Infectious optimism

My daughter plays club soccer. Like most teams, the roster changes every year as girls come and go for various personal and family reasons. And because the roster changes, it always takes a while for the team to gel when a new season gets underway.

Earlier this season, my daughter’s team lost to another club. It was a tough loss too. Our team was never in the game. They came out flat. The pace of their play was slow. Their passes were off. They missed a lot of shots. From start to finish, the team never clicked. And so it was that when my daughter’s team had a rematch toward the end of the season, I’m embarrassed to say I didn’t expect anything different. But unlike that earlier game, our team played fast, they communicated with each other, and they brought a lot more energy to the field. I wish I could say their efforts paid off with a win, but even with a tie, the girls were all smiles as they walked off the field. They played a better game, and they knew it.

A shift in momentum like what my daughter’s team experienced happens elsewhere, including the stock market. And just like in sports, sometimes all it takes is a spark of optimism, or worry, to send things moving in the other direction. We’ve seen plenty of momentum swings in the markets over the last few years. Rising inflation and interest rates, declining corporate profits, economic malaise, and the recent midterm election have given investors plenty of things to worry about. And true to form, investors have channeled that worry into selling investments and driving down the market. But just as they can be skittish and prone to overreact, investors are also hopeful, especially in the U.S.

Recent reports have been nothing to cheer about in and of themselves. Inflation is still running at an annual rate of 7.7% and the Fed funds rate is 3.75% and going higher. But investors also know that inflation is cooling, and the Fed is likely to slow the pace of rate hikes. This doesn’t mean economic conditions are back to normal, but it does mean that a more normal environment may be on the horizon. Improvement gives us hope, and investors’ hope that brighter days may still be ahead, is all it took to shift momentum and propel the market higher in recent weeks.

It is unlikely that the markets will continue a steady march upward from this point forward. There is always an ebb and flow to momentum and the ride will be bumpy. Until inflation is where it’s supposed to be—hovering around 3% or less—the actions of Congress and the Fed will keep downward pressure on assets. But investors are already hopeful. Despite the challenges we face, they are looking for the good news and finding reasons to pass along an infectious optimism.

Counting our blessings comes naturally to many of us this time of year. Americans often give thanks for having family and friends to spend the holidays with, for having good health, or for having a good job. Many of us are also grateful for the opportunity to live in the greatest nation in the world in the moment of its greatest prosperity. And with that gratitude, we remember our lives wouldn’t be nearly as blessed if it weren’t for the sacrifices of the brave men and women who serve in our military and law enforcement. And while it certainly doesn’t rank as high as family, health, or safety, we can also give thanks this holiday season for the hope made possible by these other blessings—the hope that our best days are still ahead.

~ Travis Raish, CFA

Back to basics

There are certain timeless truths about money that generations of Americans have used to grow and preserve wealth. These truths are simple—as basic as building blocks—and when we stack them together, they form the foundation of a financial plan that can help us weather difficult times. These principles are so important, in fact, the CFA Institute dedicates most of the third year, final exam, to this material.

The process to achieving investment success—the same process we use when we work with our clients—is this:

  1. Evaluate risk and return—understand your needs for income and investment growth based on your willingness and ability to take risk
  2. Allocate assets—divide your portfolio between risky investments (stocks) and safe investments (bonds/cash) to satisfy your needs
  3. Select investments—use a systematic approach to identify quality companies trading at good values
  4. Locate investments—consider tax and planning needs to place the rights assets in the right place
  5. Overlay options—supplement your assets with equity options for added income or protection, when necessary
  6. Manage expectations—encourage you to keep a long-term perspective to avoid getting caught up in the short-term emotion of the markets

There are several forces that work to undermine these principles, causing us to lose sight of our bigger goals, taking us off track. The financial and mainstream media thrive on broadcasting dramatic news. And when investors increasingly search terms like recession, job losses and market collapse on Google, the media responds with more inflammatory talk. We can make the situation worse by reacting. But instead of worrying whether this time is different and making poorly timed, emotionally charged decisions about our money, we do well to remember that Rome was not built in a day, and it wasn’t destroyed in a flash crash either.

The filter we need to help us during times like these is patience. One way to do that is to ask, “Is this moment going to be remembered in ten years?” Even during troubling times—Y2K, 9-11, the Dot-com bubble, the credit crisis, the COVID pandemic, today’s economic and societal problems—great companies with solid management teams don’t just survive these periods, they are stronger and better for having gone through what they did. Companies like Microsoft, Costco, Southern Company, and Chevron, to name a few of the leaders in our portfolios, managed through difficult times before, and they will continue to do so today.

