 I'm sure you've heard by now that Silicon Valley bank that was closed by regulators late last week. A little back story, interestingly enough, a little over 20 years ago, I worked for a bank that competed directly with Silicon Valley bank. The bank I worked for, The Venture Banking Group in Palo Alto, financed early-stage venture backed technology companies. We were a division of a larger regional bank called Cupertino National Bank which subsequently years later was purchased by Wells Fargo. Our parent bank, Cupertino National Bank was always mindful of not being overly concentrated in technology related startup companies and therefore our division was a relatively small group within the larger regional bank. This was for prudent risk management purposes. The 800-pound gorilla was Silicon Valley Bank, as they dominated the venture banking market. From what I've reviewed of Silicon Valley Banks balance sheet and read about the events that took place, there were two primary driving forces that caused their quick collapse:
The poor risk management was a mismatch between their short-term liabilities (bank deposits) and their asset base (customer loans and investments). Their huge misstep was purchasing long-dated treasuries and mortgage-backed securities. Bankers will tell you that it's imperative to match your assets and your liabilities. Silicon Valley Bank didn’t do this, and any hedges they had in previous years were taken off by the end of 2022. Credit quality was NOT the issue like it was during the financial crisis, it was a timing issue. A Very Simple Example: Imagine you said that you need money next month for a large down payment on a home, and instead of keeping the money in cash, you took the money and invested in something that could lose substantial value over the next month. This wouldn’t be prudent, even if the investment was guaranteed to do well over the long-term. In this example, your need for cash is short-term, but your investment was long-term. This is what’s called an asset-liability mismatch. What Does This All Mean? The various regulators stepped in and are guaranteeing that all depositors will be made whole. However, the investors (stockholders and bondholders) and executives will not get the government guarantee, so they are expected to lose a lot. Which I think is the right thing to do on both fronts. So how does this affect the overall banking industry and how does it affect the economy. The short answer is nobody knows exactly. But more than likely there will be some spillover effects as it seems reasonable that it will be more expensive for startup companies and early-stage tech companies to get financing. Typically, what causes a lot of short-term stress in the markets are all the 2nd and 3rd order effects which tend to be difficult to fully assess. How Does This Affect The Markets? We are already seeing some effects with other banks and the financial services sector in general. As I mentioned before there will be some spillover effects, but I think they will be very modest, fortunately overall the banking system is very secure. Most importantly, this event explicitly shows just how important diversification is – something Silicon Valley Bank learned the hard way. Because one company, or two companies, or even a handful of companies that fail should not hinder your portfolio from doing well over time - if you are properly diversified. As investors know, market gyrations cannot be avoided and are not a bug in the system, but rather a feature. Volatility in the market is unavoidable, while it's never pleasant or enjoyable sometimes great opportunities come from such volatility. In this case, it's advisable to look at this as the glass being half full, rather than the alternative. In real estate, when buying property, the key phrase that comes up time and time again is, Location, Location, Location. In the stock & bond market, it's Diversification, Diversification, Diversification. -Paul R. Rossi, CFA
0 Comments
The S&P 500 Schiller CAPE Ratio, also known as the Cyclically Adjusted Price-Earnings Ratio, measures the S&P 500’s current price compared to the 10-year moving average of companies’ inflation-adjusted earnings. Invented by Yale economist Robert Shiller, the metric has become a popular measure for understanding long-term stock market valuations. A higher CAPE ratio tends to signal lower returns in the future whereas a lower CAPE ratio signals higher returns, as the ratio reverts back to its mean. “The stock market is not the economy,” but worries of a recession have been weighing heavily on investors’ minds, although the stock market is holding up pretty well. So what is the CAPE ratio saying after the S&P 500's strong start this year? The S&P 500 Shiller CAPE Ratio has a pretty strong track record of predicting market declines. Out of 21 major market declines (defined as a 10% or greater drawdown in our white paper) since 1950, the CAPE Ratio has provided warnings for 10 of them by breaching its long-term average. The chart below shows that relative peaks in the CAPE Ratio coincide with drawdowns for the S&P 500. Knowing the ratio is directly affected by declining equity prices, the question becomes: are we seeing a relative peak in valuations to start 2023?  From a historical perspective, the S&P 500 is currently relatively expensive...although this is dependent on your lookback period. The CAPE Ratio reached a relative peak of 30.99 just before the pandemic selloff, then climbed to 38.58, its second-highest value ever, near the end of 2021. With stocks rallying to start 2023 the CAPE has climbed to around 30.38, meaning prices for stocks in the S&P 500 are nearly par with their February 2020 levels. But interpreting the CAPE’s relative level is not a straightforward exercise, like many things, it has to be analyzed and interpreted in context of many factors. Years ago, the well-regarded economist, John Maynard Keynes, warned, "the market can remain irrational a lot longer than you and I can remain solvent. A longer-term lookback shows the degree to which valuations (purple) have risen over recent years as the market has marched higher (red line).  Using the CAPE along with other indicators can provide an idea where the market sits in terms of valuation and what future returns might look like.  While the CAPE ratio isn't perfect in predicting crashes and short-term gyrations, as you can see from the 1-year stock market returns above vs. the starting CAPE ratio. It does do a pretty good job over the medium term, as valuations tend to mean revert over time. See the 5-year return of the market vs. the beginning CAPE ratio below. 
