Don't Count on Luck. Count on Preparation!
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David Edwards:
Good evening, everybody. It is just past six, Sunday evening, September 11th. David Edwards, President & Wealth Advisor at Heron Wealth, my colleague, Buff Parham, President of Parham Associates. People always want to know what Buff does when he’s not talking to me. Buff’s a long-time speech coach, presentation coach, many years experience at CBS and Univision in various producing roles. Buff, let’s jump right in.
Buff Parham:
Absolutely! Welcome back.
David Edwards:
Tonight’s webinar is entitled “Don’t Count on Luck. Count on Preparation!” I was thinking about this webinar in the context of a sailing race that my wife, Randy Kaufman, and I did recently. It was a long distance race, about 140 miles, starting from Stanford, Connecticut, sailing east to Buzzards Bay, which is just off Martha’s Vineyard, and back again. And the luck part of the race is the direction of the currents, how strong the wind is, whether it’s a stormy, whether it’s a hurricane, whether it’s dead calm.
The preparation part is analyzing three years of records from previous races to understand how long our boat would take to complete the course, about 40 hours, and then picking a good crew. We had 6 people on board, making sure we had a good mix of skills, making sure we had enough sandwiches to last 40 hours, making sure we had enough water.
David Edwards:
As we got into the last 24 hours before the race, we did an analysis of the winds and the currents and figured out our course. People have been doing this race for 50 years at this point, and I was not in there to win the race. My goal was to be safe, have fun, and come back in reasonable time. And that's exactly what we did.
When we actually got into the racing, current is a big factor. Sailboats don't go very fast. The top speed of our sailboat is eight miles an hour. You have to lean on the brake to go that slow in your car. Current is driven by tide. As the tide floods, it drives a current of 2-3 MPH headed west. When the tide ebbs, it sends a current 2-3 MPH. If you're sailing with the current, you've got 8 miles of boat speed plus 2-3 miles of current, you're going 11 miles an hour. If the current is going against you, well, now it's minus. So you've got 8 miles an hour of boat speed minus 2-3 miles of current. Now, you're only going 5 miles an hour.
David Edwards:
That’s the kind of the experience we've had this year in the stock market. Last year, the wind and the current was in our favor and the stock market went up 20%. And then for the first six months of this year, the current was against us and the winds were against us, and the market went down 22%. The market actually hit the low for the year on June 15th. Wwe had a webinar that weekend, June 17th, and I asked, “Is there any hope for investors at all?” “Sure,” I said, “There's tons of reasons why there should be hope for investors.” Sure enough, the stock market rallied 12% over the next eight weeks.
Buff Parham:
It did.
David Edwards:
That guy Edwards knows something! But then the current turned against us again. Since mid-August, the market's been generally heading down. As of this point in time, we're down 14% on the year - that's not catastrophic. We have a good boat, we have a good crew, we're moving in the right direction, we’ll get to our destination eventually.
I just wanted to bring up this story because sailing and investing have a lot in common. You have your plan, your skills and your experience, but when bad things happen, you just have to deal with it. This is one of those “just deal with it” years, where both bonds and stocks are suffering.
There was a great lead-off question. Buff, why don't you start with that question?
Buff Parham:
Speaking as a new investor and sailor, it comes as a bit of a shock to be caught in a historical moment when stocks and bonds are both going the same negative direction. I was hoping that our bond mutual funds would act as some sort of balance in these high seas. Any light you can shed on the bond market tracking within the larger macroeconomic picture at this point?
David Edwards:
Yes. It is a very strange economy right now. On the one hand, many economists and bankers are clamoring for a recession, based on the Federal Reserve raising interest rates. On the other hand, the economy, corporate revenues are booming, corporate earnings are booming. The jobs numbers are the best they've been since the sixties, average Americans are actually seeing wage increases for the first time in a long time. The numbers say that we DON’T have a recession, but the stock market is reacting as if there will be a recession and marking down future revenues and earnings. Meanwhile, the bond market's getting hammered by rising interest rates.
Buff Parham:
Right.
