The Brave New Reality Show

Wednesday, April 19th, 2017

An entity previously known as THE DONALD is now President Trump, causing fear and trembling in many circles and jubilation in others.  There will likely be some pullback on both viewpoints in the next few years but it is worth noting that sales of George Orwell’s classic 1984 have skyrocketed.  On the investment sentiment front there appears to be some consensus based on the post-election stock market upswing, that the domestic economy could grow faster than in the previous 8 years with less regulation and lower taxes.  However, the unpredictable President’s relationship with a Republican controlled Congress is a shotgun marriage at best, which went badly awry over the attempted repeal of Obama’s Affordable Care Act.  There is a lot of blame to go around but Trump’s disdain for a Republican controlled Congress reveals that unless he changes course we will likely see future legislative debacles.  Since Trump likes to boast that he doesn’t read much but watches a lot of TV, perhaps the new President should stream, ALL THE WAY, the excellent 2016 HBO movie about LBJ, and he could learn how an accidental President went about getting what he needed from Congress. For starters you never call for a vote you unless you know the result, and you can find some pretty unorthodox and unseemly ways to get the votes you need.  Trump would see how LBJ orchestrated the passage of the landmark 1964 Civil Rights Bill over a filibuster led by his close friend and former Dixiecrat ally Senator Richard Russell.  One way LBJ circumvented Russell’s filibuster was to go to the Republicans, which seemed more than a long shot at the time. But LBJ knew if he got minority leader Evert Dirksen on his side the others would follow. Fortunately he understood what button to push with the Republican minority leader and told Senator Humphrey the bill’s floor manager exactly what to do—“Hubert, kiss Dirksen’s ass so hard that he can’t sit down.” It worked:  they convinced Dirksen, the Illinois Republican that he carried Abraham Lincoln’s mantle and would cement his legacy by backing the Civil Rights Bill.  LBJ, an outsider like Trump—a role he milked expertly, always complained that the eastern establishment liberals hated him. But he made sure to keep JFK’s cabinet intact, and as he succinctly put it: “Better to have them on the inside of my tent pissing out.” Since everything is negotiable for the former real estate developer, and he’s boasted about getting some sticky deals done, he might want to take that cue from LBJ since there is another attempt at repealing the Affordable Care Act in the works with trade and tax reform bills to follow.  Perhaps VP Mike Pence and House Speaker Paul Ryan should join the viewing party.

So far the stock market generally likes what it wants to perceive from the new administration. The bullish consensus is that there is enough agreement by the concerned parties on several “business friendly “issues to promote a growth agenda. The less sanguine view voiced by economists such as Lawrence Summers, the former head of President Bill Clinton’s Office of Economic Advisors, is that the Trump team is promoting “Voodoo Economics,” and that tax policies repatriating offshore cash coupled with protectionist tariffs will not lead to increased capital investment or produce growth.  The two executive orders issued during Trump’s first week on the job might be an indication of what could ensue:  he reversed President Obama’s halt of two contested pipeline projects: Keystone, which when built will transport Canadian oil to Texas refineries and Bakken, a domestic pipeline approved and 95% completed until protesters convinced President Obama that it came too close to the Standing Rock reservation. Republican lawmakers as well as several Democrats applauded President Trump’s move, but not surprisingly he then threw a wrench into the mix by insisting that the companies involved, TransCanada and Energy Transfer use only US manufactured materials to build their pipelines.  Energy Transfer has said that’s what they intended to do and there has been some hedging by TransCanada on the Keystone supply chain. There was the expected objection to Trumps executive orders from environmental and tribal groups who had successfully lobbied President Obama.  But then unlikely allies such as the Cato Institute, a libertarian think tank funded by the Koch brothers, joined in.  The director of the conservative institute’s trade policy center vociferously objected to the President telling private companies where they have to buy their materials, describing it as “without legal authority, dictatorial and a very bad precedent.”   There is also the stunning irony of the real estate mogul turned President issuing the order since his landmark buildings were constructed with cheap non-US steel.

