Private Wealth Counsel Updates

The Right Place to Be

2010-07-13T12:50:00Z

If history serves as our guide to the future, we’re in for a rough road. This may not be the news you’d care to hear as we work our way through 2010, but it is likely. Fortunately too, it is likely temporary.

In 1912, Woodrow Wilson was elected President of the United States. In his first year in office, he was supportive of and instrumental in passing two largely irreversible and unquestionably controversial pieces of legislation. The first was the passage of the Federal Reserve Act in 1913 which created the central banking system we have today. The Act was a half step toward creating a banking system which was controlled at the Federal level, as opposed to a system which was monitored at a state level. It also laid the groundwork for the eventual delinking of the dollar from the gold standard, which turned the dollar into a fiat currency – money without real value – and allowed the Federal Reserve to become the “backer” of our bills.

The second, and equally impactful piece of legislation, was the passage of the 16th Amendment to the Constitution which established the progressive income-tax system we have in place today, and allowed the Federal government to tax individuals directly. Prior to this Amendment, the Federal government had to assess taxes to the states individually, based on census data, and it was then the responsibility of the states to assess and collect taxes from their individual constituents. Without the encumbrance of working through the states to collect tax revenue, the Federal government would find it much easier to raise taxes as needed to support Federal projects and initiatives.

Wilson, who viewed the Constitution and our government system as outdated, took pride in the passage of both instruments which drew power from the states, concentrated power at the Federal level, and which set the tone for Wilson’s term in office. During his presidency, the stock market lost almost 40% of its value, and Wilson’s term ended in 1920 with an economic depression which stretched into 1921, and which saw unemployment rise to over 12%.

The correlations between then and today are striking – we have markets, both stock and real-estate, which have lost a tremendous amount of value, we have high unemployment, and most recently, we have a White House and Congress which have again supported and passed legislation in the banking and healthcare areas which are considered by many to be irreversible and controversial, and which again concentrates more power at the Federal level. However, the most important correlation between these two periods relates to the American state of mind while these events were unfolding – it all has to do with perspective.

History has shown us that when the American people are concerned about their futures, that more restrictive policies, more regulation and a greater push to concentrate power at the Federal level leads to a depressed economy and market. In 1912, our country went from a period of relative freedom to one of relative restriction, which was not received well economically or market-wise. The relative change was disappointing to Americans on the whole, and Americans reacted accordingly. The same can be said of today, with the change from relative freedom to relative restriction.

On the contrary, a relative change in the other direction is generally well-received. Wilson’s presidency was followed by the presidencies of Warren Harding and Calvin Coolidge who cut taxes, reduced the size of government and cut the national debt by emphasizing low government spending. These changes, from relative restriction to relative freedom, were well-received by Americans, ushering in one of the greatest periods of American prosperity in history. The “Roaring 20’s” were dominated by a stock market which grew by almost 200% in eight years, with Americans enjoying an unemployment rate under 3%.

Other periods can also be used to set this example, such as the difficult economic struggles of the 70’s and early 80's giving way to the prosperity and growth of the late 80’s and 90's, and they also have in common the same facts – that restrictive Federal government controls drive markets, economies and American dispositions down, and the release from those encumbrances, freer markets, less regulation and less political corruption and manipulation drives markets, economies and the American spirit up.

The goods news is that despite the troubled times we have had as a nation over the years, the spirit of American citizens has shown the resolve to persist, and eventually thrive out of those challenges, bringing prosperity and opportunity to a new generation of people. Unfortunately, we are nowhere near that point yet, and until we get there, we can expect a very difficult economic and market environment.

This brings us to that question, if times are going to be tough, as investors, where is the right place for us to be? The answer is relatively straightforward… almost anywhere if you have a very long investment horizon. The reality is that the only element of control an investor has is in managing the opportunities and risks they expose themselves to, which holds equally true for individual investors and professional money managers alike. Empirical studies have shown this to be the case, consistently and conclusively. As investors, we have the greatest opportunity for investment success when we invest for the long term – ten to twenty years or more – when we buy investments at a discount to what we think they are worth, and when we give ourselves exposure to good ideas and companies and disassociate ourselves from poor ones. Furthermore, money managers cannot manufacture superior returns for clients, despite what they may say, which is especially true in very tough market environments. About the best that can be accomplished is for an investor to expose themselves to risks which make sense, and to minimize exposure to risks which do not, and then let the markets give them what they will. If the markets in general aren’t going to give much, investors cannot, and should not, expect much.

