• Joe Cardello

A Black Friday!

November 29, 2021

A Black Friday! “Of all the liars in the world, sometimes the worst are our own fears.” Rudyard Kipling

I trust that everyone was able to enjoy the Thanksgiving holiday weekend with family and friends. I spent Friday alone in our new Westport office as our team at August Wealth took a well-deserved rest. It was a very volatile day in the financial markets which was likely caused by the reactions to the new Covid variant spreading in South Africa, and a dearth of market participants involved in trading activity.

Events such as these result in heightened stress for many clients and investors. As someone that did not grow up with money, I never want to be in a financial situation where my lifestyle gets downgraded because I have less of it. I have always approached risk with the goal of “capital preservation and upside”. Who wants to go backward financially?

The goal of August Wealth is to protect your purchasing power and grow your net worth over the long term. Before I discuss the current state of the market, it’s important to reiterate our motivation for wanting to help you. It’s an important part of our process.

I needed to establish August Wealth for two primary reasons that go together: 1) The game of investing: This includes statistical signals and noise, and the psychology, emotion and reaction to events which impact markets. To me it is a game; I love to study it, and I spend the bulk of my time trying to figure it out. My entire professional life has been dedicated to this pursuit. 2) Helping others: Any opportunity to improve the lives of the people I have relationships with, is where I want to expend energy. The sacrifice of giving to others is the most satisfying pursuit because at the end of my short life, that is all that will be left. This is the culture that I foster at August Wealth. It’s circular and self-reinforcing.

As I said in our Thanksgiving message to our clients, I am so grateful that you entrust August Wealth to help you navigate an uncertain future. We love to serve you, and we believe we are uniquely positioned to help.

However, we are not the only ones that could do this. There are many investment styles, products, geographies, and structures that might help a family achieve this goal. We provide a path that is (I suspect) more boring than private equity, hedge funds, crypto, meme stocks, day trading; however, I believe it’s a path that will help you achieve your goals.

I have received many inquiries recently about other strategies and products. We are happy to discuss these with you, but August Wealth’s approach will stay remarkably methodical; looking for opportunities to protect your purchasing power over time. If we grow wealth at 7% per year over 10 years, in 10 years’ time that wealth will double. We will always try our best to achieve this goal opportunistically with the least amount of risk, low fees, and as much simplicity as we believe possible. We hope to perform better, but nobody knows what the future holds. We will always endeavor to put you in the best position possible.

I am not in the investing because I am a gambler; I find casinos and anyplace where odds are not in my favor uninteresting. I don’t find making money particularly “exciting”; generally, I don’t think much about “money” at all. I do think about freedom, lifestyle and the assistance to others that money can bring you.

Our aim is to help you and your family achieve your goals within your circumstances. We hope you expend your energy on the things you care most about and outsource your stress and anxiety around investments and money to us. This is what we are here for.

Black Friday Volatility: Pre-Thanksgiving, investors and travelers had moved on from Covid. Workers are getting back to the office; the narrative was that we were getting back to our pre-Covid existence. The markets were worried about demand, inflation, supply chain bottlenecks, and gas prices. Our country that wants to move away from fossil fuels found itself begging OPEC and releasing oil from the Strategic Reserve. Investing in oil and gas was finally recognized as necessary for the time being as the economy shifts to more alternative sources of energy. The press was discussing the potential for the Federal Reserve to bring forward its tapering and projected interest rate increases. Many of my hedge fund friends were betting on higher interest rates, and then...... woosh!

What seemed the obvious themes to many became highly questionable within 24 hours!

The Omicron Covid strain in South Africa became the focus, travel bans were put in place, crude oil prices, travel companies, and equity markets around the world sold off dramatically. Interest rates collapsed because demand growth has once again become questionable. The market reaction (in illiquid conditions around a holiday) might have reinforced the narrative that the world is indeed a very scary place again. Not again!

So, what does this volatility tell us? We have no certainty on Covid anymore. In a word, “fear” is back. For how long, we do not know. Is this new information signaling us to act, or is this new information just statistical noise? Back to the questions we always ask:

What do we know?