The investment markets quickly grow nervous with perceived chaos and the current occupant of the White House so far has done little to alleviate that concern.  The one orderly component that matters much more to investors than who sits in the Oval Office or what is tweeted in the wee hours is the activity of the Federal Reserve.  As was the case during the past administration, the Fed and its decisions on interest rates and open market bond purchases created the positive macro economic conditions for the financial markets. The reactions to Trump’s unorthodox presidency will likely continue and even escalate, and despite the assumption of a more business friendly environment, there is really no compelling reason to call the post-election stock market upswing a “Trump Rally.”  The more correct moniker remains a Bernanke/ Yellen rally.  During the first quarter of 2017, the Dow Jones Industrials gained 4.5% and the S&P 500 gained 5.5%.  Since the Dow Industrials contains more energy companies than the S&P, the downturn in oil prices explains the Dow lagging the S&P.  Balanced indices with a component of fixed income gained 3.5% reflecting a pullback in bonds.  Dividend and covered call Exchange Traded Funds fared better gaining between 4 and 5%.  Since the Federal Reserve has announced that there will be at least two more interest rate hikes to the Federal Funds rate in 2017and that many of the bonds on their balance sheet will be bought back, the case for dividend funds and conservative option income strategies in a gradual rising interest rate environment appears to be strong.  Most of the companies in the S&P are raising dividends and the yields on their stock are higher their own high-grade bonds. For example Johnson and Johnson common stock currently yields 2.6% while their most recent issue of AAA 5-year bonds came to market with a yield of 1.7%, roughly comparable to a 5-year Treasury. JNJ has raised its dividend annually for the past 55 years and the current dividend of $ 3.20 reflects a 90% increase since 2007, which was the last time the 5-year Treasury was at 5%.  So while the Fed is raising rates, investors seeking income from their investments will need to look beyond bonds for it will likely be several years before the 5-year Treasury is back at 5%.  Generating cash flow through dividend growth and conservative option strategies make sense in a low interest rate environment.  An article in the March 2017 issue of Institutional Investor notes that public pension funds are divesting from poorly performing hedge funds that charge high fees and are now using covered call and cash secured put selling as a way to protect their equity holdings and reduce volatility at a lower price.  In what will likely be a confusing and volatile global political landscape, a low cost hedged strategy makes sense for investors of all stripes and sizes.

Where is Jacob Schiff When We Really Need Him

Wednesday, April 19th, 2017

Jacob Schiff (1847-1920), a contemporary and banking rival of JP Morgan is a name that today does not draw much interest or recognition.  While there are multiple biographies of Morgan and other financiers such as Schiff’s in-laws, the Warburg’s, Schiff himself has largely been ignored. There are studies about his philanthropy, and he is discussed at length in Stephen Birmingham’s excellent 1967 book about the New York Jewish banking families, Our Crowd.  Yet a Google search of Jacob Schiff reveals that the most recent interest in his life and career currently comes from anti-Semitic conspiracy theorists, such as former Republican Congressman William Dannemeyer, who represented California’s 39th District (Orange County) from 1979 to 1993.  In his article, “Who Stole America,” Dannemeyer claims that Jacob Schiff was sent to New York by the Rothschild’s to take over the US banking system, which he accomplished by secretly orchestrating the formation of the Federal Reserve and then used it to finance the Russian Revolution. While these allegations are beyond being absurd, many people worry that following a bitter Presidential election with a surprising outcome, such tropes are making a comeback: but that is not why we should pay attention to Jacob Schiff.