As we mentioned in a previous post, we offer three investment strategies beyond our flagship Core Stock portfolio. One of those, our Global Dividend portfolio, recently crossed the one-year mark with great success. The portfolio has fifty stocks evenly divided between the US and international markets. Of course, these companies meet our quality standard, but we also look for companies capable of faithfully returning capital to shareholders through a stable and growing dividend, a sign that the management teams of these dominant companies will reward our patience even in difficult times. The portfolio boasts a yield of 3.9%, a pleasant bonus given most of these companies are trading at a discount to their fair value, and they still have room to grow.

To be sure, the Fed and Congress will continue to act to get inflation under control and to prop up the economy. They have complicated analytical processes that often result in confusing policies, and until investors are assured that we are on the right side of these challenges, implementing the government’s strategies will undoubtedly cause volatility in the market. Until then, we remember that investing is only one part of the process. The others—maintaining balance, focusing on the long-term, managing our expectations and even watching our spending and planning prudently—will be helpful skills during times like these.

Please contact us with any questions you have. Our door is always open. And please know we wish you and your family the best as leaves begin to fall.

– Steve Davenport, CFA

Fun Facts About Finance

Our monthly articles tend to be more serious, so this month we thought we would lighten things up with some fun facts related to money, debt, housing and income that aren’t exactly common knowledge. Enjoy!

The study of money is called numismatics.

A penny costs more to make than it is worth. According to the U.S. Mint, it cost 1.7 cents to make one penny.

One bill weighs 1 gram and 454 bills equal one pound. This means if you have $1 million in singles, it will weigh over 1 ton. A suitcase of $1 million in $100 bills weighs over 20 pounds. All U.S. bills cost less than $0.20 to make.

Here are some interesting facts about the lifespan of money:

  • $100 bill lasts 22.9 years.
  • $50 bill lasts 12.2 years.
  • $20 bill lasts 7.8 years.
  • $10 bill lasts 5.3 years.
  • $5 bill lasts 4.7 years.
  • $1 bill lasts 6.6 years.
  • $5 bills are used the most in transactions, which is why they have the lowest lifespan. We handle $100 bills the least, which is why they have the longest lifespan.

There is no such thing as “paper” money. Federal Reserve notes are made of 25% linen and 75% cotton, not paper. Two separate agencies create coins and paper money. When you think of creating money, your mind may go straight to the U.S. Mint. But in reality, the U.S. Mint only makes coins. The Bureau of Engraving and Printing (BEP) is actually the agency that makes paper money.

Most U.S. currency is outside of the United States. According to authorities, between one-half and two-thirds of the value of all U.S. currency in circulation is outside the U.S. This is mostly because the U.S. dollar is the world’s primary reserve currency.

Current U.S. total debt is $30.85 trillion. Considering that the population of the U.S. is approximately 332 million, that debt equates to nearly $93,000 of debt per person.

As of 2Q2022, total public debt as a percentage of GDP was 122.85%. For reference, Venezuela has the highest debt-to-GDP at 350%. Including Venezuela, there are only eleven countries in the world with a higher debt-to-GDP than the U.S.

Expectedly, areas with higher housing prices tend to have lower homeownership rates. According to the latest census data, 65.4% of U.S. households own their home. The District of Columbia has the lowest rate of homeownership, at 40.3%. California, New York, and Hawaii are among the states with the highest housing prices and the lowest levels of homeownership. States with relatively low housing costs tend to have higher levels of homeownership. West Virginia, which has the lowest typical-house cost, also has the highest homeownership rate, with 79.6% of residents owning their own home.

Student loan debt in the U.S.:

  • $1.75 trillion in total student loan debt (including federal and private loans). $28,950 owed per borrower on average.
  • About 92% of all student debt are federal student loans; the remaining amount is private student loans.
  • 55% of students from public four-year institutions had student loans. 57% of students from private nonprofit four-year institutions took on education debt.

The average salary in the U.S. is $58,260. According to the Bureau of Labor Statistics, the average person makes $58,260 a year in the U.S. That breaks down to around $28.01 an hour. Here are 2020 Bureau of Labor Statistics on average annual income by education level:

  • Less than a high school diploma—$30,784
  • High school education—$38,792
  • Attended some college—$43,316
  • Two-year college degree—$46,124
  • Bachelor’s degree—$64,896
  • Master’s degree—$77,844
  • Doctorate degree—$97,916

Gambling in the U.S. brings in more revenue than theme parks, sporting events, cruise ships, and music combined.

The average American pays $273 a month for subscription services.

