• The stock market is filled with individuals who know the price of everything, but the value of nothing.

    Philip Arthur Fisher

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The Quarterly Report

Iron Capital’s quarterly investment newsletter through which we share our views on investing your assets in the current market environment.

  • The Quarterly Report
  • First Quarter 2020
  • Chuck Osborne


I have struggled with what to say in this Quarterly Report. It seems somehow inappropriate to discuss any topic other than the virus. As I was leaving my office one day, I heard one of the CNBC talking heads say, “I’m scared to death of this virus, as I know we all are.” It hit me because I am not afraid of the virus, and I do not believe I am alone.

  • The Quarterly Report
  • Fourth Quarter 2019
  • Iron Capital Advisors

Do You Feel More Secure?

The Setting Every Community Up for Retirement Enhancement (SECURE) Act is the biggest change in retirement plan law in a long while. Has our federal government made you more secure? I’m reminded of a saying that Ronald Reagan used often: The most feared words in the English language are, “I’m from the government and I’m here to help.”

  • The Quarterly Report
  • Third Quarter 2019
  • Chuck Osborne


The word competition comes from the Latin word “competere,” which is best translated as, “to strive together.” When true competitors compete, they make each other better. Today too many people think being competitive is about winning at all costs. Competitors do not compete against one another; they compete with one another. They strive together, and in the end, both are made better. This is why capitalism works, and why so many don’t seem to understand that. Competition makes us all better.

  • The Quarterly Report
  • Second Quarter 2019
  • Chuck Osborne

The Wrong Lesson

We tend to want to compartmentalize our politics, as we do with everything else, but in the real world, everything impacts everything else. We can’t separate foreign policy from economic policy from social issues because it all touches everything. This also makes it difficult to isolate a particular policy and know if its impact is positive or negative. In other words, there are no control groups, and learning the wrong lessons is very easy.

  • The Quarterly Report
  • First Quarter 2019
  • Iron Capital Advisors

Old Ideas

College basketball is not the only place where old ideas refuse to die. The financial markets are full of old ideas that simply refuse to go away. For example, we simply must have a bear market because one is supposed to happen every five years. Over the history of the stock market, we typically get a bear market once every five years. The idea here today is that a bear market must be looming because we have not had one since the 2008 financial crisis.

  • I have struggled with what to say in this Quarterly Report. I have written almost every week since the crisis began, so there is not much new to report, yet it seems somehow inappropriate to discuss any topic other than the virus. Then, as I was leaving my office, one of the talking heads on CNBC said, “I’m scared to death of this virus, as I know we all are.” It happened so fast I failed to even register who said it, but it just hit me. Scared to death of the virus, as we all are.

    It hit me because I am not afraid of the virus, and I do not believe I am alone. I am not saying that the virus shouldn’t be taken seriously, nor am I judging anyone who is afraid. I am just telling the truth. The virus does not frighten me. In the same way, sharks do not scare me. I grew up near the ocean, got certified to scuba dive while still in school. There is nothing in the ocean that “scares” me. There are many things, including the water itself which I treat with respect because I am aware of the potential danger, but I am not afraid of it. I am not going to stop swimming in the ocean.

    During our first weekend of social distancing, my kids and I built some shelves for our garage. Our 12-year-old son made most of the cuts with a circular saw. This is a serious power tool. Was I afraid to let him use it? No. Did I go over the safety rules? Yes, including the need to be supervised. Our 9-year-old daughter did not use the saw, but she did drive in some screws with the drill. I was not afraid to have my kids around power tools. Am I aware of the potential danger? Of course, but that is not the same thing as fear.

    Part of not being afraid comes from knowing how to stay safe in potentially dangerous situations. The most frequent question we have received from our clients during this crisis is, “How are you all doing?” That speaks volumes about the quality of our client base, so thank you. We are all well. I am still coming into the office, which is surreal because it is like a ghost town. Thomas Healy, one of our analysts and our primary trader, is also coming in as trading is much easier to accomplish in the office. Everyone else is working from home.

    Would I be afraid of the virus if people were not taking the social distancing seriously? Perhaps, but for the most part, people are taking it seriously. Just like we know how to maximize our safety when enjoying nature or using power tools, we know how to maximize our safety from viruses. Wash your hands and keep them away from your face. We’ve all heard that. I’ll add some. Eat healthily and keep up with your vitamins C and D. Drink a lot of water, I mean a lot. Keep up your exercise, and hugely important for all health but majorly ignored: get enough sleep. Will that stop you from catching a virus? No, but the stronger and healthier you are, the more likely you’ll be able to fight it off if you do get it. How do I know this? More than 50 years of experience catching viruses. We all know this.

    I know, I know, this virus is new, and it is serious. Yes, I’m still not frightened. What if I do get it? According to the data, there is a 50 percent chance I won’t even know it. I have no proof, but based on life experience, following a healthy lifestyle probably increases my odds of being in the 50 percent. There is an 84 percent chance my symptoms will be mild. I like those odds. “Experts” claim that between 1 to 3 percent will die. First, they are wrong. How do I know? They are always wrong. They said the same thing about the 2009 H1N1, and after it was all over the real mortality rate was 0.2 percent. Not that different from the common flu, which kills 0.1 percent of the people who get it. I am not a doctor, but I do crunch numbers for a living and I would wager we end up in the exact same territory with this virus.

