A petrol bomb explodes near riot police during an anti-austerity demonstration in Athens

In my latest quarterly commentary, sent in early January, but posted on this blog on January 30th I stated:

Tempers are running high and the stakes are enormous – but the people are not going to stand by and be forced into a devastating unending depression, eventually they will riot in the streets.

Well…the people ARE being forced into a devastating unending depression with the latest vote to approve new austerity measures in order to get more money from their neighbors. The people are rioting in the streets, just as I predicted they would. This wasn’t a difficult prediction, it’s simply the natural progression of the situation.

Things are going to get worse in Greece and Europe before they get better and Austerity will continue pushing Greece into a deeper and deeper depression.

Scott Dauenhauer, CFP, MSFP, AIF

Combine with e-coli and you get...Ethanol!

Last March I reported on the idea of turning algae into fuel in Green Crude. Scientific American recently reported on a breakthrough that modified e-coli (the common and deadly stomach virus) to turn Kombu (seaweed) into Ethanol. From their article titled Genetically Engineered Stomach Microbe Converts Seaweed into Ethanol:

Seaweed may well be an ideal plant to turn into biofuel. It grows in much of the two thirds of the planet that is underwater, so it wouldn’t crowd out food crops the way corn for ethanol does. Because it draws its own nutrients and water from the sea, it requires no fertilizer or irrigation. Most importantly for would-be biofuel-makers, it contains no lignin—a strong strand of complex sugars that stiffens plant stalks and poses a big obstacle to turning land-based plants such as switchgrass into biofuel.

The article goes on to say:

An analysis from the Pacific Northwest National Laboratory suggests that the U.S. could supply 1 percent of its annual gasoline needs by growing such seaweed for harvest in slightly less than 1 percent of the nation’s territorial waters. Humans already grow and harvest some 15 million metric tons of kombu and other seaweeds to eat. And there’s no reason to fear the newly engineered E. coli escaping into the wild and consuming the seaweed already out there, Yoshikuni argues. “E. coli loves the human gut, it doesn’t like the ocean environment,” he says. “I can hardly imagine it would do something. It would just be dead.”

So it won’t be a major source of energy, but its a start! I think what scares me the most however is the last quote by Yoshikuni “I can hardly imagine it would do something”. It sounds like the start of a movie where the world population was severely reduced because of an outbreak caused by a scientist with a lack of imagination!

My point though is that the age of science is ushering in a new revolution in energy. It may take a few decades (or even a century), but our ability to create energy that is safe, clean and plentiful is about to explode (ok, maybe not the best choice of words!).

Scott Dauenhauer CFP, MSFP, AIF

This commentary was written around January 15th and distributed first to Meridian Wealth Management clients.

The January 9th, 2011 CNN/Money headline was Stock Outlook for 2011: Recovery Rally Will Continue, the chart below showed the consensus estimates:

2011 CNN/Money Forecast

The S & P ended where it started, at 1258, 42 points below the lowest estimates and 262 points below the high estimate.  A global index of stocks fell nearly 8%.  Even the consensus estimate was off by over 130 points – how could the smartest companies on Wall Street be so far off?

The truth is these companies almost never get it right, yet it doesn’t stop them from prognosticating.  It seems the more wrong they are the more often they get on CNBC.  Once again the forecasts for 2012 are rosy, the same chart forecasts for 2012

CNN/Money 2012 Forecast

The average forecast is for a 7% rise with a high forecast of almost 26% and a low of about -3%.  Given the history of bad forecasts I wouldn’t put to much ‘stock’ in these forecasts, especially considering the ending price for 2011 wasn’t even in the wide range forecasted.
Forecasting short-term results is a fools errand.  While current valuations can give you a good idea of what future returns are likely to be (even this is not perfect), there is no indicator that can tell what the market will do in the short-term.  In 2007, Money Magazine had the following to say about the stock market in 2008:

“But even though stock prices will jump around more, they’re still expected to rise in the coming year. The combination of decent if unspectacular earnings growth – about 7.7 percent – and a slight decline in the average price-to-earnings ratio next year should translate to an overall gain of about 5 percent in Standard & Poor’s 500 index for 2008.”

We all know how 2008 turned out.

