Monthly Archives: January 2016

Market Surveillance: Q4 In the Books

Thurs, JAN 28th, 2016

The key to making a good forecast is not in limiting yourself to quantitative information.” – Nate Silver

A couple of things to understand with our forecast:

1) We are not rigid thinkers. As incoming data arrives, our outlook is subject to change – either at the margin or entirely.

2) This exercise is best used as a guidepost, a framework, for how we are currently looking at markets and opportunities. It is not to be taken as an exact science, nor is it wise to marry yourself to these concepts or figures.

3) Hopefully, when reading this section what you’ll take away is a sense of the lens through which we are presently viewing the world and how this informs our approach toward portfolio management in 2016.

With that said, let’s get to some forecasting!

The fourth quarter is in the books. The U.S. economy grew at about the contemporary trend of the last decade or so for the whole of 2015: A trajectory of approximately +2.25% GDP growth has been quite consistent throughout much of this economic expansion. And this pace – while certainly less robust than in past recoveries – has been enough to add jobs (nearly +14M from the recession nadir), trigger investment, and improve general levels of confidence and household spending. The result has been solid economic progress, including surging corporate profitability and consequently a strong stock market. Meanwhile, the Federal Reserve has remained tremendously accommodative to both the real economy and the financial markets, and inflation has been at most lukewarm. Over the medium-term we expect more of the same from the U.S. economy as we see little out there that is likely to alter the present flight path.

How can we remain cautiously optimistic in light of current volatility, worries over China and potentially slower global growth? First, while numerical information is important and is something we monitor constantly, it doesn’t always reveal the entire story. For example, as we write this letter oil prices are -70% off their highs some 18 months ago and a menu of other commodities have been thumped as well. The prevailing view among forecasters has been wrong most of the way down. Now, these same seers are telling us that low commodity prices spell trouble for the global economy. They make a case for this by looking at subjective hard figures (i.e., price in this case): Lower prices must mean weak demand, right? And if true, such weak demand can’t be good. We see it differently by looking past the commodity price decline to shape our views.

Demand for commodities hasn’t changed much over the past couple of years. Folks are still driving, consuming, engaging in commerce. Businesses remain productive and the number of “widgets” produced is increasing. Labor markets and income – the lifeblood of demand – are salutary. All told we simply do not see a backdrop that fits the aggregate demand erosion thesis. Rather what makes more sense is that recent challenges in commodities markets are primarily a function of supply, not demand. Simply put, production growth of oil, gas, copper, zinc, wheat (etc.) over the years has outrun demand growth. Indeed, on a global basis companies made capital investments and contract commitments to mine, drill, and grow commodities for a world where China was going to grow at double-digit rates forever. This assessment was neither prudent nor probable. Add to this backdrop gains in technology, like fracking for oil & gas, and growth on the supply-side has been colossal.

Seven years into this global economic recovery the imbalance of supply and demand in commodities markets was bound to catch up to price. This is what has happened. And we don’t view this is a harbinger of impending doom. Instead we see this as a period of adjustment to match a world where growth isn’t +5 to +6% per year, but perhaps more like +3%. This is neither sudden nor disastrous. It’s a natural process in which the American economy and American business can succeed. We recognize that this narrative is counter to what we see in a financial media that wants to draw attention to every tick. We see an environment where the U.S. economy is still expanding and most companies are still profitable. With that said, the “easy” gains have likely been made for the foreseeable future, equity correlations are lower, and investment selection is therefore increasingly important.

A quick note on the Fed: Our House call all year was for a +0.25% December rate hike to commence the normalization of monetary policy and on December 16th Yellen & Co. finally raised the Federal Funds rate. We think that the Yellen Fed will be slow, steady, and pragmatic in normalizing rates. This “lower for longer” narrative should be supportive to both the U.S. economy and the stock market. This slow tempo is even more likely now given recent volatility and growing anxiety.

On net, we contend that the underlying fundamentals for equities – the “four pillars” as we’ve outlined in the past – are unbroken and we remain cautiously positive.

Jason L. Ware, MBA / Chief Investment Officer
Albion Financial Group
(801) 487-3700

Market Surveillance: The “Wise” Ole Bear

Mon, JAN 18th, 2016

Happy Martin Luther King Day!

This snippet was shared with me last week:

The Bearish Argument

This is actually a Jared Dillian quote; I did not steal this from anybody: ‘The bearish argument is always most compelling on the lows.’

Stated another way, the bearish argument sounds the smartest.

The commodity bears sound pretty smart. They are right! Great.

When the turn happens, they will be wrong.

In other words, there is zero probability they will suddenly just have a change of heart and get bullish on commodities right on the lows.”