    What if, against all odds, the worst does happen? Sorry, I’m not afraid. That may seem like a false boast, but it is not. There are two reasons for this. First, I know we are never supposed to bring up religion or politics, but I am a man of faith. That gives me great comfort. Secondly, I have been there. Some of our longer-term clients know this, but for those who have not been reading these pages for a decade, I should already be dead. On May 15, 2010, my wife drove me to the emergency room. I had a pulmonary embolism, which is a fancy way of saying I had multiple blood clots in both lungs. The pulmonologist told me that 90 percent of the blood flow between my heart and lungs was blocked.

    I spent ten days in the hospital, five days in the ICU. During that time, I kept getting the same stupid question. The doctors kept asking, “You walked in here?” Yes, I did.

    I had been suffering from shortness of breath for a month and had been to the doctor’s office three times about it. My wife finally took me to the emergency room because I was getting a strange feeling down both arms. The cardiologist said that I did not have a heart attack, but my heart was, “a little ticked off.”

    Every time they asked that stupid question I also got the look; the look that said, “You should be dead.” Throughout that ordeal, for whatever reason, I was never afraid. There was one moment when I saw the urgency in which the ER personnel responded to the description of my symptoms that the seriousness of the situation hit me. My wife was parking. She was pregnant with our daughter and our son was two and a half years old. I wanted the staff to wait for her, but they refused and assured me they would send her back. That was the darkest moment and I had one thought. I prayed, “God, my kids need their father.”

    I was not scared of dying, I was scared of not being there for my kids. (Sorry, Honey. I know it would have been more romantic if it had been my wife who came to mind, but I must tell the truth.) The point is that it was not death that I was afraid of, it was being out of relationship with those I love. Life is not about the avoidance of death, it is about being in relationship with one another.

    This virus does not frighten me, but there are some things that do. It scares me when people talk about this being the “new normal.” I believe they are just remembering that phrase from the financial crisis. Economists described the slower growth rates following the crisis as the new normal. It was a debatable phrase then, but now it is downright horrifying. We may need to socially distance for a while to flatten the curve, but cowering in isolation is not a permanent strategy. This cannot be normal. We cannot allow this to become normal.

    Relationship is too important. That is what we do here at Iron Capital. Yes, we provide investment counsel, but that is just our chosen field. We really deal with relationships. The last in-person client meeting I had before the lockdown was in Chicago. We greeted each other with a hug. I don’t hug every client and I assume the two ladies in question don’t hug every vendor. We hugged because, after 15 years of working together, having lunches together hearing about each other’s children, etc., we sincerely care for one another. That client is in the hotel business, and they are in my prayers every night.

    We invest in companies; we do not trade in stocks. Every client has heard me say that. Companies – or should I use the dirty word, corporations – are built on relationships. In fact, it is when large powerful companies forget the importance of relationship that they begin to fail. It is an easy thing to do. Show me a company that is good with relationship and I’ll show you a good business, led by a good businessperson.

    My wife has diligently packed more food into our house than it has ever held before, and after she did, I told her we were ordering from a local restaurant. Why? Because we care about the people who run the places we love. Economic activity is not some dirty word, it is proof of life. It is relationship.

    Which brings me to the silver lining in this dark cloud. A few evenings ago, the four of us walked our two dogs together. Father, mother, son, and daughter out with the family dogs. Norman Rockwell would have loved it, and as many of you probably suspect, we were not alone. Our neighbors were doing the same. We all made a joke of staying the appropriate distance apart as we passed on the street. One of our older neighbors said, “I love this, it is like the ’50s… all the families together.” Relationship.

    This too shall pass, and hopefully, it does not become the new normal. We may, however, learn that the late night in the office should be the rare exception, and perhaps our kids can survive with fewer activities. No one likes a crisis and we cannot wait for this one to be over, but they do remind us of what is truly important. It has been a decade since God spared my life, and seldom does a day go by when I don’t think of the dying words of Captain Miller, Tom Hank’s character in Saving Private Ryan, “James, earn this. Earn it.” Captain Miller had lost most of his men working to find and save James Ryan. What scares me? Not earning it scares me. Not caring for the relationships whose importance is highlighted in times of crisis.

    For Iron Capital, that relationship is with you our clients. That is what guides us through this crisis and will continue to guide us. Relationship is what it is all about. I hope and pray we continue to earn it.

    Warm regards,

    Chuck Osborne, CFA
    Managing Director

    April 2020


  • Politics is such a strange thing. With the impeachment circus, one would think nothing could get done in Washington; I guess they understood that and did not want to earn the “did nothing but fight each other” label. Suddenly, free trade deals are getting approved and the SECURE Act has become law.

    The Setting Every Community Up for Retirement Enhancement (SECURE) Act is the biggest change in retirement plan law in a long while. Has our federal government made you more secure? I’m reminded of a saying that Ronald Reagan used often: The most feared words in the English language are, “I’m from the government and I’m here to help.”