To be sure, I don’t know what stock prices will do in 2012, nor does it matter.  My general belief is that valuations are rich, especially given the risks we know about (add in the risks we don’t know about and there is little if any margin of safety).  While stocks may rise or fall in 2012 – they will likely have meager returns over the coming decade.  This is based on valuation models that have worked for as far back as we have data.  There are still pockets of fair valuation and we try to allocate towards those areas, but until stocks have a meaningful correction our allocations will be light.

Will the United States enter into a recession in 2012?  In my mind the question is meaningless as “valuations” matter more and I believe the U.S. is still mired in depression.  But the talk of recession is ever present and historically there have been two reliable indicators of whether or not we are headed for a recession, the ECRI Weekly Leading Index (WLI) and the Conference Boards monthly index of Leading Economic Indicators (LEI) – what are they saying?

Leading Indicator Divergence

They are saying the exact opposite of each other.  The WLI shows we are already in recession and the LEI points to accelerating growth.  Both indicators are widely followed and credible…yet neither give us any idea of what’s to come.

Next time someone tries to tell you they know where the market is headed in the short term, just smile and nod your head, they have no clue.

The real story of 2012 is going to be Europe.  Whether Europe falls apart, fixes itself or continues with the status quo – it will be the main thing affecting all markets (save for all the other things that we do not know about!).  Right now a battle is going on to save a failed European monetary system and how that battle is fought will determine the economic future of millions of people.  The crumbling of the Euro would be epic (a word that is overused, but appropriate), but could be the one thing that could save Europe in the long term.  One thing is for sure – kicking the can down the road will create even more risk and make any transition much more difficult.

Understanding Europe (If it were happening here)

Note: This is purely hypothetical

Many of you have expressed an interest in understanding what is happening in Europe.  It is much more complicated than they have too much debt.  I’ve tried to write an analogy that I hope will make Europe easier to understand.

Imagine you live in California and run major deficits (not difficult to imagine).  You have accumulated so much debt that you can never repay it.  Also imagine there is no Federal Government to allocate funds to California. Eventually, California is locked out of the credit markets – it can no longer borrow on reasonable terms.  The only way to avoid collapse is for the Central Bank to fund California (which it cannot do directly, but does so indirectly by purchasing California Bonds) or to receive transfer payments from a more healthy state, perhaps one of its trading partners – lets say Texas (I chose Texas because the politics of the two states are so different).

Texas buys everything California produces and so it makes sense for Texas to come to the rescue.  But the rescue comes with a price, Texas gets control and veto power over California’s budget and requires the people to take lower wages and to have their pensions cut, imposing a depression via austerity.  Texas also has aims to annex some California landmarks – it has its eyes on Catalina, Yellowstone and Truckee (some Texas politician grew up there).

Californians are now “subjects” of the Texans.  How long do you think Californians would put up with such a system?  Texan politicians who are not answerable to Californians and not voted in by Californians are now in control of their future.  Californians can roll over and give up – or fight.  At some point Californians would fight back – but how?  Using financial weapons.  You see, all that debt that California owes – much of it is owed to Texans and their longhorn banks.  Were that debt to become worthless, Texans would be in big trouble.

If this sounds a bit like Mutual Assured Destruction….it is.  Now there is a stalemate between the two states.  California either creates a new currency and converts their debts or Texas takes losses on their California bonds and moves on (which they are loath to do).

This is the exact situation occurring in Europe right now with California representing Greece (and really Portugal, Spain, Italy, etc.) and Texas representing Germany (and to some extent France).  There are a few minor differences, but I think you get the picture.

Tempers are running high and the stakes are enormous – but the people are not going to stand by and be forced into a devastating unending depression, eventually they will riot in the streets.  Change is coming to Europe – its just a matter of timing.  You may ask why this doesn’t happen in the US – after all, all the states share a common currency like those in the European Union, right? Yes, but we also have something that the Euro is missing – a strong central government and a tight fiscal union.  Europe either switches to this model or it falls it apart – I don’t believe they will switch as I can’t imagine a scenario where such divergent nations with such varied histories and strong nationalistic tendencies could ever exists with a central political body.

A few weeks ago my wife took me to see the hit musical “Wicked”.  If you haven’t seen it, it’s The Wizard of Oz as seen from a completely different perspective, it was very entertaining.  It reminded me that there are people who believe The Wizard of Oz was written as a monetary allegory.  If you type into google “Wizard of Oz” and “allegory” you will find a completely different take on Oz, one that is fascinating.

