Notes, Views, and the Occasional Provocation September / October 2009  

Eighty years ago a stock market crash on Black Monday 1929 ushered in the Great Depression. Until last year it was a period that many investors regarded with the same detachment they might apply to a museum exhibit of a saber-toothed tiger.

But after the recent market crash and near economic meltdown, the future looks and feels as uncertain as it did for our investment "ancestors." How do we cope with such uncertainty when it comes to our financial capital? This is the question addressed below in "Betting On More Than One Future."

May your own immediate future be filled with clear, crisp autumn skies and a happy Halloween.

Warm regards,

Milo Benningfield

Betting On More Than One Future
Yogi Berra famously counseled, "When you come to a fork in the road, take it." As it turns out, it was pretty good advice for investment portfolios. more

From the BFA Blog
Several highlights from our blog at more

BFA Media Quotes
Recent media quotes. more

Betting On More Than One Future
All powerful market rallies climb a "wall of worry," continually testing investors' faith each step of the way. As a result, one of the great ironies of such rallies is that even investors who are fortunate enough to participate in them often feel little pleasure as stock prices continue to climb.

A major reason is the consistent drumbeat of negative economic news and market commentary that dominates financial headlines after every bear market. Prognostications such as this one by former hedge fund manager Andy Kessler keep investors on edge:

The stock market still has big hurdles to clear. . . . Earnings are subpar, Treasury's last auction was a bust because of weak demand, the dollar is suspect, the stimulus is pork, the latest budget projects a $1.84 trillion deficit, the administration is berating investment firms and hedge funds saying "I don't stand with them," California is dead broke, health care may be nationalized, cap and trade will bump electric bills by 30% . . . Shall I go on? . . . Until these issues are resolved, I don't see the stock market going much higher. "Was It a Sucker's Rally?" Wall Street Journal, May 12, 2009.

The day Mr. Kessler's opinions were published, the S&P 500 Index closed at 908. Over the next few months, it rose 20% more, confounding a string of market analysts and earning the moniker "Most Hated Rally in Wall Street History" before backing off its highs recently.

Here are the eye-popping returns from March through the end of September:

Equity Asset Class Returns – March Through September 20091

The rally, in fact, is one of the sharpest in history – so strong that it has erased the losses in many diversified portfolios that managed to stay the course during the past year's market crash and near economic collapse. As an example, the Vanguard Balanced Fund (VBINX), a straightforward mix of 60% U.S. stocks and 40% bonds, was up 1.40% for the twelve months ending September 30th.

This is bitter medicine for investors who abandoned their investment strategies during the dark hours of winter and early spring, locking in their losses forever. But who can blame them? In less than a decade, today's investors have suffered not one, but two of the four worst bear markets in the last hundred years, wading through a tech bubble, a housing bubble, and the mother of all credit crises.

Now investors are being lectured on how they should have focused more on risk than return to keep their portfolios safe. But what exactly does this mean? And last year didn't the most sophisticated institutions have trouble managing their own risks, suggesting the task is easier said than done? Banks, bond insurers, hedge funds and university endowments, each in their own way, utterly failed to anticipate the near financial Armageddon and suffered disastrous consequences, even extinction, as a result.

Investment risk means different things to different people – price volatility; loss of purchasing power; potential harm multiplied by the probability of loss. But for most of us, risk means simply: the future is uncertain.

Many investors lament their inability to anticipate the market's next moves over the coming months or years. But for many people, the relevant time frame for accumulating assets and funding liabilities stretches over not just years, but decades. Here the future begins to fade into the stuff of fantasy and science fiction. As an example, consider two competing visions for the next few decades – visions that have attracted apologists of the highest caliber, but which could not be further apart.

The Peak-Oil Power-Down
In this vision, the world has a date with catastrophe within the next few decades as global oil production peaks, causing the global economy to power down and retreat to localized, even "feudal" economic systems not seen since the Middle Ages.

The lack of cheap energy will cause the world's great cities to go dark, and a period of food and energy scarcity will possibly last for hundreds of years. Alternative energy will not save us because supplies are too limited and costs are too high.2

The Techno Transformation
By contrast, others believe humanity is on the cusp of technological change so rapid and vast that life will be irreversibly transformed for the better within a couple of decades. Exponential progress in genetics, nanotechnology and robotics will surpass the limits of our imagination. Tiny robots will eliminate pollution; artificial intelligence and genetic advances will enable humans to live indefinitely without aging. With radical new alternative energy sources available, no one will miss petroleum even long before it runs out.3

Whether we're powering up or down in thirty years is anyone's guess, but either path would be disruptive, for both our lives and our financial capital. If we had to bet on one or the other future today, our guess could go wildly wrong. But with financial capital, unlike, say, a haircut or the Red Sox versus the Mets, we are rarely forced to choose between either-or propositions. The best investment strategies position themselves for many eventualities – or multiple futures – rather than only one or two.

