I do this for two major reasons:

1. I feel that we have an “alpha” advantage by picking stocks individually. For those of you who have real lives and don’t spend any time at all boning up on investment jargon, “alpha” is the value-added that an investment adviser (like myself) brings to the table. More technically, it is a rate of return that you receive that is a little bit out-sized for the level of risk that you are taking. Layman’s example: The market increases by 5% and your account increases by 5%, but you only have half of your money in the market: That’s alpha (very roughly), if you will.
2. Reason Number Two: Never Pay Retail. I read that the total markup on diamonds can approach 1000%. The reason for this is that there are a lot of hands that a diamond goes through on the way from the dirt to your digit. So goes it for packaged investment products as well; investment company, investment manager, investment manager’s stock broker, fund wholesaler, brokerage firm, broker, you. The bottom line here is that paying retail is never OK if you are buying an investment and hope to make any money at all on it.

I got this way because I am a “reformed stockbroker” and if Joshua Brown at The Reformed Broker hadn’t already snagged the name, I probably would have. I’ve had similar experiences and find myself left with a similar disdain for the industry because I’ve seen it from the inside out as well.

Joshua’s history with the industry started about the time that mine left off and it’s interesting (although not surprising) to see that things haven’t really changed, despite all the spin that’s being thrown out by commissioned brokers about how it ain’t so.

For the record, if you are a stockbroker, here is The Reformed Broker’s best recommendations about what to do with the latest packaged product that management is “suggesting” that you offer to your clients.

And if you’re not a stockbroker, then you ABSOLUTELY MUST READ IT if you don’t want to be the one wondering why you were invited to play.

Nope… I’m resolving to write more often and to be more actionable when I write. When I reflect upon bits and pieces of the past couple of years, I can see that I’m too obsessive about how I put together my posts. I agonize over a lengthy story and what feels like a great idea, until it isn’t either one of these things any more. I think it to death… or something like that.

I’ll write something, or a part of something and then have to set it aside while I tend to the real business of taking care of clients. And then, I don’t get right back to it or I’ve derailed my train of thought for the time being and “can’t” get back to it. This might go on for a few days and then one of three things usually happens…

1.) I lose interest in the article entirely. Maybe the good idea doesn’t seem so “great” or interesting any more.

2.) It’s no longer timely. It’s possible I’ve thought about exactly the right way to write or phrase something way past the time when the article is relevant and whatever I’m thinking about has already happened or resolved itself… so there’s no longer a story.

3.) I completely lose the point. I had a great point, but I don’t usually outline articles because when I start to write, I believe that I’m actually going to finish it in one sitting… and then I don’t. And then when I get back to it, there’s no obvious point that I’m trying to make anymore. Or, I’m getting old and forgetful? I can’t remember.

The point is (and I must hurry and finish here!), that I’m resolving to evolve my writing style to adapt to the little snippets of time that I usually have here and there during the day. So, posts will be more often and more in little snippets than the lengthy tomes with lots of time in between like before.

Oh yeah, and more actionable. I want to include an action item with each post. In a great start to my new resolution, I don’t have an action item for my first post about action items. Sorry, I guess it gives me something more to strive for!

One of the people that I follow off and on from time to time is James Altucher who writes, ” The Altucher Confidential”. In past lives he used to manage a hedge fund and from time to time you’ll see him as a guest on CNBC or other financially-oriented news shows. Recently, he made some salient points about Greece, the country and their debt. Here are a few items that I found the most interesting:

We first even heard of Greece in May 2010. There were some rumblings. They couldn’t pay their debt and everyone wanted to retire by some early age – what? 24 years old they wanted to retire. And then hang out on the beach and get paid by the government.

It’s 0.15% of the world’s population.

If you go to Greece (or, in my case, if you go to a pool hall in Astoria, NY which is almost entirely populated by Greek people, and many of the waitresses at the Greek diners were too beautiful for me despite the fact that I wrote my phone number down on $2 bills that I gave out as tips) they have three types of backgammon that they play as opposed to our one. No wonder they want to retire so early!

The Greek debt divided by the Eurozone GDP is similar to Rhode Island’s debt divided by the US GDP. If Rhode Island defaulted I wouldn’t care either. Rhode Island, also btw, is a beach resort. Just like Greece.

