December 7, 2022
As most of you are aware, I generally believe in free markets capitalism and democracy. Money and power tend to fight for their causes locally and globally to protect and build up their own interests. It’s generally the same for individuals as they seek to protect their own biases and self-interest. However, over shorter periods of time, focus, resources, and initiatives can move in unsustainable directions.
Good government policy, economic policy, and good religion should promote foundations that lead to positive outcomes for both the individual and the group. As we know, both individuals and organizations sometimes lose their way. As you may have noticed in many of my previous monthly pieces, I call out what I will refer to as future “train wrecks”, where it seems obvious that current policies will cause future harm. Some examples of past pieces:
Overzealous covid policies (benefits outweighed the costs) that were destined to produce significant psychological damage and poor educational outcomes.
Central bank and government stimulus that were bound to produce inflation.
Entrenched investment industry advice that promoted fixed income for safety and retirement when the returns did not justify the risks.
We all want to feel good, we all want to avoid pain, but sometimes we act in ways to assuage our emotions instead of acting in ways that are in our best interests.
People, including yours truly, love short term gratification; it’s human nature. We want a reward for our hard work, and we want to feel good. The problem is that usually fulfillment and overindulgence of those short-term desires work against us in the long run. The key to success is balance.
I would argue that the reasons I have been able to build wealth through investing are partly due to:
Recognizing that sacrificing some short-term gratification can help lead to much higher levels of happiness in the future by obtaining what I really want.
Finding ways to recognize and adjust for my own personality traits (strengths and weaknesses) in order to obtain ideal outcomes in the long run.
Working hard to focus on what genuinely matters in life, and act in a way that reflects gratitude and appreciation.
Understanding how difficult it is to work on points 1 through 3 above; many of us will not be willing to do the hard work. I focus on areas where people do not want to change detrimental behaviors, but that are likely to end up as painful future adjustments, nonetheless.
Probabilistically working out the likely path of that future change and implementing a financial strategy to take advantage of it is at the heart of my investment (and life) process.
As many of the families we serve know, the in-depth conversations around emotion and behavior are at the root of what we do. It is useful to have an objective advisor in your corner that has your best outcomes as the goal.
What we hope to achieve at August Wealth is to help families develop behaviors or outsource the management of certain aspects (particularly investment) to us, to achieve what is most important to them. We do this by:
Listening to what you want to achieve.
Identifying behaviors that are not congruent to your goals.
Suggesting small changes that (hopefully) don’t cause major lifestyle disruptions but can lead to huge benefits in the long run.
Implementing a plan that will work within your lifestyle, your personality, and your income and expenses.
Keep you accountable to the process when your emotions cause you to question and second guess the plan.
We believe financial advisors should behave in the following ways and it is our duty to act by:
Always acting as your fiduciary, and always putting your financial interests before our own.
If you suggest changes to your plan based on emotions (usually fear and greed), we will question your motives and push back.
Building a portfolio that seeks to achieve your goals by pursing efficiency and low-cost methods.
Identifying opportunities for growth and/or income that will protect your purchasing power while mitigating as much risk as possible.
Protect you from finance industry professionals that may be motivated to sell you something instead of desiring best outcomes for you.
Personally, I want to demystify this business. It is not as complicated as most people think. Many firms and financial professionals try and sell a good story that reflect current hot trends: Think “alternatives” as an asset class, ESG investing, private funds, etc. I have written on many of these topics before. There is a place for all of this in investing. However, it is essential to consider:
Why you are involved in these investment vehicles (how do they help you achieve your goals)?
Can their fees be justified (are they really achieving the outperformance they suggest?), and how much will this eat into your returns over time?
The risks of a changing economic environment (what does a worst-case scenario look like)?
How much leverage are they using to produce “outperformance”?
We never claim to have all the answers, nor do we claim that we will outperform the market. I would argue that we ask the appropriate questions. If someone is suggesting they are providing a useful investment alternative, we want to understand the strategy fully before deciding to buy in! Fortunately for August Wealth and our clients, my background helps me understand the risks, rewards, potential for alpha generation, and then help clients make sound choices as to whether a particular strategy truly makes sense for them. If you have anxiety around an investment strategy, advisor, or any other issues pertaining to your wealth, please feel free to give us a call. We may be able to help, and that doesn’t mean you will end up working with August Wealth. You may just need to address your concerns constructively with your current advisor; that can lead to the positive course change required to ensure you are confident in your plan.