David Edwards:
Normally, what happens if we are truly going into recession is that stock prices come down, but bonds rally as people rotate out of stocks into bonds. These days, investors are just selling everything. The family that wrote in is new to our firm since last September. For the first 12 months of their experience, they haven't made any money at all, which is very frustrating. And I understand that. I can say, “Well, this will eventually turn around and eventually we will make money.” But it's hard to be a new investor and experience losses to be made up later. It's like when you're in the airport and the sign goes up 'Flight Delayed' for your flight. That's so frustrating because, “Oh, now I don't know what to do.” Versus if the board says 'Flight Delayed 1 Hour', you go, "Okay, well that's not great, but at least I can go to the bar for an hour and look at my email, and come back when the flight's ready to board."
David Edwards:
So sometimes in the airport, you do get a good forecast of when your flight's going to leave, and sometimes you don't. In the stock market, you never get an exact report of exactly when it's going to go up, but it always goes up. Ever since modern economic times, 1945 forward, it's been up, it's been down, it's been up, but it always goes up. I will say this about the bonds. We use bond mutual funds instead of individual bonds, and there's two choices to make in bond mutual funds. One choice is credit quality. Government T-bills, bonds, notes are the highest quality, lowest yielding bonds. After that you get agency bonds, municipal bonds followed by high grade corporates, then high-yield corporates and then finally preferred stock, which is the highest yielding “bond” instrument.
David Edwards:
We use a package of these. The yields were about 2.5% a year ago, and now they're 4.5%. So the yields are coming up even though the prices are coming down. And then the other thing that we do is we look at the maturity of the bond funds. We knew for a while interest rates would be going up. So we deliberately have compressed our maturity band to between three and five years. A 30-year bond is very volatile compared to interest rate moves, a three to five-year bond, less volatile. Even so, it's been such a tough year in the bond market that we've lost money, at least temporarily, in the bond mutual funds. These funds will come back eventually.
Buff Parham:
Speaking of recession, is it safe to assume that we're facing a slight recession as opposed to a more brutal one? And is the inverted yield curve really a reliable signal at this point?
David Edwards:
Economists are tearing their hair out right now. With so much residual disruption after the COVID crisis, and then on top of that, you have the war in Ukraine, that nobody knows whether the traditional signals are actually giving good information. Normally, what happens is that when bond investors are anticipating a recession, they lower the yield on long-dated bonds 20 to 30 years out, and focus more on the [inaudible 00:09:02] bonds, you get an inversion. Well, we don't have that happening. And in fact, the Federal Reserve is still coming in and aggressively raising rates. So that signal is not telling us the normal information. And then the other question is, the GDP reports of the last two quarters were both negative, and that's a traditional indicator. Oh, we're near a recession."
David Edwards:
But meanwhile there's another report for gross income, gross national income, GNI, says about the GDP, and that is at a record level. So one of these two metrics is giving us bad information. Either GDP is not being calculated properly, it may be revised higher, or gross national income is the better indicator, or maybe it's going to be revised lower. So it's hard to be a policymaker right now. You have to imagine the people at the Federal Reserve are really struggling to figure out whether they should keep raising rates. Now, my opinion is they'll keep raising rates at a brisk pace at least through 2023, mostly because we haven't had a normal industry environment since 2008. Under normal circumstances, you would expect the 10 Year Treasury to be 4.5%. And it hasn't been 4.5% since 2008, it's been more like under 2%. And during COVID, it was down to about 0.5%. Now it's back up to 2% again. So there's room for interest rates to go higher, I don't think it'd be catastrophic with the economy.
Buff Parham:
And the job numbers remain pretty positive. And speaking of the Fed, do you think they'll see enough slowing of the economy before the September meeting to raise rates aggressively going forward again?
