Please Note: Market opinions contained herein are intended as general observations and are not intended as specific investment advice.
MATHIAS: Right now we’re sitting in the financial capital of the world. It’s no longer New York, it’s Washington: the Fed, Treasury, stimulus package, government stakes in GM and AIG. A a year ago all this would have been unthinkable. How do you think the administration is handling the current crisis?
VON LIPSEY: My dad started off as a fireman, and I remember the saying, “You don’t worry about water damage when there’s a four-alarm fire.” To that end, I think the administration has done a darned good job. Things could have been done better at the margins, but let’s make sure this fire is out before we focus on water damage.
KENNEDY: The Bush Administration did what they needed to do in September, but now, a half-year later, there remains a great deal of uncertainty about the government’s evolving role.
LEDYARD: We can expect a flood of U.S. dollars to dampen this fire, but higher taxes are coming down the road, especially for our higher net-worth clients, and that’s going to be a large bill to pay.
EDELMAN: It’s helpful to remember that less than a year ago we were faced with predictions of $200-a-barrel oil. We feared the breakdown of our banking system, the collapse of the dollar, and 25 percent unemployment. Today nobody talks about financial Armageddon; we’re just asking how long this recession will last. We all acknowledge that the financial regulatory environment needs to be re-evaluated, but I think that if the administration stays on course, in 20 years we’ll look back on 2008 the same way we look back on 1987.
LEDYARD: People understand risk much better today than they did a year ago, and they’re more humble, and more open to the idea that bonds and cash can be attractive asset classes. The principles of a diversified asset allocation in your portfolio apply today more than ever.
VON LIPSEY: That said, I think investors are wary of traditional portfolio theory, because when volatility spiked last year we saw poor performance in almost every area. All of a sudden asset allocation models, which work in the long term, didn’t work; and investors wanted to know why.
EDELMAN: We need to avoid the temptation to draw conclusions in this environment. This is an aberration, and the key is to re-balance through this market and maintain a long-term perspective. On a personal level, our clients’ concerns have morphed over the past nine months, from panic to anger. Right now everybody’s angry at everyone else. They’re angry at the government, at Wall Street, at the mortgage industry, at all the consumers who got loans they couldn’t afford. It’s been an emotional time for everybody.
KENNEDY: Part of the problem is that greed and short-term thinking got in the way. No one likes to sell a winner, and then, when the bottom fell out, no one wanted to sell a loser, either.
VON LIPSEY: Our ultra-high-net-worth clients are very concerned with their legacies, because they view their assets as a means, and not just as an end. Obviously people misjudged their own tolerance for risk, but going forward they’re concerned with transparency, accountability, and liquidity.
EDELMAN: Whether they have $3 million or $300 million, the real question is, “Am I still on track to achieve my goals?” Whether it’s legacy or retirement or sending kids to college: am I still on track despite this maelstrom that we’ve been through?
KENNEDY: The risk tolerance has changed. People who used to keep three years in cash have gone to five. Other clients are “mothballing” their planes. One family office chief financial officer told me that after analyzing expenses, she realized they were spending $3,200 in plant watering. Now she waters the plants.
EDELMAN: Clients are reducing spending and increasing liquidity, so that hopefully they won’t need to turn to their investments to pay the bills, because nobody wants to sell stocks that are down 40 percent. People who believed that credit cards and home equity could replace cash as a source of liquidity now realize that doesn’t work.
VON LIPSEY: The American economy remains tremendously leveraged, and people were saving at a negative pace, so for us to move to a new paradigm that involves savings will have a substantial effect on the path to recovery.
MATHIAS: Have we seen the end of tax-driven off-shore investment strategies?
LEDYARD: We’re going to continue to see current techniques become less attractive, such as the recent corporate off-shore program the Obama Administration announced, but attorneys are extremely intelligent, and new techniques are going to pop up. For pure asset protection, there are just as many on-shore opportunities as off-shore. On the tax side, however, there are plans to hire 800 new IRS agents, so we are going to see greater enforcement and more audits.
MATHIAS: So for a hypothetical investor with $5 million to grow over the long term, how, in general terms, would do you advise that person to allocate right now?
KENNEDY: We’re currently over-weight emerging markets and commodities, particularly gold, as well as high yield. We funded our over-weight to high yield with proceeds from large cap stocks, deciding that in this environment it was better to take the money for high-yield out of equity, not debt.
EDELMAN: If a client came to me and said, how much should I have in equity; my answer would be, less than you want, but more than you’re comfortable with. When people make financial decisions, they tend to emphasize emotion over intellect; today, the dominant emotion is fear, which is causing people to be less aggressive than they should be. We’re generally 10 to 15 percent international, and larger on value than growth. Firm-wide, we’re maybe 60/40 value. A lot of folks traditionally were 50/50.
