"Elephant in the room" is an English metaphorical idiom for an obvious truth that is either being ignored or going unaddressed. The idiomatic expression also applies to an obvious problem or risk no one wants to discuss.
The definition above comes directly from Wikipedia. For investors, the elephant in the room is of course the bond market. The risk of rising interest rates as the Fed exits its massive program of asset purchases is front and center. However, today unlike other periods when lurking monsters hid beneath the surface, we all see the "Elephant." You can't turn on a TV set, pick up a newspaper or read a financial newsletter without being hit in the face with the problem. The question is; "Are you doing anything about it?"
The debate over the benefits of quantitative easing has continued since its inception. Most critics of the program would agree that the swift action taken during the height of the Financial Crisis in 2008 may have prevented the collapse of our banking system. Credit markets were under siege and the domino effect could have brought down far more than just Lehman Brothers. However, the benefits of Quantitative Easing in subsequent years are far less obvious.
If you measure success by asset prices and Wall Street performance, it's a home run. If you are looking at employment and growth in the real economy, the benefits seem less clear. Frankly, the debate as to whether we should or shouldn't have doesn't matter anymore. The fact is we did it and the focus now needs to be; "What do we do now?"
Exiting Chairman of the Fed Ben Bernanke has made it clear the fed is at the beginning stages of ending this program and most economists believe the "tapering" will begin next month.
Wall Street Strategists see the risks and offer a range of solutions. Unfortunately, most investors will do nothing until they see the whites of the eyes of the stampeding herd. Sitting in long term treasuries, corporate bonds and preferreds thinking you are in safe assets, thumbing your noses at equities is like an ostrich putting their head in the sand. We are only just beginning to see outflows in bond mutual funds so the panic certainly isn't upon us. Some like Joel Naroff, Chief Economist at Naroff Economic Advisors believe the genie is already out of the bottle. In my recent interview with Joel for Newsmax, he said, “The Fed has Lost Control of the long term interest rates.”
Widows & Orphans
Those in so called widows and orphans stocks, like utilities are also at risk. Utility investors like to point out that they always bounce back when interest rates turn. The difference is rates are at historic lows and could rise for some time putting this sector particularly at risk. Utility investors will find it very uncomfortable owning an asset that pays them a 4-5% dividend while their principal declines annually. With the exception of a few, most offer growth rates that are close to the GDP, which is nothing to write home about. In addition, pay-out ratios for many are high with little ability to make more than token raises in the dividend. If you are using this sector as a fixed income alternative, dump it and move into MLP's or even a fund like Goldman's Rising Dividend Fund (GSRAX)
In his recent blog, Preparing Equity Portfolios for Rising Rates, Russ Koesterich, Chief Strategist for Blackrock answers his own question. "How should investors adjust their portfolios for slowly rising rates? Probably the simplest prescription may be to shift the portfolio mix toward stocks…"
I agree, but unfortunately for older investors approaching retirement that may not be a solution.
What can you do?
Investors over 50 cannot nor should they put all their assets in equities. Most will need some sort of balance. However, a diversified portfolio today should look far different than the typical balanced account of 20 years ago. For decades Wall Street has preached the 60/40 split between bonds and stocks as a way to reduce volatility and preserve wealth. By placing 60% of your assets in stocks and 40% of your assets in bonds, you protected yourself from the inevitable bear market. Bonds would remain stable or appreciate when stock prices declined.
Today, the battlefield looks very different. In coming years, investors may be greeted by a bear market with bonds falling faster than their stocks. Despite this scary scenario, there are still ways for balanced investors to cushion the ride.
Alternative assets have been with us for some time. Unfortunately, we often don't look beyond the headlines. Most investors aren't going to get access to Steve Cohen, Bill Ackman and the George Soros's of the world and given the recent headlines, maybe that's a good thing. However, today retail investors can choose from a wealth of mutual funds and strategies to help diversify their assets. Below are just a couple of choices.