I would add to this that the bearish argument tends to “sound the smartest” because it’s most often contrarian (i.e., equity markets rise ~73% of the time going back to the early-1920). It’s this whole idea that the bear “sees” something that the mindless Pollyannas are missing. And yet the cruel reality is if one were consistently bearish (i.e., they always sound “smart”) one would have missed +7-10% returns per year in stocks over the past ~95 years. Not smart.

My take is that being bearish post-crisis (2007-09) is still vogue and resonates with most people in today’s environment because the scars from this fat-tailed event are still fresh. It was a deep and protracted recession (worst in 70+ years), and it deeply impacted everyone’s psyche. As a result, most have now made it a habit to attempt to predict and dodge the next “big punch.” Academic studies on behavioral finance support this thesis. This lack of conviction and its pervasive presence – a recent analysis found that the word “crisis” was printed in the NYT over 7,000 times in 2015 vs. ~100 times 10 years ago – I take as a bullish sign for stocks (though, the volatility during the drawdown can be stressful).

As the late, great Barton Biggs once quipped: “A bull market is like sex. It feels best just before it ends.” This is a funnier way of saying that bull markets die on euphoria, not skepticism or fear (an idea often attributed to John Templeton). There is little-to-no euphoria permeating through the stock market today; nor has there really been any the entire way up since March 2009. This has truly been one of the most hated bull markets in history. But as I’ve said in the past, this should be good for the overall health of the stock market.

Jason L. Ware, MBA / Chief Investment Officer
Albion Financial Group
(801) 487-3700

*Images from Barron’s Magazine


White Paper: Understanding the Nuances in Investment Performance

Fri, JAN 15th, 2016

Measuring investment performance is an art, not a science. For many this notion can prompt an uncomfortable response as it repudiates what should be entirely impartial statistical information. The reality however is that there are many subjective conditions that dictate the numerical output of such analyses. Therefore, it is important to have a thorough conversation around various performance data in an effort to understand both its meaning and significance.

The first subjective gate that presented investment performance must pass through is time frame, or the specific period being measured. Take for example the following simple exercise in examining a hypothetical portfolio return versus a stated benchmark (more on benchmarks in a moment). Let’s say an investor owns a portfolio of stocks that exactly mirrors the Russell 2000 basket (“Russell”). At the time this paper was written on a year-to-date (YTD) basis this portfolio had a negative price return of approximately -2.02% through 11/23/2015. As a point of orientation the Dow Jones Industrial Average (“Dow”) is down -0.17% over this same period, resulting in this portfolio underperforming the Dow by roughly -1.85% YTD. What actionable implications can one draw from this data? Should our investor make any changes to our portfolio as a result of this information?

Now let us expand that time horizon by only one short month. Our hypothetical Russell-like portfolio return is now +0.17%, while the Dow is off -0.02%. The relative performance of this portfolio has quickly become +0.19% when studied over this second period of time! Through this lens, is this portfolio doing what is should be doing? Would it have been wise to trade out of this Russell replica portfolio and into the Dow based on our early impressions of period 1?

We are all human beings with instinctive impulses; it’s just the way we’re wired. And in this situation it wouldn’t be unusual for an investor to desire a switch based on information gleaned from the first time period. However, when adding a supplementary data point to the mix – i.e., time period 2 – this instant reaction in labeling the portfolio as an “underperformer” may have been a rush to judgement and warrants further examination.

In an effort to counter this urge an analysis of these two strategies over a longer observable period is a good place to start. Put differently, which portfolio has delivered ample and steady returns over time? In our hypothetical scenario we see the Russell basket returning +73.5%, +163.5%, and +280.8% over 10-, 15-, and 20-year periods, respectively. An investment in the Dow, meanwhile, would have delivered +64.6%, +71.1%, and +251.2%, respectively, over these same periods. How would we imagine our hypothetical investor to behave had we began our analysis with this perspective? Or perhaps even more frightening, what would have been the financial impact to one’s portfolio if they had made the decision back in, say, the year 2001 to switch from the Russell strategy to the Dow after a couple of bad months, or even bad years?

To be sure, overactive short-termism and myopic performance chasing can be damaging to an investor’s financial goals. On the other hand, long-term ownership of good businesses (stocks) and a focus on performance over extended horizons is a solid beacon in an environment fixed to 24-hour news cycles and a nearsighted measuring of returns. This rhythm affords the astute manager the latitude to administer the indispensable elements of patience and discipline.