LEDYARD: We’re emphasizing emerging markets in more commodity-based countries, like Brazil. We also have a real assets category which focuses on commodities, T.I.P.S. (Treasury Inflation Protected Securities), and private real estate, all of which move in lock-step with inflation. So when inflation does come back, these will hoprefully serve as protection. Lately, we’ve also been stressing municipal bonds, because they’ve been yielding four to six percent, tax free. So pre-tax, the return is about eight percent. Corporate bonds have been yielding anywhere from 10 to 12 percent, but that’s a little riskier.
VON LIPSEY: Bonds of financial institutions, whether government backed or the new non- government backed, gave us a nice pick up in yield. On the tax-free side we like ultra-short duration municipal bond mutual funds or instru- ments based on variable rate demand notes.
MATHIAS: It’s possible right now to buy almost anything on the stock market; for example, if you want natural gas or gold, you can buy them as Exchange Traded Funds. That’s a major structural change, that’s allowing people to take advantage of different asset classes around the world. What’s the interest level in international equity and debt among your U.S. clients?
VON LIPSEY: There is an anticipation of a weaker dollar against major currencies, which of course, may favor the international equities markets. Globally, we are slightly under-weight to the U.S. and Japan in favor of economies in the Euro zone, given current valuations.
EDELMAN: When you hear about foreign investments suddenly up 80 percent one year, there are bound to be questions. That’s not going to happen to the Dow. We’ve found that currency fluctuations raise questions, but not necessarily desire.
LEDYARD: We’ve been globalizing our clients for ten years, and we’re still at it. Consider this: today, the U.S. has about 44 percent of the world’s GDP, but it’s estimated that by 2020 we’ll have less than half of that.
EDELMAN: We all say that China has a billion people, but they actually have 1.3 billion. But we never say 1.3. It’s easier to say one. Well, the .3 is still there, and it’s equal to the total population of the United States.
MATHIAS: Shifting from the global to the local, of particular significance to our readers is the residential real estate market. Is now a good time to buy a house in the Washington area?
EDELMAN: This is the strongest real estate market in the country, and the biggest, most recession-resistant city for real estate. So yes, it’s a good time. It just comes down to whether you can get credit and you can afford it.
MATHIAS: How much of an energy exposure should your clients have right now?
LEDYARD: You’ve got to have some exposure to energy, but last year a lot of people were whipsawed by green technology stocks. Once oil dropped back below $50 a barrel, many of those companies were simply wiped out. I think what you’re going to see in green tech is very similar to the Internet bubble. All these small companies came up with great ideas, then the bubble burst and the big companies came in and gobbled them up for their technology.
VON LIPSEY: Energy is an area of tremendous tactical interest to us. We’re looking for oil price weakness to present a long-term investment entry point in the market; some energy-related limited partnerships remain attractive, especially those that don’t have pure commodity exposure, and could benefit from the re-building of U.S. energy infrastructure.
MATHIAS: Now for a fun question: What’ s the most ridiculous hype you’ve heard recently?
EDELMAN: In January, I got a flurry of emails from listeners to my radio show, all saying that on February 12, the dollar would become worthless.
VON LIPSEY: I almost fell out of my chair at the barbershop when a TV commercial came on and said that ‘experts’ predict that gold will be $3,000 an ounce.
MATHIAS: On the flip side, what indicators are you watching most closely right now.
KENNEDY: We are also keenly focused on government bond yields and credit spreads as a barometer of the unfolding economic recovery.
EDELMAN: It would be hard for me to pick one. Take for example the Volatility Index. Nobody ever paid attention to that until recently, and then suddenly it became a big issue.
VON LIPSEY: We should all should look at the change in unemployment, because when we see a deceleration, that tells us that the economy has reached an inflection point. In the meantime, I can give you a Washington indicator: Thursday evening restaurant crowds.
MATHIAS: Do you think the flight to quality is permanent? That is, do you think that investors will continue to apply high allocations to “safer” investments for a few years, then return to derivatives and junk; or is the shift more permanent?
KENNEDY: Human psychology doesn’t change much. When I have a one percent yield, and someone else is earning ten percent in the market, I will generally move my money. People are already starting to pull out of cash and go back into the market.
VON LIPSEY: At this juncture, we have a responsibility to remind our clients about what we’ve just experienced, and to temper enthusiasm for “chasing the market,” because we all tend to have very short memories.
EDELMAN: Which is why bond buyers are notoriously unhappy people. It’s just the way it is. They are either unhappy with the value of the bond, or unhappy with the yield of the bond.
LEDYARD: At the end of the day, despite all the quantitative analysis and qualitative advice, human beings tend to buy on emotion.
EDELMAN: Which is why, ultimately, our job really isn’t managing the money. What we are really paid to do is help the client always do what is in their best interests, even sometimes despite themselves.