Driehous Active Income (LCMAX) - Takes long/short bets on corporate bonds. The fund attempts to eliminate interest rate risk and seeks total return through security selection rather than making broad bets on the bond market.
Gateway Fund (GTEYX) - Gateway is a hedged equity fund that looks to reduce risk and increase income through a covered call strategy.
There are some great books on the subject like "The Alternative Answer" by Bob Rice of Tangent Capital. Bob is also the Alternative Investment Editor for Bloomberg TV. (My interview with Bob Rice for Newsmax)
The key here is that bond investors and bond mutual fund managers will have to think outside the box and use more sophisticated strategies to succeed. Top bond fund managers like Doubleline's Jeff Gundlach and Loomis veteran Dan Fuss recognize the challenges ahead for bond investors and will probably navigate the terrain better than most. Even Bond King Bill Gross, who has been hit hard by redemptions in Pimco's flagship Total Return Fund (PTTRX), says the game has changed. In a recent interview on Bloomberg he vowed to win the war for assets.
The purpose of today's article isn't to give you a definitive strategy for the battle that lies ahead, but to force you to think. If I've done that, then today's mission is a success. The clouds are gathering but there’s still time to prepare. Remember, Noah built the ark before it started to rain.
David Nelson, CFA
Chief Strategist Belpointe
Funds managed by David Nelson are long LCMAX and GTEYX at the time of publication
Over the weekend I was asked to appear on Fox News with anchor Arthel Neville to discuss the Electric Car industry. Sales of Hybrids like the Chevy Volt and the all-electric Nissan Leaf have risen dramatically and the question of the day is, why?
I admit I don't follow the industry as much as I should so I dived right in preparing for the segment. As I clawed my way through the mountain of research, I soon found with every question I answered, another two would surface. The biggest and perhaps most controversial is, "Are Electric Vehicles as Green as the Industry Says?"
First, let's go through the easy stuff. The recent spurt in sales of the Chevy Volt and Nissan Leaf are the result of a price war. The automakers are falling over themselves to cut prices and its working. With sticker prices on the 2014 Chevy Volt being cut by $5000 dealers are having trouble meeting the demand.
Recently, Honda issued an apology regarding their Fit EV's saying, "We recognize that some customers have experienced frustration as they attempt to locate dealers with available Fit EVs." Dealers are rejoicing because of the sudden surge. In a Time Magazine interview, sales manager at Honda of Santa Monica said, "It's incredible, especially since we haven't had any foot traffic or interest in the car in six months."
A lot of questions remain unanswered. "Are they making money? What are the margins and are the promotions we see sustainable? Are these programs designed to just stir up interest and what will happen to demand as these promotions are eliminated?"
According to Auto Week, Chrysler CEO Sergio Marchionne is on record saying, they will lose more than $10,000 on every battery-powered Fiat 500 it sells. Hardly a sustainable business model.
Current incentives to purchase these vehicles are very attractive. The Federal tax credit can be as much as $7500 and if you live in California maybe another $1500.
Hybrid vs. Electric
In the near term, I believe Hybrid vehicles will continue to lead the market. For most all-electric vehicles, the range simply isn't enough. The darling of the industry Tesla (TSLA) advertises a model with a 300 mile range but most are significantly below that.
Once you’ve arrived at your destination you have to charge the vehicle. In today's fast paced, I need to be there yesterday world; waiting around hours for your car to charge simply won't be an option for many. The hybrid's gas/electric drive train lets you continue on your journey long after the battery is out of juice.
I think for now, all-electric vehicles are more suited to fleets like taxi's or delivery trucks that come back to a central location at the end of the day.
That's really the question isn't it? Are these vehicles as green as advertised? The selling point behind using all-electric vehicles is they are green, with most advertising Zero Emissions. However, with everything considered is that really true?