  • Monetary policy is extraordinarily loose. Adjusted for inflation, real interest rates are deeply negative. Meaning, if you are investing in US Treasury bonds at any part of the curve, you are likely losing money through the erosion of your purchasing power.

  • Household wealth at all levels is solid because the government has been very generous in transferring money to most everyone.

  • The Federal Reserve has accommodated all the spending by the government by printing the money.

  • Covid is manageable because we have demonstrated we can live our lives despite the risks. There has been a gradual appreciation that there are other concerns that need addressing in addition to Covid.

  • We know that the virus will mutate; Omicron is one more variant.

  • We know that the drug companies are getting better with vaccines and antiviral treatments. The drug companies can alter the vaccine boosters to address virulent strains.

  • We know that demand / supply curves and the market cycle in general are likely to be different because of the reactions to mitigate Covid by Fiscal and Monetary authorities during the past 18 months. This is likely to cause more market volatility in short term time periods.

  • We know the Federal reserve and governments will err on the side of providing too much spending and too much money. This is the playbook since the financial crisis in 2008 and used to great effect in countering the Covid crisis. The fact that interest rates fell dramatically on Friday highlights this important point.

  • Economies tend to grow over time and investing in the best economies has proven to increase net worth over time.

What do we not know?

  • How virulent this Omicron strain will turn out to be.

  • How much fear the market reacts to in the short term.

  • How far will equity prices, commodities prices, and interest rates drop?

  • Will governments react out of an abundance of fear?

  • If new lockdowns occur, will that cause a negative cycle of demand and a rush to cash.

  • What is the next unforeseen event to occur?

What do I think?

  • Have a robust process that is resilient and able to deal with unknowns and uncertainty before events happen. TRUST THE PROCESS

  • I reiterate that the short term will be messy and volatile, and it will be harder for companies, governments, central banks, and investors to rely on historical models. However, the fact remains, we have never pumped so much money into the world in such a short space of time. That money will be invested and spent in ways we do not fully understand. Productivity increases and changes to the way we work and live due to technological change is also impossible to forecast. RESPECT THE UNKNOWN

  • I think we were never past Covid; it’s just developing, and we find ourselves able to live with it. When people are willing to live, they are more willing to spend. This will happen whether there are lockdowns or not. People will spend, perhaps differently than historically, but they will spend. DIVERSIFY THE PORTFOLIO.

  • Financial markets are never a one-way street; don’t get too comfortable when it seems like the investment climate is more “certain”. It is always uncertain; it is always a relative game. Focus on opportunities which have a high probability of working in the long term, but they are being neglected in the short term. In my view, there are opportunities in companies, sectors and geographies that are not popular right now, but they should contribute to our target rate of return over time. IN ORDER TO OUTPERFORM, YOU CANNOT JUST FOLLOW CONSENSUS (by definition).

  • We remain further along in the economic cycle, so we continue to be more defensive. For us, as described previously, that has meant moving to areas where we find more certainty and consistency of cash flow relative to more speculative companies and sectors. CAPITALIZE ON THE OPPORTUNITIES THE MARKET PROVIDES.

  • Use market fear to increase risk and use market greed to decrease risk. This mantra will always be used across various time frames. FOLLOW THE PROCESS, AND EXECUTE THE PLAN

Capitalizing on market opportunities: As previously discussed, I am a generalist, I look for any edge that will help us achieve the goal of protecting purchasing power and increasing wealth. I spend the bulk of my time at August Wealth exploring market opportunities and understanding our client’s risk tolerance.

We welcome conversations that are constructive in gaining our client’s trust further. We also have a diverse client base that are experts in various fields that are additive to our process. We have many partners around the globe at investment funds, family offices, private equity, and hedge funds that we work closely with that also help in our exploration of opportunity.

We also welcome questions and conversations from clients when they are hearing of different opportunities to make money. They may teach us something new, or perhaps we can vet an interesting idea. But it is essential to ask the right questions and explore all aspects of an investment idea prior to acting. We know what our strengths and our weaknesses are, and we use both to maintain a rigorous investing process. This includes any new ideas brought to us.