So where do I see future “trainwrecks” and opportunities now? Firstly, I hope you will indulge me on a topic that I have seen cause so much damage to family and friends over the years. It is a topic that is not directly related to markets but will almost certainly cause future pain for many individuals, families, and society. That is sports betting. Companies have been given the green light by governments to provide a platform of “fun betting” to the masses. It’s all about money. Money is given to politicians to make online sports betting legal. This is a future trainwreck! I am not casting judgement on how someone likes to have “fun”. Gambling, drinking, drugs, sex, shopping, eating are all good in moderation. However, these vices can be a disaster for the addictive personality. I will not go into studies around gambling addiction and how it impacts certain ages. I will only ask the following question:
Do you believe that online sports betting will result in positive outcomes for young people (especially young men) ages 18-22?
If you answered “no”, let me ask you another question? Do you believe that colleges and universities across the United States should be taking money from sports betting firms in return for promoting sports betting to their students?
If you answered no to that, let me ask you a third question? Why are we looking the other way and allowing this to happen?
I do not want to hear about all the benefits that will come from the money generated, the tax revenue, etc. It is highly unlikely to add productivity to our economy, and it is highly likely to do a great deal of harm.
I believe schools are supposed to educate our young people, to nurture and protect them, and to help them develop a solid foundation to live productive and happy lives. I do not believe gambling will help their missions! It is a shame in my opinion. However, if I were running an online sports betting business, I suspect this is a savvy growth strategy. Find a group that loves sports, think they know everything (as I did as a young man), has access to money, sign up as many people as you can for “free”, so you capture the most addictive personalities of the bunch. It should prove lucrative for many of these betting companies. It is also likely to end very badly for most people, and by knock on effect badly for society.
For full disclosure, my bias is against gambling. I don’t understand gambling unless the odds are in my favor. Of course, there can be “fun” bets with a friend on this or that outcome, but that is because the motivation is to win bragging rights. Office pools, NCAA brackets, masters golf, all add a bit of fun even if it’s total luck. However, how can you “win” money if the odds are consistently against you? The more you bet, the more you eventually lose if the odds are against you. It is simple math; it is illogical. So, again, my bias is always going to struggle with something that is not rational (whatever the topic). There are instances where this isn’t always useful; just ask my family. But on this topic, I think it is easy to spot the future train wreck.
Some people suggest to me that what I do for a living is “gambling”. I suppose there is some truth to that in my previous career as a hedge fund manager. However, when I speculate, I look for situations where the odds are in my favor; I am compelled to make a bet in that case. If the odds are in my favor 55% of the time, and I do thousands of speculative trades over the course of my lifetime, with a good risk management system, chances are that I will become wealthier over time. There are even some professional gamblers that place bets ONLY when the odds go in their favor. These are generally the people the casinos and betting companies do not allow to “play”; I wonder why?
At August Wealth, we manage ownership of certain assets; that is not gambling. Crypto, meme stocks, short term trading, is gambling, but that is not what we do. In the portfolios we manage, we predominantly own companies and bonds. We trade dollars for ownership in various parts of the economy with which we live and consume. As our ownership in companies and government and corporate bonds earns money, we accumulate our share of this over long periods of time. They pay us for the use of our hard-earned dollars. This is the much easier and much more (admittedly) boring way to grow wealth. It does not provide for a rush of dopamine most of the time. Much of the time, our biggest challenge is to convincing people to stay with a somewhat boring, slow changing strategy. If we are able to continue to outperform, it really can only be recognized over long periods of time throughout the economic cycle.
Where to from here? Overall, there is not any new market insight that I have not discussed already, but I will recap and perhaps add a few observations:
I think the odds are that the official inflation numbers are going to print lower; this will become a focus for media attention. This will provide the relief in the near term for the Fed to slow its pace of interest rate increases as they have already started to suggest.
Here are some talking points doing the rounds in market circles:
There are many historical indicators that are pointing to higher recession risk.
The Fed hikes until something breaks (we can argue that a few things have broken in 2022).