You likely never read much into The Wizard of Oz and thus never saw the rich imagery claimed.  It might be because Baum never intended Oz to be a monetary allegory. In fact, Bradley Hansen, a Professor of economics at the University of Mary Washington was quoted as saying “the true lesson of The Wizard of Oz may be that economists have been too willing to accept as a truth an elegant story with little empirical support, much the way the characters in Oz accepted the Wizard’s impressive tricks as real magic”.

Baum may never have intended Oz to be a political or monetary allegory, but I figured I could take a stab at turning it into one.

The European Wizard of Oz Symbolism

Right now in many European countries, the citizens feel like Dorothy, stuck in Oz (The European Union) wishing they could get back home.  They are stuck in a currency that is killing them and they want to get back to their old currency where they had some modicum of control over their future.

Unfortunately, the Wicked Witch of the West – played by Germany’s Angela Merkel is dead set against letting countries out of the Euro, instead she prefers more control over them.  It is unclear if Glinda the Good Witch (Christine Lagarde, head of the IMF) will be strong enough to control the situation.  Will Dorothy, joined by the Scarecrow (Greek leader Lucas Papademos), the Tin Man (French Leader Nicholas Sarkozy) and the Lion (Mario Draghi, head of European Central Bank) make it to Oz (the United States Federal Reserve) and find what they are looking for from the Wizard (Co-Wizards Ben Bernanke and Timothy Geithner)?  They will certainly find that the Wizards have no power either and they, the people really hold the power, if only they would exercise it.  Will Europe follow the Yellow Brick Road (the Euro) to destruction or will it break apart with each country in charge of their own destiny (and their own currency)?  Only time will tell, but the adventure promises to be just as entertaining as The Wizard of Oz, but with consequences that will reverberate throughout Munchkinland (The Earth).

Ok, so likelihood is you have no idea who most of those people are, that’s okay – they likely won’t matter much soon anyway.  My whole point is that Europe is on the verge – of what, only time will tell.

Investments

I’m still not a believer in gold and think that the hyper-inflationist and currency collapse crowd is dead wrong.  If anything the dollar could become stronger with deflation being the global headline risk.  Those predicting doom in American because of our debt issues will be found to have been foolish as we are monetarily sovereign – unlike Europe.  This doesn’t mean we don’t have structural problems to deal with, we are in a depression and there is nothing on the horizon that would change our course.  The good news is that we are not in a deep “Great” depression.  This is of little solace for the unemployed and poor, but this country will rise again, just not anytime soon (barring some major unexpected event).  I am still cautious with Risk assets and believe future returns will be low in all major asset classes.

One thing is for sure, 2012 is going to be another interesting year.

Scott Dauenhauer, CFP, MSFP, AIF

NAPA members may serve as either fiduciaries or non-fiduciaries, but are committed to clearly disclosing their fiduciary or non-fiduciary status to their ERISA retirement plan clients.

What struck me about this first is that ASPPA/NAPA was careful to insert “ERISA” as a modifier to “retirement plan clients”.  I’m convinced this modifier would not have been included if NTSAA was not part of ASPPA.  The real question is why this principle only applies to ERISA retirement plan clients and not all retirement plan clients.  Putting that aside for a minute, my whole disclosure piece the other day was partially espousing this principle.  If an advisor gives advice they should be fiduciaries, if they are selling products they should disclose they are not fiduciaries and not use monikers like “financial advisor” or “planner” or “consultant”.

It seems to me that if this principle is good for NAPA, it should be good for NTSAA.  Remove the term ERISA and apply to both organizations.

Scott Dauenhauer  CFP, MSFP, AIF

Fiduciary or Not? Participants Deserve to Know

It is no secret that I am a critic of the ASPPA/NTSSA/Graff policies of favoring unlimited vendors and noncompetitive, imprudent individual retail annuity products in 403(b) plans and allowing non-fiduciaries to service school employees.  Non-fiduciary advisors  servicing school employees should also make it clear that they are NOT registered to provide participant advice.  It is my opinion, that a properly run single vendor system is the best way to increase participation rates, contribution amounts and to help school employees retire in dignity.  ASPPA believes that any vendor should be allowed to offer their products – with no fiduciary oversight.

