Leaving Little to Chance

On the list of past predictions about the future that came true, one often rises to the top because of its relevance today. In a 1909 interview with the New York Times, inventor Nikola Tesla said, “It will soon be possible to transmit wireless messages all over the world so simply that any individual can own and operate his own apparatus.”

The development of wireless communications revitalized a stagnant telecom industry in the 1990s. Today, mobile phones and wireless communications are the norm. Of course, it took more than eighty years for Tesla’s prognostication to come true. Soon, in this case, meant decades, not years. But that is the problem with many predictions—it’s not so much a matter of if they will come true, it’s when.

There is little difference between December 31 and January 1, the end of one year and the beginning of another. After all, it is just one more day. But each new year brings with it a host of new predictions from everyone with a platform. This is especially true with people associated with the stock market, the economy, and those with vested interests in the fields of technology and business.

Back in my mutual fund days, we used to play a game. At Christmastime each year, the portfolio managers would make predictions about what the new year would bring. They would try to predict which companies and industries would perform the best, where the stock market would end, and what direction interest rates would trend. Then they’d tuck away their predictions, revealing them at Christmastime the following year. Some predictions happened quickly, some not at all, and some, now with the benefit of hindsight, only came to pass many years later. But we always had a big laugh about how many unexpected things happened—things we never could have imagined.

As we look forward to 2022, there are countless predictions about how much interest rates will rise, whether the economy will grow, if the Fed will get inflation under control and how well we will get along with some of the bigger bullies on the block, namely Russia and China. Especially with investments, relying too heavily on near-term predictions often leads to disappointment. Even though we know interest rates are likely to rise, the economy is likely to grow, and inflation is likely to shrink, we can’t know how soon or by how much. And perhaps most importantly, investing based on hoped-for outcomes with economic conditions that are beyond our control doesn’t put an investor in a position of strength.

The wiser approach to investing is to take a longer view. In that sense, there are some themes we think are likely to drive future growth in the economy and long-term returns in the stock market. In transportation, electric vehicles are becoming mainstream especially as more manufacturers enter the market. In communications, companies are making it easier and safer for us to stay informed and connected. In healthcare, precision medicine is making treatments more specific, safer and less costly. In banking, protocols for transferring money faster and more securely are giving a stodgy industry new life. These are just a few examples, but taking a long view allows us to ponder and profit by the astonishing achievements of industrious people.

We cannot know what this year will bring. We cannot control what the Fed or Congress will do. But we can buy exceptional companies managed by smart people, companies that offer products and services that are necessary and desirable, companies that don’t just survive economic turmoil, they thrive in the wake of it. By investing this way, we control what we can, leaving as little as possible to chance.

Around the Tree

I came to Atlanta from Boston 16 years ago. I still get the comment, “you aren’t from around here, are you?” because I have a Boston accent—I work hard to hide it, but it still comes through sometimes. When I arrived in 2005, I noticed how many of my neighbors had also relocated from other cities to Atlanta. Now, I feel more like a native while Northerners keep coming down. I love the weather here and the friendliness of the people. I have raised my kids here, and this past spring, my youngest, Jack, will graduate from SMU in Dallas.

I met Travis at a CFA Society Atlanta event almost ten years ago. We stayed in touch and in October, I joined him at Circa Capital. For the last 20 years, I have been helping families preserve wealth and generate income through the use of equity options—investments that allow you to buy or sell a security for a specific period of time. Some clients work at a company their entire career and acquire a large amount of stock. I help these clients manage their concentrated stock, applying special techniques to help them reduce risk or generate income.

In addition to my work with clients, I am also very committed to helping young adults achieve financial literacy, so they can start their working lives with a plan. I believe all of us in the finance industry owe it to our communities to pass along our knowledge and experience, giving the next generation of investors the skills they need to succeed.

When I think about the Circa Capital motto, “Growing and Preserving Wealth,” I believe James’ and my backgrounds align more with Preserving wealth, while Travis’ expertise is more aligned with Growing wealth. All three of us are familiar with the markets and I am excited that we can bring a tremendous amount of experience and energy to helping our clients.

