When one bets on a sporting event the facilitator of the
bet, referred to as a bookie, charges the
winner of the bet the vigorish. The
vigorish, commonly known as the vig, is a fixed percentage of the bet that serves as compensation to the bookie
for providing numerous betting options (liquidity) and the financial surety of
collecting on winning bets.

Financial
institutions, like bookies, are intermediaries. They link borrowers with
lenders and investors and provide financial
security similar to bookies. The fees, or vig, they charge can be thought of as
a tax on capital transactions and thus a tax
on the economy. If the vig is excessive,
individuals, businesses, and the government
are unnecessarily sacrificing capital and wealth to bolster the profits of financial institutions.

“The problem with the war (Vietnam), as it often is, are the metrics. It is a situation where if you can’t count what’s important, you make what you can count important. So, in this particular case what you could count was dead enemy bodies.” – James Willbanks, Army Advisor, General of the Army George C. Marshall Chair of Military History for the Command and General Staff College“If body count is the measure of success, then there’s a tendency to count every enemy body as a soldier. There’s a tendency to want to pile up dead bodies and perhaps to use less discriminate firepower than you otherwise might in order to achieve the result that you’re charged with trying to obtain.” – Lieutenant Colonel Robert Gard, Army and military assistant to Secretary of Defense Robert McNamara

Verbal

“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.” – Charlie Munger

As described in a recent article, Has This Cycle Reached Its Tail, an appreciation for where the economy is within the cycle of economic expansion and contraction is quite important for investors. It offers a gauge, a guidepost of sorts, to know when to take a lot of risk and when to take a conservative approach.

This task is
most difficult when a cycle changes. As we are in the late innings of the
current cycle, euphoria is rampant, and everyone is bullish. During these
periods, as risks are peaking, it is very
challenging to be conservative and make less than your neighbors. It is equally
difficult taking an

The following article was posted for RIA Pro subscribers last week. We believe this article points to a precarious situation in the market that investors should be aware of. We hope you enjoy this article and get a better flavor for the benefits of becoming a RIA Pro subscriber.
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“So, first of all, let me assert my firm belief that the only thing we have to fear is fear itself” – Franklin Roosevelt March 4, 1933

Those infamous words were spoken by President Franklin D. Roosevelt at a time when the nation was mired in the great depression, and the stock market had collapsed 80% from the highs of 1929.
We argue in this article that today, fear is exactly what we should fear as a wave of complacency rules the

We asked a few friends what the picture below looks like, and most told us they saw a badly drawn bird with a wide open beak. Based on the photograph below our colorful bird, they might be on to something. 

As you might suspect, this article is not about our ability to graph a bird using Excel. The graph represents the current bull market and economic cycle as told by the yield curve and investor sentiment.

As the
picture is almost complete, the bird provides a clue to where we are in the
current cycle and when the next cycle may begin.
For investors, one of the most important pieces of information is understanding
where we are in the economic cycle as it offers a critical gauge in
risk-taking.

Cycles

Economic Cycles- Economic cycles are frequently depicted with a

On Sunday, March 11, 2019, Federal Reserve
Chairman Jerome Powell was interviewed by Scott Pelley on 60 Minutes. We
thought it would be helpful to cite a few sections of their conversation and
provide you with prior articles in which we addressed the topics discussed.

We have been
outspoken about the role of the Fed, their mission and policy actions over the
last ten years. We are quick to point out flaws in Fed policy for a couple of
reasons. First, is simply due to the enormous effect that Fed policy actions
and words have on the markets. Second, many in the media seem to regurgitate
the Fed’s actions and words without providing much
context or critique of them. The combination of the Fed’s power over the
market coupled with poor media analysis of their words and actions might

“It’s difficult to make predictions, especially about the future.” – Niels Bohr

On November 28, 2018, Federal Reserve
(Fed) Chairman Jerome Powell gave a speech at the Economics Club of New York
that sent the stock market soaring by over 2%. The reason cited by market
pundits was the reversal of language he used a few weeks earlier suggesting
that the Fed still had several more rate hikes ahead. In other words, he
softened that tone and seemed to imply that the Fed was close to pausing.

By most accounts, Fed policy remains
very accommodative but the “Powell Pivot”, which began in late November and
continues to this day, hinges on an obscure metric called R-Star (r*).  Even though interest rates have been held low
and vast amounts of liquidity force fed into markets through

A scorpion asks a frog to ferry it
across a river. The frog tells the scorpion he
fears being stung. The scorpion promises not to sting the frog saying if I did
so we would both drown. Considering this, the frog agrees, but midway across
the river the scorpion stings the frog, dooming them both. When the frog asks why the scorpion replies that it was in its nature to do so.