Based on previous cycles, once the Federal Reserve pauses its interest rate hikes, it usually cuts soon after.
Any of these outcomes are possible. Then we must consider the degree or deepness of recession and future rate cuts. I also believe there is a reasonable chance the Federal Reserve will keep rates higher for longer. But the truth is that I do not know what will happen, and even if I did, it’s not clear that the prices of equities and bonds will go down from here. Hence, we should be invested to protect wealth over the long term. Because even with inflation coming down in the near term, I do not believe holding cash will protect you over time. I bet prices of goods and services in the future will continue to rise as they always have over longer periods.
As discussed previously, official policy reactions to Covid, people’s changing behavior, and global trade and politics have, in my opinion, created more uncertainty for markets. I will respect that uncertainty, focus on what we think we know, and give ourselves flexibility to change course when circumstances change.
What this means: • All portfolios have more fixed income in them because:
Rates have risen considerably and rapidly which means we will be paid an income stream that likely will contribute to protecting our wealth.
As official inflation prints catch up to lower prices from energy, food, shipping, etc., we expect the Fed to slow rate hikes which should keep fixed income prices stable.
They should lower overall portfolio volatility compared to equities.
• Continue to hold metals and mining because:
Profit margins, revenue growth, cash flow of these companies remain very attractive.
Potential structural change in demand as metals are essential to transition to electrification of economies globally (away from fossil fuels).
Historical prices for many of these companies are still depressed because of China Covid policies and depressed demand and the US Dollar appreciation in 2022. Because many of these companies are based internationally, a rising dollar depresses the global price of these securities. Making the investment attractive for dollar-based investors.
Dividend yield payouts from these companies are attractive.
• Increased international equity exposure because:
Attractive valuations for dollar-based investors.
China seems to be more pragmatic in engaging: ▪ Loosening Covid controls. ▪ Easing monetary policy. ▪ Seeking common ground with competitor countries.
We are not investing in China directly because we find many decisions are political and seem arbitrary for financial markets. Financial markets are secondary to politics/control.
• Incremental increases in the following areas where we had been very underweight:
US Tech companies because we sat out most of the decline in the Nasdaq which is down nearly 30%.
Inflation index bonds
• As always, we have a diversified portfolio of equities (this represents economic ownership of companies in the USA and internationally), but the overall weighting remains defensive because of the attractiveness of fixed income and the uncertainty as discussed. We do not believe in being aggressive in this environment.
Observations on your portfolio: You may have noticed that your portfolio is correlating less with the overall market index like the S+P in the short term. This is by design. Our hope is to construct portfolios with less risk than the overall market index, but still try to match or beat the index over time (subject to your risk parameters). In the near term, the portfolio performance has deviated because of the increased weight in international shares, mining and metals, and increases in fixed income allocation. If you would like to learn more about our portfolio construction process, please let us know and we can walk you through it in more detail. One other point to note in the current environment, is that your portfolio holds no private investments; all investments are traded on public exchanges. Unlike many of these private investments, your portfolio is marked with current pricing at the end of every day providing you an accurate up to date valuation.
As I mentioned above, I hope to demystify this business. Protecting your wealth does not need to be unnecessarily complicated or expensive to achieve your goals. In fact, if you can do it less expensively and more efficiently, why wouldn’t you do that? I will admit, it is less exciting than making or losing a lot of money on a particular horse, stock, or college football team. I often say to people that want to speculate or try to beat the market, “by all means, scratch that itch”. Trade crypto, meme stocks, make sports bets, or whatever else you think you may have an edge in. Hell, you might get lucky; it happens, and that’s what keeps people coming back for more. Those sports betting companies are betting on just that!
Our suggestion is always to open “itch scratching” accounts in very small size compared to your total investible assets so that if it all goes wrong (as is often the case), it will not detract from achieving what you truly desire in the long term. It’s all about balance and moderation. Get it right, and you can possibly have the best of both worlds.
Just so you don’t think I’m a complete bore; for my dopamine hit, I am betting (with my heart of course) on the TCU Horned Frogs to be National Champions and Max Duggan for the Heisman Trophy!
I hope you and your family have a Happy Holiday season.
As always, I want to express my sincere gratitude for allowing the August Wealth team to serve you. We feel very fortunate to have you in our lives.
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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