The largest and most powerful banks and brokerages such as JP Morgan Chase, Wells Fargo and Goldman Sachs are richly valued, but the public perception of the companies and their management is closer to an all time low.  Recently Wells Fargo dismissed its CEO after being fined for engaging in deceptive sales practices, which included rewarding employees who opened unauthorized accounts for the bank’s customers. In 2014, JP Morgan Chase, paid out an eyeball popping record fine of $920 million to settle legal claims resulting from rogue bond trading in London. This debacle linked to one trader, known as the London Whale, resulted in a $6 billion loss for the bank, which they did not accurately state in their earnings report.  In the same complaint it was revealed that the firm had ignored many red flags and continued to do business with Bernie Madoff despite filing a document with a UK regulator in 2008 stating that “his returns were too good to be true.”  JP Morgan Chase’s Jamie Dimon, a widely admired CEO, initially described the $6 billion loss resulting from the London Whale trading debacle as “a tempest in a teapot,” but later admitted that neither he nor the bank’s London management understood enough about the complex derivatives being used by his own traders. Shortly after JP Morgan Chase paid the record settlement, Mr. Dimon received a significant increase in compensation.  Goldman Sachs CEO Lloyd Blankfein was praised and rewarded for keeping his firm in good financial shape during the financial crisis of 2008.  In 2010, however, this success was called into question by an SEC fraud complaint concerning an investment partnership called Abacus, created by Goldman Sachs so that hedge fund manager John Paulson could bet against sub-prime mortgages during the 2008 financial crisis.  Goldman needed to find investors plus an institutional manager to take the opposite side of the trade, but never informed them that Paulson had selected the bonds.  The bond fund manager told the Senate committee a Goldman trader who was later dismissed assured his firm that Paulson was an equity investor in the partnership. When confronted with these facts, Mr. Blankfein testified that Goldman had “no moral or legal obligation” to inform their clients that Paulson’s fund had selected and sold short the mortgages they were buying.   After Goldman settled the SEC fraud suit for a then record $550 million the firm admitted that they should have been more forthcoming about the short positions in Abacus and other similar debt instruments.

In an interview with the Financial Times following the SEC settlement, Mr. Blankfein proclaimed that Goldman Sachs was in excellent shape and back to “doing God’s work.” Presumably he was referring to the contribution his firm makes to the liquidity of the mortgage securities market which does greatly benefit the public and most people know very little about except for what went wrong with it in 2008.  Wall Street CEO’s could do much more to engage the public about their activities that help Main Street but also address the growing antipathy directed at their banks when they do fail at risk management and ignore their own red flags.  “I owe the public nothing!” JP Morgan famously bellowed at a reporter who dared to ask him a question about his railroad deals.  That was in 1901 however, and his bank had not received a taxpayer-funded bailout.   Whether they like it or not, the thriving beneficiaries of the 2008 bailout clearly do owe the public something.

These events would have likely both troubled and baffled Jacob Schiff.   Unlike JP Morgan, he did not have his name on the bank, which explains some of his anonymity, and he gave charitable gifts as acts of public philanthropy. Without Schiff, the Henry Street Settlement House, which aided tenement dwellers in New York, the American Jewish Committee, which rescued Russian Jews from pogroms, and the Jewish Theological Seminary would not exist.  Yet none of these institutions bear his name.  He worked for his father-in-law at Kuhn, Loeb, succeeding him as Chairman and made the firm a major player in financing railroads.  Perhaps his best known and signature deal was the restructuring of the then bankrupt Union Pacific Railroad in 1895—a transaction that per the prevailing code between Jewish bankers and their Protestant overlords, Schiff first offered to Morgan who declined the opportunity–something he later very much regretted.  “Let the Jews have that one,” was a phrase often heard on Wall Street in the 1890’s and in this case Kuhn, Loeb gladly accepted.  Schiff, according to one of Morgan’s early biographers knew more about railroads than all of his competitors put together, and “had probably inspected every railroad tie from Baltimore to Denver.”  As a result, Schiff, who Morgan referred to as “that foreigner,” better understood Union Pacific’s potential value and significance to mining, forestry and the growing US economy.  Long before globalization was a word, the key to Schiff’s signature triumph was to attract international investors, and it is fair to say that without his efforts the largest American railroad would not have survived.

What Jacob Schiff did by himself to create and complete the restructuring of Union Pacific in 1895 would now involve at least four separate departments of an investment bank: he was the merchant banker willing to risk capital on an opportunity others had missed, the underwriter who created the equity securities, the credit analyst who determined the interest rates and maturities of the bonds, and the domestic and international syndicate manager who oversaw where they were placed and at what price. In an environment where the playing field was not level, Schiff made sure he understood his bank’s business better than anyone else, because not doing so would definitely lead to failure. As noted by Stephen Birmingham in Our Crowd, Schiff believed and practiced his motto, that “our only attractiveness is our good name and reputation for sound advice and integrity.”

