More Investments Doesn’t Necessarily Equal A Safer Portfolio (Audio Podcast)

January 11, 2020

On this week’s podcast, Karl discusses several items to consider when building the proper investment portfolio.  Also, Karl warns investors that just because you have several different securities, that doesn’t guarantee you’re any safer.

Hey, hey. Good morning everybody. Welcome to the podcast. My name is Karl Eggerss. Thanks for joining me. We appreciate it. If you’re brand new to the show, welcome aboard, tons of ways to get the show. You can have it delivered to you.

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That’s what weed we do and we have tons of advisors at covenant to help you with that and we all have different specialties at Covenant to help you through those questions. All right, so let’s jump right into the show here and let’s do a quick recap of what happened this week.

It’s interesting when I talk to people, especially those that don’t necessarily watch the stock market every week or every minute as I do, you would think by talking to folks that the stock market is down and it’s down quite a bit.

I mean with all this impeachment in China and Iran, surely the stock market is down and yet, as late as Friday morning, we hit all time highs on the stock market, all time highs. So it isn’t even down, yet it feels that way to some and it’s kind of interesting and it’s again, because most people are focusing on the news and equate that negativity to the stock market.

The news flow in the stock market, two different animals. So on this show, we’re going to talk about a little bit about this week and then we’ll get into a couple of other things. So we saw with the tension between US, the US and Iran, we saw oil obviously jump up.

Brent went over $70 per barrel and WTI got into the mid ’60s and then by the end of the day Monday, oil actually reversed and then after being down 200 points, the Dow managed to actually end up 70 points.

So we started to see volatility pick up a little bit and then Tuesday was really the day after the bell, pretty quiet day, but after the bell, it was reported of course that Iran had launched missiles to Iraq targeting a base with US servicemen on it.

Immediately the Dow futures fell about 300 points and as we went into the evening, it was about 400. As soon as there was no casualties reported and President Trump tweeted out, “All is well.” The future’s regained every bit of the losses overnight and really, if you woke up the next morning, hadn’t watched any of that, you wouldn’t have known anything happened with the stock market.

But when that happened, gold went above $1,600 an ounce. It’s the highest level for gold actually since 2013. Oil went up about 4%, but as the day went on Tuesday, both of those things reversed and if people are bearish on the market.

In other words, they believe it’s definitely going down because there’s so much bad stuff going on, they just can’t catch a break. The bears can’t catch a break because news flow comes out like that and then immediately, buyers are there to step up and buy the dip and we’ll touch on that 400 point move in just a minute.

Wednesday, the Dow did obviously recover those losses as I mentioned and finished up 150 points on the day on Wednesday and it was up almost 300 points at one point and oil reversed … Oil actually was down 5% and that was, it’s a reminder that if we don’t have geopolitical tension as bad as people think, oil is having a tough time because of the fact that we have a lot of it and it’s all due to the fact that we have been becoming energy dependent the last few years and we’re starting to see the benefits of that.

Now, obviously if these things get worse in terms of cutting off the passageways, you’re going to see oil spike quite a bit, but we haven’t seen that yet and I believed that at the time, it was interesting because I thought this is interesting.

If Iran sends these missiles and from what I understand there was about a 15-minute warning and there were no casualties, they can go back to their people and kind of puff their chest and say, “You know what? We did retaliate.” Knowing full well that they didn’t really do any damage to the US in terms of casualties or anything else and so it was kind of like, “Okay, we’re even now.”

And that seemed to be as the week went on, it got very quiet and that’s what we saw in the market just went up and in fact on Thursday jumped another 200 points, very quiet news day finally on Thursday and then Friday, we did get the jobs report that was released, 145,000 jobs were created in December.

The estimate was for 160, so a little lighter on that and then November’s was revised down by 10,000 unemployment rates, still about three and half percent. So still a lot of people working and with that, there wasn’t, that wasn’t a employment report that really we thought would move the markets and it really didn’t.

You saw the Dow kind of went above 29,000 on Friday and then it kind of reversed back and finished down about 130 points, but not related to the jobs report I don’t believe, just probably into the week profit taking because of the fact that it was a very news-driven week and it could have gotten a lot more volatile than it was. but look, this is still a strong market and this is not about when we see episodes like this where there’s some tension, geopolitical risk, whether it’s the North Korea, remember that a year ago with North Korea and nuclear discussions or lack thereof and then in threats or this with Iran, markets will have knee-jerk reactions to this.

But it’s a great lesson that again, over the longer term, this is about the liquidity coming in the market which the fed dropping interest rates as we’ve talked about and it’s also about earnings and it’s about the economy as a whole.

All of those things are okay, right? We know the jobs market is great, we know there’s plenty of liquidity in the market and we know that while the economy could be growing faster and is still vulnerable, it’s not reassessing and so that’s what’s led to this rally and so when we get situations like what we saw earlier in the week with with Iran and then the retaliation, you’re going to get knee-jerk reactions from the equity markets and the reason why, and this is probably going to continue to get worse and worse over time is that a lot of the trading going on Wall Street is algorithmic trading.