The average secured credit card’s APR is currently 18.1%, for example, while credit cards for people with excellent credit charge 13.13%. On average, Americans have four credit cards. As of 1Q2022, Americans owe over $800 billion in credit card debt.

According to the Social Security Administration, retirement benefits are only designed to replace approximately 40% of the average worker’s wages.

The average credit score in the U.S. is at an all-time high of 711. FICO scores break down in the following manner:

  • 800 to 850: Exceptional
  • 740 to 799: Very good
  • 670 to 739: Good
  • 580 to 669: Fair
  • 300 to 579: Very poor

When making an investment, the “Rule of 72” can help you understand the time it will take for it to double: you divide 72 by the expected rate of return to estimate how many years it will take to double the original amount.


  • 101 Fascinating Money Facts » Savoteur
  • 42 Incredibly Fun Facts About Money I Bet You Didn’t Know –
  • 21 Fun Money Facts You May Not Know! | Clever Girl Finance
  • Consumer Debt Statistics & Demographics in America
  • Money Facts: 16 Mind-Blowing Truths About Money | Reader’s Digest (
  • 99 Mind Blowing Money Facts [2022] (
  • 60 Personal Finance Statistics You Should Know About [2022] (
  • Average 401(k) Balance By Age—Forbes Advisor
  • Median Home Price by State 2022 (
  • 2022 Student Loan Debt Statistics: Average Student Loan Debt—Forbes Advisor
  • Debt to the Penny | U.S. Treasury Fiscal Data
  • Federal Debt: Total Public Debt as Percent of Gross Domestic Product (GFDEGDQ188S) | FRED | St. Louis Fed (
  • Fun Facts ~ Finance | Project Venture (
  • 47+ Fascinating Financial Literacy Statistics in 2022 (

Good ideas – learning from history

The Pulitzer Prize winning author and historian Samuel Eliot Morison said, “we ought to read history because it will help us behave better.” No other reflection about the virtue of understanding our roots could be truer than this. Not only do we have to know where we have been to understand where we are, but knowing history can help us make better choices about how we want to get where we want to go. It’s common and easy to apply this principle to government, politics and law, but it is also true in economics.

Though the soup du jour on the investment menu for the past twenty years has been index investing, an investing principle at work for more than a century is that of owning quality business and buying them at reasonable values. This is the strategy that made Warren Buffett and Benjamin Graham, his predecessor and teacher, famous. It is the strategy that has benefitted investors for generations, helping them grow and preserve their wealth. It is also the strategy we use at Circa Capital.

The version of the quality-value approach we use in our Core strategy has few moving parts. We buy companies we feel have a sustainable competitive advantage—companies that are the best or only businesses that do what they do. We buy these companies when we believe they represent a compelling value. And we start each company with the same weight. This keeps us from playing favorites; after all, if the company meets our exacting standards, it deserves to have a fair weight. We also balance the portfolio across sectors and industries because we want our portfolio to be driven by the same forces as the US economy. Over many years, this approach has delivered predictable results, which is what most investors appreciate.

Not everyone thinks about quality and value in the same way. Some appreciate companies with more growth potential. Others prefer bellwether companies with more stable forecasts. We like to think our Core strategy offers a good blend of both; a mix of companies likely to profit in any economic environment and others that are disrupting industries with new technologies, products, or services. Still, for those investors who prefer one tone over the other—more growth, more value or more income—we also offer strategies that are more specific.

Our Growth strategy emphasizes companies that are expected to continue to grow well within their respective industries. Naturally, there is an emphasis on certain sectors like technology and demonstrated growth companies like Amazon, Google, and Microsoft with a strategy like this.

Our Value strategy emphasizes companies that are well-versed at generating stable cash flows in a variety of economic environments. This also leads to an emphasis in certain sectors like energy and financial services, and companies like Chevron, Berkshire Hathaway, Johnson & Johnson, and Walmart.

Our Global Dividend strategy is for investors who are comfortable investing a greater balance of their portfolio in foreign companies, knowing that all the companies are likely to generate stable cash flows to pay a consistent and hopefully growing dividend. Many companies like Novartis, Siemens, and Barclays operate in traditional, dividend-paying industries, and are represented in a portfolio like this.

Just like our Core strategy, in our Growth, Value, and Global Dividend strategies, balance is key. This comes in stark contrast to many of the most popular index products. Many broad market portfolios have upwards of 20% invested in just four companies—Apple, Amazon, Google, and Microsoft. Growth-tilted portfolios often have over 40% invested in those same companies. These funds are largely driven by the fortunes of these four companies. Certainly, these businesses are exceptional, but so are Costco, Ecolab, Amgen and a host of other companies that have earned a place in a portfolio of high-quality businesses, and not as the footstool of Big Tech.