The most likely scenario from here is that this depressed environment will persist, and could persist for years, until there comes another point where the American people feel a relative, but important shift in their condition toward the positive. This also means that investors shouldn’t expect significant positive returns from their portfolios during this time, and should concentrate on buying relatively stable investments with solid income and predictable growth prospects. It also means, though, that for investors with longer time horizons, the long future is looking potentially very bright. Historically, investors who could stomach investing in more troubled times, and who emphasized buying good companies at good prices during those periods, were also the people who realized the most significant growth in their wealth when the good times came back around.

For investors today, that means being selective, but consistent, in putting money to work today, knowing that the fruits of those labors may not pay off for some years to come. If, however, you believe that the U.S. will recover and thrive eventually, as it always has, that’s the right place to be.

Investment Update: Paychex

2010-05-12T21:04:06Z

This week, we added shares of Paychex (PAYX) to our clients' portfolios. As
the second largest payroll processing company in the US, Paychex has built
itself a significant business servicing the needs of small and medium sized
businesses. Payroll is a function most businesses don't want to handle for
themselves because of the potential legal problems and the time-consuming
nature of the activity. Naturally, once a company finds a payroll
processor, they tend to stay with them for years because of the high
switching costs.

Not only does the company have low overhead, but Paychex is also highly
profitable, and even though their growth has slowed somewhat due to the
economy, recessionary periods also tend to produce more entrepreneurs and
thus, more potential clients for Paychex. The yield in excess of 4% and the
fact that the company is trading at a fairly significant discount to what we
think it is worth also make the stock a great value.

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*These comments are provided as a courtesy to those who have an interest in
staying apprised of the investment activities of Private Wealth Counsel, LLC
and its related companies. These comments are not intended as a
recommendation or a solicitation to buy or sell an investment. *

Investment Update: Procter & Gamble

2010-05-10T20:20:27Z

On Friday, we purchased shares of Procter & Gamble (PG). With a very strong
lineup of products consumers use every day, a strong business, undisputed
customer loyalty and great profitability, Procter & Gamble is considered one
of the highest quality companies around. Recently the firm brought in new
leadership to help improve profitability in light of the economic downturn,
and this bodes well for the firms position and market share in the short and
long run.

As importantly, in a fortuitous series of events, Procter & Gamble was the
subject of a Wall Street trading error which caused the stock's price to
plummet for a short period of time. Needless to say, we believe that
someone else's mistake in this case, is our gain in the long run, as we were
able to buy shares for about as inexpensive a price as we could imagine in
this environment. The icing on the cake is the 3%-plus dividend, making
this a great investment opportunity for our investors looking for potential
stability, growth opportunity and income.

***

*These comments are provided as a courtesy to those who have an interest in
staying apprised of the investment activities of Private Wealth Counsel, LLC
and its related companies. These comments are not intended as a
recommendation or a solicitation to buy or sell an investment. *

Over-Stimulated

2009-11-12T22:00:00Z

Never count the United States out. History has never seen a nation rise to such dizzying levels of aggregate wealth as quickly as our great nation has, and as beneficiaries of this trend, we have one ideal to thank – freedom. It has been through our freedom to pursue opportunities – businesses being developed, dismantled and redeveloped – that so few have had so much on such a grand scale. In that sense, the United States has been the single-greatest incubator of new businesses and emerging technologies since the dawn of man. However, even though our long-term record remains intact, we have had many patchy moments along the way which always cause the short-sighted to call these sentiments, and the future of our great nation, into question.

We’re in one of those patchy moments now. Over the past 80 years, two manipulations have worked to help us through these stretches of discomfort or periods of outright despair – lowering taxes and enticing us to borrow. Both manipulations put more money in the hands of spenders, and for those of you keeping track, this is the essence of “stimulus”, the most overused word coming out of Washington over the past 18 months. Whether it has come in the form of bailouts, Cash for Clunkers, first-time home-buyer incentives or good-old-fashioned cheap credit, our “friends” on Capital Hill are determined to stimulate us.