Like a good superhero, it may be well worth your time to make sure your CAPE fits before leaving the house. -Paul R. Rossi, CFA Probably the most famous formula in finance is what's called the Black-Scholes Model and it's a model to help value options. The inputs below are what go into the Black-Scholes model.
-Paul R. Rossi, CFA  Let’s assume that you have determined the price you are willing to pay for a particular stock or a stock index. And let’s also assume that you are not willing to pay more than what you determined to be a fair price. Let me share a way that sophisticated investors buy stock. A good way to describe this strategy is to use an example: Let’s assume your account is currently 100% in cash and the S&P 500 index is currently trading at 4,000, but you don’t want to buy at the current level, you believe the market is overvalued and will only buy if the market is at or below 3,600 (10% lower than the current price). There are a couple of strategies you can employ: First option: If you are willing to wait, you could just hope that the stock market falls to 3,600 and then place your order. If the stock market never drops to 3,600, your account will remain in cash. - This is the non-sophisticated way. Second option: You could sell a Put Option. By selling a Put Option, you will collect what’s called the option premium. - This is the sophisticated way. So how does this work? For example, you could sell a 1, 3, 6, or 9-month 3,600 Put Option on the S&P 500 index and receive a credit in your account immediately. There are 3 things that can happen at expiration of the Put Option that you sold.
If the stock market remains above 3,600 at expiration, you can roll into another option position to collection premium once again. You can continue to do this as long as you'd like or until you end up purchasing the shares. To add another level of sophistication to this strategy and increase your returns even further, you can purchase US Treasuries (instead of holding cash in your account) to support the Put Option position to generate additional returns. In a nutshell, if you are going to buy the index when it hits 3,600 anyway, why wouldn't you pick up an additional few percentage points in a relatively short period of time by using this strategy? On a side note, this strategy typically pays out more when it's employed to purchase individual securities. There is almost an infinite number of ways to implement this strategy, as you can change the expiration date and/or the price you are willing to pay, which is called the strike price. In other words, your premium amount could be substantially more or less depending on these factors (and others). To corroborate this strategy, Microsoft and other companies in the 1990's executed this strategy for several years and made hundreds of millions of dollars. In some quarters, Dell Computer made more money selling put options than selling computers. Click here for learn more about how options are valued. This strategy is typically reserved for sophisticated investors who understand the nuances of stock and index options. However, if you do understand them, it can feel like you took the red pill from the movie The Matrix. It can pay to know your options. -Paul R. Rossi, CFA Important Note: Options should only be used by investors who know and understand the risks involved. Options are complex financial instruments. The value of option contracts are based upon many factors that need to be understood before buying or selling options.  Did you know that Neil Armstrong was very close to never stepping on the moon? The Apollo spacecraft had traveled over a quarter of a million miles and commander Neil Armstrong and lunar module pilot Buzz Aldrin were preparing to land, when they had mere seconds to decide if they needed to abort their mission. As the astronauts were descending toward their landing site, the lunar space craft's computer system started flashing error code 1202. It was well rehearsed during training that if certain error codes came up, the astronauts were to abort the mission, no matter how close they were to landing. Mission control and the astronauts had to make a quick decision to abort or proceed, and the decision fell to a 24-year-old engineer sitting at mission control. He understood what the 1202 error meant, and if it could be ignored or not. The 1202 code was an indicator that the computer system was overloaded, causing the program to temporarily halt, but he determined it didn't pose significant risk to landing the spacecraft. So mission control overrode the flashing 1202 error code and gave the Apollo crew the "Go" order to continue their landing sequence, and as they say...the rest is history. Investing signals, much like the Apollo 11 computer system, can be quite complex as investors use large amounts of data to generate predictions about the market and economy. And just like the Apollo’s computer system that can become overloaded, economic models are vulnerable to false alarms, which can lead to incorrect investment decisions. Investors must exercise caution and use multiple indicators to confirm investment decisions. Just as the astronauts had to trust their extension training and experience to make a critical decision in the face of an error code, smart investors should use a systematic approach to make informed investment decisions. Investors can mitigate the risk of false signals by using several market and economic indicators. Relying on a single data point, or a small data set can be problematic at best. The Apollo 11 error code 1202 and investing signals share similarities; they are vulnerable to false alarms, which can lead to incorrect decisions. Investors can mitigate this risk by having a well-designed plan that provides a course of action should a 1202 error code start flashing or for any error code that might start flashing. Having a well-designed plan inherently means that the plan has flexibility as new information comes to light, conditions change, or the goal posts have moved. Expect error codes to flash from time to time, that's part of the journey. Also understand your success will be determined by how you react to them. -Paul R. Rossi, CFA  Albert Einstein is widely recognized as one of the greatest minds of the 20th century. He made numerous contributions to the fields of physics and mathematics, but his wisdom extends far beyond the scientific realm. Here are a few quotes by Einstein that are relevant to investing, along with explanations of how they can be applied to the financial world. "In the middle of every difficulty lies opportunity." In the context of investing, this quote can be interpreted as the idea that market downturns and economic recessions present opportunities for smart investors to pick up undervalued assets at a discount. While it can be tempting to sell in a panic during a market crash, those who take a long-term perspective and have the discipline to stick to their investment strategy can reap significant rewards. "The only source of knowledge is experience." This idea emphasizes the importance of learning from experience, both in investing and in life more