In 1913 Schiff led the reorganization of the Pennsylvania Railroad and Kuhn Loeb partnered with JP Morgan to finance building the Penn Tunnel under the Hudson River.  The project was controversial and how best to replace the 103-year-old tunnel remains so today.  Schiff, Morgan and their investors were roundly criticized by muckraking journalists and President Theodore Roosevelt chastised Wall Street Bankers as ”the malefactors of great wealth.” Yet Schiff corresponded extensively with Roosevelt, and later Wilson.  He tried to persuade both Presidents that the country benefited from the efficient management of the nations railroads and other industries such as steel and oil that resulted from monopoly ownership.  But in this case he badly misjudged the political headwinds and was called before a hostile Congressional Committee investigating his interlocking interests.   In contrast to his current counterparts, Schiff appeared without lawyers, openly testified about his transactions and cleared up some misconceptions, but the amount of securities underwritten by Kuhn Loeb became part of the public record and was in itself controversial. Today’s bank CEO’s might want to emulate both Schiff’s business and charitable ethos.  He ultimately gave most of his wealth away (as Warren Buffett plans to do), and firmly believed that he owed the American public not just something but a great deal.  In an environment with entrenched warring political factions, where too-big-to-fail financial institutions remain insular and are losing the public’s trust, a large dose of Jacob Schiff would be most welcome.

Brexit and Beyond

Friday, September 9th, 2016

Following the surprising British vote on June 23 to leave the European Union, alarm bells sounded worldwide with dire warnings from investment experts such as George Soros and political pundits such as George Will saying that the world as we knew it was coming to an end. Yet after a short global market selloff the dire assessments were quickly scaled back and rephrased to a “let’s wait and see” response. More recently the Brexit trauma rumblings have been replaced with predictions about new market highs. None of this should be too surprising since we heard similar alarm bells from after the Russian debt meltdown in 1998, the 2001 Internet bubble, the 2014 Greek debt crisis and most recently the Chinese currency devaluation in 2015. Also we should not be too surprised about the one group of clear early winners on the vote to leave the EU: British shrinks. According to an article in The Guardian, a London psychologist reported that her appointment calendar, previously languishing had suddenly ratcheted upward and nearly every session was about how to deal with “The Vote.” There is instability and anxiety,” said the London psychologist, “but alongside of that there is “some exhilaration, as many are for the first time caught up in the fate of their country.” One client after seeing her therapist tweeted that she planned to send the invoice to exiting PM David Cameron, who probably did not head directly to his shrink: he was caught unawares on a reporter’s microphone happily humming as he cleaned out his office and left 10 Downing Street. Far too much ink was spilled on what tune he might have been humming or why, and perhaps that is one of the better commentaries on the vote. All of the hue and cry over Brexit and previous “this time it’s different” pronouncements brings to mind Mark Twain’s comment about Richard Wagner’s music: “You know, it’s really not as bad as it sounds.”


One of the most respected and successful fixed income managers of the past decade, Jeff Gundlach of Double Line Capital had some noteworthy commentary on the current state of the bond market:

“There is something of a mass psychosis going on related to the so-called starvation for yield.”

