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Investors

Opportunity in Volatility:Investor OrientationBluemound Asset Management, LLCPresented by Kirk SpanoThis investor orientation is a summary of various other more complete reports andvarious other publication by Kirk Spano, i.e. MarketWatch.com


Mistake 1: Volatility is bad On the contrary, from volatility we get ourbest opportunities to buy low and sell high. Investors correlate high volatility with risk.That is only true if you do not know theapproximate intrinsic value of aninvestment, i.e. what a company is worth ifyou bought it lock, stock and barrel. Byknowing roughly what a company or groupof companies is worth, we can makeinformed buying and selling decisions abouttheir stocks. The same holds true for otherassets. In addition, low volatility periods generallylead to very inflated asset prices eventually.We are nearing the end of such a periodnow. From 2012 to early 2015 volatility hasfallen to multi-year lows. Bottom line, we can use volatility to ouradvantage by understanding value.Mistake 2: Broad diversification is good “Diversification is protection againstignorance. It makes little sense if you knowwhat you are doing.” Warren Buffett The common belief is that moreinvestments are better. Past a certain point,we know that is not true. Long-termstatistical analysis demonstrates thatowning stock in more than 30 companiesdoes little to reduce risk, and in fact,damages returns. A better approach to diversification is tofind a few non-correlated assets atappropriate prices. For example, in additionto a focused equity portfolio, havingexposure to currencies, commodities, fixedincome or private equity can reduce risk. Understanding the value of assets, versusbeing a collector of assets, is what bringssuccess and safety as an investor.


Drivers of Economic and Financial GrowthPopulation Demographics◦ Ultimate Driver of DemandCapital◦ Any produced thing that can improve economic development, i.e. machinery, labor, financeGovernment◦ Fiscal◦ MonetaryNatural ResourcesHistorically, younger, lower debt, highly skilled populations, living in resource rich nations withsound legal systems have prospered the most. Today, there are few countries that fit all of thosecriteria. Among those that are close, the United States ranks highly on that list.In America, although there is the slowly retiring Baby Boomer generation, there is also the largerMillennial generation at the beginning of their careers. The work force while not at its peak, is highlyskilled. By historic standards, the United States is moderate debt (although in danger of becominghigh debt in the next two decades). Finally, America is extremely resource rich and by comparativestandards, legally sound.


Global debt is about $57 Trillion higher than just before the financial crisis of 2008 (McKinsey).◦ The rise in debt corresponds to 286% of global economic output from 269% before the crisis.While debt theoretically might not matter as there is a creditor for every debtor, what we knowsocially, is that eventually debtors decide to or must default on debts in order to maintainstandard of living. Think about the “strategic defaults” of homeowners who simply left keys on thecounter and abandoned homes from 2008-2012, or what is going on Greece today, or the angstthat helps fuel much rage in America’s cities, or what is on the verge of happening in many othernations.While energy is currently less expensive than the recent past, food, water, medicine and othernecessities are seeing significant inflation. Not only is this a hindrance to global economic growth,it is another potential flashpoint socially. What happens if lower capital spending in energy resultsin more expensive energy?The four largest economies, America, China, Europe and Japan are all getting older. Only the U.S.has a balanced outlook over the next couple decades. The other three populations are all facingmassive social spending on retirement and healthcare.Technology is making amazing leaps. Moore’s law for semi-conductors seems to be gettingapplied, at least partially, to other fields, such as, solar energy, communications technology,biotechnology, agriculture and water purification (nascent).Global financial markets and most governments are more levered now than in 2007, althoughU.S. institutions have remained less so. In addition, U.S. household debt has declined by about18% vs the 16% increase in government debt. U.S. corporate debt is relatively flat.


Demographics Are Widely Ignored• As there are more people,there is more demand forgoods and services.• Without proper investment,this can have an impact onnatural resource necessities,i.e. water, food, energy…• Demand is heavily influencedby the average age of apopulation.• People in their 30s and 40sdrive demand the most asthey form households.• As populations attain higheraverage ages and peoplebecome more dependent ongovernment programs,economic growth and overallstandard of living suffers.United Nations


Global Growth Will Never Be the Same…The combination of less favorable demographics, higherdebt constraining investment and technologically drivenchanges to productivity will lead to lower growth long-term.


In general, overvalued, but not in bubbleterritory.The bond market on the other hand is in abubble. And that’s very dangerous forstocks if there are defaults.


Is The Secular Bear Market Over?Probably not.


The Dynamic Between QuantitativeEasing and Asset PricesFed expansion of it’s balance sheet was meant to create economic growth and drive assetprices back up. They succeeded partially on growth and fully on asset prices.


The stock market generally drops aftermargin falls…


First and foremost, the direction of the dollar.If the dollar continues to strengthen, then there will be an asset price correction.◦ Although 86% of the U.S. economy is domestic, a price spike is dangerous because of theinterconnectivity of global business and economics. Gradual strengthening of the dollar is goodfor American standard of living.As I discussed in 2012 on MarketWatch, just before the dollar rally began, I believe thedollar is going into a historic bull market.Janet Yellen’s decisions about raising interest rates will have a direct impact on thedollar. If she raises too much, too soon, a dollar spike could occur. If she raisesgradually and pauses for markets to adjust, the U.S. could have a multi-year period ofimproving standard of living and asset markets would fully recover relatively quicklyfrom any correction. If she raises too little, too late, we will see another market bubbleand eventual crisis. Finding the right balance is her challenge.


As the dollar gets stronger, foreign assets becomecheaper to buy with dollars.This includes products and investments.Thus, expect an eventual correction in foreignassets and the stocks of American companies thatrely on exporting non-essentials (about 15% ofcompanies), as well as, a sympathy drop in pricesof other stocks.


The dollar is the “crisis currency.” People flock to it during times of crisis. Having dollarswill be very valuable during the next correction or crisis.Consider a Currency hedge position in brokerage accounts, i.e. long the dollar, short aweaker currency like the Euro or Yen. This has been a remarkably effective trade the pastthree years. Not only has it been profitable, but it is a non-correlated asset to the stockmarket, offering true diversification.A currency hedge can go up if the dollar drifts upward or spike higher in a crisis, giving youan asset that can be sold and converted into cash in order to buy depressed assets.A slower economy leads to lower earnings and P/E compression for stocks.Oil has already been declining –this is normally an indicator of an economic slowdown.Sometimes, return OF principle is more important than return ON principal. That time ispartially here already and the longer the bull market in equities lasts without a correction,the more fully we are in that time. Don’t chase returns at the end of a bull market.


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