    The biggest change in the SECURE Act for most retirement plans will be the safe harbor for retirement plan sponsors who wish to provide annuities as options in the retirement plan. If you have a retirement plan at work then your employer is the sponsor of that plan. The plan sponsor, your employer, has a fiduciary responsibility to you as an employee and a participant in the company’s retirement plan. That means all the investment options must be prudently selected keeping all the characteristics in mind, including but not limited to fees, appropriateness, and the risk-and-reward potential.

    As a result, annuities mostly have been eliminated from retirement plans. This new act protects plan sponsors from their fiduciary liability for putting annuities in the plan. As one can imagine, the insurance industry thinks this is awesome.

    So, why is that not so great for you? I very rarely, if ever, use the word never, but an investor should never, ever, ever buy an annuity. Before I just let that statement settle in, I want to make a point: One of the problems in our modern discourse is that we have provided platforms that allow every- one to express their opinion. Certainly, everyone is entitled to an opinion; however, all opinions are not created equal. If one has spent a lifetime studying a certain field, then her opinion should count more than someone who read a tweet.

    I started my career working in the insurance industry. I am a Chartered Life Underwriter and a Fellow of the Life Management Institute (“life” here meaning life insurance, not life coach). I was at one point in my career the content editor for the Life Office Management Association’s annuity textbook. When is comes to annuities, my opinion should carry some weight.

    In fairness, my opinion has changed over the years. I used to believe, as many academics and consultants still do, that annuities had their place. The reason is, that annuities, in theory, could be very helpful. After all, an annuity provides the consumer with a lifetime stream of income which is guaranteed by the insurance company. In theory, that is very attractive.

    The problem is that we do not live our lives in theory. We live in the real world, and in the real world, annuities are outrageously priced, overly complicated traps. Several years ago I met with a client who was an attorney. He had purchased an annuity several years before our meeting and wanted us to review it for him. We went through the contract and outlined the various fees, restrictions, etc. He kept saying, “That isn’t right. That is not what I was told.” We kept showing him the contract. He was growing more and more frustrated and finally blurted out, “I would never have agreed to that.” To which I responded, “You’re a lawyer, didn’t you read the contract?”

    There are not enough billable hours in the world for a lawyer, or any consumer for that matter, to actually get through the average annuity contract. In the real world, annuities are just too complicated. All that complexity does two things: First, it makes it difficult to understand what you are actually paying. According to Morningstar, the average cost for an annuity is between 2.18% and 3.63%. The second reason for all that complexity is to minimize how much the word “guaranteed” could cost the insurance company.

    Years ago, I reviewed an annuity contract for an institutional plan sponsor client who was considering adding it as an option to their plan. The brochure said that the participant would be guaranteed to retire with the highest balance the portfolio had seen, even if the market had dropped since that point. The contract said that was the number the insurance company would use to calculate monthly annuity payments if the participant chose to that option, which fewer than 2 percent actually do. If they took their money in any other way, they would receive the actual market value. In other words, the “guarantee’ the participant paid outrageously for meant next to nothing.

    The fallacy of annuities is that somehow retirement income needs to be “guaranteed.” Safe? Yes. Reliable? Absolutely. But, guaranteed? Well, your income during your working years was never guaranteed. Was that a problem? Firing employees is harder in some states than others, but it can always happen. Even the best companies are not immune to business downturns. During one’s working years the best she can ask for is a good job at a good company. I’m excluding entrepreneurs here because these are obviously risk-takers. However, the type of person who wishes for safe and reliable is the target of the insurance company. Safe and reliable retirement income can be generated at a far higher rate and lower cost than any annuity. Never buy an annuity.

    The new SECURE Act does not require anyone to buy an annuity and I doubt many will. Plan sponsors may be more willing than before to offer annuities, but even then, it is only an offer. The participant has the final say.

    In return for this giant handout to insurance industry lobbyists, we got a few positives and one big negative. The positives are that the age at which one must start withdrawing funds from one’s retirement account has been moved to 72 from 70.5. Remember, the government allows us to save money into the retirement plan without paying income tax on it. They allow that money to grow without us having to pay taxes on the growth. They eventually want their taxes. We are living longer, and that logically means that we will be working longer and retiring at later years. This change is frankly overdue and likely too little of a move, but it is progress nonetheless.

    The act also makes it easier for companies to auto-enroll employees into the retirement plan. While employees can also opt out, many employers have moved towards enrolling employees automatically into the retirement plan. This helps with the very human trait of inertia. Many employees lose out on retirement savings due to a simple lack of action. The downside to auto-enrollment is that most companies do it at very low savings rates. We would suggest that most employees should contribute approximately 10 percent of their income to the retirement plan, and that is low compared to most in the industry (the reason for that is a newsletter in and of itself). Regardless, most employers auto-enroll at 3 percent of income and may increase it to 6 percent.

    The tradeoff in all of this comes to people who have inherited a retirement plan from anyone other than a spouse, most typically a parent or grandparent. Historically, when one inherited a retirement plan, the required distributions would begin right away, but they were calculated based on life expectancies. For a young person inheriting such a plan, the mandatory distributions could be kept small and the bulk of the investments could continue to grow tax-deferred.