Some questions clients bring us:

  • Last year, my attention was called quite a few times to the following companies that we “should” have owned because they were going to be great long-term opportunities. Companies like: Zillow, Robinhood, Zoom, Draftkings, Nikola, Beyond Meat. These have not been great investments recently to say the least, and nobody seems to be mentioning them recently. That isn’t to say there are no opportunities to make money in these names, but they are highly speculative and highly uncertain.

Our response: concentrate on companies that have a particular niche, low competition, not easily replicated, produces lots of free cash, high returns on capital, high margin, and high growth rates. If they don’t meet our criteria, we leave those companies alone. We may miss some opportunities, but our goal is that historical 7% per year target which compounds annually to double wealth in 10 years if we achieve it.

  • This year I have had numerous inquiries on “covered call strategies”. For those that do not know, usually the fund manager buys companies with low P/E multiples, high dividends and then sells call options for additional income. I know some managers and advisors that do this almost exclusively in their business for clients. I won’t get into the myriad of reasons why this is highly inefficient, but I will state the obvious fact that no strategy works all the time.

Our response: Be wary of anyone that suggests a strategy for you as if they are teaching you a novel way to obtain retirement income. It is possible to employ strategies such as “covered calls” when volatility or “fear” is priced high relative to actual volatility or “fear”. Sometimes these opportunities exist, but if the opportunity doesn’t exist, you are capping your returns and taking excessive risk. This seems illogical to us.

  • Crypto. The inquiries on this topic are running extremely high, and I have been told by many 20-year-olds how silly adults are for not putting more into crypto. They may well have a point. I cannot advise you professionally on this asset class given our business structure. However, I can point out that despite opportunities, the uncertainties are vast.

Our response: I personally did a great deal of research years ago, and I have personally owned Bitcoin and Ethereum. This is a developing ecosystem, and it is highly uncertain. For most clients, even if I could make a recommendation, I would say it is unsuitable from a risk perspective.

  • Tax. There have been so many questions from people not wanting to pay tax on investments where they have made vast sums of money. It makes sense to minimize your tax bill; it is clearly a drag on investment performance. Wherever tax can legally be minimized we try to minimize it; this should be obvious.

Our response: If you have a high concentration risk of your net worth in a particular security, and the uncertainties for investment in that security are increasing, you should ask the question about how you will feel if that security drops 25, 50 or even 75% in value. Is that within your tolerance? Making decisions based on tax avoidance alone is generally not a wise investment strategy.

What is missing from the above questions? The above topics can become distractions because they fail to ask the most fundamental questions before embarking on any investment action (inaction): What are you trying to achieve with this investment? How much are you willing to lose on this investment? How does this investment contribute or reduce the risk in your portfolio?

If you haven’t stopped to fully understand these questions first, why are you considering the investment at all? Is it FOMO (fear of missing out) if the prices rise? Is it fear of losing money or having enough income? Is it an unwillingness to pay tax because you have a personal aversion to tax? Is someone preying on your fears through an advertisement to sell you something? These are not sound reasons to make investment (or any) decisions. These are considerations only once we have answers to the fundamental questions.

What’s the bottom line? We work as your fiduciary. Your best interest is our interest.

Once we understand you and what is important to your family, it is our obligation to push back in areas we believe are incongruent to your desires. We won’t always be correct nor successful in convincing you, but we will do our best. I believe we should own decisions together as partners. If you tell us you want to invest (or remain invested) a substantial portion of your wealth in a particular strategy or company for spurious reasons, it is our responsibility to explain why that is unlikely to be in your best interest. The easy decision is to acquiesce to your desires, but we would rather lose you as a client than to invest your wealth in a product or strategy we believe will detract from what you are trying to achieve.

If you have any questions or comments on the above, as always, I would love to hear from you.

Lastly, to see some of the ways “Covid” money (totaling $4.5 trillion; an amount greater than the entire US Federal budget in 2019) is being invested to transform the US and global economy, it’s worth reading the following article from the November 24, 2021, edition of the New York Times:

Joseph Cardello, Principal August Wealth Advisors, LLC 51 Riverside Avenue, First Floor

Westport, CT 06880 Direct (916) 461-9451 toll free (800) 985-9477

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