David Edwards:
Yeah, I think the next meeting will be a 0.5% Increase. It was 0.75% at the last meeting. So the jobs numbers are interesting. Way back in the Clinton administration, they created this treaty NAFTA, North American Free Trade Association, and then effectively shift blue collar jobs to Mexico and Canada and overseas. And we learned the limits of outsourcing all those jobs to overseas in COVID, when all of a sudden we couldn't get stuff anymore. And even though COVID is not really a significant issue in the United States right now, it's still a very significant issue in China, they just simply close down whole cities whenever there's an outbreak of COVID. So you have this constant interruption of supplies from overseas. And then also there's a strategic vulnerability. If 100% of your chip production is in places like Taiwan, and Taiwan gets invaded by China, it's going to be a big problem making the stuff that we like.
David Edwards:
So there was a bill that passed the Senate recently, signed by President Biden, to onshore back to the United States chip production, and actually invest a lot of money in doing that. And those are going to be great jobs for a lot of people. Now, the other thing that I never really like very much is that people that are economists are very eager to prescribe raising rates and killing employment because when those job losses show up, it rarely affects white collar people, but it hits blue collar people pretty hard.
Buff Parham:
Yeah.
David Edwards:
So, "Huh, your solution is to harm someone else in order to make yourself economically secure." I'm actually cool with inflation being high for a while, it's already coming down. Gas prices that were pretty high at the start of the summer, June plus $5 a gallon, $5.25, we're now back down to below $4. So we have a 20% reduction in gasoline prices. And I think that will continue once we get past September, which is the end of the summer driving season, I think gas prices will keep coming down. So the psychology of paying $100 a tank, well, now we're back to $80 a tank. And in COVID, it was like $40 a tank, it was really crazy."
Buff Parham:
The right direction though.
David Edwards:
Yeah.
Buff Parham:
I'm going to mention my crude oil question. Now, get this, there's been some expert commentary that crypto can serve as a legitimate hedge against downturns in the equity markets. Really?
David Edwards:
Yeah, really. Every decade or so there's something that people get excited about. God, it was the internet era back around 1999 or so. And I remember there was a company that produced fish oil and they rebranded themself as an internet stock, and just took off, everyone jumped into it. So I have never allowed one of our clients to invest in crypto. I've always told them, "Listen, if you want to buy it for yourself, be my guest. I will not buy it for you."
Buff Parham:
Right.
David Edwards:
At the start of the year, Bitcoin, which is the best known crypto, was at$ 60,000 a unit, it was at $40,000 a unit by April. It's been around $20,000, $19,000, $21,000 the last couple of weeks. I do notice that there's a 100% correlation between the direction of Bitcoin and the direction of the stock market. And so what that means is that the same day traders that are trading crypto were also day trading options and futures on the market. And the two are tightly tied together.
Buff Parham:
Tied together.
David Edwards:
What I notice is that when crypto falls, it falls sharply and then it kind of eeks that little gains over time and then falls again. And what's going on there is the psychology of people that are trying to get out of loss-making positions. Every time it goes up a little bit, they go, "Oh, I can sell some of my stuff." But then every time it starts to fall precipitously, no one wants to touch it. So eventually, Bitcoin will decouple from the S&P 500, which is there's real value attached to the S&P 500, and will continue down to $10,000 or $5,000 or $1,000. Most of the cryptos that have ever come out ever have been worth zero by now. And there was a fund, a couple of dudes from I forget what university, they had a hedge fund that was invested in crypto. Well, turned out it wasn't hedged all, it was leveraged crypto fund, and they vaporized a trillion dollars of their own client's money in a matter of weeks. And then they'll say, "Why did I invest?" Well, because that, I don't want my clients losing that kind of money.
Buff Parham:
Conspiracy theory manipulation, moving forward. Given the massive infusion of military aid from NATI, it looks like Ukraine is really winning a war of attrition against the Russians.
David Edwards:
Yeah.
Buff Parham:
What should we expect to see next?