    Well, the government wants their money. Going forward if anyone inherits a retirement plan from someone other than one’s spouse, then he will have 10 years to take all the distributions. The government will get their taxes much faster, and likely at a higher rate as beneficiaries will be taking out larger sums which will likely push them into higher tax brackets. This is a provision that makes sense in theory but will likely not go over well in practice. Time will tell if relief will be given.

    As with everything that Congress does there is an endless list of other details, but these are the major points. The two biggest benefactors are the life insurance industry and the Treasury, but there is something in there for us. The obvious solution to the so-called retirement crisis (which we discussed in our 2014 Q3 Quarterly Report, “The Retirement Myth”) is to work longer. Giving us another 1.5 years to let our retirement grow is not much, but it is something. I don’t know if it makes us more secure, but it is a start. +

    ~Do You Feel More Secure?

  • I’m a competitive person. There, I said it. I love competition, and I get it honestly. Growing up in my family, almost everything was a competition. My parents both enjoyed watching sports on television and back then there was no cable package that allowed you to watch the game you wanted, which meant often we would watch games we did not really care about. The conversation would go something like this:

    “Who is playing?”
    “Green Bay and Chicago”
    “Who are you pulling for?”
    “I guess I’ll pull for Green Bay.” “Okay, then I’m pulling for Chicago.”

    We just thought that was normal. If one family member pulled for one team, then you pulled for the other. Otherwise, there was no competition, and what is the point of that?

    Today many people seem to look at competition as a bad thing and I guess I can understand why. Many people think they are being competitive when they are not. Several years ago, I read “Changing the Game” by John O’Sullivan. O’Sullivan was a competitive soccer player and a soccer coach on every level from youth to professionals. He tells the story of watching his kids play soccer when they were very young and it was all fun, and right next to their game was a 10-year-old game. In that game there was no fun being had; parents were yelling, coaches were yelling, and the kids were serious as heart attacks. One comment he made hit home with me: he said that having coached for 20 years he knew something about competition, and what he saw on that field was not it.

    The word competition comes from the Latin word “competere,” which is best translated as, “to strive together.” When true competitors compete, they make each other better. When great athletes are asked what they miss most in retirement, they usually say the competition; they do not say the winning. Of course it is more fun to win, but the true joy is in the competition itself. True competitors never take short cuts, and this is where the age-old adage comes from, “winners never cheat.”

    Today too many people think being competitive is about winning at all costs. Earlier this year, the United States women’s soccer team won the World Cup. During the tournament much was said about the fact they drew a very tough path. Notably, they had to go through France, which many saw as their main rival. Pundits were saying it would be better to have an easy route into the finals. The reaction of the players and coaches was exactly what one should expect from competitors: They wanted to play France. They did not want a short cut, and they couldn’t even understand why spectators thought an easy way would be better.

    Many people just do not get it. Competitors do not compete against one another; they compete with one another. They strive together, and in the end, both are made better.

    This is why capitalism works, and why so many don’t seem to understand that. Competition makes us all better. I am old enough to remember what American-made cars were like in the 1970s. Then the Japanese cars started becoming popular, partly because of fuel efficiency, but largely due to the reliability; the German cars started eating away at the luxury end of the market for the same reasons. Then, Ford made “quality job one,” and the American cars got better.

    Back then many people feared that Japan would surpass us and that we would cease to be the world’s leading economy, which proved to be a false narrative. Today those fears are pointed toward China, and to a lesser extent, the European Union. It is my opinion that this is once again a false narrative. Let’s look at why.

    If China is our competition, we need to know what game we are playing. If we are playing football, soccer, basketball or baseball, the high score wins. Then again, if we are playing golf, the low score wins. We are playing international trade.

    In my book, when you play trade, the competitor who ends up with the most stuff is the one who is winning; yet many people tend to believe it is the opposite. For years the United States has gotten far more from China then we have given them. Some think that is a problem; to me it sounds like winning, but even then, it is probably overstated. For most of those years, services have either not been counted or under-counted. We are now a service-oriented economy, so we would be winning by far less if we counted correctly.

    The more sticky issue with China is its use of intellectual property and so-called forced technology transfers; this is where the current negotiations keep breaking down. As a true believer in capitalism, I have to say that I have mixed feelings here. I certainly do not think someone should steal another’s intellectual property, but is it really stealing? In some cases it may be, but most of the time these were agreements made by American companies who wished to do business in China. Here is one of the great benefits of a capitalist system that often gets ignored: Every single transaction in capitalism is voluntary. No one ever forced Apple to make and sell iPhones in China; Apple voluntarily chose to do so.

    If American companies made bad deals that they now regret, why should we bail them out? This is one thing that critics of capitalisms have right: In real capitalism, there is no return without risk. Sometimes those risks come true and when they do, a company and its executives should pay the price. There is no such thing as a business that should not be allowed to fail, and if one drives his business into the ground, then he should have to live with those consequences. True champions are not those who never fail; they are those who fail and get back up. This should be as true in business as it is in anything else.