Most important: Since the time of Augustus in 20 BC, Greece’s bills have been paid by other countries. All the way up to Ronald Reagan in 1989 who was terrified the Soviet Union would have access to the Mediterranean so kept paying Greece’s bills. So the EU knew this going into the situation that Greece can not live without the kindess of strangers. THIS HAS BEEN KNOWN FOR 2030 YEARS!

In 1981, the top 5 banks in the US were 263% exposed to South American countries that TOTALLY DEFAULTED! Zero! THANK GOD the word “contagion” had not been invented yet by some media Einstein. What happened next in the US? 20 year Stock market BOOM!

So ok, what’s our exposure to not only Greece but let’s throw in Portugal, Spain, Ireland, Italy. Other than Ireland, all prior leaders of the world. Total exposure in the top 5 US banks? 8% Glory Be! You know what this means? It means I should NEVER be able to turn on the TV and hear the word “Greece” unless I am watching some backgammon tournament on ESPN 3.

This isn’t to say that the stock market won’t produce a wild ride if investors (pushed by the media) head for the exits en masse based upon a contagion fear theory currently trumpeted about by the media. For this reason, it’s important to respect the potential for market volatility.

But, it’s also a pretty good reason not to get our shorts in a bunch about the whole Greece-Europe-Contagion thing and recognize that; while we should respect the market movements that others may cause because of it (this is the world that it appears we now invest in); we might also view it as a possible buying opportunity once calmer heads prevail.

It’s difficult to check your hunches at the door, but I still manage to stay disciplined and only act on what the actual facts are saying. It also serves to remind me of the title of one of my favorite author’s books, “Dig Your Well Before You’re Thirsty.”  (Harvey Mackay, if you’re interested).

Although sales related, the basic tenet of Harvey’s book is that you need to build your network and to prepare your groundwork BEFORE they are needed. If you wait until you find yourself unemployed or looking for some other professional assistance, it is far too late to attempt to build a plan.

Now, while things are good, is the most important time to prepare a plan of action for market malfeasance. Paradoxically, this one best time also happens to be the least motivational time to do it. And it is this very recent market history with its unbroken chain of recent successes that makes me an even more vocal voice in the woods… and the same reason it gets so danged hard to get people to listen right now.

If you haven’t already done it, it is time to build in a backstop of courses of action to keep you and your investment portfolio on course to your personal goals regardless of what might lurk around the boom-bust corner that the markets have become in the past few years. My clients and I already have. See how we accomplish this here.

Why? Because things couldn’t be better.

Oh yeah, and she’s damn good at it. Seriously… like professional-grade damn good.

Yes, she has rules too. One of her rules is that if something’s coming into the house, another item must go out. We’re way past the “accumulation” stage of our lives and we’re now in the “upgrade” stage.

(My rather crude translation of this is, “You can’t put ten pounds of sh** in a five pound bag”, but now that I’ve actually written it down, it doesn’t sound very bright.)

Another rule is that it has to be actually worth something. You would be surprised at the amount of good stuff that some people will practically give away. I can’t figure out why people do this, but they do. Too tired? Too lazy? Just way too sick of looking at their own junk? I have no idea.

But because these people are out there, my wife never goes anywhere without a jeweler’s loupe and a diamond tester. These are admittedly odd things to keep in your purse… but the payoff can be handsome for the trouble. That and she’s addicted to the hunt.

And all along the way of the Never-Ending-Great-Treasure-Hunt that her travels are, along with the gold and platinum and various diamonds, rubies and what-not gems and doo-dads and unwanted heirlooms come the oddball bits and pieces of the equivalent of the precious metal family’s loser child: Silver.

Her silver hoard was mostly represented by orphan spoons, charms, bracelets, candlesticks, and the like that have kind of come along for the ride like barnacles on the Cutty Sark. But every now and again, even the great sailing ship comes in to dry dock to scrape off the barnacles. And such it was recently for the accumulation of silver whatsits and doodads that she decided the time was ripe to be unceremoniously “scraped off”.

And in the “scraping off” process, she matter-of-factly inquired of me about the price of silver. Out of curiosity I suspect because she’d heard a blip about it on the news. Even though I don’t personally trade commodities, I still keep a sideways eye on them because they can occasionally affect the stock and bond markets and at the moment they seem to be on everyone’s mind. But I only peek out of curiosity, or if someone asks me about something commodities-related and I need to sound smart.