We don’t buy companies just because they are participants in a popular theme, or companies that are cheap for good reason. Momentum and deep value strategies like these are popular among some investors. Chasing after fast moving stocks or emerging industries, hoping to ride the wave up, or buying companies on the verge of collapse, hoping they can rebound, can make an investor a fortune. But investors have lost fortunes also, being on the wrong side of those trades. They are more like gambling than investing and carry too much risk for most investors. That’s not our style. We like knowing that the companies we own have been through tough periods and are stronger because of it. And our clients like knowing what they own and why they own it. Just like we know that riding a bicycle down a flight of stairs is a bad idea, we don’t have to be bandwagon investors in risky investments to know the same.

To give you more insight into our strategies and what an investor might expect from each, we are producing a series of short informational videos. You can look forward to seeing these in your inbox over the next few months.

What the Fed’s actions mean for us

Given the expectation for the Fed to continue to increase “rates” over the course of this year, we thought it would be helpful to provide some context on just what this means. The rate being described here is the federal funds rate, which is the benchmark or central interest rate in the U.S. financial market. This rate influences a myriad of other rates, including the prime rate, mortgage rates, rates on loans and savings, just to name a few, and is therefore vital to consumer wealth and confidence.

Now some background information. To begin, we start with the Federal Open Market Committee, or FOMC, which is the policymaking body or committee within the Federal Reserve System that makes key decisions about interest rates and the growth of the U.S. money supply. The Federal Reserve, or the Fed (U.S. Central Bank) was given the responsibility for setting monetary policy by the Federal Reserve Act of 1913 to serve as the country’s central bank. Monetary policy encompasses the measures employed by the government to influence economic activity, specifically by manipulating the supplies of money and credit and by altering the rates of interest.

As part of its monetary policy, the FOMC meets eight times during the course of a year to set the target federal funds rate. The federal funds rate, or fed funds rate, represents the interest rate that depository institutions (think banks, savings and loans, credit unions) charge each other for overnight loans. Please note that depository institutions are required by law to meet minimum reserve requirements equal to a certain percentage of their total deposits in an account at a regional Federal reserve bank – to cover withdrawals by depositors and other obligations. So, in respect of these reserve requirements, it may be necessary/desired to borrow/lend excess reserves from/to one another. The rate that the borrowing depository institution pays the lending depository institution is determined between the two and the weighted average of all these types of negotiations is called the effective federal funds rate. The effective funds rate is basically determined by the market but is influenced by the Fed via the above-mentioned target fed funds rate.

Please note that the federal funds rate differs from the discount rate (also referred to as the discount window), which is the interest rate that the Federal Reserve bank (i.e., one of the 12 regional Federal Reserve banks) charges on loans to commercial banks and other depository institutions. The discount rate is set by the Fed’s board of governors. Lending at the discount rate is part of the Fed’s function as the lender of last resort, and represents an important monetary policy tool. This lending by the Fed to depository institutions plays a significant role in supporting the liquidity and stability of the banking system and the effective application of monetary policy. Sometimes, banks borrow money from the Fed to avoid liquidity issues or cover funding shortfalls. The Fed funds rate is usually lower than the discount rate.

The current fed funds target rate is 1.50% to 1.75%, having been increased by 75bp (or 0.75%) at the most recent FOMC meeting that took place in June, which represented the largest rate move since 2000. The move was prompted by escalating inflation pressures (recent 40-year high inflation as measured by June 2022 CPI of 9.1% – highest since December 1981, driven largely by food, gas and energy costs). There remain four FOMC meetings in 2022 (July, September, November, December). The probability of another 75bp hike at the July 26-27 FOMC meeting is currently 98%.

The Federal Funds rate and the Prime Rate track along with each other very closely.

Short- and mid-term ARMs (adjustable-rate mortgages), such as the 5/1 ARM (fixed rate for the first five years then switching to an adjustable rate for the remainder of the term) shown in the graph above, are also affected by trends in short-term interest rates. As lenders’ cost of obtaining funds to lend changes, some of those reductions or increases are passed to borrowers in the form of lower (or higher) starting rates.

Long-term rates, such as 30-year fixed-rate mortgages, give less consideration to short-term rates, responding instead to economic growth and inflation pressures. Mortgages more closely follow other long-term rates, such as the yield of the ten-year Treasury Constant Maturity (theoretical value of a U.S. Treasury that is based on recent values of auctioned U.S. Treasuries).