    At Iron Capital, we often tell prospective clients that we have never refused to work with someone because of the size of their portfolio, but we have refused to work with people for other reasons. You see, transactions in a capitalist society are voluntary. We would never dream of spending resources lobbying the government to force those people to be more to our liking. When we really think about the situation, it seems absurd. If we can come up with a national agreement that prohibits technology transfers to China, then that would certainly make individual companies’ jobs easier. However, if these negotiations fail to make such a breakthrough, then we should remember that these companies chose to do business in China. They were not forced.

    The trade war with China may or may not pay off in the end; only time will tell. The current situation, however, is clearly slowing our economy. The result is that the Federal Reserve Bank (Fed) has reversed course from last year and begun to lower interest rates. Some suggest that they have not gone far enough. Once again, I am a very competitive person, but even I know that not everything is a competition. Interest rates in the United States are at or very near historically low levels, but compared to places like Germany, our interest rates are high. As of this writing the yield, or interest rate, on the 10-year U.S. Treasury is 1.61 percent, and the yield on the German 10-year is -0.50 percent. This means that if an investor were to loan money to the U.S. government for ten years, then she would get her money back plus interest of 1.61 percent per year. If that same investor loaned her money to Germany, she would get back her money minus 0.50 percent per year.

    It has been suggested that the Fed is losing by not trying to match countries like Germany in the race to lower and lower rates. In my opinion, this should not be a competition. Each central bank should be doing what they believe is correct for their country. However, let’s say it is a competition. Once again, with any competition, we have to know how the scoring works. Who wins the high score or the low score?

    Let’s give this some thought. What causes interest rates to rise or fall? We know the Fed sets a target for overnight rates, but the rest of the interest rates are set by the market. Investors chose to invest or not to invest in an auction. The prevailing rate is the one that satisfies the most investors. If investors are willing to accept a 1.6 percent return on their investment, it means they believe that return is fair in comparison to what other options they have. In other words, this is a poll on what investors believe the future economy will look like. The higher the interest rate they demand, the more growth they believe will occur in other investments. The lower the rate they settle for, the more they believe other investments will not grow very much. To be willing to accept negative rates is to believe that more money would be lost if one invested in anything else.

    With this realization, it sure sounds to me that the country with higher interest rates is the one who is winning. Just to check that theory, look at the current Gross Domestic Production (GDP) growth. In the second quarter of this year the U.S. economy grew at 2 percent. The German economy, on the other hand, shrank 0.1 percent. Germany is on the brink of recession if not already in one. Again, it isn’t a competition, but if it were, we would be winning.

    Competitive games are zero-sum. This means that there is a winner and a loser. My daughter loves to play Candy Land and Chutes and Ladders. Anyone who has ever played these games knows that they are actually the same game with different graphics. However, if we are playing one and I win a few times in a row, then we must switch to the other game. In Candy Land and Chutes and Ladders, there is one winner and everyone else loses; there is a plus one and a minus one for a zero-sum.

    Life is not like that; life is not a zero-sum game. Life is more like a marathon. Sure, there is some professional athlete who wins the race, but what every serious marathon runner is interested in is their personal best. They compete mainly with themselves, striving together with the other runners to achieve their goals. This is a far better representation of the competition of life.

    This is what we try to explain to our clients: When we talk about prudent investing being absolute return-oriented and not relative return-oriented, we are talking about focusing on reaching your goals. We do not want to focus on beating some artificial benchmark or, for that matter, your neighbor. Real competitors know that competition is not win-at-all-costs. Sure, we want to win, and it is that desire that drives us to strive. In the end, however, the striving together is what it is really about. Hopefully our representatives negotiating a better relationship with China and Europe understand that. “Iron sharpens iron, so one person sharpens another.” Competition can make all of us better if we understand what it is really about.

    Warm regards,

    Chuck Osborne
    CFA, Managing Director


  • How does a baby learn to walk? This is a question I often ask at the beginning of every season when I coach youth sports. The answers I get are often entertaining, but seldom do I get the answer I’m seeking. I will hear, “By putting one foot in front of the other.” I might hear, “Mommy helps him.” However, I seldom hear the real answer: A baby learns to walk by falling down, and as any parent could tell you, they fall down a lot.

    We learn from our mistakes. That is the point of the lesson. It does not take long for young boys and girls to learn that mistakes are bad. Human nature being what it is, the natural response to mistakes is to deflect or deny, but what one needs to do is own his mistakes so he can then learn from them. Many adults are still working on owning their mistakes. As a coach, I preach this all the time. Learn from our mistakes, and make only new mistakes.

    That is the secret to improving at any endeavor. There is one potential problem: What happens when we learn the wrong lesson? This past spring I was coaching my daughter’s soccer team. One of her teammates was inbounding the ball and threw the ball in from the side of her body instead of over her head. Kids do this a lot because they have a dominant hand and that is the hand they throw with. It is not natural to everyone to throw the ball directly over one’s head with both hands. I stopped to point out the mistake. We have a ritual called CLaPing for mistakes. The C stands for “claim” the mistake, the L stands for “learn” from the mistake, and the P stands for “play through” the mistake.

    So, I blew the whistle and we clapped for this girl’s mistake. I asked her what she thought the mistake was, and she said something I did not expect. She thought someone else should have thrown in the ball. We straighten that situation out, and the player in question learned how to throw the ball in properly, but it made me think. All this emphasis on learning from mistakes is great, but what happens if they learn the wrong lesson?

