The Election and The Markets

The Election

Freedom is the freedom to say that two plus two make four. If that is granted, all else follows. – George Orwell, “1984”

I passionately urge all readers of this letter, who are registered to vote, to proudly exercise your freedom to vote on or before November 8. If you are not registered to vote, please consider becoming registered, so that you can participate in deciding the future of our great country. If you don’t vote, you don’t get to complain!

From my perspective, there has never been a more consequential election in U.S. history. Regardless of one’s political leanings, one thing is clear: America is advancing away from constitutional democracy and toward Socialism[i] faster than at any other time in our history. Most glaringly, from an economic perspective, mathematical facts such as two plus two makes four, are increasingly, and recklessly, being disregarded. There is, perhaps, no greater evidence of this madness than the insistence of many U.S. politicians that America can borrow our way to a more profitable future, entirely at tax-payer expense (i.e., at the expense of our children and grandchildren). How long can a household survive when it continually spends more than it takes in?

A recent example of this misguided thinking is the so called “student loan relief plan” which, according to economists Brian Wesbury, Robert Stine, Strider Elass, Andrew Opdyke, and Bryce Gill is expected to add at least $426 billion to the federal deficit.[ii] These same economists note that, with the exception of the COVID years, FY2022 [9/30/21 – 9/30/22] spending as a share of GDP was the highest for any year since World War II[iii]. To make matters worse, all this spending occurred while the economy was expanding, a pattern which violates even the Keynesian economic theory[iv] that government should borrow in periods of economic contraction (i.e., recession) and then pay back the debt during times of economic expansion. Instead, our government has been borrowing record amounts while the economy is expanding. For more than two centuries, America’s consistent fiscal pattern has been to reduce federal debt when the economy is expanding. There has never been this much spending during a time of economic expansion in U.S. history. How are we going to pay back the debt when the economy is in a recession? 

If one regards inflation as an evil, then one has to stop inflating. One has to balance the budget of the government.– Ludwig von Mises, “Economic Policy: Thoughts for Today and Tomorrow”

Every American has the right to vote their conscience, without fear of reprisal, being “cancelled”, or being bullied. I am not ashamed to share how I will be voting because I sincerely believe the following issues matter greatly to the survival of our republic, and thus the freedom, success, and prosperity of every American. I am voting for candidates that demonstrate a solid understanding of economic principles and the  evil of inflation, are committed to putting America’s economic and security interests first, and pledge to, and have a credible history of, strongly defending freedom of speech and the rule of law.

The Markets

Our Market Environment Indicator (MEI) recently turned positive, resulting in an increase in market exposure and a reduction in cash in our tactical strategies. Strong rallies are quite common in bear markets, so it’s too early to tell if this is a false signal, or if we have entered a new cyclical bull market. For now, we are cautiously overweight risk assets while waiting to see if the bear market is really over, or has further to run. Even if this is only a bear market rally, eventually a rally like this will mark the start of a new cyclical bull market. Trying to predict if this will be a sustainable rally is impossible. Instead, our approach focuses on adjusting portfolio risk exposure based on what the MEI is telling us, versus trying to anticipate what the market is going to do in the future.

We are deeply grateful for the privilege of serving your wealth management needs—it is a stewardship we take most seriously.

Sean Gross, CFP®, AIF® | Co-Founder & CEO

Sean Gross, CFP®, AIF® is the Co-Founder and CEO of Telos Wealth Management, LLC, a Registered Investment Adviser located at 656 North Miller St., Wenatchee, WA. Sean can be reached at 509-664-8844 or at Info@TelosWealth.com.

---

[i] Though some prefer the term progressivism for the political movement that views the government as the solution to America’s problems, I believe this is a dangerous canard. Even if one disagrees with this conclusion, history suggests that progressivism leads to socialism and socialism leads to communism. 