broadly. Investors can gain valuable insights from their successes and failures, allowing them to refine their strategies and make better decisions going forward. Additionally, it's important to seek out advice and information from experienced investors and financial professionals to help increase your knowledge and understanding of the markets. "Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn't, pays it." This quote, which is often attributed to Einstein, highlights the power of compounding, which is the process of earning interest on both the original investment and any interest earned in previous periods. By investing early and consistently over a long period of time, an individual can take advantage of the power of compounding to grow their wealth significantly. "Intellectual growth should commence at birth and cease only at death." This quote speaks to the importance of continuous learning and self-improvement. In investing, it's important to stay informed about economic trends and developments in the market, as well as to continuously educate oneself about different investment strategies and tactics. By staying curious and open-minded, investors can remain flexible and adapt to changes in the market. "The only thing that interferes with my learning is my education." Einstein nails it with this one, it highlights the danger of being too rigid in one's thinking and approach. In investing, it's important to remain open to new ideas, new approaches, and new economic conditions, even if they conflict with what has worked in the past. By being willing to challenge one's own beliefs and assumptions, investors can stay ahead of the curve and identify new opportunities. Albert Einstein's insights and wisdom can be applied to the world of investing in numerous ways. By embracing the power of compounding, embracing opportunities during difficult times, continuously learning, and remaining flexible, investors can make informed decisions and work toward achieving their financial goals. -Paul R. Rossi, CFA  Options are a type of financial instrument, (also called derivatives) that give the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price on or before a specified date. They can be used in an almost unlimited way in investment portfolios, let's take a look a few ways they can be used:
Options are not for everyone and understanding the risks and potential benefits are important before using options. However, for certain individuals and under certain circumstances, options can be a great tool. The more tools in your proverbial toolbelt the better. If your only tool is a hammer, then every problem looks like a nail. -Paul R. Rossi, CFA  Most of us have heard the saying, "Comparison is the root of all unhappiness." And I would agree...most of the time. However, when it comes to BEER and investing, I would have to disagree. More on this in just a minute. First things first. Investing really boils down to opportunity costs. Opportunity cost: is the potential benefit or gain that is given up when an individual or organization chooses one course of action over another. It is the value of the next best alternative that must be forgone in order to pursue a certain action. Opportunity cost is a key concept in economics and decision-making. It helps individuals and organizations weigh the costs and benefits of different choices and make the most efficient use of resources (time and money). Opportunity costs should be considered in the context of your priorities and goals. In terms of investing, let's use this idea of opportunity cost to evaluate investment options...and that's where BEER comes in. Before we get to BEER, let's quickly talk about what's called "Earnings Yield." Earnings yield is a measure of the profitability of a company or index when compared to the price being paid. The earnings yield is calculated by dividing the EPS (earnings per share) of the index by the current price. It is the inverse of the well-known P/E ratio. In the simplest terms and all else being equal, the higher the earning yield the better. The power of the earnings yield is the ability to use it as a comparison tool...and now that's where BEER comes in. BEER stands for Bond Equity Earnings Yield Ratio. The bond equity earnings yield ratio (BEER) is a tool that can be used to evaluate the relationship between bond yields and the earnings yield in the stock market. BEER has two parts, the numerator is represented by a benchmark bond yield, such as the two, five, or ten-year Treasury Bond, while the denominator is the current earning yield of a stock benchmark. A comparison of these two numbers can be used to get an idea if bonds or stocks are more attractive relative to each other. The idea behind the BEER ratio is that if stocks are yielding more than bonds, then they are undervalued; inversely, if bonds are yielding more than stocks, then stocks are overvalued. For example, if the P/E ratio of the S&P 500 is 18, then the earnings yield is 1/18 = 0.056 or 5.6%. And it is easier to compare this number to bond yields than to compare the P/E ratio to bond yields. Some investors believe if the ratio is above 1.0 the stock market could be said to be overvalued; a reading of less than 1.0 indicates the stock market is undervalued relative to bonds. BEER Highlights
Limitations of BEER
It's important to understand that BEER is not a standalone measure, and it's important to consider other factors such as economic conditions, company performance, and overall market sentiment when making investment decisions. BEER can be a useful metric for comparing the relative value of bonds and stocks. It can be used to help investors make decisions about how to allocate their investments between the two asset classes. However, it is not a standalone measure, and other factors must be considered when making investment decisions. So go enjoy a nice cold beer as you use BEER to help you make more informed investment decisions. -Paul R. Rossi, CFA  There’s a so-called term in the Wall Street lexicon called “Smart Money.” Smart Money are institutional investors, endowments, pension funds, ultra-high net worth individuals, etc. Supposedly these institutions, organizations, and people, know more than everyone else in the room. They believe they can see around corners; they understand the markets at a deeper level and are better informed. And the media is constantly parading them around as such. The insinuation is that if you're not "Smart Money," then by default, you must be "Dumb Money." Some other definitions of Smart Money Investopedia says, “Smart Money is the capital that is being controlled by institutional investors, market mavens, central banks, funds, and other financial professionals.” Jason Zweig of the Wall Street Journal wrote in his somewhat satirical book, The Devil’s Financial Dictionary, that "Smart Money" is defined as, "those investors who know which stocks to buy, when to sell them, every tidbit of information that can influence the price, what the companies' executives are thinking, how geopolitical events will affect every market, and so on - as in “the smart money isn't buying yet” or “the smart money is