I was thinking it had been somewhere in the $20’s, but I was wrong… very wrong: Silver had gone vertical. After about thirty years of languishing between $5 and “who cares”, the loser child had suddenly gotten a PhD! It was almost 50 bucks an ounce. Of course, I had to check a couple of times… but, yep it was closing in on $50.

So she hustled “the hoard” down to a friend who owns a jewelry store that buys such things for a percentage of the melt value. She had a quicker step to get down there this time, I suspect because the price of the stuff seemed a bit out of line with reality. But, other than that it was all rather routine and typical. She’s a frequent customer.

The deal was done, a check was pocketed and it was back to business as usual for the Never-Ending-Great-Treasure-Hunt that her travels are.

And during the next two weeks (right up to today even) the price of silver has collapsed. It’s lost about a third of its value: It was around $48-plus an ounce and now it’s in the low $30’s. It’s been an historic selloff… dramatic and speedy.

I know my wife doesn’t care. She accumulated a large position at cheap prices over a long period of time. She then sold her entire position, without emotion when the market appeared to have lost its senses. And then she moved on to “business as usual” without another thought.

She just executed the perfect trade.

In his best-selling 2007 book, Black Swan: The Impact of the Highly Improbable,” Taleb argues that these models are essentially useless because they ignore the stark reality of cataclysmic-sized risks that have rocked the financial markets time after time. He contends that probability models are based on a dilution of major, market shifting events (black swans) that, while rare, have the effect of rendering the models nearly ineffective.

Models that only assume the existence of white swans rely upon scenarios that exclude the real possibility of events such as the Lehman Brothers collapse, the near failure of AIG, or the collapse of the housing market, and the potential financial collapse of several European countries. With such events occurring more frequently, it seems that we’re surrounded by more and more cliffs.

This leaves investors who ascribe to MPT or other probability models in a perilous position where probable risk has been severely underestimated, and without a way to react except after the damage has been done. While MPT may be an appropriate tool to analyze historical returns, its danger as an investment tool is that it can provide a gilded view of future performance. Those investors utilizing MPT may, in fact, be walking backwards towards the cliff with their eyes on past investment results and little concern for impending disasters.

In our previous writings we have been fairly clear on our stance that MPT doesn’t work because it is largely based on risk calculations that implies knowledge of future uncertainties, which is impossible.  It also assumes that people, as a whole, do act rationally, which has been disproven time after time.

We have also politely suggested that, absent a crystal ball, investors who formulate their own thoughts and opinions, or who are thoughtful enough to seek the advice of those who follow their own thinking, are better positioned to survive, and even thrive in uncertain times.

Taleb reinforces this principle in a list of his own ten principles for protecting your portfolio against “black swans” that were quoted a couple of years ago in the Financial Times.  His ninth principle states, “Citizens should not depend on financial assets or fallible “expert” advice for their retirement. Economic life should be definancialised. We should learn not to use markets as storehouses of value: they do not harbor the certainties that normal citizens require.

We believe that, if you “definancialise” your investment approach and, instead, focus on what it is that is most important for you to achieve, you’ll not only avoid the cliffs, you will gain a firmer grasp of your financial future.

The approach is simple, easy to understand, and it centers on you.  Please feel free to contact me for a brief overview.

By no means is this a source of frustration for me.  I know how difficult it is to run against the herd.  It’s natural to feel isolated and vulnerable when you see the masses moving off into a different direction leaving you to your own doubts about the validity of your direction.  Would you feel any different if you knew they were heading towards a cliff in the dark of night?  While that is not necessarily a certainty, our contention is that an overreliance on lab-generated portfolios can lull investors into a blinding complacency that will impede their ability to change direction before they reach the edge.

Rather, my frustration is channeled into the army of well-meaning, but misguided advisors out there that continue to promulgate investment myths based on flawed models that have yet to prove their validity, and, in fact, have led many institutions and millions of individual investors over a cliff.