All of these factors have weighed on the stock market. But the steps the Fed has taken have been necessary and should result in lower inflation and a stable dollar over time. This will not keep investors and the market from worrying over what the next few months will bring, but smart moves today will help support a healthy and growing economy in the future … a benefit for everyone.

Finding a way forward

There are many experts coming out with estimations before the June Fed meeting. We would like to provide some context and perspective about what the Fed is considering.

In economics and investments, most of our education involves looking at past events so we can learn from them, especially to help avoid making the same mistakes in the future. But unfortunately, we are in uncharted territory. This environment is like no other. And while looking at prior Fed activity is instructional, the Fed never convened following a global pandemic or while the US supported a state in Europe at war with Russia. Today is unique and so must be the Fed’s response, building a potential path forward with the world as it is today, and not as it was.

The Fed funds rate (the rate member banks of the Fed charge to each other) is 1%, and the Fed is using this rate to try to get inflation under control. Inflation is commonly measured by Personal Consumption Expenditures (PCE) which is currently 8.6% and the Consumer Price Index (CPI) ex food and energy, which is currently 4.5%.

Economic theory says that raising the Fed funds rate higher than “inflation” is the surest method for getting inflation under control. But that would require the Fed to push interest rates over 8%, which is almost ridiculous considering the Fed is unlikely to push rates to even 4%. We have had an unusual period where inflation has not been a factor for over 20 years. And the Fed has been good at stimulating the economy during this period, but now they need to learn a new trick … unstimulating the economy without pushing it to recession.

When the Fed meets for two days, it can feel like the Cardinals are gathering to pick a Pope. We wait for smoke signals as if they are going to tell us what’s “really” happening. But the Fed comprises government employees who have a responsibility to control inflation while ensuring maximum employment. They don’t have a mandate for maintaining stock market values.

The Fed is scheduled to raise rates 0.5% in June and 0.5% in July, followed by another 0.25% in September and 0.25% in October. Most analysts expect the Fed to raise rates by 1.5% in total before the end of the year. With current rates at 1%, that would bring us to 2.5%. The market is reacting accordingly, fearful of the unknown, wondering if the Fed might have to raise rates more than expected.

Because the Fed has been slow to acknowledge inflation (for nine months, the Fed has called the price increases “transitory”), they are now sensitive to being late to the party. At 8.6%, inflation measured by PCE was still too high despite the actions the Fed has already taken. And the volatility we have experienced in the stock market comes as investors wonder if the Fed pushing rates to 2.5% will be enough, or if they might have to go as high as 4.5%. Extra increases are what economists, investors and some Fed members have talked about, but few people have been listening. And while these changes in Fed policy are significant, they are not life changing.

We are sharing these details so an increase in interest rates of 0.75% in June or July, or more increases in the fall, won’t trouble you, should they occur. Certainly, those buying a house or car will pay more in a higher rate environment. And borrowing, which has been uncharacteristically low for a long time, has changed; the days of “free money” are possibly ending. The Fed will continue to raise rates until they get the desired effect, but some investors are fearful of these changes. These changes in response to inflation and a tough economy have also made for a rough market. But as Walt Disney so eloquently put it, “After the rain, the sun will reappear. There is life. After the pain, the joy will still be here.”

The future is uncertain. We can search for answers as the problems become clear. The volatility of markets will always be present at different levels, with uncertainty being one catalyst. And it’s important to understand a situation from a historical perspective, but we also must realize that our markets will probably look different in the future. Information travels much faster now and investors’ reactions to changes also affect investments and markets at lightning speed. But these are immediate reactions, emotionally charged and often overblown. For a long-term investor, volatile market swings are tough to watch, but they are not of much consequence over time. And our investments—companies chosen because they represent the very best combinations of quality, value and opportunity—are the best way forward in uncertain times such as these.

Innovation and valuation

The phone rang. Mike unzipped his North Face, apparently unconcerned with the temperature even though was ten degrees below zero. He fished around in his pocket and pulled out the phone, grinning as he glanced at the screen.

“You’ll never guess where we are,” he said into the speaker.

“Where?” the voice at the other end said.

Mike looked around. “The top of Highline.”

A moment passed while the caller collected his thoughts. “You’re in Vail?”

“Not just in Vail … we’re on the mountain!”

“Your phone works there?”

The boy said the words I still couldn’t get past my lips. From the moment the phone rang, I could hardly believe my ears. Getting a call when you’re standing at the top of a mountain in Colorado may not seem like a big deal today. But this was 1994. Cell phones were expensive, few people had them and they barely worked in the city. Getting a call while standing cliff side in the middle of nowhere was unimaginable.