Indeed, long-term investors are the financial market equivalent to marathon runners. Yet in today’s fast moving connected world of always-on digital information, social media, intense scrutiny on quarterly earnings results, and enormous pressure to deliver short-term results, we are often clocked every 100-meters as though we are running sprints. This does not make sense and fuels a fundamental mismatch that can lead to flawed measurements, or worse yet strategic mistakes towards an investor meeting their long-term financial goals. Quite simply, it’s the wrong tool for the wrong job – like asking for a hammer to screw in a bolt.

A more suitable and effective analysis is to observe the two portfolios over a much longer period of time in order to smooth out shorter-run dispersions and more clearly assess the consistent pace and performance of an investment portfolio. Patience and discipline are paramount to long-run investment success, much like the way we would evaluate a marathon runner.

The second subjective gate that performance must pass through is relative bench-marking. In our previous example, why did we select the Dow as our relative measure? Why not the S&P 500? Wilshire 5000? German DAX, or the Shenzhen in China? MSCI World index, anybody? How about stocks in the U.S. health care sector, or in energy? Did these perform better or worse than our portfolio? How would the presentation of this material have affected our evaluation? And more important, what can we do with all of this information? Does it make us better or worse decision makers? We belabor the point, but what’s key to appreciate is that there are almost an infinite number of options one can choose when buying stocks (or index funds), and thus scenarios for comparing actual returns against theoretical opportunities are equally as vast.

We certainly recognize that it is easy to get caught up in the media hype obsessing over the one or two most widely-cited indices. Nevertheless, we believe that this focus is an arbitrary exercise and tells us nothing about the merits of an individual investor’s portfolio needs, strategy, and financial goals.

Albion Equity Performance

With this understanding we encourage our clients to apply the same analytical framework when assessing Albion’s investment management acumen. And we are pleased to report that our marks here are emphatically positive. Our ultimate goal as holistic wealth managers is to help our client’s reach theirs. At present we currently manage assets for over 400 families, across 2,000+ accounts, each with unique situations and needs. This custom and client-centered approach does not lend itself to a one-size-fits-all performance figure. Rather, we firmly believe that the purest gauge in measuring our value and determining our performance can be seen by whether or not our clients are happy and retain our services. Indeed, it is this behavior that embodies the most conclusive vote of confidence and judgement of our ability we can think of.

Albion has been in business for 33 years, and over this time our annual client turnover rate is approximately 2%. This is a very low level for this industry; a fact that we are extremely proud of. In addition to the custom nature of our services, industry rules as they apply to fiduciary managers – the highest standard in the investment industry – makes it quite difficult for us to formally engage in traditional returns reporting conventions.

To help you understand why, a brief description of the difference between fiduciary and suitability standards is necessary. It sounds complicated, but essentially the difference between the two standards refers to the guidelines that spell out the obligations financial services professionals have to their clients.

The suitability standard gives advisers the most wiggle room: It simply requires that investment vehicles fit clients’ investing intents, time horizon, and experience. As a result the suitability standard invites conflicts of interest pertaining to compensation, which can greatly influence what financial products are pushed onto clients. Conversely, the fiduciary standard requires advisers to put their clients’ best interest ahead of their own. For instance, faced with two identical products but with different fees, an adviser under the fiduciary standard would be bound to recommend the one with the least cost to the client, even if it meant fewer dollars in the company’s coffers – and thus his or her own pocket.

We think it is clear which standard is superior, and we take very serious our adherence to these principles. Yet, this also handcuffs us when it comes to presenting official performance data to prospective clients. Meanwhile, those firms that follow the less rigorous and conflict-riddled suitability standard are permitted wide latitude in providing this data. While we argue that this is frustratingly irrational, we also recognize that we do not make the rules and therefore must follow industry regulations as they are, not as we wish them to be.

With that said, here’s what we can share with you.

While we are active managers tirelessly monitoring markets in real-time keenly attune to present information, at our core we are long-term oriented (i.e., the “marathon runner”). Consequently we are proud of the excellent results we have generated for our clients. However there are times when even the best managers will have soft spots in their returns. An example of this for us would be the year 2012 where we left some upside on the table in our equity portfolios and underperformed the broad averages in a conscious decision to protect our clients’ hard-earned nest eggs.

In 2012 the world got very scary, very quickly. The U.S. economy had turned sour in the late-spring (particularly employment data) and Europe was at the height of a potential Greek debt default and ensuing contagion. Not only was Greece looking into the abyss, but the entire European periphery (e.g., Italy, Spain, and Portugal) was fragile enough that any policy misstep would have likely held grave consequences. There were riots in the streets, sweeping anti-euro sentiment, and against this backdrop we made an active decision as active managers to raise cash to protect our client’s assets. Our calculus at the time was while a decent chance did exist that this strategy would dent short-run performance if the market moved higher; the sheer magnitude of the market downside if things collapsed necessitated a defensive posture. Indeed, if the euro had fractured during this time the ripple of global banking contagion, general fear, and economic retrenchment would have been disastrous to equity markets. The probability of such a scenario in our view was high enough to warrant more than a healthy dose of caution. As holistic wealth managers with a fiduciary responsibility we had to act in the best interest of our clients.