[ii]Drop in Budget Deficit is a “Sugar High”, https://www.ftportfolios.com/Commentary/EconomicResearch/2022/10/31/drop-in-budget-deficit-is-a-sugar-high

[iii] Ibid

[iv] Keynesian Economics Theory: Definition and How It's Used, https://www.investopedia.com/terms/k/keynesianeconomics.asp

Market Environment Update, Summer 2022

Summer is finally here, or is it? While summer doesn’t officially arrive until Tuesday, June 22, I’m using “Summer” in the name of this letter for two reasons: 1) by the time you read this, the summer solstice will have likely already occurred; 2) I’m looking beyond our seemingly endless spring (or, is it winter?!) with optimism and hopefulness that warm weather will finally arrive on the longest day of year! Regarding the summer solstice, I am always a little discouraged when I realize, just as warm weather arrives and my plans for summer fun begin, the days get progressively shorter. I still have a very hard time accepting this! 

In our Winter 2022 letter, I wrote the following…

Following the market lows of March 2009, the S&P 500 has generated an average gain of 18.6% per year, which is well above the long-term average annual gain of 9.7% since 1927. This statistic alone suggests that the U.S. stock market cannot continue at the pace of the last 12+ years. There will be a reversion to the long-term average gain, and a reversion to the long-term average means there will be years in which the market produces returns which are significantly less than the long-term average, including negative returns.

Our Market Environment Indicator (MEI) turned negative last week, resulting in a reduction of market exposure and an increase of cash allocations in our tactical strategies. It is too early to tell if this is a false signal, if the market has entered a short-term correction, or if it is the beginning of a long-term bear market.

We now know the MEI reversal to negative in January was definitely not a false signal: Since the beginning of 2022, the broad U.S. stock market, as represented by the S&P 500, has lost over 23%. What we do not yet know is if this is merely a cyclical (short or intermediate term) correction, or the beginning something much worse and longer term. Like every other so called “expert” in this business, I don’t know! While I wish I could offer more encouraging news, I would be speculating and to paraphrase Mark Twain: June is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.

If you spend more than 13 minutes analyzing economic and market forecasts, you've wasted 10 minutes.^[i]

Heeding the sage advice of Peter Lynch, I'll spend less than 3 minutes of your time telling you I believe the market is likely to get worse before it gets better. While there will certainly be short-term periods of positive performance, the overall trend of the market remains negative, i.e., the MEI has not yet signaled that it’s safe to increase market exposure. Until it does, we remain very cautious, with high cash balances and low market exposure in our tactical account investment strategies.  

Inflation is always and everywhere a monetary phenomenon.^[ii]

Moving on from the stock market to the economy, I feel compelled to write on the subject of “inflation.” I intentionally put inflation in quotes, as I believe the phenomenon of what is commonly called inflation is tragically misunderstood. I began this section with a quote from Nobel Prize winning economist Milton Friedman. I’d like to expand on Friedman’s claim by quoting my favorite economist, Ludwig von Mises, who may be the most hated and most understudied economist of all time, at least among today’s MMT-centric[iii] economists, whose radical theory may have irreversibly transformed U.S. government economic policies, with devastating financial consequences for American households…

Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check. But people today use the term `inflation' to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise. The result of this deplorable confusion is that there is no term left to signify the cause of this rise in prices and wages. There is no longer any word available to signify the phenomenon that has been, up to now, called inflation…As you cannot talk about something that has no name, you cannot fight it. Those who pretend to fight inflation are in fact only fighting what is the inevitable consequence of inflation, rising prices. Their ventures are doomed to failure because they do not attack the root of the evil. They try to keep prices low while firmly committed to a policy of increasing the quantity of money that must necessarily make them soar. As long as this terminological confusion is not entirely wiped out, there cannot be any question of stopping inflation.[iv]

What von Mises was trying to explain is that inflation (an increase in the money supply) is the cause of rising prices vs. the phenomenon of rising prices. What people commonly call “inflation” today (i.e., rising prices) is actually the result of inflation (i.e., an increase in the money supply). This is a very important distinction, especially as America wonders, how did we get here? It seems quite evident that it did not start with supply chain issues or a war in Ukraine. To illustrate this, in the following chart note the exponential increase in gas prices corresponding with the unprecedented increase in federal spending (i.e., actual inflation, per Friedman and von Mises) beginning with the U.S. economic shutdown at the beginning of the Covid-19 pandemic…

Out of crisis comes opportunity. You make most of your money in a bear market; you just don't know it at the time.[v]

What might we expect to see, going forward? Remember, I don't know! However, ignoring the previously cited wisdom against speculation, it would seem that negative U.S. stock market performance is reflecting economic weakness which is now present and likely to get worse. In fact, some of those who keep close track of such things believe the U.S. has already entered an economic recession (two consecutive quarters of economic decline, as measured by GDP). If correct, stock market performance is likely to get worse before it gets better.  