The 1990s were incredible years for innovation and development, not just for mobile tech, but for the Internet as well. Of course, at the time, cell phones were luxuries. The Internet was too slow to be entertaining and had little use beyond email. At best, most people figured it was just going to be another marketing channel for businesses—an alternative to advertising through television, radio and print media. But especially for those of us in our twenties and thirties, we knew something important was happening around us. We just didn’t know how big it was going to be.


Against that backdrop, Netscape made its debut. The company had a web-browser and was one of the first of its kind to help people get connected to the Internet. It was a big deal for the company to go public. Money managers fell over themselves, clamoring to get shares for their funds. And the big investment banking firms of the day had a party doling out shares to their favorite customers. But the company was less than two years old, and it was far from profitable. Investors didn’t really know what the company’s business model was either. Netscape was a strange new company in a rapidly developing market and the biggest question everyone had was how much the shares would cost.

Days before the offering, investors were expecting to buy shares for $14. But at the last minute, bankers upped the price to $28. Within minutes of the start of trading, the market for Netscape took off and that same day, shares traded into the high $70s before settling into the mid $50s by the closing bell.

On its face, the Netscape IPO might seem like an incredible success. After all, investors more than doubled their money in one day. But the founders of the company left a lot of money on the table by selling their shares for $28 when the market was willing to pay significantly more. The investment bankers responsible for the deal didn’t even come close to understanding what the company was worth, and it showed.

The challenge of knowing what an investment is worth is not unique to companies like Netscape. It’s a challenge that has confounded investors for hundreds of years and even with the advancements in technology and investment theory we have had, they are challenges we still face today.


On a normal day, stocks can gain or lose 2-3% as investors react to news. But lately, stocks have been more volatile, some gyrating 5-10% or more in a single day. By historical standards, this is a volatile market, and it has everything to do with the growing number of concerns weighing on investors’ minds.

The rising price of oil, a war in Europe, tensions with Russia and China, economic malaise in the US and the UK and inflation running at near historically high levels—maybe the market could shrug off one or two of these issues, but investors are obviously having trouble digesting all of them at once, especially when they are interrelated. All these issues affect corporate revenues, profits and ultimately the prices we are willing to pay for shares of their stocks. And inflation? Well, inflation makes it hard to answer the question “what is a dollar worth?” A dollar certainly doesn’t buy what it did 18 months ago, and if it’s hard to know what a dollar is worth, it’s equally hard to know what dollar-denominated assets like stocks should be worth too.

We expect the Fed will solve the inflation problem—it is their prime directive. This will answer the question of how high interest rates must go and should also give insight into the relative health of the US economy. Solving inflation won’t help solve the high price of oil or fix tenuous relations with trade partners, but even with a few answers, understanding the value of assets like companies and real estate becomes easier.


There are some things we can get away with as investors during exuberant times that we can’t when the future is cloudy. This doesn’t mean that we can be sloppy as investors because that’s never the case. But it does mean that when the economy is humming, we can own faster growing companies even if they aren’t very profitable. Companies in growth mode can plow much, if not all, of their profits into growing their businesses when they expect times to be good. That was the environment we enjoyed for much of the last decade.

When the economy slows, growth companies often must be less aggressive, focusing more on financial stability and corporate profits. We are in one of those environments now, and as you may have noticed, we have made a few changes to our portfolios to reflect this condition.

Earlier this year, we distanced ourselves from China—moves that made a tremendous amount of sense given the Chinese government’s unwillingness to play well on the world’s stage. More recently, we made a few changes toward companies with stabler balance sheets and cash flows, and less risk of declining profitability while the economic malaise continues. Among the incomers is Estee Lauder (EL), the quintessential upscale body care company that has shown resilience through even some of the toughest global economic conditions, Merck (MRK), a drug manufacturer with a pipeline of highly profitable and protected drugs, and Lam Research (LRCX), a semiconductor tools company that is unique in both its scale and its product offering. These companies have growth potential, but they are highly profitable and can absorb some trouble if it takes longer than wanted to get the economy moving in the right direction again.

Inflation primer

Treasury Inflation-Protected Securities, or TIPS, are U.S. government bonds that are indexed to inflation. TIPS provide protection against inflation (or the rise in price of goods and services), intended to protect investors from a decline in the purchasing power of their money. If inflation rises or increases, the principal value of TIPS adjusts upward to reflect that inflation increase. Conversely, if there is deflation, the opposite occurs and the principal value adjusts downward to reflect that deflation. Please note that we are talking about inflation and deflation as measured by the Consumer Price Index (CPI). Inflation results in a rise in the CPI, whereas deflation results in a decline in the CPI. Importantly, the initial interest rate or coupon of the TIPS will not change, but the principal amount will change, resulting in higher or lower interest or coupon income (fixed interest or coupon rate multiplied by the adjusted principal value). The inflation adjustment to the principal is cumulative.

