SANDCASTLES, AVALANCHES AND LANDSLIDES

By Richard Crum, CFP®

Among my more vivid childhood memories are beaches, sandcastles and plastic shovels. I guess we could add in my sense of frustration and incompletion as well. They are not altogether fond memories. I will try to explain why, but before doing so you may be wondering what any of this has to do with taking care of people's money. Give me a second. I'll try to connect the dots.

First, I must tell you about my friend Jim and a remark he made to me the other day that initiated this whole line of thought. He said he never recalled a time in his economic memory where he felt as uncertain about his or our nation's future. He did not know whether our next direction would be up or down, nor did he have even an inkling about any investment he himself might consider. He did not know whether to charge, retreat or hold his ground.

By the way, Jim is no novice. He is financially astute and has followed financial and real estate markets for over thirty years. He is a prodigious reader and devours virtually all forms of global economic reports. He is both an analyst and a seer. I would also regard him as a savant of sorts.  He has accumulated a modest fortune for himself, by himself, and has been quite generously retired for awhile now. Seldom is he indecisive or short of opinions.
 
And so, you may be wondering, what does any of this have to do with sandcastles?

Well, to start with, I never recall building a single sandcastle that did not ultimately self destruct. And, it never seemed to be the result of my engineering capacity or lack thereof. Perhaps it is why I added frustration and incompletion into my descriptive vocabulary above. You see all of a sudden, for some inexplicable reason, with the addition of what seemed to be just one single added grain of sand; the whole thing would tumble downward. Alas, my castle would collapse. My work was incomplete yet, unbeknownst to me then, I had just learned one of my more vivid money management lessons. Some things are simply unknowable . For that then, thank you, beach.

In today's financial world our sandcastles are assembled with debt, not of sand. There is corporate debt, municipal debt, federal debt, foreign debt, homeowner debt and a legion of credit card debt. Every single person and every single entity seems to owe a whole lot to a whole bunch of people and God-forbid should there be a card pulled from the stack .

Avalanches, landslides and collapsing sandcastles all have a single thing in common. Each action is precipitated by a single, seemingly random, occurrence or addition. Think of the fall of Lehman Brothers in September 2008 as the event (grain of sand) that led the nation and entire world into a downward spiral to the edge of economic collapse.

There is way too much owed by too many people to too many institutions and government bodies worldwide. The threat of default, at some or many levels is not only possible, it is highly probable. Quantifying the psychological fallout from a sovereign nation's default is not even measurable. So, the questions remain. When will the dominoes fall and how many will there be? How much destruction might any given avalanche cause? What caused my sandcastle to tumble?

This mountain of debt places each of us atop a most precarious footing and we all wish that there was someone, somewhere, who we could rely on to both understand and stabilize things. Unfortunately, our reckoning is that even our most prestigious of central bankers and global economists do not and cannot, respectively. Their remedies and offerings are made with a smile on their face while having their fingers remain firmly crossed behind their respective backs.

This, in my opinion, is why Jim is uncertain. Perhaps he's just built more than his share of sand castles in his day.

IT'S YOUR MONEY AND WE'RE
STICKING WITH WHAT GOT US HERE

How might any of this affect your personal asset values? We know the stock market has had a pretty nice nine months of recovery. So, in the days immediately ahead will we continue along this positive path? Or, will economic events cause us to retreat from here and revisit those scary market lows of March 2009? Is the next move up or down? And, quite separately, have we touched the bottom of this real estate market yet or will the next round of mortgage debt and foreclosures lead to yet another landslide? Will there be inflation or deflation and, accordingly, how should we posture our investment holdings? Those are the questions.

We feel we better serve you by refraining from the guess and, rather, maintaining our poise and balance. We want to be in a position to adjust to any change that might present itself. We believe we should stick with our game plan of managing the risk in your account while allowing the overall framework of investment diversification (spread) to carry the day. We will avoid making any heavy bet on any single situation, likelihood or occurrence. Our system is what got us here and we are quite comfortable staying within it.

OUR LIKES

We are pretty well convinced that the world's demographics (the decade long stream of the world's population that will be reaching retirement age) will present a strong demand for investments that pay dependable levels of income. Every retiree will seek to supplement income to support his or her requisite lifestyle. The alternatives of working longer or depleting remaining capital are far less desirable.

It is in this context that we have placed a heavy emphasis on income generating investments in your holdings. For example, we favor certain master limited partnerships, especially those specializing in pipelines supplying natural gas and other energy needs across the U.S. They pay out high levels of income while their business models are pretty simple and the demand for their services quite high. We also favor certain utilities that provide essential services nationwide for the same reasons. They too offer attractive payouts. There are quite a number of other companies in your portfolio that fit a similar context.

When one contrasts this level of income with today's market realities where safe alternatives such as money market funds, U.S. Treasury Bills, Bank savings and CD's pay less than 1% per year, the future demand for what we own becomes more obvious and robust.

If so, we may well come to find that we are doubly rewarded with higher income and appreciation in the value of these holdings.

OUR DISLIKES

As you have surmised, we are afraid of too much debt suffocating a given entity and leading to both default and bankruptcy. From an investor's point of view, it's pretty fruitless to hope to recover much of one's investment given this eventuality.

It is with this in mind that we're nervous about nations, municipalities and corporations that simply owe too much with too little reserve. Our burgeoning national debt here in the U.S. is a topic of grave concern, yet we find that it is still relatively low compared with that of other premiere economies such as China and Japan (the second and third largest in the world). Japan's debt ratio, for example, is nearly four times that of ours while their economy labors to pay for its mounting obligations.

Meanwhile, many of the Euro stalwarts are equally bad or worse as their economies teeter as well. Greece, for example, is on the verge of default while Spain and Italy are about as bankrupt as a country can get. Will there be a default of a Sovereign nation? And if so, what might the ramifications be? One can only guess. We do know that we have steadily deemphasized foreign securities for quite awhile now. We are avoiding both the Euro and the Yen and believe these currencies and economic systems will garner their fair share of negative headlines in the months ahead.

We are also choosing to deemphasize certain overburdened U.S. states such as New York and California. Ultimately, their finances are tapped out and they will find themselves at the mercy of federal government's largess. We're not quite sure what the national appetite is for that debt right now and how any of this might work itself out, but some of the result will be none too pretty. We would rather not be among their creditors for the time being.

Too much debt is the world's premiere economic problem. It negatively affects everything. It is tough, relentless and unforgiving. So, to the degree we can sidestep likelihoods of default we will do so. In the meantime we would rather cast our lot (and your money) with known demographic trends and into areas that we perceive to be safer havens.

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