On February 20, 2019, the Federal Reserve released the minutes from their January policy (FOMC) meeting. As leaked last week by Fed Governor Loretta Mester, and discussed HERE, it turns out that in January the committee did indeed discuss a process to end the systematic reduction of the Fed’s balance sheet, better known as Quantitative Tightening (QT).

Within the minutes was the following sentence:

“Such an

Recently, Wall Street and the Financial Media have brought much attention to the flattening and possible inversion of the U.S. Treasury yield curve.  Given the fact that an inversion of the 2s/10s Treasury yield curve has predicted every recession over the last forty years, it is no wonder that the topic grows in stature as the difference between the 2-year Treasury yield and the 10-year Treasury yield approaches zero. Unfortunately, much of the discussion on the yield curve seems to over-emphasize whether or not the slope of the curve will invert.  Waiting on this arbitrary event may cause investors to miss a very important recession signal.
The Incentive to Lend
A friend approaches you and asks for a loan. You are presented two options, lend her money for two years at 2% annually or for

“That is some crazy talk” – Bill Gates on the topic of MMT
In our article, MMT Sounds Great in Theory… But, we dove into the latest and greatest of economic thinking, Modern Monetary Theory (MMT). This theory is crucially important for investors and citizens to understand as its popularity is spreading like wildfire. The theory promises to be a strong force in the coming election and a challenge to the popular Keynesian policies that are widely adhered to by most governments and central banks.
Free healthcare and higher education, jobs for everyone, living wages and all sorts of other promises are just a few of the benefits that MMT can provide. At least, that is how the theory is being sold. Regardless of the apparent unreasonableness of such promises, it’s not hard to imagine

Economics on Gilligan’s Island

Famed economist
Henry Hazlitt wrote the economics classic, Economics in One Lesson: The Shortest and Surest Way
to Understand Basic Economics. The book is quite
popular and has sold well over one million copies. While the content is
brilliant, what makes it distinctive is the simple clarity he uses to explain
complex economic concepts.

We try our
best to follow in Hazlitt’s footsteps and explain economics without the
complexity and jargon so often used by trained economists. One of our
techniques is to bring an economic concept to its most basic level so that it’s
easily understood by all readers. While at
720Global, we produced an animated video, The Animated Virtuous Cycle, which allows a ten-year-old to understand the complex economic topic of

There are
countless ways to evaluate equities, and they
all have glaring flaws. Equity valuation is not a science with predictive formulas.
It is subjective, and the formulas
themselves and the interpretation of the results rely on an estimate of what
the future holds.

Some models use
historical data under the assumption that the current trend will be predictive
of the future while others use forecasts
that differ from the past. It is a rare
occasion that the past neatly maps out the future or, for that matter, that anyone
accurately predicts the future. No model represents the holy grail of investing,
but understanding their inputs and outputs can reveal a lot about relative
valuations and the sentiment of a market. As investors,
we need to take into account all types of valuation

“Gradual inflation has a numbing effect. It
impoverishes the lower and middle class, but they
don’t notice.”—Andrew
Bosomworth, PIMCO Germany, as quoted in Der Spiegel

Media reports
and political candidates have been stressing the rising wealth and income
inequality gaps in the United States. They do so to advance their agendas, but
the problem is real and they are justified in raising it. At the same time,
both groups are largely overlooking an important piece of the puzzle in the way
they talk about it. To properly diagnose
this important problem, we need to
understand the role the Federal Reserve plays in managing economic growth and how
it contributes to these rising imbalances. This article examines the Federal
Reserve’s monetary policy objectives and their stated inflation goals

The Kansas City Federal Reserve posted the Twitter comment and graph below highlighting a very important economic theme. Although productivity is a basic building block of economic analysis, it is one that few economists and even fewer investors seem to appreciate.

The Kansas City Fed’s tweet is 100% correct in that wages are stagnating in large part due to low productivity growth. As the second chart shows, it is not only wages. The post financial-crisis economic expansion, despite being within months of a record for duration, is by far the weakest since WWII.
Productivity growth over the last 350+ years is what allowed America to grow from a colonial outpost into the world’s largest and most prosperous economic power. Productivity is the chief long-term driver of corporate