TIPS pay interest two times per year, at a fixed rate, i.e., the interest rate does not change, but the interest payment varies with the adjusted principal value of the bond. The fixed rate is applied to the adjusted principal. So, the amount of interest could be higher if the adjusted principal increases because of an inflation change, or could be lower if the adjusted principal decreases due to a deflation adjustment. Upon maturity of TIPS, the investor receives the adjusted principal or the original principal, whichever is greater (even if a deflation adjustment caused the adjusted principal balance to fall below the original principal).

So let’s look at how adjustments work under both an inflation change and a deflation change. Using an example of an investor purchasing $1,000 in TIPS at the beginning of a year with a coupon rate of say 2%, if CPI measures no inflation, the investor will receive $20 in coupon payments for that year. Assuming inflation rises by 2%, the $1,000 principal of the TIPS would adjust upward by $20 to $1020 (2% inflation x $1,000 principal) and the coupon payments would total $20.40 for that year. If deflation materialized, say to the tune of -4%, the $1,000 principal of the TIPS would adjust downward by $400 to $960 (-4% deflation x $1,000 principal) and the coupon payments would total $19.20 for that year. Even with deflation, at maturity, the holder will receive the greater of the adjusted principal of the TIPS or the original principal. The investor is never at risk of losing the original principal if held to maturity. So, in the example of the 4% deflation adjustment, resulting in the adjusted principal of $960, the investor would receive $1000 principal upon maturity. Please note, however, that if sold before maturity in the secondary market, there is the possibility to receive less than the initial principal.

CPI inflation adjustments are made semiannually and the inflation adjustments of a TIPS bond are considered taxable income by the IRS even though an investor would not see that money until the bond is sold or it reaches maturity (please note that TIPS are exempt from state and local income taxes, but are taxable at the Federal level). Holding TIPS bonds in a retirement account could help to minimize the tax impact.

The difference or spread between the yield of a TIPS bond and the yield of a traditional Treasury bond of comparable maturity is known as the breakeven rate. This breakeven rate represents the inflation expectation or inflation outlook over the life of the bond. Accordingly, the yield on a TIPS bond is equal to the traditional Treasury bond yield minus the expected inflation rate. But note that the spread between TIPS and traditional Treasury bonds is not a faultless predictor of inflation, as both instruments are subject to market forces and investor emotions. If the CPI were to average more than that spread or difference over the life of the bond, then the TIPS would deliver a higher total return than the traditional Treasury bond. However, if expected high inflation fails to materialize, then the TIPS could underperform traditional Treasury bonds.

When the traditional Treasury bond is trading at a yield below the expected inflation rate, the yield on a TIPS bond declines into negative territory. A phenomenon known as “the flight to safety” or “the flight to quality” explains why investors sometimes accept negative TIPS or any other treasury yields. In times of marked economic uncertainty, investors’ fear of losing their investments frequently overwhelms their desire for tolerable returns.

Considering the recent escalation of inflation pressures on goods and services and the related mounting consumer concerns, as well as the likelihood of questions and interest that may arise around these securities, we thought it was important to provide an overview of TIPS. Circa Capital currently has no bond portfolio exposure to TIPS and we do not anticipate that changing over the near-term. Negative yields, heightened interest rate risk and concerns around accurately forecasting inflation rate adjustments in the future supports our preference of utilizing traditional Treasury bonds (via Vanguard ETFs) over TIPS. We will continue to monitor inflation and its impact on TIPS and their performance relative to traditional Treasury bonds to determine if allocation change/modification is warranted.

~ James Callahan, CFA

Volatility – the price of admission

Photo by Arthur Osipyan on Unsplash

When we think about the prices of items that we purchase, there is always a question about how much “value” we are receiving. Investments are no different. When you own a company, in theory, you are receiving a share in the company’s future cash flows. This sounds great when the company makes money. But what about when the economy is slowing? Less cash flow means a lot less stock price.

The steadiness of cash flows matters to investors and companies know this. Companies want investors to see them as solidly profitable, growing, and able to deliver enhanced products and services. Running a company comes down to managing the business through changing economic environments (i.e., pandemics and recessions). The ability for us to understand our companies starts with understanding the value the shares represent and continues with understanding the quality of the company’s earnings. In both areas, there is a need to balance risk and safety.