    This is an easy trap to fall into. It is especially easy when dealing with economic issues. Economics is part art and part science; that is what economists will tell you anyway, and I guess there is some truth to that in the sense that it is at least partially mathematical. The problem with soft sciences like economics is that there is no actual way to test theories using the scientific method. For those who have blocked out their middle school science projects (whether from boredom or years of therapy), here is a quick reminder: The scientist comes up with a hypothesis. To test the hypothesis, the scientist sets up an experiment.

    The hypothesis might be that fertilizer makes plants grow faster. To determine if that is the case, the scientist will grow two plants, one fertilized and the other not. To make sure that it is the fertilizer that is making the difference and not some other variable, a good scientist will ensure everything is the same except for the fertilizer: the same type of plant, same soil, same exposure to sunlight, etc. That way, the scientist can know that she is seeing the difference that fertilizer makes. The plant that does not get the fertilizer is known as the control group. It is a vital element of the scientific method.

    There are no control groups in economics. Economics is not done in a laboratory; it takes place in the real world. When we make an economic decision, such as buying a house, we cannot set up an alternative universe in which we didn’t buy the house. Years later, we may see the purchase of the house as a great decision or a big mistake, but the truth is we have no way of knowing what our lives would be like had we not purchased that house, and don’t underestimate the importance of that purchase.

    It probably will not surprise our clients and friends to learn that in my life, I have owned just two houses. We preach long term and we practice what we preach. My wife and I purchased the second of those houses nine years ago and I now believe that both of my home purchases have been good decisions. Due to the nature of my work, and this newsletter, you all are probably thinking about the financial impact of my purchases. My home purchases have been fortunately well-timed in that regard. My first home was purchased before the Federal Reserve (Fed) fell in love with low interest rates, so I benefitted from the inflating of the housing bubble. My second home was purchased close to the lows in real estate caused by the bursting of said bubble. So, as homeownership goes, I’ve done well.

    But, that isn’t what I’m talking about. My daughter, who was born six weeks after we moved into our current house, spends most of her days at home playing with her best friend, who happens to be a neighbor. Being our neighbor is the only connection the two girls have – her friend goes to a different school, a different church, etc. If we had not purchased this house, we would not know this family, and my daughter would have a completely different best friend. What a difference that would make in her childhood.

    The house we purchased impacts many aspects of our lives that have nothing to do with the simple math of real estate investment. I believe we have made good choices, but the truth is that I have no way of knowing what our lives would be like had we made a different decision. Economic choices are dynamic and impact more than we realize.

    If this is true in the simple example of buying a home, imagine what various impacts economic policy decisions have on our society. We tend to want to compartmentalize our politics, as we do with everything else, but in the real world, everything impacts everything else. We can’t separate foreign policy from economic policy from social issues because it all touches everything. This also makes it difficult to isolate a particular policy and know if its impact is positive or negative. In other words, there are no control groups, and learning the wrong lessons is very easy.

    In the 1950s, ’60s, and ’70s, we had very high tax rates. According to the Bradford Tax Institute, income tax rates peaked in 1944 when we had a 94 percent tax bracket. Through the next 30 years, the highest bracket was 70 percent. The 1950s and 60s were a time of great economic expansion for the United States; many now point to this and claim that high taxes do not slow economic growth.

    That is a false lesson, desperate for a control group. Two larger forces were impacting our economy at that time in our history. First, in the aftermath of War World II, the United States was the only industrialized nation which had sustained no damage to our industrial capabilities. Every single one of our “competitors” was having to completely rebuild. To this day, our primary ally, Great Britain, remains a shadow of what it was prior to the war. We were the only show in town and as we all know, that kind of competitive advantage can mask many inefficiencies.

    In addition to our global industrial advantage, we had our entire Armed Forces full of soldiers and sailors coming home to start families: The baby boom. These families created this new place called the suburbs and an entirely new stage of human life known as the teenage years in which, unlike any generation to come before, parents subsidized childhood consumerism. Lessons from the War translated to technological advances in our homes. What began with dishwashers and air conditioning ended with personal computers in everyone’s homes, just like a young Bill Gates dreamed.

    When I was in college, one of my professors liked saying that the economy was stronger than any government. This is what he meant. When a country has historic global competitive advantages and you combine that with booming demographics, policy will be overwhelmed.

    That all came to a screeching halt in the 1970s. The rest of the world had caught up, and the baby boom was over. Price controls, which President Nixon thought we could get away with (because it was the kind of thing we had been getting away with), led to one of my most vivid memories of the ’70s: gas lines. One hasn’t really lived until he has roasted in the sun, sitting on the nice vinyl seats in a pea-green Pontiac Ventura with the windows rolled down and the air conditioning off because you were afraid of running out of gas before you could get to the pump…which would happen from time to time and was actually why I was in my sister’s car in the first place. If we didn’t make it, I would have to get out and push while she steered.