“Ted Williams described in his book, ‘The Science of Hitting,’ that the most important thing – for a hitter – is to wait for the right pitch. And that’s exactly the philosophy I have about investing – wait for the right pitch, and wait for the right deal. And it will come… It’s the key to investing.” – Warren Buffett
Many investment managers tempt investors with historical returns by using them as indicators of future return expectations. Unfortunately, even if they are clairvoyant, a buy and hold strategy based on a “known” long term return is likely not in a client’s best interest. Buy and hold strategies that are solely focused on a long-term total return fail to consider the current state of valuations, the risk reward profile, and therefore the path of returns the market may take

On the day after Christmas when investors were sad with the coal they found in their stockings, Santa provided some Boxing Day cheer. The S&P 500 posted a 5% gain, in a rally that was widely expected. We along, with many market technicians, had been highlighting the extremely oversold conditions and thought a relief rally was inevitable. The question was just a matter of when.
Of note, the most vocal about the potential for a short term rally appeared to be those with longer term bearish outlooks. In particular, John Hussman who over the past few years, has repeatedly made a strong and compelling case for the market dropping 50% or more. On Wednesday morning with the market barely green, he posted the following bullish statement on his Twitter account:
ICYMI: “While we don’t observe

A special thank you to Peter Cook, CFA for co-authoring this article with us.
Imagine an island called Stiltsville, where a person’s value is based solely on their height. In order to increase their value, people living on the island used to wear platform shoes. A person wearing six-inch platform shoes would suddenly be more valuable than a person of similar height who wore normal footwear. Eventually, platform shoes were replaced by stilts, three-foot stilts were be replaced by six-foot stilts, and so on. People eventually rose to be the height of giraffes. The main point is that, on an island where height is valued above all else, people will try to game the situation to their advantage by increasing their height by any means available.
People from other lands would look at the people of

Clues from the Fed II, an RIA Pro article from November 28, 2018, provided important insight into one of Jerome Powell’s most important speeches as the Federal Reserve Chairman. We share the article to provide context to this article as well as to demonstrate the benefits of subscribing to RIA Pro.
Since the latter stages of Chairwoman Janet Yellen’s term and including the beginning of Powell’s term, the Fed has been on monetary policy autopilot. As a result of policy actions taken following the financial crisis, the fed funds rate was so far below the rate of inflation and economic growth that they felt comfortable raising rates on a steady basis without much regard for economic, inflationary and financial market dynamics. In Fed parlance, they were not “data dependent.”
Based on Powell’s

The price depreciation of risky assets in the financial markets continued through most of November but took a breather late in the month. The rebound in the final week provided for month-end to month-end optics that were otherwise better than what one might expect had they been watching markets transpire day-to-day.
Performance across the fixed-income sector was reflective of the recent challenges that extended into November. The list of issues included the sell-off of General Electric stock and bonds, Brexit uncertainty and the devastation and financial uncertainty associated with the California wildfires. The market reaction to these events has been justifiably imposing and leaves investors to consider the anxiety-inducing potential for contagion risk.
Money flowed into the safety of

In 1897, Virginia O’Hanlon asked her father if Santa Claus was real. He said she should ask The Sun, a prominent New York City newspaper of the day. Back then there was no fake news apparently, so if the Sun put it in print that there was a Santa Claus, there must be a Santa Claus.

Francis Church, an editor for The Sun, penned the response which contained the now famous phrase “Yes, Virginia, there is a Santa Claus.”
As the holiday season rolls around, many investors have a similar question; will there be a Santa Claus rally? In this article, we examine historical data to see whether Saint Nick will provide holiday cheer to investors or the Grinch will foil their wishes.
The Santa Claus Rally
The Santa Claus Rally, also known as the December effect, is a term for the occurrence of more

On November 27, 2018, the CFO from United Technologies (UTX) stated that his company will focus on deleveraging and not stock buybacks. This announcement comes as General Electric (GE) is struggling mightily to retain investment grade status and its stock is nearing levels last seen during the depths of the financial crisis. While there is much to attribute to GE’s decline, massive stock buybacks in 2016 and 2017 are largely to blame.
To wit: “The root problem at GE — and why the stock is where it is — is poor capital allocation,” said RBC Capital Markets analyst Deane Dray.
Corporate debt now stands at record levels versus GDP as shown below. While the debt has been used to fund expansion and R&D it has also been used to fund record numbers of share buybacks. The pitfalls of such a

Throughout modern financial history, the ability to borrow at a 5% rate on a 30-year mortgage was considered a great deal. Over the past ten years, mortgage rates falling to between 3% and 4% have warped perceptions. Evidence of this fact can be found by the sticker shock and home buyer consternation that the currently available 5% mortgage rate is causing. The rate shock is not limited to home buyers; the home building sector has fallen over 30% since it recorded a record high in January 2018. Notably, a month before hitting that record, the popular SPDR S&P Homebuilders ETF (XHB) surpassed the previous record high established at the peak of the housing bubble in 2006.