As of June 30, 2016, Mr. Gundlach’s flagship fund with $61 billion in assets held just 3.4% of its assets in US Treasury Bonds, which is a new low for actively managed bond funds. In the past 30 years the yield on the 10-year Treasury has dropped from 7.5% to 1.5%. Most of that decline has occurred in the past 10 years: on June 30, 2006 the 10 year Treasury yield stood at 5.2% and now is 1.5%. A staple of moderate allocation investing for both institutional and retail investors has been the classic 60/40 equity-to-fixed-income split. The economist and investment manager most closely associated with this idea, Peter Bernstein, said in a white paper written in 2002 that the allocation should be permanent given the unpredictability of both the markets and investor psychology. For Bernstein and others the 60/40 balance was as much a philosophical stance as well as a financial credo and reflected the thinking of Warren Buffet’s mentor Benjamin Graham when he noted: “successful investment management is about the management of risks rather than returns.” This balanced account approach has done very well in the 14 years since the Bernstein article because of outsized returns from the bond market following the financial meltdown of 2008. But getting a big return from bonds was not the thinking behind the idea. Bernstein argued that even though the 60/40 balanced portfolio trailed a more aggressive allocation it was still the preferred path since it took emotional responses to market swings out of the equation. Many billions of dollars worldwide are still invested along those guidelines, but is the classic 60/40-fund allocation still a viable strategy? The party if not already over may be ending. In Germany a 10-year Bund, or German Treasury came to market in July with a negative yield. How long the buyers of these bonds are willing to pay the German government for the privilege of lending it money remains to be seen. This event is more noteworthy than Mr. Cameron humming as he left the Prime Minister’s office yet there are no reports about German psycho-therapists having an upsurge in business on account of “The Bond.” Global markets have not seen the negative yield on German Treasury bond as the end-of-the world as we know it. In fact, many commentators currently perceive it as a simulative plus, although there are dissenters. Bill Gross, formerly the head of PIMCO, told CNBC: “a liability is a liability and contrary to capitalism as we know it. “ Yet despite the attempted “QE Hail-Mary’s” by the central banks, capitalism, as we know it seems to be bumping along reasonably well. The US economy keeps growing steadily, even at plough-horse rates, and the crashing bond yields tilt asset allocation models in favor of equities, especially high quality dividend paying stocks, and conservative yield enhancing option strategies. For as Mr. Gundlach aptly noted, investors, crazed or not, are going to have to find investment yield somewhere: 80/20 funds here we come!


Something else that is also not as bad as it currently sounds is “globalization.” After all if both Donald Trump and Bernie Saunders are in agreement on something being a disaster, then it is probably not all that bad and certainly deserves a second look. Long before controversial trade agreements such as NAFTA, and Trans-Pac, globalization played a large part in building the US and world economies. In the late 19th century US railroads would not have been funded without the capital from European investors. Yet the alarm bells we hear now were sounded then because American First adherents expressed concern about Wall Street bankers such as JP Morgan and Jacob Schiff being controlled by the Rothschild’s. Schiff quietly ignored the nativist anti-Semitic critics and single-handedly restructured the bankrupt Union Pacific Railroad with capital from British and German banks. The largest rail transport company in the US would probably not be in existence today but for Schiff’s brilliant global deal. For what it is worth, Schiff is still blamed (or credited) by conspiracy theorists for infiltrating the Federal Reserve and financing the Russian Revolution with Rothschild money. JP Morgan, sometimes Schiff’s ally but far more often his competitor in financing railroads and companies such as Westinghouse and US Steel, had no problem aggressively bashing those who questioned his dealings, famously shouting at a New York reporter: “I owe the public nothing!”

So we have seen discontent about so-called rigged global financial alliances before and we will see it again. The Brexit vote while unexpected will likely be a manageable protest against immigration. While political and financial talking heads continue to scurry and comment, many companies and entrepreneurs are already lining up to make money from the disruption. Some early winners have been British manufacturers with exports rising by double digits since the vote. The service sector especially in London is still doing very well and the feared mass exit of financial companies from the City of London has not transpired. Donald Trump who has done pretty well from globalization with off-the-books golf course deals (some suggesting that he may not want to show his tax returns for that reason), continues to rail at immigrants and beneficial trade agreements. The British, European and American nativists all send messages on IPhones and tweets via their laptops, go home and watch the Olympics on LED flat screen TV’s without seeming to consider that if they had their way none of these devices would be available or affordable. To put this in very simple terms for Trump, Bernie, Libertarian Candidate Gary Johnson (who admitted he needs a geography lesson), globalization in all areas of investment and trade has been and will be a major and very beneficial component of the US economy for all income groups. A telling comment was made last year by John Bogle, the founder of Vanguard Funds, who was asked about his recommended allocation to international equities: “there’s no need to own any since US companies do so much of their business globally.” This very straightforward answer would be music to the ears of the early global investors in US companies.

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