Is a recession coming?

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Last week Wednesday (the 14th) was a bad day, at least it was a bad day for the markets. I actually had a pretty nice day, maybe you did too. The market took a hit though, the DOW was down 800 points (about 3%), its worst day of this year, and other indexes didn’t fare much better. The chatter is heating up, the next recession is on the horizon! But is it?
Well, the Wall Street Journal certainly seems to think so. In an article title Stocks losses deepen as a key recession warning surfaces published last week, the WSJ espouses the fearful sentiment pervading the industry last week. A few quotes:

Whether the events presage an economic calamity or just an alarming spasm are unclear. But unlike during the Great Recession, global leaders are not working in unison to confront mounting problems and arrest the slowdown. Instead, they are increasingly at one another’s throats.

This sounds especially bad. At least in 2008 people were trying to fix the problem!

“The stars are aligned across the curve that the economy is headed for a big fall,” said Chris Rupkey, chief financial economist at MUFG Union Bank. “The yield curves are all crying timber that a recession is almost a reality, and investors are tripping over themselves to get out of the way.”

Yikes, sounds like someone is about to get trampled.

The U.S. economy has shown signs of weakening in recent months, but high levels of consumer spending in the United States have helped enormously. Still, the escalating trade war between Trump and Chinese leaders has stopped many businesses from investing. And there are signs that the large tariffs he has placed on many Chinese imports is costing U.S. businesses and consumers billions of dollars.

If this isn’t a rollercoaster of emotion I don’t what is. Signs of weakening? Oh no! High levels of consumer spending? Okay, so not too bad. Tariffs are costing U.S. business and consumer billions? Run from the market!

I kid, but this is actually serious stuff. The WSJ is only one among many news outlets forecasting the next crash. The problem is, no one knows when the next crash will be, regardless of ‘key recession warning’ claims, because the market moves on new news and information, things that no one knows. Unless of course, you know the future.

Just today, exactly one week later, we’ve got a new narrative in the news: Stocks are on a comeback. Dow rises 250 points. The rollercoaster is exhausting.

Instead of tuning into the cycle, remember that great returns don’t come from any ability to time the next crashThe market recesses sometimes, and it could be contracting now, or next year, or in five years. We don’t know when, we just know that’s how the market works. The disciplined investor who has a plan for whenever the next crash comes and a coach to get them through it will always win.

Coach, Financial

You don’t hear the term ‘coach’ tossed around much in the finance world. If you do it usually refers to some sort of business coach, a coach for the professionals. In the normal world, financial professionals are typically called financial planners or financial advisors, not coaches. But here’s why I like to call myself a coach:
A financial planner/advisor is someone who provides some sort of product or service (or both) in return for a fee, which is effectively sales. Some of them are fiduciaries (meaning they’re obligated to put the client’s best interest first), some are simply looking for suitability (whether or not a certain product could be considered suitable for a customer, not what would be best for the customer). Many of them mean well, but they fall short in one key area, they don’t ensure the success of their clients. The job is to provide a product (financial plan, insurance product) or service (investment advice, meetings) which may help (or hinder) investors to varying degrees, but it’s not to provide an outcome.
Dalbar’s (an investor research company) Quantitative Analysis of Investor Behavior study shows that average investors underperform the market year after year. Morningstar’s annual Mind the Gap report shows that investors even underperform the funds that they’re invested in (largely because of active movement and bad timing) year after year. The worst part is that most of these investors are working with planners and advisors. So what gives? One of the biggest components of the problem is that the professionals helping clients are salespeople, not coaches.
There are two opposing ways to define the customer/financial professional relationship: cater or care. Most financial professionals cater to customers. If the customer wants a certain product, the professional is ready to fill out the paperwork. If the customer wants to shift investing strategies, the professional is ready with three other options. What’s best for the customer in these scenarios is effectively irrelevant. Professionals end up filling orders (catering) instead of coaching and educating clients on options that fit best with their goals (caring). Add in the commission trap problem and it’s almost impossible for many financial professionals to truly care for clients. Instead of investing in the success of the client, they’re focused on keeping their business alive.
In contrast to this, a financial coach is interested in one thing: helping people achieve their goals (caring). The relationship is not driven by products or sales but by a partnership working towards an outcome. The whole orientation is different. Where a typical financial professional is looking for ways to fit products onto perceived problems, kind of like trying to plug holes, a coach is looking toward the long term success of a client and working with them, year by year, to achieve that success. Ensuring the success of a client includes many things, including financial products and services, but the key ingredients are educating and coaching. Educating so that clients know how and why they’re invested the way they are. Coaching so that clients are empowered to stay the course. Things get scary, pitfalls abound, it’s probably going to be a long journey, a coach walks alongside to ensure your success.