However, if the stock market follows the historical pattern, at some point in the future--likely in the midst of even worse economic news and, most importantly, when we least expect it--disciplined investors will look beyond the then present economic conditions and put money back into risk assets, expecting better returns in the future as the economy improves. This is the pattern I’ve witnessed countless times in over 32 years in the money management business. If this pattern repeats, I suspect it will not be immediately observable, let alone believable, and the majority of investors will be reluctant to commit investment capital. In the scenario I’m describing, I expect that demand for risk assets will slowly, quietly resume while the financial prognosticators are still talking about the end of the world! When this occurs, our Market Environment Indicator (MEI) will guide us, as it has so many times in the past. Until then, we remain cautious, hopeful, and entirely confident in the observation of Shelby Cullom Davis: Out of crisis comes opportunity.

Summer has arrived!

Sean Gross, CFP®, AIF® | Co-Founder & CEO

Sean Gross, CFP®, AIF® is the Co-Founder and CEO of Telos Wealth Management, LLC, a Registered Investment Adviser located at 656 North Miller St., Wenatchee, WA. Sean can be reached at 509-664-8844 or at Info@TelosWealth.com.

---

[i] Legendary investor Peter Lynch, former manager of the Fidelity Magellan Fund, who is widely considered one of the most successful and well-known investors of all time.

[ii] Milton Friedman, “Inflation Causes and Consequences”, Asian Publishing House, 1963

[iii] Modern Monetary Theory (MMT) is a [non mainstream]…economic framework that says monetarily sovereign countries like the U.S., U.K., Japan, and Canada, which spend, tax, and borrow in a fiat currency that they fully control, are not operationally constrained by revenues when it comes to federal government spending. Put simply, such governments do not rely on taxes or borrowing for spending since they can print as much as they need and are the monopoly issuers of the currency. Since their budgets aren’t like a regular household’s, their policies should not be shaped by fears of a rising national debt. (https://www.investopedia.com/modern-monetary-theory-mmt-4588060)

[iv] “Inflation, An Unworkable Fiscal Policy”, Ludwig von Mises

[v] Shelby Cullom Davis, one of the greatest value investors the world has ever known.

Market Environment Update

The essence of portfolio management is the management of RISKS, not the management of RETURNS. All good portfolio management begins with this premise.[i]

Following the market lows of March 2009, the S&P 500 has generated an average gain of 18.6% per year, which is well above the long-term average annual gain of 9.7% since 1927. This statistic alone suggests that the U.S. stock market cannot continue at the pace of the last 12+ years. There will be a reversion to the long-term average gain, and a reversion to the long-term average means there will be years in which the market produces returns which are significantly less than the long-term average, including negative returns.

People somehow think you must buy at the bottom and sell at the top. That's nonsense. The idea is to buy when the probability is greatest that the market is going to advance.[ii]

Our Market Environment Indicator (MEI) turned negative last week, resulting in a reduction of market exposure and an increase of cash allocations in our tactical strategies. It is too early to tell if this is a false signal, if the market has entered a short-term correction, or if it is the beginning of a long-term bear market. For now, we are managing risk and patiently waiting for the MEI to signal that “the probability is greatest that the market is going to [continue] to advance”[iii].

Sean Gross, CFP®, AIF® | Co-Founder & CEO

Sean Gross, CFP®, AIF® is the Co-Founder and CEO of Telos Wealth Management, LLC, a Registered Investment Adviser located at 656 North Miller St., Wenatchee, WA. Sean can be reached at 509-664-8844 or at Info@TelosWealth.com.

---

[i] Benjamin Graham, The Intelligent Investor

[ii] Martin Zweig, fund manager and author

[iii] Ibid

On the Eve of the Election

Posted by Sean Gross, CFP®, AIF®

A quick note to, hopefully, ease your minds on the evening before what is being described as the most consequential election of our lifetime...