This time, however, Americans in general and the banks specifically aren’t cooperating with Washington. In order for stimulus to work, money must be spent, and the Federal Reserve’s (the Fed’s) favorite tool for achieving this end comes from enticing us to borrow with lower interest rates. Americans have shown an unwillingness to take on more debt, but let’s leave that out of this debate for now. Even if we did want to borrow, banks must be willing to lend, which brings us to the problem du jour… the Fed has delivered the cash to the banking system, but banks are unwilling or unable to lend it. This is in stark contrast to most of the last 50 years in which banks have lent almost everything they could in order to maximize their profits.

Take 2007 as our most recent example of the good-old-days. In any given month in 2007 for example, banks had $41 billion in reserves and had reserve requirements (the amount of depositors’ cash they had to keep in reserve to stay in the good graces of the Fed) of $40 billion. This extra $1 billion was basically money looking for a borrower. However, banks today have $620 billion in reserves and have reserve requirements of only $62 billion… 10 times the amount required! That represents over a half-trillion dollars which could be borrowed, spent and could otherwise be out in the system that is instead sitting on the sidelines. That's an awful lot of "stimulus" which has not made it into the marketplace, and it also has the potential to be an inflationary bomb.

Here’s why. Technically, that money isn't circulating in our economy, so it's not having an inflationary pressure. If banks do begin to lend that money, it will represent a doubling of the monetary base since 2007, which would almost certainly mean a devaluation of the dollar and inflationary pressure. Money in many ways is like any other commodity – if the supply increases with everything else held constant, the value tends to drop. Since there isn't commensurate economic growth to require that much money be in the system, more money in the system means each dollar is worth a little bit less (i.e. inflation). If the Fed pulls money out of the system to curb the pressure of inflation, and thus drives interest rates up (very likely), it will have a depressing effect on the economy as consumers will be even less likely to borrow and spend.

In the end, we have a high probability of either having good economic growth and a dollar wrecked by inflation or bad economic growth and a stable dollar... neither is good for the United States. Before we all sound the alarm bells though, running madly with arms flailing down our suburban streets at this uninspiring thought, be reminded of this – the depression of the 30’s was followed by the industrial boom of the 40’s and 50’s, the inflation-ridden 70’s were followed by the technology-driven 80’s and 90’s, and the roller-coaster economy of the 2000’s will certainly be followed by better years to come. After all, you can never count the United States out.

- Travis Raish, CFA

Surfing the Wave of Stupidity

2009-02-17T15:06:00Z

How did we get into this mess? Well, if by “mess” we are talking about the slump which is cratering economies, stock markets and real-estate values on a global scale, the answer is relatively simple… we over-spent. The unfortunate thing about this situation though, is that the quickest solution to the problem is not the one being pursued by our government.

To explain this contradiction, let’s take stock of where we are. It shouldn’t surprise anyone that the United States has developed into the most prosperous, wealthy and influential country in history. The basic freedoms we have as Americans have allowed for this, and it is most evident in the quality of life we enjoy. Our average family income outstrips the incomes of every developing country by a staggering margin, and most developed nations as well, which is very evident to anyone who has had the opportunity to travel abroad.

But as is the case with all wealthy nations throughout history, our focus has ever-grown toward spending our wealth and consuming goods and services. Certainly this philosophy can benefit everyone to an extent – after all, if the United States and our European counterparts choose to spend our wealth, businesses here and abroad can generate an income and can also grow. This is the heart of capitalism – as we earn income, we can spend, which generates revenues for businesses, which can then pay their employees, and the cycle continues.

Problems arise, however, when markets and economies are massaged into performance, which is precisely what our government has done and is continuing to do. At Washington’s request, quasi-governmental agencies like Fannie Mae and Freddie Mac made credit easy to get, and then guaranteed that debt with taxpayer money, so that everyone who wanted a home could have one. Stated another way, our elected officials encouraged a system where people could borrow beyond their means, and then guaranteed those loans by abusing their ability to dip into the pockets of responsible, hard-working Americans for more tax dollars.

