• Bill Bullock

2014 Third Quarter

Remember the negative volatility we experienced a few years ago? It seems it is back and it will probably be here for a while. We have Europe and China's economies slowing down, the first EBOLA death in the United States and the Islamic State (ISIS or ISIL) winning some major battles on the doorstep of Turkey - a member of NATO. Pretty depressing stuff. And keep in mind we are in the middle of one of the most volatile months - historically speaking - of the year. To see this volatility taking place in the stock market is not extraordinary, rather it is normal - especially given the large positive returns we have enjoyed over the past few years. With all of that said, I believe a pullback might be healthy for the market over the long haul.


This may be a myth, but I have read in the past that the volatility the stock market experiences in the months of October and November is directly related to farmers having to sell their crops and the buyers having to sell stocks to purchase the fruits of that harvest. With more sellers than buyers in the stock market, there is downward pressure placed on the market.


Another possibility for the huge market swings as of late: In 2013 the S&P 500 was up 32%. Earlier this year the S&P 500 was up 8-9% above where we ended last year. While I am hoping we are only in for a correction, which is a decline of 10%, we should be prepared for a possible bear market, which is a decline of 20% or more. As John Bogle pointed out yesterday on CNBC, underlying corporate valuations typically have small incremental increases in their value over weeks, months and years. The stock market allows you to see your valuations on a minute by minute basis. He believes speculators, as opposed to investors who seek the long-term return, are driving this volatility. His proof? Twelve of the most actively traded stocks on October 8th traded $60 billion for the day and $50 billion of that $60 billion was in exchange traded funds, which can be traded intra-day. In other words, he believes the speculators are driving the exchange traded funds (ETFs) that track the index. I would add that these ETF movements are more likely driven by larger institutional investors like hedge funds and pensions as opposed to resurgent small day traders. Nevertheless, Bogle's conclusion was to stay the course and focus on the long-term and try to ignore the crazy market swings.


There are some benefits that you and I can take advantage of during these wild times. First, if there is a security that you have always wanted to liquidate that has a large unrealized gain in a taxable account, now might be the time to sell it so that we keep your capital gains tax to a minimum. Also, for those clients who are adding to their portfolio via dollar-cost averaging, you should welcome this volatility. Remember, you want to buy when the market is cheap.

I want to switch gears and discuss our fixed income investments for a moment. As many of you have read over the past couple of weeks, Bill Gross, our star PIMCO Total Return, PIMCO Low Duration and PIMCO Unconstrained bond fund manager, abruptly left PIMCO and moved to Janus funds. Specifically, Mr. Gross will be running the Janus Unconstrained Bond fund, which in assets is tiny with only $13 million under management. This compares to Gross' PIMCO funds which had hundreds of billions under management. The story goes that he resigned, but we later found out that he was going to be fired by the firm he founded about 40 years ago. While this sounds absurd, it sounds like the pressures of running a giant firm became too much for the 70 year old. He was known to have a short fuse and there were stories about him shouting at co-workers from time-to-time. Many of his lieutenants told his boss at the parent company, Allianz SE, that if Mr. Gross doesn't leave the firm, they will. Allianz saw the writing on the wall and began succession planning. Once Gross received news of his imminent firing, he started making some telephone calls. He ended up going with one of his former co-workers who now leads Janus funds.


In the meantime, I have been busy doing my due diligence for possible successor bond mutual fund managers. I am viewing this event as an opportunity to try some different ideas within our fixed income allocation. Obviously, I am concerned about the possibility of increasing interest rates in the not-so-distant future and I am also concerned about keeping any alternative fund expense ratios to an absolute minimum. One nice thing is that we will not have to worry about any capital gains exposure - bond funds rarely have built in capital gains due to their monthly income distributions. I should also mention that one of the options I am exploring is simply keeping the money at PIMCO. Several of the fund managers who have taken over the helm of Gross' former funds have some stellar resumes. In fact, a couple of them won Morningstar's coveted "Fixed Income Manager of the Year" awards over the past few years. Just because Mr. Gross left doesn't mean all of the brains behind PIMCO's process will be leaving. Anyway, this is a decision I will make within the next few weeks, but it will be a long-term purchase - I am reluctant to have a lot of turnover with my fixed income mutual funds. I will certainly keep you posted of any changes made to your portfolio.

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