The commission trap

So you’re an investor, and you’ve got seemingly unlimited options for your money. Some seem awesome, some look a little suspect, and for the most part, you’re not really sure what’s going to work and what to stay away from. Typically, you’d talk to some type of financial advisor. Or you’d succumb to your own hubris and decide to get online and do this whole investing thing yourself until it becomes clear that you’ve made a huge mistake, then you’d talk to some sort of financial advisor. But now instead of trying to figure out how and where to invest money, you’re trying to figure out how to pick a trustworthy advisor who can help you with the investing part. Well, I’ve got one piece of advice: watch out for the commission trap.

There are several different ways that financial professionals are paid, the two most common are through fees and through commissions. Some advisors only charge one way or the other, some do both.

A fee-based advisor means that if you’ve got money invested, the advisor collects a fee (usually a small percentage) from your investments every year. It’s a pretty simple, pretty common model, and it makes sense because the advisor is invested in your success. It definitely doesn’t mean that the advisor is trustworthy, but you can at least take comfort in the fact that it’s a sensical payment model.
On the other side is the commission trap. There are a few bad things about commissions:

  • It means you’re buying a financial product. Advisors who collect commissions only get paid when a client buys something. Financial products, while veiled as beneficial to the customer, are generally not the best option. They prey on people’s desire for security and charge a hefty premium for it (annuity). What a financial product offers can almost always be had for a fraction of the cost with a much higher ceiling for growth by simply investing in the market. Not every product is always bad, but you definitely shouldn’t be buying lots of financial products.
  • It means the advisor is collecting a large commission. These products, specifically annuities, will pay out massive sums to advisors who can peddle them. Commissions between 5% and 10%, and sometimes even more, are common. That means if you take your $500,000 investment account and buy an annuity, the advisor could be collecting between $25,000 and $50,000. That’s a lot, suspiciously a lot. Brokers will pay advisors these kinds of fees is because the product is extremely lucrative for brokers, which means it’s probably not super beneficial for customers. 
  • It means there’s a conflict of interest for the advisor. They’re stuck with the tough decision (or maybe not so tough) of educating and caring for their client and promoting their best interests or putting food on their own table for their own kids, or taking a super nice vacation, or whatever else you could get excited about buying for $50,000. Unfortunately, the advisor’s interest will likely lean toward the $50k. Better not to put yourself, or the advisor, in a conflicting situation like that. 
  • It means that you’re probably not getting coached. Advisors who sell products aren’t evil (mostly), but they have to function more like salespeople than advisors or coaches in order to survive. Best case, the salespeople are catering to clients, giving them what they want without trying to rip them off. Worst case, the salespeople are manipulating or aggressively pushing bad products to people. Either way, coaching doesn’t enter the equation. There is no correlation between a customer’s desire for or the suitability of a product and the long term success of a client. So instead of coaching and educating clients, financial salespeople end up helping clients orchestrate their own financial purgatory, never making progress towards their goals. 

So keep an eye out for the commission trap when you’re evaluating an advisor.