Think about it. Your electric car is sitting in your garage charging. Your home is attached to the electric grid and in turn to your local electric utility which is more than likely burning fossil fuel. Perhaps, even a dirty fuel like coal?
Ozzie Zehner, a scholar at the University of California who worked at General Motors on Electric Vehicles, is one of the industry's leading critics. In a recent article, Unclean at Any Speed, he points out many miss-conceptions of the electric car industry. When considering emissions, he believes it is important to look beyond the fact that the electric vehicle doesn't have a tail-pipe. There are other environmental costs as well. He points readers to a study conducted by the National Academy of Sciences. He goes on to say that much of the research available is funded by the auto makers who dominate the electric vehicle industry and stand to make a profit.
A major headwind for the industry can be found right in our own backyard. If we put the right policies in place, our nation has a chance at becoming energy independent in the next decade. I'm not certain gasoline prices will remain as high as they are right now. If traditional energy sources fall in price as we develop these resources, plugging in may prove less attractive than filling the tank.
Here is where I come out on the subject. I think the industry is exciting and electric vehicles are certainly part of the solution but given the fuel options we have available right now, it shouldn’t be jammed down our throats. I think energy independence for our country is the key to our future and electric vehicles are just one piece of the puzzle. It would be criminal to waste this opportunity to free ourselves from mid-east oil and those who control it.
David Nelson, CFA
Newsmax Anchor and Chief Strategist at Belpointe
Content is King, is a phrase that puts fear in the hearts and minds of cable company executives and gets louder each time one of its providers decides it’s time to raise prices. Technology, which has a way of disrupting business models, is about to wield its sword once again. While each of these creates a significant headwind for Cable companies, these forces are now colliding creating the Perfect Storm with an industry sailing straight into the vortex.
Cable, which has its beginnings as early as 1949, has made a very comfortable living acting as toll collectors on the Television super-highway. Unable to continually pass on increased costs, the industry is facing a future with declining margins and possibly fewer premium subscribers.
The evidence continues to pile up with the most recent example right here in New York City. CBS (CBS) and Time Warner Cable (TWC) have until Wednesday to strike a carriage deal that covers re-transmission rights. CBS is threatening to go dark if a deal isn't reached. While it won't be surprising to see this fight go beyond the deadline, come fall, Time Warner Cable Execs will be forced to confront the inevitable. They just don't have the leverage and will succumb to the demands of their customers. CBS is the media home of the New York Jets and Time Warner Cable will face the reality that their fans like football a lot more than they like them.
The wild card in this battle is Aereo Service, backed by Barry Diller. The service uses antennas to pick up freely transmitted broadcast signals and streams them to paying subscribers. They do not pay re-transmission fees to networks and as you might expect, there are several law suits. Aereo recently had a court decision go their way when the Court of Appeals for the second circuit of New York refused to hear broadcaster appeals. In a recent New York Times interview, media analyst David Bank for RBC Capital Markets said he would not be shocked if the distributor somehow used Aereo to skirt the blackout, or encouraged subscribers to do so. He wrote in an e-mail message, “I think it would be more of a ‘negotiating tactic’ than a real business solution.”
This fight is a big deal for CBS as it has been for other networks like FOX and Disney. CBS plans to quadruple re-transmission revenue by 2017. While they may not achieve that lofty goal, fees will most likely rise and cable company margins will be forced lower.
Comcast (CMCSA) management probably understands the challenges better than the rest of the industry. They’ve been trying to buy content for the last decade. Comcast launched an unsuccessful bid to acquire the Walt Disney Corporation (DIS) in February, 2004. Realizing the importance of content, CEO Brian Roberts cut a deal with General Electric (GE) in 2009 to become the majority partner of NBC Universal. They bought the remaining 49% equity stake earlier this year. The street applauded this move sending up their shares 8% in a single day.