As we get into December, we look back on the year that has been, even as we look forward to the holiday season and the new year. Twenty twenty-one has been another year filled with the challenges of COVID. Even so, the markets were stronger than their historic average, increasing 24% year-to-date through November.

Perhaps a surprise to everyone, the most successful sector year-to-date was energy and the least successful was consumer staples. This highlights how difficult it is to predict what will work and what won’t. It also supports our decision to be balanced across sectors, and this year, that strategy has certainly worked.

There are a lot of reasons to celebrate for those with a well-balanced portfolio. GDP is growing and unemployment is declining. Of course, there are areas of concern also—inflation, stimulus politics, and the central banks. There will always be areas to watch and opportunities that present themselves to long-term investors.

“It’s not what’s under the Christmas tree that matters, but who’s around it.” ~ Charlie Brown

Last month, I experienced the wedding of my daughter, Meghan, in Houston. She is the oldest of my kids and the first to be married. It was a very exciting time for our family, and everyone there seemed so happy to be celebrating after such a long time away from each other. It really feels like we are starting to appreciate who we have with us, and enjoy the moments!

There is a lot to be thankful for as we end 2021. The new year will be here quickly and we hope you and your family can stop, enjoy and celebrate the season.

~ Steve Davenport, CFA

Giving Thanks

I have heard it cynically said that one of the quickest and easiest ways to make a lot of money is to borrow it and not pay it back. Regrettably, loaning money, like investing in stocks, entails risk. But unlike a stockholder who enjoys ownership in a company, a bondholder is a lender to a company, and therefore has a higher priority than stockholders for a claim on a company’s assets.

When a company borrows money, it often issues bonds that typically fall within the category of corporate debt. Many factors determine the cost of that debt to the company. The bondholder receives interest and expects to receive the principal they gave the company when the bond matures. Bonds don’t often provide the growth of stocks, but they deliver a relatively safer source of total return and offer the potential for capital preservation.

Another potential benefit of bonds is diversification. Given their dissimilar responses to market events, stocks and bonds have a lower correlation and, therefore, can be complementary. Stocks are the riskier of the two asset classes, and they tend to be more volatile. While bonds usually offer a smaller return, that return may be more stable. Treasury bonds offer a reliably lower correlation to stocks than corporate bonds and have the added benefit of no state and local taxes, no credit risk, no liquidity risk and no default risk relative to corporate debt.

We believe an allocation to bonds (via ETFs and mutual funds) in a diversified portfolio is essential to reducing risk and volatility and preserving capital. We believe these allocations should emphasize U.S. Treasuries, high quality tax-efficient municipal bonds and high-quality corporate bonds—principally investments with a low probability of default.

As a new member of the team, I would like to express my genuine appreciation for the trust you place in Travis, Steve and me, to oversee your hard-earned capital. As a New Englander, as a CPA and as a former corporate bond research analyst, I am guided by the principles of conservatism and pragmatism in my role. To me, this means striving to preserve the capital that you worked so hard to attain, by investing in the highest quality bonds we have available. With historically low interest rates, growing inflationary pressures and a rapidly changing economy, it is our belief that a focus on the preservation of capital and purchasing power is imperative.

Collectively, we continue to strengthen Circa Capital in various ways, including the recent acquisition of a Professional Liability (Errors & Omission Insurance) Policy. Despite it not being required for advisory firms, we deemed this level of protection indispensable, considering what you have entrusted us with. Our belief is that the quality of our operations must be consistent with the quality of the investments and strategies we recommend and use for clients.

It is our sincerest wish that you all get to enjoy time with family and friends over the coming Thanksgiving Holiday. The past twenty months may have been challenging for all of us, but perhaps that will strengthen our appreciation for the most important things in life, and things we may have previously taken for granted.

~ James Callahan, CPA, CFA

A Trope This Side Of Hollywood

You slump onto the couch as you kick off your shoes. It’s been a long week and you realize the sigh has been leaking out of your lungs ever since you walked through the door. Fortunately, the remote is exactly where it should be—one couch cushion over. In seconds, you feel the cool plastic warming in your palm, the screen warming to the red “N” of Netflix.