dumping emerging market stocks now." He goes on to say, “the Smart Money is in fact an imaginary being, something like the three headed hydra of Greek mythology. Cut off one of its heads and two will grow back although both will be empty as “the smart money” is nothing more than an illusion fabricated by people who enjoy picking others pockets." Let’s review just a couple of recent happenings that prove Jason's Zweig's point. FTX FTX had a who’s who of finance and celebrities pushing this as a great investment. Well known venture capital firms like NEA, Sequoia Capital, Softbank, and celebrities like Tom Brady, Shaquille O’Neil, Seth Curry, and billionaire investor Kevin O’Leary all got fleeced. They invested hundreds of millions of dollars, and it's gone to zero. The FTX fiasco is still unfolding, and it will probably be months if not years before all the details emerge and we learn how deep the rabbit hole goes. Theranos This company was touted as a breakthrough health technology company when it was founded back in 2013. Founded by 19-year-old Elizabeth Holmes, Theranos ended up raising more than $700 million from venture capitalists and private investors. At one point it was valued at $10 billion. Theranos had a who’s who on their board, this included: U.S. Secretary of State George Shultz, William Perry (former U.S. Secretary of Defense), Henry Kissinger (former U.S. Secretary of State), Sam Nunn (former U.S. Senator), Bill Frist (former U.S. Senator, senate majority leader and heart-transplant surgeon), Gary Roughead (Admiral, USN, retired), Jim Mattis (General, USMC), Richard Kovacevich (former Wells Fargo Chairman and CEO) and Riley P. Bechtel (chairman of the board and former CEO at Bechtel Group). The company claimed that it had developed a quick, inexpensive, and easy way to test blood. These claims were later proven to be false and a fraud. Elizabeth Holmes has recently been sentenced to 11 years in prison. Investors lost all their money. This so-called term "Smart Money" is a farce. They would like you to believe that they are so much smarter than everybody else and they’re working in a higher dimension of space-time that only they and Einstein can comprehend. The truth is, you’re smart if you:
Don’t get pulled off of your strategy by others, whoever they may be, and whatever background they may have. Peter Lynch said it best in his book, One Up On Wall Street, "Dumb Money is only dumb when it listens to the Smart Money.” -Paul R. Rossi, CFA 
In the span of just a few days, cryptocurrency exchange FTX, the world’s third largest cryptocurrency exchange with more than 1 million users, filed for Chapter 11 bankruptcy. A few days later, cryptocurrency lender BlockFi announced that it was "not able to do business as usual" and paused client withdrawals as a result of FTX’s implosion. Then the lending arm of crypto investment bank Genesis Global Trading announced it was pausing new loan originations and redemptions. The FTX fiasco is reminiscent of Bernie Madoff, the mastermind of the biggest investment fraud in history after he defrauded more than 40,000 people of over $65 billion. Considered by many to be the archfiend of the financial world, his Ponzi scheme will haunt the financial industry for years and the FTX debacle is resurrecting some of the same fears in the minds of investors and regulators. The epic Ponzi scheme Madoff ran and the spectacular collapse of FTX both underscore a harsh reality: Many folks don’t understand how investment firms operate, what they are invested in, and not sure what to look out for. It’s important for investors to understand:
So how do you make sure you don’t run into the next Bernie Madoff or FTX? One way is to assure that your advisor does not oversee every part of your investing. Here are four questions to ask your advisor:
Madoff controlled the first 3 exclusively. And for the 4th, he was able to find a small outside auditor to help him with his scam and sign off on the phony returns. Your advisor might be selecting securities for you but listen carefully to how they answer the next three questions. Do Your Homework Investors need to ask lots of questions and if anything doesn’t feel right, or your advisor balks at your 4 questions, or doesn’t want to provide you with their Form ADV…don’t walk away. Run. -Paul R. Rossi, CFA I'll ask it again, why are we surprised? Several legendary investors have been pounding the table for years and no one wanted to listen. Jamie Diamon, the head of JPMorgan Chase who successfully navigated the bank through the financial crisis and who many consider to be one of the finest bank CEOs has called it "worse than tulip bulbs" and a "fraud." Warren Buffett, the greatest investor of all time hasn’t been shy about his views, saying "it will come to a bad ending." And Charlie Munger has called it "rat poison squared." More recently, Larry Fink, CEO of BlackRock the largest asset manager in the world which manages over 10 trillion in assets has said, "I actually believe most of the companies (crypto related) are not going to be around." So why are we surprised that we’re seeing crypto companies, crypto assets, and related investments crash and file for bankruptcy. How does this happen? One powerful force that drives people to make irrational decisions is that it's next to impossible to argue against someone, when that someone wants to get rich quick...and many crypto enthusiasts thought they could get rich quick. As an individual investor, do you really think you have More Insight, More Experience, Deeper Knowledge, and a Better Understanding than these three individuals when it comes to investing? Read that last sentence again. Really, do you? I'm proud to say, my firm never promoted, never endorsed, and never believed in crypto investing. Many financial institutions (including Fidelity Investments) and advisors (like Ric Edelman) have pushed their clients into this so-called "asset class." Yes really. Investors are paying their financial advisors for sound investment advice, not for get-rich-quick schemes that in the end never work out well. -Paul R. Rossi, CFA 
You’ve spent years building a retirement nest egg, then the market takes a nosedive. You’re down $150,000, then $250,000 or more. Now you think maybe you should change how you invest or maybe investing isn’t for you. You are not alone in your thinking. The financial adage says, “A recession is when your neighbor loses their job, a depression is when you lose your job.” We all think we can handle loses in the market until it actually happens to us. “A man who carries a cat by the tail learns a lesson he can learn in no other way.” - Mark Twain Making financial decisions alone, especially during times of market volatility, can be especially challenging. It’s easy to make the wrong choices when you see hard-earned money disappearing. But when it comes to investing, having a steady head and hand is crucial. If you make spontaneous decisions based on emotion or the ever-present ebbs and flows of the market, then you risk turning your carefully invested funds into little more than gambling money. How do you keep yourself from becoming a gambler?