While content providers, exercising their new found bravado and muscle, present an enormous headwind for the industry, the real threat comes from technology. It took a while but the dream of broadband being able to carry unlimited streaming video content is now reality and will change the face of broadcast forever.
In most cases, the cable industry is the internet pipe that carries the broadband content. However, that represents what is commonly referred to as the dumb pipe. Uh oh. I said it. "DUMB PIPE." The word is almost profanity in the world of cable and they do everything they can to dispel the image.
Google (GOOG), Apple (AAPL), Intel (INTC), and Microsoft (MSFT) all have plans to get in on the action. The success of both Netflix (NFLX) and Amazon's (AMZN) streaming services are certainly a catalyst. Netflix has moved beyond being just a streaming service and is investing in original content. "House of Cards" was well received by both the critics and the public. This certainly sets the stage for more investment.
Last November Google fiber installations began in Kansas City. In a very detailed report regarding Google's Fiber plans Goldman (GS) analyst Heather Bellini, CFA pointed out that Google could bring targeted ads to the $60 Billion TV add market. They could also expand fiber to offer outdoor Wi-Fi.
Cable companies recognize the threat and are trying to force the Genie back into the bottle. In a recent Bloomberg Article, journalists Andy Fixmer & Alex Sherman pointed out that Time Warner Cable CEO Glenn Britt recently told analysts “Time Warner Cable has more than 300 contracts, and some of them may bar media outlets from providing content to online pay-tv services.”
As these contracts rollover, I think Cable companies will find large media outlets like Disney, Viacom (VIAB) and NBC Universal are far too powerful to be forced into contracts that restrict their ability to deliver content.
The final straw is young people cutting the cord with Cable. Forbes points out that a recent Nielsen study shows 5 million U.S. homes have "Zero TV." That's up from 2 million in 2007. They go on to point out that "Zero TV" does not mean zero video. Streaming is filling the void and in this capacity Cable is likely to remain the "DUMB PIPE."
While earnings and free cash flow multiples are still attractive in the cable industry, we are at, or rapidly approaching an infection point. In the media space investors should focus on the content providers like CBS, News Corp, Viacom and Disney. Cable investors will need to come to grips with the harsh reality, "Content is King."
David Nelson, CFA
Disclosure: Funds run by Mr. Nelson currently own DIS, VIAB, CBS & GOOG. CMCSA was a recent sale.
I'll give you a hint. It isn't the leader of the free world, the head of the Chinese communist party or the rogue leader of a terrorist state. No, it's that mild mannered gentleman who every so often steps in front of the cameras and announces what weapons he intends to deploy in his war to stamp out: inflation, deflation, recessions, bubbles, unemployment and any other mandate he chooses to take on.
I'm of course speaking about Chairman of the Fed Ben Bernanke. The debate rages in Washington and on Wall Street as to his performance but I think most would agree that his actions during the financial crisis helped avoid what could have been the collapse of the U.S. Financial System.
Since then his quantitative easing programs have received mixed reviews. His fans point out that U.S. markets have pushed to all-time highs and inflation has remained in check. However, critics suggest, the rise in markets is unsustainable and that the staggering debt on the Fed balance sheet will prove impossible to unwind and robs from our children's future.
Let's assume, for the sake of argument, that Mr. Bernanke’s prescription for our economy and markets is just what the doctor ordered. The fact remains that "The Most Powerful Man on the Planet" isn't an elected official.
Ben is coming to the end of his term and most agree that he has no intention to continue. As a matter of fact, in a recent interview President Obama said that "Chairman Bernanke has already stayed a lot longer than he wanted or he was supposed to." That seems like a clear signal he is gone at the end of his term.
It is once again time for the President to choose a replacement. For some time Fed Governor Janet Yellen has been considered the most likely successor. However, recently a name from the past, Larry Summers, has also been mentioned as a candidate. My issue is the following. What if the new "Man or Woman of Steel" isn't up to the job? Is the entire fate of our nation's economy tied up in the success or failure of one individual?