    Another memory of that time was the purchase of my first suit. My father took me to a men’s store where he bought his suits and introduced me to the salesman who helped him. While I was being measured for alterations my Dad asked our salesman why he was not the manager. He had worked at the store for a long time. The gentleman informed us that he had been offered the role multiple times. He turned it down because the raise that would come with the promotion would put him in a higher tax bracket and he would end up taking home less money.

    High tax rates hurt the economy; that means they hurt people, and mostly they hurt people who are trying to move up in the world. They are a hurdle. We finally learned that lesson and in the 1980s, we got tax reform. Thirty years of economic prosperity followed, even though all the outside benefits we enjoyed in the 1950s had long since gone.

    Today, we are addicted to low interest rates. The policy disasters which led to the 1970s caused, among other things, high inflation. To finally kill that problem, the Fed raised interest rates. I can remember getting double-digit growth on bank certificates of deposits. Ever since, central banks have been able to stimulate the economy by lowering interest rates…until now. As of my writing, interest rates on German 10-year bonds are negative 0.37 percent and Japanese bonds pay negative 0.14 percent. So if an investor loans money to Germany or Japan for the next 10 years, she will get back less than she loaned them.

    Does all of this lowering of interest rates work? The truth is, we don’t really know. The Fed claims to have saved us in the financial crisis, but could that have been a false lesson? We don’t know what would have happened if the Fed and other central banks around the world didn’t lower interest rates to historically low levels, because there are no control groups in economics. What is interesting is that the low interest rates of today are like the high tax rates of the 1950s and 1960s in that their purpose is to fund unsustainable government spending. Then it started as paying for the war and morphed into paying for the “Great Society.” Today we are largely paying for the unfunded promises of yesteryear’s politicians. Only time will tell, but ultimately it seems like a similar end will have to come.

    The market is all for cuts in interest rates, but that very well may be a false lesson.

    Warm regards,

    Chuck Osborne, CFA
    Managing Director

    ~The Wrong Lesson

  • The difficulty lies not so much in developing new ideas as in escaping from old ones.”
    — John Maynard Keynes

    The University of Virginia Cavaliers are the 2019 NCAA Men’s Basketball Champions. They defeated the Red Raiders of Texas Tech. Both teams got to the final game with a similar formula: tough-as-nails defense and patient ball control offense. In other words, they play slow. A lot of basketball fans don’t like it, and I will admit that I prefer a faster pace game myself, but I suspect that coaches Tony Bennett and Chris Beard would agree with Dean Smith who once said, “I wasn’t trying to make it a good game, I was trying to win.”

    The strangest thing about the game to me – other than that it didn’t even start until after my bedtime – was the halftime commentary. I usually love the banter supplied by Charles Barkley, Kenny Smith, Clark Kellogg, and Ernie Johnson Jr., but after the first half in which Texas Tech did not make a single shot from the field for the first seven minutes, Kenny Smith set out to explain why neither of these teams could win the championship. You see, there is an old idea in basketball that if you have the better team then you want to play fast, and since the best teams usually win, most champions have played at a faster pace.

    The idea stems from basic strategy. Dean Smith used a golf analogy to explain it and I’ll borrow from that: If I were to play Tiger Woods in golf, my odds of winning decrease with every hole we play. On any one hole, I could get a birdie and he could bogey or worse; however, over the course of 18 holes, the fact that he is much better than I am will give him an increasing advantage.

    In basketball, by slowing the game down the inferior team can decrease the number of possessions, giving them a better chance of pulling off an upset. This idea is so entrenched that it has become a common belief that only lesser teams play slow and therefore slow-playing teams cannot win the championship. Kenny Smith played for Dean Smith at the University of North Carolina. Coach Smith might be famous for the four corners delay game, but most of his teams played fast. He was a strong believer in the fast break, and frankly usually had the better team so wanted to speed up the game.

    I understand the slower game of UVA and Texas Tech not being Kenny Smith’s cup of tea, but as he sat there arguing that no team can win a championship playing the way that both teams in the championship game play I was wondering what in the world he was thinking? One of these teams had to win. They were the only two teams left, and by the way, they were the only two teams left because they beat everyone they played in the tournament. I don’t know if this is the future of college basketball, but I do know this: the old idea that slow teams cannot win championships was just proven false.

    College basketball is not the only place where old ideas refuse to die. The financial markets are full of old ideas that simply refuse to go away. For example, we simply must have a bear market because one is supposed to happen every five years. Over the history of the stock market, we typically get a bear market once every five years. The idea here today is that a bear market must be looming because we have not had one since the 2008 financial crisis.

    Before I debunk this idea I must freely admit that I use the five-year average all of the time. Many of you already know this because we have had that conversation. How long should we give a manager to know if she is doing her job? At least five years, because that is the average length of a full market cycle, with the cycle being bear market, recovery, bull market, and then another bear market.

    Five years is, however, an average, much like the typical southern summer thunderstorm lasts 20 minutes. Anyone who has lived in the Southeastern United States knows this. However, this does not mean one can simply set his watch for 20 minutes when the storm begins and then safely walk outside. It is not that simple.

    This market does not have to go down simply because it has been so many years since it has happened. For one thing, the very idea that the market has not experienced a significant downturn since 2008 is misleading. European stocks suffered their setback in 2011. Most stocks in the S&P 500 suffered in 2016 as only the FANG stocks kept the market above water.