When the stock market takes it on the chin, you really learn whether you are a gambler or an investor. -Paul R. Rossi, CFA 
There are three individual company factors that influence a stock’s performance. The first is the company’s earnings, the second is the expected future growth of those earnings. The third factor is how investors value both the current earnings and the expected growth of those earnings - which is called sentiment. A company’s financial reports tells us how well the business has just performed, however, it does not tell us anything about investors’ sentiment. One way to measure investors’ sentiment is the Price-to-Earnings ratio (P/E). The P/E ratio can tell you a great deal about what investors think of a particular stock AND the sentiment of the overall stock market as well. Components of the P/E Ratio The P/E ratio for a stock is computed by dividing the share price by the company’s annual earnings per share. If a stock is trading at $40/share and its earnings per share are $2, then its P/E ratio is 20 ($40/$2). Enthusiasm on the part of investors can lead to what’s called “P/E Expansion,” and conversely a lack of enthusiasm on the part of investors can result in “P/E Contraction.” P/E Expansion refers to when investors’ perceptions improve, and as a result, they are willing to pay more for a dollar’s worth of earnings. On the other hand, P/E Contraction refers to a period when investors’ perceptions worsen, and as a result they are willing to pay less for a dollar’s worth of earnings. For example, if the average P/E ratio for stocks falls from 19 to 15 (21% decrease), while overall earnings remain unchanged, this is an example of “P/E Contraction.” In short, investors sentiment drives P/E ratios. Different companies and different industry groups can trade at very different P/E ratios even if they are generating the same level of profit per share. In other words, two companies may both report earnings of $1 per share, but one stock will trade at $20/share while the other trades at $30/share. This can be due in part to several factors, like the quality of the earnings, the consistency of earnings, the expected future growth in earnings, expectations of the sector/industry, etc. If investors are excited about a particular company, the companies’ shares may be driven up and therefore its P/E ratio is driven up right along with the stock price. On the other end of the spectrum, if investors feel that future earnings look weak, its P/E ratio may deteriorate and remain low. It's important to understand whether the current P/E ratio is presently relatively “high” or “low.” This can be quite challenging, although it can be done. There are three ways to assess a company’s P/E ratio:
Generally, if the current P/E is at the lower end of a company’s own historical P/E range, or if the company’s current P/E is below the average P/E of similar companies, the stock may be
Ideally, if a company is able to consistently grow its earnings, investors may become enthusiastic about the company’s long-term prospects and place a higher value on it and therefore it will trade with an above average P/E ratio. That being said, emotional buying and selling at the extremes can push stocks into overbought or oversold levels. Conversely, a stock’s P/E ratio might be low simply because its future earnings prospects look weak. And this may or may not represent a good value at that price. The stock may not rebound in any meaningful way until investors perceive there to be some catalyst to the company’s earnings. This can create a “value trap,” where a stock looks cheap, but its cheap for a reason. As a stock’s price rises, investors need to pay close attention when a stock gets bid up to an excessively high P/E level. In the heat of a bull market, it is not uncommon to find “hot” stocks trading at a P/E of 50 or more. While this can go on for some time, eventually a stock’s price and P/E ratio comes down when its future prospects are more in line with the overall market. When this happens, the ensuing price decline can be swift and painful. Exceptionally low or high P/E ratios can highlight potential opportunities or dangers. Understanding what is driving a stocks P/E ratio is important, as it is not uncommon for a stock or the overall stock market to have an unusually high or low P/E ratio for an extended period of time due to the above factors. And there you have it, now you understand how the P/E ratio can be used to determine the sentiment for an individual company as well as the overall market. -Paul R. Rossi, CFA  I would guess it probably doesn’t. In fact, many times you probably find beauty in sun sets, I do. Why doesn’t it scare you? Because you know that this is a repeating process, and as adults we understand it’s just the rotation of the earth that causes the “sun to set.” We learned as children that morning comes without fail. Let’s use the setting of the sun as an analogy in how we can think about recessions. Somewhat like the path of the sun across the sky rising and falling, recessions are preceded and followed by periods of economic growth. One cannot happen without the other.