Mortgage rates play a large role in housing affordability, which greatly affects housing sales and prices, economic

“The journey of a thousand miles begins with one step.”  – Lao Tzu
In a tiny first step on December 16, 2015, the Federal Reserve (Fed) did something they had not done in over nine years. From the unprecedented starting point of zero, they raised the Fed Funds rate. Since, they have begun to allow their swollen balance sheet to contract in what can only be characterized as another unprecedented event. Although monetary policy remains extreme and real rates only recently have turned positive, these measures mark the end of an era of maintaining extreme financial crisis monetary policy in the United States.
Reversing these experimental policies initiates a new set of dynamics which will gradually reduce excessive liquidity from the financial system. Just as quantitative easing (QE) and zero

“Inflation is everywhere and always a monetary phenomenon.” – Milton Friedman
This oft-cited quote from the renowned American economist Milton Friedman suggests something important about inflation. What he implies is that inflation is a function of money, but what exactly does that mean?
To better appreciate this thought, let’s use a simple example of three people stranded on a deserted island. One person has two bottles of water, and she is willing to sell one of the bottles to the highest bidder. Of the two desperate bidders, one finds a lonely one-dollar bill in his pocket and is the highest bidder. But just before the transaction is completed, the other person finds a twenty-dollar bill buried in his backpack. Suddenly, the bottle of water that was about to sell for one-dollar now

There is an old saying that proclaims, “it’s not the size of the ship, but the motion of the ocean.” Since this is a family-friendly publication, we will leave it at that. However, the saying has a connotation that is pertinent to the bond market today. Much of the media’s focus on the recent surge in yields has been on the absolute increase in numerical terms. The increase in rates and yields, while important, fails to consider the bigger forces that can inflict pain on bond holders, or sink the ship. When losses accumulate and fear of further losses mount, volatility and other instabilities can arise in the bond market and bleed to other markets, as we are now beginning to see in the equity markets.
Since 1983, fixed-income investors have been able to put their portfolios on autopilot,

“I’m a low interest rate person” – Donald Trump 2016
On Donald Trump’s hit TV show, The Apprentice, contestants competed to be Trump’s chief apprentice. Predictably, each show ended when the field of contestants was narrowed down by the firing of a would-be apprentice. While the show was pure entertainment, we suspect Trump’s management style was on full display. Trump has run private organizations his entire career. Within these organizations, he had a tremendous amount of unilateral control. Unlike what is required in the role of President or that of a corporate executive for a public company, Trump largely did what he wanted to do.
On numerous occasions, Trump has claimed the stock market is his “mark-to-market.” In other words, the market is the barometer of his job performance. We

Here are two statements from the Federal Reserve’s Federal Open Market Committee (FOMC) immediately following their interest rate decisions of August 1, 2018 and September 26, 2018.
August 1, 2018 – In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1.75-2.00%. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.
September 26, 2018 – In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 2.00-2.25%. The stance of monetary policy remains accommodative, thereby supporting strong labor market

Here are two statements from the Federal Reserve’s Federal Open Market Committee (FOMC) immediately following their interest rate decisions of August 1, 2018 and September 26, 2018.
August 1, 2018 – In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1.75-2.00%. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.
September 26, 2018 – In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 2.00-2.25%. The stance of monetary policy remains accommodative, thereby supporting strong labor market

Investor preferences shift between active and passive investing in a cyclical manner. Periods where the market has a strong tailwind of momentum behind it tend to attract a greater demand for passive strategies especially when that momentum carries on for a prolonged period of time. Alternatively, periods of market turbulence tend to swing sentiment back to active investing as a means of avoiding the risk of large losses. In the most recent bullish cycle the combination of market direction and the availability of index-friendly instruments like exchange-traded funds (ETFs) have resulted in an unprecedented shift towards passive strategies and securities.
To clarify the difference between the two investment approaches, active investing seeks to outperform the market by beating a benchmark

If all goes well for nine more months, the post-financial crisis economic expansion will become the longest economic expansion in recent U.S. history. The U.S. stock markets are also on a tear, having just become the longest bull market since World War II. Regardless of your views about these trends continuing, the fact of the matter is that they are both much closer to ending than a beginning. Ray Dalio recently quantified this continuum, declaring that the economy is in the 7th inning, implying another one to three years of continuation.
While the markets can certainly keep motoring ahead, as Dalio and many others expect, there are some factors supporting the bullish case that investors should contemplate.
While this list is not by any means exhaustive, it does offer many of the most