What that means is very sophisticated programmers are programming computers to do artificial intelligence in terms of trading, but also literally seeing newswires cross and if the term US and missile is somewhere in there, sell spy, sell spyers and that’s exactly what happened.

So these aren’t humans reacting necessarily. There are some humans trading for sure, but when you get these very quick moves, this is all because of algorithms and and programmed computer trading and that’s probably going to continue to get almost worse to a certain extent.

What does that do for you and me? Well, had the market opened down 400 or 600 or 800, it would have caused a little gut punch, right? A little pit in our stomach and we would have wondered is this going to continue, but it also gives us opportunity because that knee jerk reaction is news driven and as I just said, it’s not about us killing an Iranian terrorist, that’s going to get the market to move, but what’s going to make you money over the long-term is the profits of the companies going up in the stock market and then the stock market reacts to that and goes up. That hasn’t changed because we killed somebody.

So having said that, it is an opportunity to buy in those instances, and I’m not saying day one, but I’m saying sometimes, this program trading can also be our friend just like it can be our enemy. Now, the program trading can lead to more volatility than we normally see.

You could say it could have happened in the flash crash 1.0 in 2010. You could say it happened in flash crash 2.0 in 2015 when we saw stocks open up or down, I should say 15% some of them in August of 2015 and then early in January of ’18, we saw the member of the volatility issue where the VIX spiked up and it caused a bunch of funds to blow up and it caused even more volatility.

Those are all things that are not humans saying, “I’d like to buy 100 shares of stock or sell 100 shares of stock.” This is computer programming jamming orders through and there’s a supply demand and balance and you see big, big moves and so we saw that Tuesday evening and again, a 400 point move on a Dow Jones that is approaching 29,000 is not a big move percentage wise.

A one or one and a half percent move isn’t that big of move historically, but in our minds, we still believe a 400 point move is big because 400 Dow points is 400 Dow points, that’s how our minds are programmed to think and so we don’t like to see that, but it wasn’t, still wasn’t a huge move.

It wasn’t a thousand point move in the Dow Jones which would have been maybe a 4% move or a 3% move, I should say. We didn’t see that, but we did see some volatility and it could have continued especially if there’s casualties and that’s the type of risk that’s always in the stock market which is why most of us have some balance of stocks to bonds, to real estate, to other assets, things that move differently from one another so that we can mitigate that risk over time.

But that, just keep in mind, the program trading and some of the wild swings we see are usually computer-driven and they may add to the volatility. So especially as we get into the election, you could see more of that.

We never know what’s going to be the news event that’s going to cause the Dow Jones or any of their market to to jump or sell off as much as it does. Now, we get all this bad news and I ran across an article this week and I thought, “You know what? This is a really good time to share some of this information.”

You’d think about your parents, your grandparents, maybe you telling your kids things have never been this bad, boy, back in my day things were so much better. There was an article that came out this week, Morgan Housel who’s written some good stuff.

He had some … Actually, the title of the article was it’s a … 2020, what a time to be alive and it caught my attention. Listen to some of these stats and I’ve actually mentioned some other things in past podcast that don’t get talked about enough, but we are living in a great time.

In 1981, the auto fatality rate was 21 and a half per 100,000 people. In 2018, it was 11.18 so half as many fatalities in 2018 as we saw in 1981 due to the safety of cars, seat belts became a requirement, airbags, all of that, right? Very important.

How about inflation? You hear about inflation. Do you know the five years prior to 1981? So 1975 to 1980, inflation, the cumulative number, say it’s 5% a year, that’d be 25%, that number, the cumulative inflation was more in those five years than the cumulative inflation in the 25 years before 2020.

Think about that. We’ve had very low inflation. Now we’ve had pockets of inflation, obviously medical costs and things like that, but pound for pound, inflation is much lower than it was in the ’70s great for us.

The homicide rate was just over 10 per 100,000 Americans in 1981. Five in 2018 so that means 16,000 fewer Americans were murdered last year than would have been had the rate not improved during most of our lifetimes.

This is a big one too, infant mortality rate. It’s fallen by 54% since 1981. Average miles per gallon for cars, about 15 in 1981, about 22 in 2017 and that’s going to continue to go up. We know that as well. Adjusted for inflation, the median personal income, this isn’t talked about enough.

The median personal income has increased from 22,682 in 1981 to 33,706 in ’18. Now remember, you’re going to, you may say, “Oh yeah, over time, doesn’t stuff go up?” This is adjusted for inflation, so Americans have become almost 50% richer, pound for pound in 2018 than they were in 1981.

In the 10 years prior to 1981, almost 26,000 people died in commercial aviation accidents. In the 10 years from ’09 to 2019, only 9,000. Amazing. The number of cigarettes smoked in the US peaked in 1981 at 640 billion cigarettes.

