blog Thoughts on the Closed End Fund MarketWe have been investing in closed end funds for our clients for more than a decade. Over that time, we have developed an extensive knowledge of the unique nature of that market and the intricacies of how closed end funds operate for investors. Since March of 2009, we have applied this knowledge in managing the Essential Absolute Return strategy with excellent results until the last twelve months. In the early days of this strategy, we invested primarily in corporate action situations that were low risk and which provided relatively steady and predictable returns. Many of those corporate actions were a direct fallout of the 2008 financial crisis. As the effects of that crisis faded, so did the number of opportunities of this type. More recently, we have focused on convergence trading. We believe the closed end fund market is structurally inefficient which gives rise to temporary mis-pricing of assets, relative to their "normal" value. We try to buy mis-priced funds, and then wait for the pricing to return to average or normal levels. These types of opportunities tend to give rise to more volatile return streams (both positive and negative) and, because we never know when markets will return to normal pricing, the timing of such returns is uncertain. However, because of the leverage inherent in most fixed income-oriented closed end funds, our clients earn a high current income stream which serves to mitigate somewhat the risk of price declines. Over the past twelve months, closed end fund discounts have widened to levels not seen since the financial crisis of 2008. Yet, there has been no crisis, no significant widening of spreads (except in a few emerging markets where we have limited exposure), and no dramatic changes in the levels of short or long term interest rates. There have, however, been periods of market uncertainty caused by concerns about the US Federal Reserve raising interest rates, a potential Greek default or exit from the Eurozone and China's boom and bust A share market. These events had relatively little impact on our holdings' underlying net asset values. Yet discounts continue to widen. This time period has left us wondering if something has fundamentally changed in the closed end fund market. There have been a few developments: (1) the market for new closed end funds is quite muted and new funds that are being brought to market have more innovative structures designed to limit discounts; (2) the number of institutional investors has grown to the point where pure corporate action arbitrage opportunities are now rare; (3) fixed income exchange traded funds continue to gain popularity, potentially distracting investor interest away from closed end funds; and (4) investors have been hearing for years that the end of bond bull market is upon us and they need to prepare for rapidly rising rates. The first two factors should actually bring more rational pricing to the closed end fund market, not less. The last two factors may actually be depressing the demand for closed end funds among retail investors, making a return to rational pricing more difficult. We believe the fourth factor - fear about the impact of rising rates - is likely the biggest contributor. For many reasons, we believe this fear is overblown. Over the course of the past year, we have continued to selectively add to positions in closed end funds that meet our investment criteria, only to see discounts on these funds widen further. And we have allocated additional client (and personal) assets to this strategy, believing that the opportunities now present are extraordinary. We hear the same story from our fellow institutional investors in closed end funds. Here is a chart recently published by RiverNorth, a well-known manager in the closed end fund space. Taxable Bond Funds: 30-day Moving Average Discount June.1997-June.2015Source: Morningstar, Inc. As you can see, discounts have only been at this level immediately prior to the last two recessions. In 2000, discounts quickly recovered, even before the recession fully kicked in. In 2008, the financial crisis wreaked temporary havoc with all financial assets before a strong recovery kicked in. We believe this time period is more likely to be like the early 2000s but there is of course no assurance that it will turn out that way. We are exercising patience in waiting for prices to return to more normal levels with the comfort of knowing that we are able to buy the assets of closed end funds at 10-15% discounts off the prices available directly or through open end mutual funds or exchange traded funds. July 30, 2015 Essential Investment Partners, LLCEssential Investment Partners Blog|
|Essential Investment Partners Blog A few thoughts about mutual fund share classesThe US Supreme Court weighed in Monday of this week on an arcane area of the mutual fund world: whether 401(k) plan sponsors have a continuing obligation to search for the lowest cost share class options for their participants. Leaving aside the details of that case, investors might be wondering whether similar logic might be applied to mutual funds selected by their investment advisers. Here at Essential Investment Partners, we are fiduciaries for our clients so we are required to put their best interests first, always. In the context of selecting share classes, that means we pick the share class we believe makes the most economic sense for our clients. The math involved is usually pretty straightforward. Typically (though not always), the difference in the annual cost of a fund's "investor" class and its "institutional" share class is 0.25%. On the flip side, our clients typically pay a $25 fee to buy an institutional share class and there is no upfront fee to buy the investor class. So the question is: what is the breakeven point? If we assume a one year holding period, the answer is $10,000 (10,000 X 0.25% = $25).This is the rule of thumb we use in selecting share classes for client portfolios. If the purchase is for more than $10,000 and we expect to hold the fund for at least a year, then we buy the institutional share class, if it is available. (Not all fund companies offer institutional share classes and some that do have very high minimums that our clients might not be able to meet.)This is just one of the elements we consider when making investment decisions for our clients. And, there may well be circumstances when an approach other than our rule of thumb for share class choice is appropriate.Back to the US Supreme Court case for a moment. This is likely to turn into an "inside baseball" case before it is done because of the complexity of how fees are shared in 401(k) plans. That is a subject for another day. However, we are happy that the Court took up a case that is likely to shed light on the importance of the costs of retirement investing. And, most importantly, how we should be putting plan participants' long term interests first. Essential Investment Partners Blog|
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