If we understand recessions are going to come and then go, we shouldn’t be overly concerned about the next recession - assuming your financial house in order. Some areas that should be thoroughly reviewed:
Assuming everything is in order, let’s look at the glass half full and look past the next recession with our eye on the growth period that will follow the next recession. Just as the sun will rise after the sunset that preceded it, there will be another prosperous period that follows the next recession. -Paul R. Rossi, CFA  We all need to make a living. However, making a living shouldn’t be the goal, the goal should be to make a life. Making a life is being mindful of our limited time by living the way you want to live. It’s living life on your terms. Would you like own your own business? Travel more? Spend more time with family and friends? Write a novel? Become an expert in another field of study? With the media’s obsession on the economy, oil prices, interest rates, and stock price movements, one key question that gets completely overlooked is, “Are you trying to make a living or a life?” Live the Life You Want. Ask any business owner their top reasons they run their own business and you will likely agree with all of them: control your destiny; choose the people you work with; take on the risk; reap the rewards; challenge yourself; follow your passion; get things done faster; personally connect with clients; and feel pride in something you own. How Do You Want to Live Your Life? We help clients build the life that they want to live. Often one’s money and values are not properly aligned. A great financial advisor helps point out those discrepancies and highlight ways money can match your values. Some seem to believe that financial planning involves only planning the finances of our lives. Many planners cut right to the planning without exploring the “why” behind the money. We identify our client’s deepest values which makes it easier to talk about important life changes, some easy and some hard. It’s important we talk about values and goals because it’s pointless for us to make financial planning recommendations if we don’t know what’s important to our clients and how they want to live. Know precisely what you want in life. We help clients have a clear path.
It’s only knowing where you currently are and the journey you’d like to experience before a well-designed road map and be constructed. A comprehensive financial plan deals a lot with finances, but it’s more than that, it’s tool to help you Maximize Your Return on Life. I believe “you can do anything you want; you just can’t do everything you want.” -Paul R. Rossi, CFA  We recently celebrated Labor Day and it’s a good time to reflect on why we work and what we derive from it. The ideal answer should be that it gives your life energy and meaning. If it doesn’t, you might want to consider how to move in that direction. Labor Day became a federal holiday in 1894 and now also marks the unofficial end of summer. Summer trips wind down, students leave for college, football season gears up and we anticipate the cooler days of fall with enthusiasm. This is especially true if you are in a hot area of the country, and who doesn’t appreciate a 3-day weekend? Work Matters There is now a common understanding that meaningful work is a major component of human well-being. Interestingly, it does not matter whether the work is paid, volunteer or pro- bono, or you are working hard at home raising children. What We Do Matters Researchers at the Gallup organization have been exploring the subject for decades. A not-so-startling finding: Our happiness and feelings of well-being are a function of liking what we do each day. Tom Rath and Jim Harter explain in their book, Well Being: The Five Essential Elements, “…at a fundamental level, we all need something to do, and ideally something to look forward to, when we wake up each day. What you spend your day doing each day shapes your identity, whether you are a student, parent, volunteer, or retiree…” Yet only 20% gave a strong “yes” when Gallup researchers asked, “Do you like what you do each day?” If 80% are unhappy with daily activities, the rest of their life is likely to be out of whack and it’s likely your well-being will suffer. Well-Being Matters If you are to successfully live your life, your health, relationships, social connections, your sense of place, the fact that you are where you belong in terms of where you live, work, and interact with friends and people, as well as your spiritual home, are all key components of well-being. Defining Strength When you reinforce your talent with knowledge and skill, you have strength. A talent is a naturally recurring pattern of thought, feeling or behavior productively applied. A skill is the ability to move through the fundamental steps of a task. Knowledge is what we know. A strength, then, is a powerful, productive combination of talent, skill, and knowledge. When you are doing anything from strength, you feel it, you know it, and you love it. If you want to recalibrate and infuse your life with new energy, a revitalized sense of purpose, and a sense of comprehensive well-being, remember that: What you do matters. You matter. Build your strengths. -Paul R. Rossi, CFA Picture: SR-71 spy plane, it was the United States most advanced and fastest flying plane in the world, literally flying faster than a speeding bullet. It carried no weapons and was designed in an era when engineers used a slide rule. The SR-71's sole purpose was to keep the United States safe by being able to capture photos of our enemies' movements. The SR-71 was shot at many times, but was never shot down, as it was designed and flown by people who had an unbelievable sense of purpose.  What is asset allocation? “Don't put all your eggs in one basket,” this phrase probably says it most succinctly. How important is Asset Allocation? Studies have shown that asset allocation decisions can explain more than 90% of the variation in a portfolio's return over time. Asset allocation involves diversifying and owning various asset classes. These asset classes might include domestic stocks, bonds, international equities, real estate, cash, and several other categories. Ideally, the various asset classes do not move in tandem (highly correlated) with each other. As a group, every asset class carries a unique expected rate of return and level of risk. Typically, the assets will react differently under varying market conditions, such as during a strong economy, slow growing economy, shrinking economy, low inflation, high inflation, etc. As an example, one asset class may rise in value while another asset class falls over the same period of time. The ultimate goal of asset allocation is to construct a diversified portfolio that pursues the maximum rate of return in exchange for taking on a certain level of risk. One way to measure this return to risk proportion is called the Sharpe Ratio, named after Noble prize winner William F. Sharpe. The Sharpe Ratio = (return of the portfolio - return of the risk-free rate) / (standard deviation of returns). The idea is to generate the highest returns for a given unit of risk, i.e., the higher the Sharpe Ratio the better. Some research has shown that portfolios invested in assets that are not highly correlated with one another may perform better over long-time horizons and carry less risk than portfolios that are heavily weighted toward one type of investment. We might call this, getting a "free