In BSW Blog, BSW Philosophy, Economic Outlook, Portfolio Commentary

“Progress is man’s ability to complicate simplicity.” – Thor Heyerdahl

This intriguing quote was laminated to a chair in a coffee shop near Tabernash, Colorado, an unlikely place to find such a pearl of investment and life wisdom.  Yet its sentiment rings true, particularly now, as we take stock of 2012 thus far, what lies ahead, and most importantly, the underlying purpose of our endeavors.  BSW’s purpose is to make life better for our clients and staff – a simple, clear objective that reaches beyond the blunt tools of money and investments to the ideas, insights, resources and perspectives that enable you to avoid and eliminate complexity and live life to its fullest.  To that end, this quarterly update will discuss our framework for the investment and financial markets in the coming years, along with actionable research on improving one’s happiness and quality of life.

3Q12 Review, 4Q12 Outlook, & Forward-Looking Framework:

Global equity markets rallied in the third quarter following: 1) European Central Bank (ECB) President Mario Drahgi’s promise to “do whatever it takes” to defend the Euro and then backing up this bluster with the Outright Monetary Transactions plan to buy unlimited amounts of short-term sovereign debt; 2) The German constitutional court ratifying the $640 billion European Stability Mechanism government bailout fund; and, 3) The US Federal Reserve’s announcement of Quantitative Easing 3 (QE3), or as we call it, “QEternity,” and pledge to keep interest rates near zero until 2015.

Though seemingly complex, the actions of the ECB and the Fed are just more of the same money printing.  Although a simple concept, money printing has profound implications for your investment portfolio, how to make sense of the likely future, and even your quality of life.

Interest Rates & Real Yields — End of the Road for the 30-Year Bull Market in Bonds . . .

Consider that in 2007, it took $22,000 invested in a taxable money market earning 4.5% (the national average yield five years ago in October 2007) to generate $1,000 of taxable income.  Today it would take $3.3 million invested in a taxable money market earning 0.03% (the national average now) to get that same $1,000.  This is very troubling and very foreboding for several interconnected reasons which we call the Paradox of Thrift:

  1. As more and more baby-boomers enter retirement, they must necessarily shift their investments from growth toward income and capital preservation.
  2. By doing so, however, they increase demand for fixed income – which lowers yields further (yields move inversely to price).
  3. As rates of return decline, retirees are faced with three choices: a) Save and invest more money to get the same income (see illustration above); b) Work longer; and/or, c) Spend less.
  4. Unfortunately, each of these decisions offers dire consequences for the economy – the Paradox of Thrift, which goes something like this:
  • If everyone saves more, consumption declines.
  • If consumption declines, we need less stuff and fewer workers to make that stuff, resulting in slower growth and higher unemployment.
  • This slower growth and higher unemployment prompts Central Banks (like the Fed and ECB) to lower interest rates (When all you have is a hammer, everything looks like a nail.)  As rates go down (or stay down), the pattern is reinforced.

This dynamic has already played out in Japan, where an entire generation (the so-called “Lost Generation”) of young people has been saddled with entrenched unemployment and underemployment as older Japanese workers stayed on they job to bridge the income gap from low yields.  (Incidentally, the yield on the 10-year Japanese government bond is a whopping 0.7% – 60% lower than US Treasury yields.)

Although the US is not yet trapped in the Paradox of Thrift, the signs and symptoms are worrisome: anemic GDP growth, record low yields, record amounts of cash holdings, and lingering unemployment (unemployment for persons younger than age 24 is more than 12 percent and for workers age 25-34 it is more than 8%) – not to mention the looming fiscal cliff and proposed tax increases on savings and investment.

While this may all seem terribly gloomy, that is certainly not its intention.  Rather, the aim is simply to provide the backdrop and context necessary to be the chess player, not the chess piece.  Helping simplify complex situations to enable informed and thoughtful decisions is one of the ways BSW strives to accomplish its purpose of making life better – as innumerable studies and evidence demonstrate that having a clear, established, and adaptable plan for the future is one of the clearest paths to success and contentment.

In this vein, pioneering Harvard researcher Sean Achor and colleagues have also identified five daily practices (Gratitude, Journaling, Exercise, Meditation, & Acts of Kindness) that have the largest potential for positive changes in happiness and well-being.  So, as a reward for reading all the way to the end of the post, treat yourself to this short (~12 minute), outstanding, and insightful TED lecture on the Happiness Advantage.

Sean Achor: The Happiness Advantage

We hope this summary provides you with better insight into your portfolio and BSW’s outlook.  If you have any questions regarding our positioning or would like to discuss your portfolio in greater detail, please don’t hesitate to contact BSW.

-David Wolf, Chief Investment Officer

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