    The downturn that occurred in the fourth quarter of 2018 was technically a bear market, which by definition is a market down more than 20 percent. Some are already dismissing it, however, because it lasted such a short time. Granted the only real issue was this very idea that a bear market must happen simply because it hasn’t.

    Similarly, there is an old idea that the economy as a whole must go into recession because a recession is supposed to happen roughly every five years. The market cycle mirrors the economic cycle, although the market is usually ahead of the actual economy. Again, the idea is that there is a cycle where business does well, they expand, then they over-build and the economy slows down to adjust. After the recession, there is a recovery and we do it again. The last recession in this country ended officially in 2009. We are overdue based on the idea that this average time span must hold.

    Again, the problem here is that real life is just not that simple. In our current circumstance there is a question of when the last recession actually ended. Several years after the technical end of the recession, surveys showed that most people still thought we were in a recession. This is because the “recovery” was the most anemic recovery we had experienced, at least since the Great Depression. The rate of growth was half our normal average, let alone the normal recovery boost. So yes, the recession was over, but it did not feel like it.

    Which matters more: the academic definition of a recession being two consecutive quarters of negative growth and the end being a return to positive growth, or what real people feel in their pocketbooks? If most Americans thought we were still in a recession, then I’m of the opinion that we were in a recession. After all, economics is mostly psychological. This does not mean it isn’t real, but it does mean that what actually happens is hugely influenced by what we thought would happen.

    For example, if people become convinced that a certain bank is on the verge of collapse, then it will almost certainly happen. It matters not that the bank was perfectly sound when this belief took hold. People believed the bank was not safe and therefore started withdrawing all of their assets from the bank. Enough people withdraw their assets and all of a sudden the bank is actually in trouble – the self- fulfilling prophecy. So, I’m willing to go along with the view that we have not been out of the recession nearly as long as the experts say.

    However, even if they are correct, it is clear the economy has not grown in total nearly as much as it usually does in a full cycle. If we are growing half as quickly, does it not seem logical that the cycle would take twice as long?

    Of course, even if that were not the case, these timelines are just averages. We do not go into a recession simply because it is time; we go into a recession because businesses and individuals have expanded too rapidly and need to correct that by temporarily ceasing growth or even shrinking it. To use an example many would understand, a recession is like a new homeowner being “house-poor.”

    Most homeowners have been there. We fell in love and bought the house which was, in reality, just out of our price range. Now we have this great house and no money. So the annual vacation gets cut. We fire the lawn service and reintroduce ourselves to the lawn mower. We make excuses for not going out to dinner with friends. Time passes, raises eventually come, or maybe we can refinance and things improve.

    So, have we bought too much house? There really are no signs of this being the case. The key I always use is the employment situation. Our unemployment rate is at 3.8 percent and has been below 4 percent for longer than any period in our country since the 1960s. Not only is unemployment low, but wages are growing faster than the rate of inflation. More importantly, they are growing faster on the lower end of the scale. This does not make for an economy which is about to go in reverse.

    Another old idea is that the Fed raising interest rates will slow the economy. The truth about interest rates, like so many of these ideas, is more complicated. The Fed raising rates early in an economic expansion is usually a good thing; it means the economy is growing again. The economy and the stock market both tend to grow as interest rates rise. It is when rates peak that the economy and the market start to head in the opposite direction. So now our old ideas are related: what one thinks about the Fed’s raising rates is directly related to how close she thinks we are to the end of the cycle and another recession. Late last year all we heard was that we are late in the cycle. If that is true, then the Fed raising rates is bad. But, is it true? One would not know it now. We seem to be still chugging along.

    Ultimately all these ideas persist because of the fatal flaw of economics as a science. In the hard sciences, the scientific method requires a control – this group gets the experimental treatment while this other group gets a placebo. The treatment works or it does not. There is no control group in economics. The truth is that we don’t know how much Fed policy influences the real world. Many believe, myself included, that the actions of our Fed in the immediate aftermath of the financial crisis saved us from a far worse outcome. However, there is no way to actually know that. We can- not set up an alternative universe in which the Fed did nothing. All we can do is look at history and attempt to learn as much as possible from it. The problem with that is every time it is a little different: the Fed raised rates and the market dropped in the 4th quarter of 2018; the Fed softened their talk and the market rebounded to begin 2019.

    At the same time, the trade negotiations with China looked bleak in the Fall of 2018 and much better in the early days of 2019. Was the market responding to the Fed or to trade talks? This is the problem with these old economic ideas – they are impossible to prove and just as impossible to disprove.

    What is an investor to do? Investing is much like basketball in the sense that there may be differing styles, but some fundamentals are constant. Some teams play fast and some play slow. Some investors seek rapid growth and some seek steady income. All great teams play defense. All great investors are risk-averse. All great teams have an identity and they stick to it. North Carolina plays fast, Virginia plays slow, both have now won championships in the last few years. They are who they are. All great investors have a process and they stick to that process through booms and busts. All understand that it doesn’t really matter what others say or think; an idea, old or new, is only good if it works.

    Warm regards,

    Chuck Osborne, CFA
    Managing Director

    ~Old Ideas