Despite these large macro risks the S&P 500 finished the year up +16%, while the Dow returned +10.2%. For us, our abnormally high cash level created a drag on equity returns causing us to end the year only slightly positive. And while this does skew the various short-run performance data sets, we own this decision and would do it again if the environment called for it.

We feel very strongly and take very serious our duty to protect client assets. In our view this form of cognitive, yet assertive risk management cannot be captured by traditional attribution and returns reporting methods. Please do not mistake our explanation as an excuse. Quite the contrary, we believe that it is precisely these types of active decisions and attention to downside protection that helps drive investment returns over the long-run. As such we felt it both appropriate and necessary to provide this context.

As the world chewed through some of the more terrifying moments of that year – e.g., German Supreme Court ruling declaring the euro bailout mechanisms legal; a restructuring of Greek debt from the private sector to the IMF / ECB / EC who could better absorb potential losses; euro members assembling the sound regulatory framework necessary to backstop the financial system; etc. – we scaled back into quality stocks utilizing our time tested rigorous fundamental approach.

Hindsight is always 20/20. Was this a sound decision to go to cash given the severe risks we were seeing, or should we have put our blinders on and gritted our teeth through it? In discussing this with our clients at the time, an analogy we found helpful in imparting our thinking as we made this decision is as follows.

Suppose you were offered a free flight to anywhere in the world. Rome; the pyramids of Egypt; Japan; the South Pacific; any place you’ve most wanted to visit is now at your finger-tips at no cost to you. Sounds great, right? The catch is there’s a 20% chance that the plane you’re riding on will be involved in a horrific crash. Would you accept the offer? Put differently, there’s an 80% chance you make it there just fine. And yet does that make you feel any better about accepting this deal? Probably not. Why? Because the risk – albeit far less likely relative to the odds of a gain – holds such grave consequences that it is simply not wise to chance it. This is precisely how we viewed the stock market and the potential negative impact on our clients’ portfolios during the global chaos in 2012.


Wealth management has an almost unlimited number of variables and unique situations. Unfortunately, the desire by the media and Wall Street marketing to distill down this complexity into imperfect short-term investment returns data, particularly in cohabitation with a randomly selected arbitrary benchmark, has created a distraction that few can afford to have.

Chasing short-run manager performance can be every bit as damaging to long-run portfolio returns as hopping in and out of hot and cold stocks without any attention paid to the fundamentals of the underlying companies. While we surely understand the virtue of considering market returns as a component of the overall wealth management picture there is far too great a focus placed on it, both versus stated benchmark(s) and over increasingly shorter time horizons.

This works in both directions. When a manager is crushing it with great returns above their specified benchmark over short periods of time, publicizing this as sustainable and reason to invest is every bit as imprudent as eschewing a smart, high quality manager with a laudable and principled investment philosophy demonstrating sound long-run risk-adjusted returns. Sometimes we fall into the former category, but we will always fall into the latter.

Without question, what matters most is creating the right investment portfolio to achieve your financial goals. This is challenging, and candidly it always has been and likely always will be. But, it is a worthy and important goal – one that all of us on the Albion Team are proud to devote our professional careers to helping clients attain.

Jason L. Ware, MBA / Chief Investment Officer
Albion Financial Group
(801) 487-3700

Market Surveillance: The Force Awakens … in China … on the Wrong Side of the Bed

Sun, JAN 10th, 2016

It was a bad week for stocks. The S&P 500 suffered a -5.96% drop in 5 days. This sounds horrible … and it is. But a dose of perspective is warranted: Back in August – the last time China fears infected US stocks – we had an -11% sell-off in 5 days! OK, so maybe this current sell-off isn’t quite as violent as originally perceived.

But what do we make of it?

What’s going on?

Continued chaos out of China (PBOC cut Yuan reference rate 8 days straight; reports suggests more to come), global growth concerns (See: oil, commodities continuing to fade), geopolitical scuffles (North Korean H-bomb test?, Saudi Arabia + 3 cutting off diplomatic ties with Iran), pre-earnings jitters (Q415 results begin next week), valuation (still lofty, to many), concerns over the path and pace of Fed policy normalization in 2016 (John Williams, Loretta Mester and Stan Fischer all suggested this week that the pace may be quicker than markets would like to see) … all amid carryover bearish momentum from December 2015 resulting in the worst 5-day start to the year. Ever.