Nassim Nicholas Taleb, one of my favorite investment philosophers, has been on a mission to expose risk models, such as MPT, as pure academic folly, and his latest rant actually is an indictment of the Swedish Central Bank (the issuer of the Nobel Prize in economics) for legitimatizing a theory that has led to market crashes and huge government bailouts. (‘Black Swan’ Author Says Investors Should Sue Nobel for Crisis. Bloomberg. Oct 2010).  Taleb holds no malice for the theorizers. He wants to hold Nobel accountable for rewarding a destructive fallacy.

While that may seem like a drastic, and perhaps, improbable step, Taleb has cast a light of controversy on the underlying problem of probability models that have undeservedly earned academic respect and legitimacy for which there is no valid basis.

Stay tuned for my next post wherein I dissect the controversy of probability models as they apply in your investment decision-making.

If you have questions or comments regarding the use of investment models, I would appreciate hearing from you.

Since we don’t believe in the old-school “buy-and-hope” investment strategy (see “How Investing Got Broken”), we tend to sit around for a while (usually in cash) waiting for opportunities… and then we strike and sometimes make a whole year’s worth of returns in a few months… which is a little bit of what happened recently.

In it’s simplest form, asset allocation for most people means that they hold varying percentages of different asset classes all the time. The theory is that when one asset class performs poorly the other asset class will be performing well… thereby smoothing out the bumps… and unfortunately, guaranteeing mediocrity.

Our approach is a little different (see “How We’re Fixing It”) because we prefer to sit on the sidelines until the time seems reasonable to make a move. We don’t feel like we have to be doing something for the sake of keeping busy or pretending that “busy-ness” is the same as profitability.

In an off-the-cuff moment to my client, I equated our management style to that of a hyena stalking prey. We sit in the grass off of the side of the path watching and waiting for an easy opportunity to pass by. We are conserving energy (capital) while we wait so that we will have the energy (capital) to pounce immediately when opportunity presents itself.

There can be long periods of solitude followed by intense periods of feasting, but there is also relatively little risk to the hyena’s life. And this fits our style nicely, thank you.

Dear Client,

To say that the last three months have been dramatic is to REALLY say something because it comes on the heels of a heart-stopping stock market selloff followed by a mind-bending reaction rally… the likes of which haven’t been seen since Herbert Hoover was in office.

And who could forget that that it has been only about a decade since the stock market last showed us it’s “teeth”? It’s certainly been an era to feel like one could easily get “bitten” as an investor.

Of course recently, just at the point that it feels like we deserve to have some stock and bond market stability, we are again subjected to the kind of volatility extremes that have been cropping up more and more often the last few years. Have we been shown that we’re only living in the “eye of the financial storm” at the moment?

The first quarter of 2010 seemed to come and go quietly as we moved toward ever higher highs. I jotted a web site update in mid-May as I noted that I was feeling a certain level of complacency creeping back in to investor’s attitudes about the markets. Since then I’ve also been reminded by a client of a web site update from February of 2009 in which I wrote the following…

At present, I’m thinking that we’re probably looking at some serious deflation for a while and then a very muted, long term half recovery that could stretch out to a decade or so.

This leads me to a place where cash is king at the moment for most of our money.

Fortunately, these things usually unveil in slow motion. So slow in fact that people begin to dismiss their earlier premises and question their previous conclusions even though they are probably still correct.

Could it be just that simple? Could it be that many investors have dismissed their earlier correct assumptions because it is all taking so long? Is this “thing” so massive and lumbering that it can only unfold in “slow motion”?

During the second quarter, the buzz suddenly became about sovereign debt, which we’ve known for a while was going to become a problem one day soon. It appears that “one day soon” might be nearer than we thought and the market has been asking the question, “If the rescuers need rescuing, who is left to bail out whom?”

The tacit assumption has long been that China will provide some base level of support for the balance of the world via overwhelming demand for everything in the face of an otherwise global economic slowdown. However, there’s been recent chatter about a growing housing bubble in China and speculation that this might just be “the other shoe” to drop on an otherwise fragile global economy, bringing Round Two of the Global Financial Crisis with it.

But it hasn’t been just the stock and the bond markets that have been particularly quarrelsome the past few years. It’s been downright difficult, if not treacherous being an investor in any arena. For instance, real estate did something that it has never done before: It decreased in value. Conventional wisdom had it that despite the leverage routinely used by real estate investors, it was still considered a “safe” investment because real estate prices have never, ever gone down… not even during the Great Depression. The only safe bet now is that investors will never look at real estate investments the same way again.