It’s October. On the way into the neighborhood, you passed your neighbor—the one who’s already turned their home into a cobweb-covered haunted mansion replete with tombstones on the lawn and a giant spider climbing up the chimney. Maybe I’ll do that next year, you think, knowing you’ll be lucky to carve a pumpkin by the 31st. Still, the mood is set, Halloween is in the air and you settle on watching something spooky.

Before long, the teenagers in the B-flick you picked are partying at a lake house with no adults in sight. The kids hear a noise outside. “Where’s Fluffy?” the bubbly cheerleader says to the high school quarterback when she realizes the family dog has gone missing. “Probably ran off with a werewolf,” the class clown says in his mockingly macabre voice. Then he walks out the door to look for the dog, entering the darkened forest alone.

Moments later, the kids shudder at a scream from the woods and it’s then that you get up to make yourself some popcorn because even though you’ve never seen the film before, you already know what’s going to happen next. The teens will split up. The girl-next-door will look for the class clown in the forest. The now not-so-bubbly cheerleader will go to the toolshed. The bookishly handsome nerd will go to the boathouse. The quarterback, saying he’s going to look for a phone, will slink into the basement to hide. And of course, with logic and reason thrown out the window, bad things start to happen.

You know this is what will happen because that’s what always happens to teens in horror flicks. These are the tropes of the horror genre. We expect and recognize them because the situations and outcomes are predictable. And moviemakers know certain tropes attract moviegoers which is always a recipe for success.

Beyond books and movies, tropes exist elsewhere. And some professions, like financial services, are even built on them. Recognizable patterns don’t allow us to predict the future, but we can follow them to deliver highly probable outcomes. And because markets, industries and economies all move in cycles, we can know certain things about what’s likely to happen in the future, just by studying the past.

* chart courtesy of multpl.com

The 1970s were marked by high inflation, a spiraling and disastrous condition for an economy. Americans then watched as the cost of everything from gas to food to housing to healthcare rose faster than their incomes. And when businesses could not pass along the rising costs of their supplies to consumers, they had a choice—lay off workers or go bankrupt. Most chose the former. Unemployment rose. Businesses produced fewer goods. There were more shortages, rising prices and even higher inflation; the vicious cycle continued.

We are in a similar situation today. To their credit, Washington politicians acted quickly when Covid hit, sending stimulus checks to counter lost wages from quarantined workers. But stimulus can only ever be a short-term solution. Very specific conditions must exist for government spending to spark a slumping economy and unfortunately, those conditions are not present today. Even if businesses could find more workers, they have supply chain issues preventing them from getting the materials they need to make more of whatever it is they sell. Just like the 70s, when there is too little to go around, prices and inflation rise.

Tropes be true, we know what the inflation remedy is. We’ve seen this story unfold before and we also know what the likely outcome will be. The Fed needs to pull money out of the economy to strengthen the dollar. Interest rates will rise (back to a more normal level in today’s case) and the economy will probably slow (a bit) as businesses adjust.

The good news is that these are not in the 70s. Inflation is rising but it is still manageable and it hasn’t been a problem for long. Businesses should adjust quickly to a stronger dollar and higher interest rates so any slowness in the economy is likely to be short-lived. As long as Americans rejoin the workforce, unemployment will go down, spending will increase and the economy will start growing again.

The better news is the quality companies we own—profitable businesses with sustainable competitive advantages and experienced management teams—are the companies that tend to do well in environments such as these. That doesn’t mean they don’t lose value in a slumping economy. But quality is always attractive to investors, and quality companies tend to recover faster. Owning a group of them puts an investor in a very strong position.

We expect teens in horror movies to use poor judgment. After all, they don’t have the benefit of a fully functioning frontal lobe. Of course, neither do politicians. But unlike their teenage counterparts, we can count on our elected representatives to fulfill another, greater trope—they are self-preservationists, always doing whatever it takes to keep their jobs. If the prospect of incurring some short-term discomfort eliminates the risk we have a 70s-style unemployment problem, many politicians will take it, allowing the economy to reset and paving the way for Americans to go back to work. In the meantime, we are well-positioned to weather the conditions ahead.

Travis Raish, CFA