Just about everyone is now bearish (5-month low in bullish sentiment, per recent AAII data), and this has created a large and swift market response. Meanwhile, Friday’s NFP jobs report came in at +292K net new jobs added for December with little signs of accelerating wage inflation. A Goldilocks report on the Fed and US economy, indeed.

Regarding China – likely the 800-pound gorilla on the trading floor – the big question now is how much of the turmoil reflects rule changes and other policies at the Chinese stock market, and how much is based on broader economic fundamentals that might have a further impact on global growth leading to a nasty outcome? Paul Krugman opined on this in Friday’s New York Times. Paul seems more worried about a “hard-landing” than I am (though he caveats financial linkages – i.e., global contagion).

What’s my best-guess short-run outlook?

I think present market action feels similar to August … where we saw 5 or 6 nasty distribution days in a row that took the market down into official correction territory (-11%, very quickly).

From the beginning of that sell-off on 8/18/15 until it double-bottomed in late September it took 5-6 weeks to wash out. Will it run the same course this time? Maybe. Maybe not. Nobody knows for sure. But before last August we had traveled roughly 3 years without an official market ”correction”, and when it finally hit it was amid a period of seasonally poor returns (September is historically the worst month of the year for stocks). I suppose what’s different this time around is that we recently had a steep correction (the aforementioned late-summer period) that moderately refreshed the market, and January is typically a good month for stocks. This could lead one to logically conclude that the selling may be more condensed in this episode.

There’s a good chance that we’re oversold at current levels; for example as of Friday’s close only ~15% of S&P 500 stocks are trading above their 50-day moving-averages (and the majority of these are in defensive sectors, like utilities and consumer staples). The last time we saw similar internals was, you guessed it, August 2015. In addition, when lifting the hood on the S&P 500 index we see that nearly 20% of stocks in the index have been knocked down twice as much, or more, as the broad market to start the year, and over 50% of stocks in the index are -20% or more off from their 52-week highs. So, again, there are signals to suggest that this move may be a bit overdone. But that doesn’t mean the sell-off won’t continue. In fact, for now anyway, the path of least resistance seems lower; it may get a bit worse before it gets better.

Bigger picture, the month of January is purportedly a reliable directional barometer for the rest of the year, per the Stock Traders Almanac. Going back to 1938, if January ends higher the full year should be positive too, with a positive correlation about 75% of the time (and vice-versa to the downside). But keep this in mind, this barometer has essentially broken down over the past decade. Since 2005 there have been 4 years where the market had negative returns in January yet ended the year higher (2005, 2009, 2010, and 2014). Conversely, 2011 saw a strong start to the year only to end exactly where it began. More recently, the past two Januarys have looked like this:

2014, -3.56% (S&P ended the year up +11.4%)
2015, -3.10% (S&P 500 -0.73%)

In the aggregate since 2005 that’s a success rate of just about 50%, which is what you’d except from a coin toss.

For a slightly different perspective, I came across two data tables on Twitter from Ryan Detrick, CMT that I found useful in providing additional context (see bottom of page). The first one highlights that going back to 1900 there have been 14 instances of awful returns in the first 5 days of the year. In 7 of those 14 periods the market ended the year higher (50% of the time), and down the other 7 (50%): we’re just tossing coins again. So, should we read too much into this terrible start to 2016? Probably not. The second table plots 19 other times where we’ve seen steep 5-day sell-offs (across various months, and years), which admittedly makes the current -5.95% drawdown look tame by comparison. I suppose it’s a bit like having a cold and seeing someone suffering from a bad case of the flu. Your day just got a little better after seeing that.


I remain fairly bullish. We have just worked our way through perhaps the toughest 2 or 3 quarters – broadly speaking – for companies in this recovery (i.e., mid-to-late 2015). A decline in oil and the strong dollar has paused profit growth, but I think as we lap these moves the outlook for earnings into 2016 looks OK. And stocks against this background are not expensive, particularly when one considers very low interest rates and inflation. That said, the easy gains have likely been made for the foreseeable future, correlations are lower, and stock selection is therefore important. I continue to believe that at this stage in the bull cycle a true bear market will not engross stocks without a US recession. And here, I just don’t see this in the card for 2016 given the robust, durable, and rather broad-based economic substructure with few signs of excesses building in either the economy or financial markets.

The bull market may not be not over yet, but amid the existing volatility I am sure glad our portfolios are holding some cash.

Happy New Year!

Jason L. Ware, MBA / Chief Investment Officer
Albion Financial Group
(801) 487-3700