lunch"...stronger returns with less risk. These well diversified portfolios are sometimes referred to as efficient portfolios. Efficient portfolios are designed to pursue the maximum rate of return in exchange for a given level of risk. What are some ways to go about implementing an asset allocation plan? Strategic Strategic this method establishes and then maintains a specific combination of assets based upon expected rates of return for each asset class. Tactical Investors actively overweight and underweight segments of the market to capitalize on potential short- term market opportunities. When investors reached their short-term profit goals or do not have a strong opinion on segments and sectors they may buy or sell positions in order to return to a core asset allocation Valuation Based with this approach, investors constantly adjust the mix of assets based on their (relative or absolute) valuation. As certain investments get cheaper, and investor will buy more of the asset class and sell as they get more expense. For example, investors may sell existing positions in asset classes that have increased in value in and buy assets that have decreased bringing the mix back to the long-term proportions that are best for the investors risk and return goals. Rebalancing & Flexibility The importance of establishing the right asset allocation mix is important, however maintaining it overtime is equally important. Over time as the different assets move up and down it may become necessary to make adjustments to maintain the right proportion. This adjustment process is called rebalancing. Although it is important to create an asset allocation plan when constructing a new portfolio, it is equally important to assess your allocation over time and remain flexible. Investors can add new investments to fill gaps in their target allocation or to adjust their portfolios as their life situation and goals change. An annual or quarterly review of your asset allocation plan also gives you an opportunity to review other aspects of their financial plan (risk tolerance, goals, major life changes, etc.). Your asset allocation should support and sync with your overall financial plan. It is important to understand your portfolio's asset allocation, as it may be the single most important determinate of your portfolio's performance. -Paul R. Rossi, CFA Bipolar disorder is a mental disorder that causes unusual shifts in mood, energy, and activity levels. These moods range from periods of extremely “up,” elated, irritable, or energized behavior (known as manic episodes) to very “down,” sad, indifferent, or hopelessness during the depression phase. – National Institute of Mental Health (NIH). I’m not a mental health expert (my wife is), but doesn’t bipolar disorder sound eerily like what the stock market suffers from? The stock market goes through wild swings of optimism and then can quickly shift to periods of severe depression, then back to optimism, with this cycle continually repeating. Want just a few examples?
Going back a bit further we can see similar patterns throughout the stock markets history.
If we deem that the stock market suffers from bipolar disorder. What can we do about it?
Maybe we can learn from what the National Institute of Mental Health recommends for treating bipolar disorder in individuals. First, we need to understand it's a lifelong illness and usually requires lifelong treatment. However, the NIH says following a prescribed treatment plan can help people manage their symptoms and improve their quality of life. Their (abbreviated) treatment plan includes a combination of:
Let's use the NIH as a template for our suffering stock market and related investors. First, we need to understand that the stock market suffers from this condition and it's lifelong.
As investors, we will be dealing with the stock market and its bipolar disorder for the foreseeable future. Since we as individuals can’t “fix” the disorder the stock market suffers from, we need to decide how we are going to interact with the market when it’s going through its various periods of hopelessness and manias. -Paul R. Rossi, CFA Why are so many of the same companies mentioned in the news day in and day out? The Scatterplot below might help explain why: The chart shows all 500 companies of the S&P 500 represented by light purple circles. In contrast, some of the largest companies are displayed in other colors. These highlighted companies each earned (Net Income) $20+ Billion dollars over the last 12-months and several are worth over a Trillion dollars.
 And now you know why these companies are so prominently featured in the news. They are behemoths in every sense of the meaning. When they hire or fire, enter new markets, create new products, build new buildings, they have a deep and wide impact within their respective industry. -Paul R. Rossi, CFA  Above is a chart of the U.S. GDP (Gross Domestic Product from 1947 - 2022). Since the end of World War II, the U.S. economy has grown tremendously. GDP is now a staggering 10 times larger than it was back in 1947. Oh, and by way, this includes enduring 12 recessions (grey lines) along the way.  Above is a price chart of the Dow Jones Industrial Average going back to 1930. It includes some major world events, The Great Depression, several wars, and 15 recessions. If I was a betting man (and I am), I wouldn't bet against the United States continuing to grow and do well over time. The key part of this phrase being, "well over time." We are going to experience some tough times both now, and in the future...this unfortunately is unavoidable. Plan accordingly. Tough times don't last, but tough people (and investors) do. -Paul R. Rossi, CFA 
Many times opportunity comes wrapped inside a scary situation, dealing with hardship, or simply accepting change. But nearly every time it ends up requiring a person to step outside themselves and take the proverbial leap of faith. What’s a Bear Market? It’s an opportunity… and it’s scary, it's a hardship, and it requires taking a leap of faith. What is the conventional definition of a Bear Market? The Securities and Exchange Commission (SEC) defines a Bear Market as a period of at least two months when a broad market falls by 20% or more. The Standard & Poor’s 500 index, which includes virtually all of the largest and most well-known U.S. companies is in an “official” bear market (if you didn’t know this already), since its peak on Jan. 3, 2022. Since 1928 there have been 26 Bear Markets with an average length of 289 days. No doubt about it, psychologically a Bear Market can be challenging. The impact can be particularly hard for investors who do not have a well-designed plan as they see their retirement accounts and investment portfolios shrink. And this can create a self-fulfilling cycle, as investors perceive an impending bear market tend to prompt investors to sell even more, thus pushing prices down further and prolonging the pain. What psychologists call a “Negative Loop Cycle.” What's the good news and what opportunity might a Bear Market provide? For those investors who have psychology and time on their side, a Bear Market can offer:
So during a Bear Market, there are quite a few things an investor might do, and probably the most important idea you might consider changing is the nomenclature from Bear Market to “Opportunity Market.” -Paul R. Rossi, CFA  Let’s break down the metrics and details used that every person who invests in their company’s retirement should pay attention to.