David Edwards:
Yeah, so why do we care about the war in Ukraine? Well, because Ukraine is a major exporter of grains. So that [inaudible 00:16:04] impact around the world, especially in Africa, and where people kind of eat. It has an impact on the price of energy. Right now, the Russians are pretty much shutting down gas transfers to Europe this winter. So then the Europeans are going to have to hustle around and get their gas from somewhere else, and it's hard to blow it up on a big ship and transport. We said when the war broke out last February that for Putin, invading Ukraine would be swallowing a porcupine. Hard to get in, even harder to get out. And of the scenarios that we worried about at the time, the first scenario was overnight successful invasion, didn't happen. Second scenario, what we've seen for the last six months, which is a war of attrition. The third scenario is the Ukrainians actually push the Russians out of Ukraine. Fourth scenario is nuclear war. So hopefully we won't get to that.
David Edwards:
So now we're in the third phase. The Ukrainians are starting to push the Russians out. And the reason why they're able to do that, I think it's basically boils down to morale. The Russian soldiers don't want to be in Ukraine. There's nothing in it for them. And given a choice between running away or surrendering or deserting, you can see that a lot. On the other side are the Ukrainian people and the population of Ukraine is about 45 million. There's about 10 million able-bodied men and women who this is their homeland. And what we've learned from the Vietnam War and what we've learned from the Russian invasion of Afghanistan, and what we've learned from the American invasion of Afghanistan, is that people will fight and fight and fight and fight and fight for their homeland. And the Ukrainians are better organized, better morale. They've been getting very advanced weapons from the Americans and the Europeans, they've put them to good use.
David Edwards:
The Russians have slowly been lobbying dumb shells [inaudible 00:18:05] range, with no particular strategy. They're running out of shells. It was noted this week that they're now buying artillery shells from North Korea, which is kind of a sad commentary. The Chinese are not providing them with weapons because they're afraid of harming their own relationship with the United States in terms of manufacturing exports. And just in the last 24 hours, we saw the Ukrainians overrunning an entire province in Northeastern Ukraine. And now that puts more pressure on the Russians in the South, who have a very long, thin line across the top of the Black Sea. If that line gets severed, all of those troops get encircled.
Buff Parham:
Yep.
David Edwards:
And I'm trying to think of what Putin's mind is right now. He just seems to be delusional about how things are going. He spent yesterday, Saturday, opening a Ferris wheel park in Moscow. That's not serious. So we'll see. We're also getting into winter and it's going to be a lot harder to fight in the wintertime than it is in the summertime. Mud is a soldier's worst enemy. I don't think things are going well for the Russians.
Buff Parham:
Yeah. Speaking of Putin, we're watching him curtail transmission of oil and gas to Europe. What's the eventual ripple effect on this move with the US equity markets?
David Edwards:
Yeah, so the United States is a net exporter of energy products right now, oil and natural gas. So we're kind of isolated, and we'll have energy here. Prices went up because the whole world was reconfiguring transportation routes, and now things have settled down a fair bit. And so a lot of Russian oil is now going to India and China, at a discount. The Europeans are in a tough situation because they don't have a natural replacement for the natural gas they were buying from the Russians through the North Sea. They've mothballed a lot of their nuclear power plants. They're going to have a tough winner, they're going to have to tough it out. I think the Americans will be relatively isolated by comparison.
Buff Parham:
Well, that's all I've got. How about you?
David Edwards:
Yep. I just took a quick look at the chat session and we'll give people one minute to toss in the question or two, and then if not, we will kind of take it easy tonight. Here in Upstate New York, it's still summertime but already we've seen some leaves turning. And where you are there's probably a solid month to go before the leaves start to turn.
Buff Parham:
Yeah, we're still in the eighties.
David Edwards:
Yeah, well, we're here in the sixties. So anyway. So Buff, I didn't see any questions come in.
Buff Parham:
Okay.
David Edwards:
And so we're going to enjoy the evening off. Have a good one.
Buff Parham:
Glad to have you back.
David Edwards:
Yep, thank you. Bye.
Buff Parham:
Bye-bye.
David Edwards is president and wealth advisor with Heron Wealth, a $500 million registered investment advisor based in New York City working with 225 client families across the U.S. and around the world.
At time of publication, Edwards and/or his clients held positions Amazon, Apple and Google.