Unfortunately, it's a lesson that many investors fail to learn even after disastrous experiences such as the one they had last year. For example, after the tech bust in 2000, when many investors were burned by concentrated bets in growth stocks, they turned to make equally concentrated bets in real estate, which then suffered its own boom and bust.

This year many investors are placing their bets on bonds. Of the $273 billion that investors have put into open-ended mutual funds so far this year, well over 90% of that money has gone into bond funds. Investor interest in individual bonds has also increased.

The push into bonds is understandable. Beginning last spring, with the stock market near its recent low, financial headlines revealed what for many investors was a surprising fact: bonds have sometimes outperformed stocks not just for years, but for decades.

But in eschewing stocks for bonds and concentrating their portfolios in only one or two asset classes, investors are making an implicit bet on a narrow future and one which resembles, more or less, the recent past. As always, it's a perilous bet.

The conditions that produced outsized bond returns in recent decades – in particular, the high interest-rate environment of the late 1970's and early 1980's – have gone the way of David Cassidy & The Partridge Family, mood rings, and Studio 54. With interest rates at historical lows today, bond investors can count on neither high income today nor high capital gains tomorrow to help recreate the returns of yesteryear.

The techniques for managing risk include diversification, hedges, and investing with a margin of safety. But employing these techniques effectively requires care in establishing your long-term strategy to begin with and then making necessary adjustments – not radical changes – over time.

To do this requires striking a balance between discipline and flexibility; it requires, in other words, a "middle path." But while the path is often clear, Buddhists and dieters alike know that it is rarely easy. It takes a lot more wherewithal to nosh on only one or two cookies than it does to abstain altogether or gobble the whole bag.

Avoiding extremes with your portfolio is one of the surest ways to navigate the extremes of the market. Chances are, though, that many investors will continue to flock to one end of the market spectrum or the other. For as the writer and futurist Aldous Huxley observed:

The charm of history and its enigmatic lesson consist in the fact that, from age to age, nothing changes and yet everything is completely different.

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From the BFA Blog
You can access our blog at or by going directly to the home page of our website at You can also click on the links below to go directly to recommended posts.

WSJ: The Perils of Chasing Yield
Wall Street Journal columnist Jason Zweig does a good job describing how much risk investors expose themselves to by jumping from stocks to bonds.

Harvard Endowment Lessons
The Harvard Endowment's 27% drop in its 2009 fiscal year provides valuable lessons for individual investors.

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BFA Media Quotes

Recent Media Quotes
Wall Street Journal, October 5, 2009

Milo was quoted in Anna Prior's article, "The Price of Green," which addresses mutual funds that invest in alternative energy and "clean tech" companies. Milo noted the risks involved: "'Any time you make a sector bet, you are making a very narrow bet that has lots of opportunities to go wildly wrong,'" says Milo Benningfield, founder of Benningfield Financial Advisors in San Francisco. Just make sure you are 'comfortable with that and have the capacity to take on that risk.'" Read the article.

BusinessWeek Online, August 27, 2009
Milo was quoted in Ben Steverman's article, "How to Prepare for Higher Taxes," which discusses ways to minimize exposure to higher income tax rates that may be coming. Milo noted that higher taxes may boost interest in tax-managed mutual funds. But he cautioned that while tax implications are important, "You don't want to make an investment move purely for tax reasons," Benningfield says. "To me, tax uncertainty is nothing compared to investment uncertainty. I'm more concerned about where commodity prices are going than tax rates." Read the article.

That's it for now. Thank you for reading. Please look for our next newsletter in December.

Best Regards,

Milo Benningfield

1 All index data calculated from returns from 3/1/2009 to 9/30/2009; asset-class performance based on the following indices: U.S Large Cap Value on the Russell 1000 Index; U.S. Small Cap on the Russell 2000 Index; U.S. Small Cap Value on Russell 2000 Value Index; International Large Companies on MSCI EAFE Index (gross div); Emerging Markets on MSCI Emerging Markets Index (gross div).

2 See, e.g., The Long Emergency, James Howard Kunstler, (Grove/Atlantic, 2005).

3 See, e.g., The Singularity Is Near: When Humans Transcend Biology, Ray Kurzweil (Viking Press, 2005).

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