By identifying and understanding these metrics for evaluating funds, you are one step closer to finding the best funds to invest in to help you reach your financial goals. -Paul R. Rossi, CFA For a lot of investors, when you bring up the term "FAANG," they understand what you are referring to, as the term has become quite ubiquitous. The term FAANG refers to the stocks of: Facebook (Meta) Apple Amazon Netflix It can be argued that these five companies have changed the way we work, live, and communicate. They have changed our lives in so many ways...and along the way investors have done quite well (mostly). But like most things, it depends how we measure returns, or more accurately how long has an investor has owned these companies. Investors get dramatically different answers to the question, "How well are these companies doing?" depending on the time period they are measuring. Let's review how well they've done over the following time periods:
Short answer is, they are Up, Down, Down, Up, Up, and Way Up.  5-Day Return: UP  3-Month Return: DOWN  1-Year Return: DOWN  3-Year Return: UP  5-Year Return: UP  10-Year Return: WAY UP Investors have been handsomely compensated over the last 10-years, gaining more than 10x their original investment. And during the last several years the P/E Ratio (a valuation metric) has been coming down on these companies collectively (chart below). This is good news for investors. New investors are now able to buy these companies at valuation levels never seen before.  What's interesting is that many other companies and their corresponding stock have similar patterns, over the short-term they tend to be up and down quite a bit. The next time you hear the old adage, "What goes up, must come down." You can ask them, "Over what time period?" -Paul R. Rossi, CFA Financial professionals rely on long-term historical averages when making capital market assumptions and not all starting points are the same. Investors should take current stock valuations into account as they make financial plans and allocate assets. Getting into the market when stocks are highly valued can work against an investor. Even over time horizons as long as 20 years or more investing in high valuation environments can lead to below average returns. Conversely if stock valuations are low when the investor begins, this can lead to above average returns over an economic cycle. Even young investors with long time horizons should be mindful not to assume too much risk in an overvalued market even if the long-term return eventually averages out to what was initially anticipated. Lets take a look at an interesting situation between historical growth rates and a well-known valuation metric used by financial professionals called the P/E ratio. The ubiquitous P/E ratio, which is defined as the (Price per share) / (Earnings per share). The P/E ratio has units of years, which can be interpreted as the number of years of earnings to pay back purchase price. P/E ratio is often referred to as the "multiple" because it demonstrates how much an investor is willing to pay for one dollar of earnings. Right now, large well-known Technology companies are being priced at valuations below their historical 3-year average (chart below).  Now let's compare this with four companies below which are classified as "Consumer Staple" companies. These are companies that sell essential products used by consumers. These are typically goods that people are unable or unwilling to cut out of their budgets regardless of their financial situation. This makes these companies non-cyclical in nature.  Below is a Scatter Plot of both the Technology and Consumer Staple companies from above. This graph is comparing their current valuation (P/E on the x-axis) vs. 3-year Earnings per Share Growth (Y-axis). As is apparent, the Technology companies have had substantially higher earnings per share growth (Y-axis) while their current valuations (X-axis) is lower. On the Scatter Plot, the upper left corner would be the best quadrant and the lower right would be the worst quadrant.  So what are these numbers and charts saying? These 3 charts are conveying the following:
What does all this mean? Collectively the four Technology companies look inexpensive relative to the four "so called" safer Consumer Staple companies. Keep in mind this doesn't mean that these Technology companies can't go lower. All else being equal, it's better to own a company or a collection of companies with higher earnings growth and a lower valuation. -Paul R. Rossi, CFA 
Seven seconds. Seven seconds is the somewhat popular belief of a goldfish’s memory. Apparently after seven seconds the goldfish has completely forgotten what happened prior. Whether this is true or not, let’s go with it for now. I would say in some sense, having a goldfish's memory can be an advantage. However, understand that the media wants you to have a long memory, more akin to the memory of an elephant (assuming you believe that elephants have great memories). They want to fill your head will all the things that went wrong, are currently going wrong, might go wrong, and will go wrong far into the future after we have all passed away (recent news title: the sun will die in approximately 5 billion years and how this will impact us). Why? It keeps us all hooked to what they are going to say next. And that’s how they make money. Never forget that. The financial media would like you to believe that it's important to know what happens every day in the markets. They want you to know when the market is down 3% for the day, down 5% for the week, or down 10% for the month. In this case, be like a goldfish. Give it seven seconds, no more. I don't know anyone that measures their own personal success in days, weeks or even over the course of a year. For example, college typically takes four years or more for an undergraduate degree and a graduate degree can take several more years after that. We all measure the graduate on their success in graduating after years of studying. Professional success is no different. It takes years to become an expert. I’d like to hear of any professional athlete who mastered their sport in a day, week, month, or even a year. How about a surgeon? How many years before they are considered an expert in their field? Physicist, Contractor, Accountant, you name it, no one masters anything measured in anything smaller than years or decades. Investing success is no different, it is measured in years and decades, not in days, weeks, or months. Mastering the markets is more about mastering yourself rather than actually mastering the markets. How do you master yourself? By mastering your emotions and your memory. This is what makes investing so hard. -Paul R. Rossi, CFA |