By 2017, it was 249 billion and falling. Now, I would like to see how many of those people are vaping now, but that’s a whole another story. Heart disease deaths have declined from over 400 per hundred thousand Americans in 1981 to just 168 per 100,000 by 2015.

Had there not been any improvements, that means there’s 754,000 more people living that would have died from heart disease if we were back in 1981. How about this? IBM sold its first PC, 1981 it’s 5150 PC for $1,550, but adjusted for inflation, it was $4,400.

Imagine paying $4,400 for a computer today and by the way, it was Morgan Housel says it was pretty much useless. Pretty much useless. Now, that same amount of money can buy a Chromebook for every student in an average middle school class.

It’s just amazing and the last one is dementia rates have fallen 44% since the early 1980s and that’s just some things, I mean there’s a ton of these types of statistics out there.

When you hear the news and you watch news, I actually temper my news watching because it’s all negative. Every bit of it is negative and so stand back for a minute and think when you can tell your lights to turn on in another room and they do it and you can have a heated steering wheel or heated seats or air-conditioning seats in your car, if you can just have air conditioner in your car or in your house, I mean we’re living in some pretty good times.

So just wanted to cheer you up a bit after all the negative news we saw this week. Now, I want to move onto one more topic and it is I met with a gentleman this week and had a good amount for save for retirement and really wasn’t the question of, “Can this money last?” But what’s the best way? What’s the optimal way to manage the money?

And as I was looking over the statements from another broker child that will remain nameless, the gentleman had at least, at least 50 different mutual funds, if not, 75. Multiple accounts, multiple mutual funds and I said, “Well, tell me about your experience in terms of, of risk.”

He said, “I have no idea. I have no idea what we own. I don’t get … I get the statements but I don’t get any explanation. I don’t know why we own certain things. There’s always movement going on.”

Well you guys know that, I don’t know what the average mutual fund owns in terms of the number of holdings, but it could be 300, 400 different stocks. You multiply that times the number of mutual funds over diversification and the lesson is just because you own more does not mean you’re safer and I explained that to him and then looked at it and said, “By the way, this is almost all stocks. It’s not a balanced portfolio even.”

When you have that many positions and you don’t have some type of software to analyze it, to figure out where your holes are, where you’re exposed too much or too little, it’s a problem.

So we’re running through that analysis right now, but I could look at it in five minutes and tell him kind of where some of those holes were, but we’re going to do some in depth analysis to figure out, “Is he exposed too much to the stock market? Number two, does he have enough international for example? How much large cap growth versus small cap value does he have? Is he going to get hit if the dollar falls? Is he going to be hurt if interest rates rise too much?”

Even if I didn’t change his risk, I could simplify his life tremendously because he can accomplish the same thing that he’s getting right now with probably 10% of the securities. So if you own a lot of different things, don’t believe just because you have all those different things that you’re safer.

I think 2008 was a fantastic lesson for that that what’s real diversification versus fake diversification. Fake diversification is simply I own a lot of things, therefore I’m diversified.

Well, in 2008, when the correlation goes to one meaning, stock market falls and everything else goes with it, you’re exposed to see what is … Well, how are you really diversified?

And nowadays, because we had 2008 as a reference point, I can put in my computer, in our software, do our analysis. I can look back and stress test the portfolio to see what would have done in 2008 and then where are some of the holes and that’s what we do.

We do stress tests on portfolios to get an optimal portfolio because again, people that had just a simple portfolio of stocks and bonds in 2008 had a very, very tough time. Owning just a large cap value and small cap growth and those types of things and that’s it, they’re all going to move together when there’s panic in the streets and there is a real sell off.

We’ve had sharp sell-offs in the last couple of years, but they’ve recovered very quickly. We haven’t seen a sell-off that stays down there for a while and maybe gets worse and lasts even longer.

It will happen at some point for some reason. So really diversifying is making sure you own things that do have the ability to move differently from something else in the portfolio and that you have enough income and so forth.

That’s where we need to get that gentleman and it does also really start with what does he need to earn to accomplish what he wants. What’s really fascinating, kind of the second part of meeting him, what was really fascinating was when I said, “Based on what’s your spending and if this portfolio is balanced and continues to grow, you’re going to end up with more money than what’s sitting here right now. What do you plan on doing with that? Are you going to give that to your kids?”

“No, my kids are … They make a lot more money than than I ever did. I don’t want to leave it to them.” “Well, do you want to leave it to charity?” “I don’t think so.” “Well, what are you going to do with it? Because if you don’t do anything, your kids are probably going to get it.”

So we had that discussion and that’s something we’re talking through and we’re going to help him with those legacy goals, maybe philanthropic goals and develop those goals and then help him execute that the best way, in the most tax efficient way possible.

So hope that’s helpful to you. Hey, have a wonderful weekend everybody. Don’t forget, and the telephone number 210-526-0057. Hey, have a great weekend. Be careful out there and I’ll see you back here next week.

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