Give The People What They Want

This article was originally published on on January 23rd at 9:00am EDT

In addition to founding the Barnum & Bailey Circus, P.T. Barnum is also famous for vocalizing some harsh truths, like “A sucker is born every minute,” and “Give the people what they want and they will give you what you want” (where what you want is their money). Barnum was part entertainer and part politician, but in reality all of his efforts were meant to “put money in his own coffers,” as he publicly professed.

The strategy of giving people what they want can work well at a circus, but in the wealth management business it could be a recipe for long-term underperformance and dissatisfied clients.

How can giving clients what they want result in them being dissatisfied?

Clients are unlikely to admit this but part of the reason they hire an advisor—or a team of advisors—is to keep them from making poor decisions, and also serve as a sounding board for the good ones.

The challenge in managing money is that the most successful long-term strategies often involve not only preventing clients from getting what they think they want, but also giving them things they don’t want. Naturally, I’m talking about short term investment ideas and not the level of respect and attention with which clients ought to be treated.

Unpopular Ideas Get Bullied

Six months ago we recommended investors consider lightening up on their US Equity exposure and instead seek out better values abroad, Europe specifically. At the same time we suggested long-dated US Treasury Bonds might outperform equities for the duration of 2014. This was not a popular recommendation at the time—our domestic stock markets were hitting new highs week after week and not too many were seeing further upside in the 30-year Treasury Bond, especially with the culmination of QE fast approaching.

So far we have been wrong about European stocks outperforming our own—the Vanguard European Index Fund (VGK) is down about 9% over the past six months, while the S&P 500 (SPY) is up about 4% on a total return basis. But the long-dated Treasury Bond, as represented by iShares 20+ Year Treasury Bond Index (TLT), is up 18% over the same time period.

What did “the people” want six months ago? They wanted US large cap stocks, they wanted floating rate senior loan funds (like BKLN & SRLN) to take advantage of invariably rising rates, and they wanted nothing to do with bonds for the same reason—especially not the highly-interest-rate sensitive long end of the curve.

As we mentioned above, US large cap stocks (SPY) have not been a money loser, though also not a huge winner. As interest rate movements have flummoxed the majority and proceeded lower still, long-dated bonds have shot through the roof while floating rate funds have suffered, albeit slightly, in conjunction.

Now, just because an idea is unpopular does not make it a good one.

Today we are hearing about all the dangers lurking in the energy sector, the high yield market (due to anticipated further weakness in the energy sector), and—even today—how Europe’s QE program is certain to come up lame.

What do “the people” want?

More US large cap stocks, with no exposure to energy or high yield. And in a world with increasing uncertainty, it seems small cap stocks should be shunned (small = risky) and the smart thing to do is to avoid having anything un-American in your portfolio. Or your Twitter feed.

We have made the argument here before that, in addition to being fairly valued by pretty much any historical metric, US large cap stocks face significant headwinds courtesy of the strong dollar. We are starting to see material impact to big companies’ bottom lines—American Express (AXP), McDonald’s (MCD), and International Business Machine (IBM) are three Dow Components that have attributed earnings weakness to currency volatility (i.e. a strong dollar).

Small companies (generally this means market capitalization under $2 billion) do much less, if any, of their business overseas. As such, there is very little to worry about from a currency standpoint. Consider either the Vanguard Small-Cap ETF (VB) or iShares Russell 2000 (IWM) for broad-based exposure to a stronger, and still strengthening, US economy.

In regards to the ECB’s bond-buying program announced today, it was argued by bears that it would be unlikely to have the desired effects. The desired effects being a pickup in loan issuance, higher asset prices (inflation), and ultimately lower unemployment.

The same exact arguments were made about our own easing initiatives here in the US six years ago. Those arguments have been proven wrong over and over, and investors who followed the doomsayers have been robbed. In addition to the open-ended bond buying program, Europe has added fuel to the fire in the form of cheaper oil—for now, anyway. The benefits to European companies and consumers could be enormous as the EU uses 18 million barrels a day, and produces less than 4 million. We own the Vanguard FTSE Europe Index (VGK), which also sports a generous 4.5% yield.

Lastly, despite the past three months having been a challenge, we have lost no confidence in the Master Limited Partnership space and their place in client portfolios. We have maintained, if not increased our allocations to this asset class during the recent energy sell-off, averaging in when necessary at lower prices. MLPs are an infrastructure and demand play; demand for the product (oil, gasoline, natural gas, propane, etc.) does not drop with lower prices. Quite the opposite.

We don’t think it will be long before the market takes its foot off the MLPs’ neck. But the opportunity is now and not later… Consider buying the JPMorgan Alerian MLP index (AMJ) for tax-deferred accounts or individual names like Enterprise Products Partners (EPD), Ferrellgas Partners (FGP), Oneok Partners (OKS), Plains All-American Partners (PAA), and Williams Partners (WPZ) for taxable accounts that don’t mind a K-1. The names listed above represent a very diversified cross-section of the space, with exposure to oil, natural gas, and propane, and also exposure to both midstream and terminal/storage assets.

In investment management, we must look beyond both positive and negative headlines. Remember that anything appearing in the headlines has already been priced into the stock, sector, or fund. That means the most favorable entry points often coincide with the scariest headlines. And vice versa.

As advisors, our job is not to “give the people what they want,” but to make sure they get what they need….

If you have questions or would like to engage in a dialogue, please don’t hesitate to give us a call.

Adam B. Scott
Argyle Capital Partners, LLC
10100 Santa Monica Blvd, #300
Los Angeles, CA 90067
(310) 772-2201 – Main

Adam Scott’s profile on RealMoney can be found here.

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