If that makes you angry, it should, but before we get indignant and point fingers, we must acknowledge that our government isn’t entirely to blame in this. After all, the government and the banking system only made the money available to us; we had to spend it, which is precisely what happened. As a group, Americans have lost sight of what it means to save and live within our means. For over fifty years we have increasingly looked to our incomes of the future to pay for the things we want today. “No interest for 12 months” and “No money down” have become hallmarks of the American way of life in the past decade as we have borrowed against our individual futures to provide greater levels of comfort for us today. In that sense, we have become like a nation of three-year-olds throwing temper tantrums, except we’re crying for flat-screen televisions, Nintendo Wiis and new cars instead of for Barbies and GI Joes. What’s worse, our elected officials have borrowed and are continuing to borrow from our children’s futures to shore up the problems we are dealing with today, all in the name of “economic stimulus.”

If that also makes you sad, it should, but before you get on your soapbox about whether Democrats or Republicans are more to blame, don’t. Collectively, they have led by example and have done an exceedingly poor job of demonstrating the virtues of prudence and public service. It has been said, and rightfully so, that Democrats like to tax and spend, and Republicans like to borrow and spend, but the problem with both of these stances is that the emphasis is always on spending. Given that our government doesn’t produce any goods or services, they spend by borrowing or taking money from the people who do. So that is where we are today, with the government’s solution to our problems resting in their ability to spend even more money they don’t have, and to encourage you to do the same.

This sounds kind of stupid, because it is. The rescue efforts of our federal government are largely focused on getting us to borrow and consume more, even at a point where the average, suffering American is praying for ways to pay down their mortgages, second mortgages and credit card balances, not looking for ways to add more debt. What makes even less sense though, is that Washington wants us to turn a blind eye to their rampant spending on earmarks and entitlement programs, and to ignore the fact that our mortgages, second mortgages and credit card balances are going to be even harder to pay down when the they inevitably raise our taxes in the future to pay for all this.

As you may have guessed, it is difficult to spend your way out of a predicament that was caused by over-spending in the first place. And while this is the essence of what the feds are attempting to do, there seems to be a slight silver lining glinting at us on the horizon – Americans don’t seem to be buying into it. Remember, in order for their plan to work, we have to borrow, borrow, borrow and then spend, spend, spend. But after years of borrowing against their homes and tapping their credit cards, the average American consumer seems to have recognized the dangerous reef below the surface in continuing to surf that ever-growing wave of stupidity tied to the borrow and spend cycle.

So what does this mean for a true economic recovery and for that much anticipated stock market rebound? One of two paths is likely at this point. The first path posits that the feds, whose appetite for spending is almost never thwarted, will find it within themselves to spend enough money to make up for the consumer’s unwillingness to do so, and in doing so, will also leverage our beloved country’s future, devalue our dollar and will cause inflation to rise to double-digit levels. What’s worse is that the artificial stimulus may cause Americans to return to their old spendy ways, with no lessons learned, doomed to repeat the same cycle until the next economic bubble bursts with possibly graver consequences.

The second path, which is healthier in the long-run though possibly more painful in the short-run, suggests that Americans will continue to reject the cheese in the government’s borrow and spend mousetrap in favor of shoring up their personal finances by paying down debt and living simpler. Slower consumer spending will certainly hamper a speedy turnaround. However, breaking the debt cycle now means we will be a financially healthier country when we inevitably come through this recession.

Given a choice between the two scenarios, we hope Americans continue to choose the healthier path even though it may take longer, because it naturally places us on a better, stronger foundation in the years ahead. After all, a couple of years of a sluggish economy and dampened stock returns seem a small price to pay for the security of our children’s futures.

Incidentally, the better solution to our problems which we alluded to in our opening paragraph, is for our government to reduce taxes or better still, eliminate income taxes in favor of a consumption tax. Consumer spending accounts for about 70% of the growth in our economy, so encouraging people and businesses to spend is helpful if you want to expand the economy. However, in contrast to the government’s plan of encouraging us to borrow more money we don’t have, lowering or eliminating taxes encourages people to spend money they have already earned. Though this process would still take time because Americans may still choose to pay down their debt before they spend, the overall economic and market recoveries would be more rapid with the government alleviating some of the tax burden from the shoulders of American workers.

- Travis W. Raish, CFA