The prediction problem

Investing is hard. If you’ve visited this blog in the past you’ve probably noticed a lean against active types of investing (buying and selling stocks all the time). Trying to predict the market, pick winning and losing stocks, find the best times to be in or out of different market sectors is really hard. Actually, the data suggests that it’s impossible, or at least no one has ever consistently been able to do it (Efficient Market Hypothesis). So prudent investing doesn’t leave space for active investing, the two don’t mesh. For many people, that’s not a satisfactory conclusion. We like to think we actually can pick winners, maybe not every time, but at least most of the times. We like to think we actually can see trends and understand market movements. We like to think we can make predictions. Well, call me a downer, but those instincts aren’t very helpful.
I’ve been reading through Factfulness: Ten Reasons We’re Wrong About the World – and Why Things Are Better Than You Think by Hans Rosling, a scintillating read. Rosling makes the helpful point that predictions about anything are never certain (he even specifically references the market), and advises readers to be especially wary of future predictions that don’t acknowledge that fact. So here’s my question: why is the future so tough to predict? Here’s my stab at it, with some helpful input from Rosling: the future tough to predict is because the world is far more complicated than we like to think. Rosling notes that the complexity of the systems involved make accurate future predictions essentially impossible. It’s impossible to predict the market because there are billions of factors to consider, all moving and changing every second. Even if we were able to consider each of the billions of factors, we would still have trouble guessing which direction they’ll each move because none of us knows the future. It just doesn’t make a ton of sense to actively trade stocks based on our limited understanding of market factors, not even for professionals. But there’s still happy news here. Even though we don’t know how the market will move today or next year, we do know that the long term general stint of the market is up. So we can actually stop worrying about predictions and news and market trends, those things ought to be the least of our concern, all we have to do is own the whole market as efficiently as we can and stay on for the ride. Owning the market efficiently is a separate discussion, that’s something professionals can actually help with, but the first step is to admit the prediction problem.

Thoughts on capitalism (part 4)

4: Capitalism isn’t perfect.

I wanted to finish up these thoughts on capitalism with an observation: capitalism is great, but it’s not perfect. Again, many of these thoughts are extracted from John Addison Teevan’s Integrated Justice and Equality which I can’t recommend highly enough, and a few are gleaned from Not Tragically Colored by Ishmael Hernandez.

Capitalism does not contain values, it’s amoral. It can’t distinguish anything on any basis besides price. For capitalism, there’s no difference between a missile and a bushel of apples besides its market value. This basically means that capitalism is as good (moral) as the people who are utilizing it.

Capitalism relies on the self-interest of humans, a pretty reliable foundation. However, apart from values, self-interest can quickly and easily devolve into greed. Greed is a problem, Teevan argues that it ‘flattens the soul.’ Greed changes the equation from self-interest to gross indulgence. It’s the opposite of moral, and it can wreak havoc on society.

We know that capitalism is the single greatest sociological economic force in creating wealth and alleviating poverty. But we also know it’s not perfect, it can be manipulated for greedy ends, harming people and environments. So what’s the solution? A popular conclusion is to hand over responsibility to the government to regulate and stipulate and care for the underprivileged, that personal generosity and compassion should be delegated. That’s a bad idea, for a few reasons:
(1) Government compulsion stifles generosity and compassion within society. Generosity means giving, void of any obligation or compulsion. When the government requires and stipulates giving, generosity dies. Not only do people resent the government for taking from them, they learn to resent the people to whom their proceeds are redirected. They learn to hold what they have closely. Why do you think CPA’s do so well? It’s not because they help people pay taxes, they help people pay the least amount of tax possible. People lose compassion when it’s delegated to the government.
(2) Redistribution deprives people of their dignity. Recipients of government ‘compassion’ efforts don’t receive a gift, whatever they receive becomes a right, an entitlement. Instead of gratitude, they learn to demand more. Instead of self-reliance, they learn dependence. Part of a person’s self-worth is lost in all this.

Instead, in order for capitalism to work in society, shared moral values, specifically personal compassion, are required. The delegation of personal generosity and compassion from the people to the government is destructive for everyone. Capitalism is as strong as the values of the people who embrace it. “P.J. O’Rourke is alleged to have quipped that civilization is a bootstrap operation: we have to work at being civil. We cannot assume that the bounty of wealth or the freedom to enjoy it can be continually provided without continual care” (Teevan, p121).