Investment theory states that to achieve higher returns, investors must take higher risk. If investing was riskless, then everyone would buy, and the advantages would disappear quickly as prices rose. As investors, we must take a long-term (i.e., 7-10 years) view of the companies we own and the economies they operate within. Conventional wisdom states that when you are in a storm, it is best to get out of the rain. And people have the tendency to look at the current state and assume it will continue (recency bias). But in investing, this is often short-term thinking, and it’s counterproductive. We have to step back and to realize that all storms end and the sun will come out!

As an example, consider the VIX index, a measure of expected volatility in the stock market over the next thirty days.

The pattern over the prior year shows three peaks on December 6, January 23 and March 7. The blue and red lines are the 50 and 200-day moving averages, respectively. Higher volatility (a higher VIX index) usually equates to more fear among investors and lower stock prices. And because the blue line is increasing faster than the red line, we know that volatility and fear have increased recently. There are two reasons for this; the Fed announced multiple interest rate increases and Russia invaded Ukraine.

US markets have had unusually high levels of liquidity for many years. By raising interest rates, the Fed hopes to combat inflation. But this often leads to other problems, like a slower economy. And while Russia’s invasion of Ukraine doesn’t seem like it should affect the US economy, it does. Because Russia supplies much of Europe’s natural gas, sanctions and shortages have disrupted the flow of oil and gas everywhere.

We will continue to watch these global events as they unfold, and we are always mindful of how economic events are likely to affect the companies in our portfolios. We have even taken advantage of the recent turmoil in the market to make a few adjustments to our portfolios. After all, volatility can be an opportunity, especially when it gives us the chance to buy more quality companies at lower prices.

There was a saying made popular during World War II, “keep calm and carry on”. Perhaps during these trying times, rather than inventing new sayings and slogans, we would do better to embrace the insights of older generations who faced and overcame significant challenges. Stay safe!

– Steve Davenport, CFA

The power of compounding

As a prominent historical figure, there are few who could match the accomplishments of Ben Franklin. Founding Father, Diplomat, Scientist, Inventor, Politician and Publisher exemplified some of the roles he occupied during his remarkable life. Beyond helping to draft the Declaration of Independence and the U.S. Constitution, helping to negotiate the Treaty of Paris, which ended the Revolutionary War, publishing Poor Richard’s Almanack and inventing bifocal glasses, Ben Franklin’s understanding and demonstration of the power of compounding underscored his financial acumen and provides a valuable financial lesson for all.

When he died in 1790, Ben Franklin bequeathed in his will, 1,000 pounds sterling, which was the equivalent of $4,444, to each of the cities of Boston (his native city) and Philadelphia (his adopted city). This act allowed him to sponsor civic virtue and satisfy his fascination with the power of compounding interest. He requested that for the first hundred years, each of the 1,000 pounds sterling would accrue interest and be used to fund loans for young married tradesmen starting out in business. At the end of 100 years, the cities would be allowed to spend 75% of the principal of the money on public works. The remaining 25% was to remain invested until another 100 years had passed, at which time the cities would be allowed to spend that on whatever they wanted. Franklin’s objective was to help people understand the importance of compound interest. As Franklin himself liked to describe the benefits of compounding, “Money makes money. And the money that money makes, makes money.”

The compounding paid off for both cities. By 1990, over $2 million had accumulated in Franklin’s Philadelphia trust. Franklin’s Boston trust fund had grown to $4.5 million, more than twice the amount in the Philadelphia trust fund. Ben Franklin’s financial lesson proved enormously astute.

Granted, nobody has even 100 years to compound investments, let alone 200, but the concept of starting early, investing regularly, staying disciplined and patient, and allowing compounding to do the heavy lifting cannot be understated when it comes to investing. Most investors have a 30-year to 40-year horizon. Saving and investing regularly is imperative to achieving financial goals. Remaining disciplined during times of market stress and not trying to time the markets are critical components of wealth building. Staying disciplined, invested and re-investing can prove hugely beneficial over the long-term due to compound interest and compound returns.

The chart below illustrates and helps to visualize the power of compounding by showing the monthly savings required to reach $1 million at retirement (assumed to be 65 years of age) at various ages. The earlier one starts, the longer the compounding runway, and the smaller the monthly savings required to reach $1 million.

Source: Business Insider

However, it is equally important to note that compounding can also work against you. An example of this would be when high-interest credit card debt builds on itself over time. Here, compounding serves as a powerful inducement to pay off your debts as soon as you can and start saving and investing your money early.

And, if further confirmation of the power of compounding is needed, it is rumored that Albert Einstein described compound interest as the eighth wonder of the world and said that those who understand compound interest, earn it. Those who do not, pay it.

~ James Callahan, CFA