Other types of investments have all experienced similar difficulties: Private loans, small business loans, real estate loans and partnerships, even previously assumed long time successes such as Bernie Madoff and a host of other Ponzi-schemers that have all been discovered to be “swimming naked” the moment the money tide went out.

So, while the financial turmoil of the past couple of years wipes out or changes much of the world’s conventional wisdom, it also performs a “cleansing” that presents new opportunities with new players in a new financial landscape.

All of the turmoil of the past few years will one day pass and the opportunities will be there for those of us who refuse to focus on the past. We need to keep our focus on keeping our minds open to the new and different opportunities that most certainly will present themselves in the future… while persevering through the “creative destruction” that we find ourselves in the midst of today.

Our Current Outlook

Bill Gross of PIMCO (Pacific Investment Management Co) speaks of an economic era that we are entering that he is calling the “new normal”. In recent papers he has been going into great detail as to the justification behind his theory, but basically “new normal” means an extended period of sub-par growth throughout world economies.

A favorite theory being embraced by what I believe might be the majority of investors is this theory that some day in the not too distant future we will be wrestling with some significant inflation pressures… possibly even a stagflation situation (stagnant economy, rising prices).

Over the past year or so, I’ve been inclined to side with those that anticipate inflation, but now I am beginning to modify my view of our future world. I’m beginning to consider the possibility that our current Keynesian monetary policy of flooding the economy with money MAY NOT lead to inflationary pressures. After watching unemployment not respond to unprecedented government spending, and housing not respond to historically low interest rates, I’m starting to see the US economy and perhaps the world economy as a “leaky bucket”: We continue to pour more and more into the bucket, but it is leaking out just as quickly (or even more quickly).

What is the “leak” in the bucket? I believe the “leak” is the process of deleveraging… up and down the line… from the smallest of consumers struggling to pay off their JC Penney charge card all the way up to the nation of Greece struggling to pay down their country’s debt.

Until the world deleverages, nations can pour as much money as they want into their respective economies and still not see net economic gains. They can throw it toward bailing out the banks, or homeowners, or other countries. At the end of the day it is just moving it from one side of someone’s balance sheet to the other side of someone else’s balance sheet.

The only solution is time. We need time as individuals and as nations to deleverage ourselves. I’ve expressed my thoughts to many of you that our financial issues are “generational”… meaning that it will take a generation for them to work themselves through. For example, our exit from the housing crisis could come as a result of enough people walking away from their mortgages… but it will only transfer the debt to the bank and then to the government as the bank is again bailed out and then ultimately on to you and me in the form of higher taxes or an extended slow-growth economy. Another way to exit the housing crisis is to wait for enough people to have paid down enough of their mortgages to again be “above water” allowing normalcy to return to the housing market. I’m assuming it is to be a combination of both… but the end result is the same: It will take time. This is my version of Bill Gross’s “new normal”.

While one set of opportunities has been winding down for the last few years, a new set of opportunities has yet to reveal itself. This leaves us in a bit of a “no man’s land” in the investment landscape. But again, to simply persevere and avoid chasing “old” opportunities will insure our ability to take advantage of our as yet unseen future.

Specifically

I anticipate that US Treasury securities will continue to be our baseline method providing the ability to persevere for the next who-knows-how-long. I believe that part of the new normal involves some moderate level of deflation for the foreseeable future, allowing your purchasing power to increase even without any real investment returns.

I expect that we will continue to see extended and significant moves up and down in the stock markets… probably quite similar to what we experienced between the end of 2007, down to the March of 2009 lows and then up to the April of 2010 highs. Our opportunities in the stock market will come by accepting that there is a disconnect between the stock market and the economy and by taking advantage of the volatility that we are sure to experience because of it.

Although the market may show little to no net increase over the next decade or two, I would expect that between positioning in and out of Treasuries as appropriate and positioning in and out of equities as appropriate, our clients will continue to persevere… and quite possibly prosper.

As always, I am honored to be your guide through these historical times. Please feel free to call or email if you have any questions or need any assistance.

Jeff Snell

Managing Member, JR Snell Capital Management, LLC