Some make comparisons of the Fed to the Supreme Court. After all, Supreme Court Justices aren't elected. I think the comparison doesn't hold water because the dirty little secret of the Fed is that despite a 12 member structure it is the Chairman who counts. Alan Greenspan dominated the Fed during his tenure and that tradition seems to have continued during Bernanke's reign.
Even Superman Makes Mistakes
Just a few weeks ago, Chairman Bernanke stepped before the cameras at the conclusion of the last FOMC meeting. I have to admit he didn't look well and appeared uncharacteristically nervous before the cameras. At one point he paused for a drink of water in Marco Rubio fashion. After announcing plans to start the "taper" and eventually reduce the $85 Billion per month in purchases he seemed to veer off course with drawn out analogies hoping to better explain his rhetoric. Perhaps sensing like a comic that the performance wasn't going well, he talked about how we should pretend he is driving in a car and not stepping on the brake but just taking his foot off the accelerator.
Fund managers and traders didn't buy it and a swarm of sell programs were launched. Stocks, Bonds and Gold fell while interest rates and the dollar rose. In the days following that meeting, a parade of Fed Governors talked to the press trying to walk back the Chairman's comments. However, the damage had been done.
Then, almost without warning speaking before an audience in Massachusetts, Mr. Bernanke seemed to take back much of what he said at the FOMC meeting. In any event he said, given the weak employment picture and an inflation rate that is below their target "the Fed needs to be more accommodative." What changed in just a couple of weeks?
Ben Blinked! The markets threw a temper tantrum and like many parents he capitulated.
Markets of course soared on the news and for now stock investors are whispering "God Bless Ben Bernanke." All of this works flawlessly until one day it doesn’t.
We need to have an honest debate on the structure of the Fed and the power it wields. The current system is an accident waiting to happen and is far too dependent on one individual's ability to get it right.
Check out my recent Newsmax interviews with Congressman Scott Garrett and Joel Naroff where we discuss Fed Policy.
David Nelson, CFA
Chief Strategist Belpointe
Late last week the US Army announced it was suspending its tuition assistance program for soldiers seeking to advance their education. US Army spokesperson Lt. Col Alexander said, “This suspension is necessary given the significant budget-execution challenges caused by the combined effects of a possible year-long continuing resolution and sequestration.”
Our government, which lately seems comprised of limousine liberals and social Darwinists lied to our service members. Let me remind you that these are the same young men and women who are risking their lives while the President plays golf and members of congress point fingers at each other like adolescent school children.
Mr. President, Congress - "DO YOUR JOB!" You should be embarrassed that the first casualties of Sequestration are those on the front lines of freedom defending our nation.
As the proud parent of a US Soldier I remember the heavy emphasis placed on the tuition program as recruiters encouraged my son to join. You know what? He would have gone anyway, because he wanted to serve his country. I am outraged that our nation’s leaders continue to cash their paychecks while failing to keep promises to those who give so much.
Recently, I attended my son’s graduation from Military Police training at Fort Leonard Wood Missouri. I remember sitting in a large auditorium with the other proud parents as we watched the soldiers march in. Before the ceremony started we were shown a short film of soldiers training in the field, climbing into helicopters armed and ready for combat. It looked like an elaborate Hollywood production until you realized that these were not actors, they were our sons and daughters.
It suddenly hit me that our society has started to resemble the popular book and movie, "The Hunger Games." Will Children pay the price for their parent's greed?
Think about it. Over the last few decades we’ve continued to live beyond our means both in the public and private sector. We've racked up $Trillions in debt hoping to keep our economy afloat long enough so our children can pay the tab decades from now. We continue to support an entitlement mentality and are moving closer to a cradle-to-grave solution that can only be paid for by future generations.
Government's failure to live up to a promise made to our fighting men and women is just the beginning of what we will steal from our children.
Parent of a US Soldier