• We remain cautiously optimistic: In spite of the recent sell-off, our Market Environment Indicator (MEI) remains positive.
• Economic data continues to show surprising growth.
• The market is not pricing in, so does not appear to be expecting, a disastrous outcome tomorrow.
• Now is NOT the time to sell.
• Economic outcomes appear to have a low correlation to election outcomes: https://www.jamesinvestment.com/docs/Fools-Gold.pdf
• VOTE! Bad officials are elected by good citizens who don’t vote. — George Jean Nathan
• Stay Calm—human beings are terrible at predicting the future: https://qz.com/1752106/why-are-humans-so-bad-at-predicting-the-future/
• When all the experts and forecasts agree, something else is going to happen — Rule #9 from legendary market strategist Bob Farrell's "Ten Rules of Investing".
• Choose FAITH over doubt and COURAGE over fear!

The End of the Beginning or the Beginning of the End?

Only recently, we were all making summer vacation plans, shaking hands, giving hugs, and even exchanging an affectionate peck on the cheek with those we’re closest to. How quickly and dramatically things change! The coronavirus epidemic has induced panic selling in the markets, untold job layoffs, and will likely lead to a recession as economic activity comes to a grinding halt across our great country. 

We are not only concerned about the impact the coronavirus is having your investment portfolios and the economy; we are equally concerned about the practical impact it may be having on you and your families. If you need anything—toilet paper, food, etc.—please let us know! While we may not be able to meet every need, there are certainly others in our network of relationships who we know would be delighted to help.  

It's waiting that helps you as an investor, and a lot of people just can't stand to wait. – Charles Munger, Vice Chairman of Berkshire Hathaway and Warren Buffett’s investment partner.

All this chaos has led to intelligent conversations with a few of our clients, who have extra cash to invest, and have asked if this is the time to buy. While panic selling is often a contrary indicator signaling that it’s time to buy, we think this situation is likely to get worse before it gets better. Since our Market Environment Indicator (MEI) turned negative a couple weeks ago, our tactical strategies remain positioned with low allocations to stock instruments and high allocations to cash and ultrashort-term bond instruments, and we will remain so until the MEI reverses to positive. Until then, this is the most important thing to remember: “It’s waiting that helps you as an investor…”

Bull markets are born on pessimism, mature on optimism, and die on euphoria.  The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell. – Sir John Templeton, considered by many as the greatest global stock investor of the 20^th century.

An evaluation of past infectious outbreaks/epidemics (SARS, MERS, Avian Flu, Ebola, etc.) may give us a clue of what to watch for. In these past outbreaks/epidemics the market did not bottom until sometime after the daily rate of new recoveries of those who were previously infected exceeded the daily rate of new infections. We’re not there yet with this outbreak, so we believe caution is the best approach until the relationship in these trends improves (more here: https://www.worldometers.info/coronavirus/coronavirus-cases/). However, it’s important to note that even when we reach this point, because so many will have already been infected with the coronavirus, the outlook, fear, economic consequences, and dire forecasts are likely to only get worse. It is in this very environment of “maximum pessimism” that next bull market will begin.

When the time comes to buy, you won’t want to – Walter Deemer, legendary technical analyst, author, and 57-year investment industry veteran.

The good news is that we are now moving into a period where smart investors are beginning to evaluate bargains, looking at investments that are likely to do well in a recessionary environment, and even grow exponentially when the economy eventually recovers…which it will. For now, we do not think this downturn has fully run its course and are waiting for the MEI to signal when it’s time to increase risk again. If our past experience is any indication of the future, the MEI reversal will come at time when the news is still very bleak and few believe the market will ever stop going down, let alone ever go up again. Remember these words: “When the time comes to buy, you won’t want to.”         

We are overwhelming grateful for your friendship and the privilege of serving your wealth management needs, which we will continue to do with the highest level of devotion, stewardship, and integrity. Please let us know if you have any questions, concerns and/or physical needs we can help with. 

Sean Gross, CFP®, AIF® | Co-Founder & CEO

Sean Gross, CFP®, AIF® is the Co-Founder and CEO of Telos Wealth Management, LLC, a Registered Investment Adviser located at 656 North Miller St., Wenatchee, WA. Sean can be reached at 509-664-8844 or at Info@TelosWealth.com.

---