While I think Single Vendor is the best route, I am also a realist and understand that a single vendor environment is not going to happen overnight (actually, it has in many progressive school districts).  It got me thinking about what can be done to protect current participants who are stuck in a non-oversight multi-vendor program or even a program that does have oversight but has multiple vendors.

ASPPA is working on a compensation disclosure document that will be voluntary for agents (presumably the vendors won’t be required to participate, but this is unclear to me).  Why it is taking so long to create such a simple document is beyond me, but what it won’t include is a statement as to the fiduciary status of the agent or broker selling the product.

The inspiration for this blog post came from financial planning thought leader Michael Kitces at Nerds Eye View.

I believe that if ASPPA is truly interested in disclosure – they should follow the guidelines Kitces sets out.

Kitces recently wrote The Public Deserves A Choice, But It’s Not Fiduciary Vs Suitability which echoes my view (but is much more coherent!).  Michael has granted me permission to reprint the post in its entirety below, but first I’ll quote from it:

In the ongoing debate for the fiduciary standard, supporters of fiduciary have suggested that everyone in financial services should be subject to the standard, while those opposing have responded that consumers deserve a choice between fiduciary and suitability; in essence, they simply suggest that we should let consumers choose whatever method of financial services they prefer, and may…the best model win. But to me, the choice presented is a false one (see Dauenhauer’s False Choice post): the real choice is not between fiduciary advice and suitable advice, the difference is between fiduciary advice and suitable product sales (emphasis added). In other words, the real choice we should present to consumers is between advice and product sales, and the real goal of the planning profession should be to focus on who is and is not qualified to deliver advice.

Before I unpack the above statement, I’d like to quote from NTSAA representative Robert  Richter (www.savemy403b.org) who has opposed my views:

We have established a joint task force with the National Education Association and the Association of School Business Officials to create fee disclosure standards for public school 403(b) plans. These national standards will allow public school employees to make apples to apples comparisons of different 403(b) options so they know clearly how much they are paying and what services they are paying for. As we know in the 401(k) industry, it’s not all about fees and public school employees should not be denied the opportunity to work with a personal advisor and product provider they trust.

What we learn from Richter is that ASPPA/NTSAA is quite concerned about allowing “…public school employees to make apples to apples comparisons of different 403(b) options…” and so I propose we allow them to do just that.  Of course I want fees and commissions disclosed, but if participants need apples to apples comparisons to make good decisions on their 403(b) fees, we should also allow them to compare “advisors” on such a basis.

I am calling on ASPPA to practice what they preach and require that those who want to work with public school employees and give “advice” be a fiduciary and those that sell product must disclose they are NOT advice givers and NOT acting as fiduciaries.  ASPPA should adopt this policy for any non-fiduciary who becomes a member of ASPPA or its member organizations.  ASPPA should support the following dictum layed out by Kitces:

If you don’t want to be treated as a fiduciary, that’s fine; just don’t offer advice, and don’t hold yourself out as offering advice. People who offer securities or insurance products for sale eliminate the words “financial advisor” or “financial consultant” from their business cards, and simply hold themselves out for doing what they do: registered representative, stockbroker, or insurance agent. Those who offer advice hold themselves out as advisors, and subject themselves to the appropriate standard.

This compromise allows for non-fiduciaries to still work with 403(b) plans that have chosen to stay multi-vendor, they just can’t give advice.  In a private e-mail with Kitces (which he has granted me permission to share), he made the following analogy:

“I still view it as analogous to the medical industry. You can be a doctor and give advice, or be a drug company and sell your products (albeit also subject to some amount of regulation and oversight). But you can’t be a drug company giving advice about drugs; advice is fiduciary and products are not, but advice is separate from products.”

I’ve always held the position that advice givers should be fiduciaries, it is time that ASPPA endorses this common sense (which happens to be current law (Section 202(a)(11)(C)) position.  This will allow school employees to make a true apples-to-apples comparison among the advisors they choose while also providing the proper disclosure.  It preserves the “choice” position that ASPPA has so desperately clung to, but puts clear parameters around that choice as well as clear disclosures.  Sell product or give advice – but be clear about it.

Kitces goes on to say:

But the real point here is that fiduciary advice vs suitability advice is a false dichotomy; the only kind of advice is fiduciary advice, delivered in the best interests of the person receiving the advice. Merriam-Webster defines the act of advising as “to give (someone) a recommendation about what should be done” (emphasis mine); in other words, telling the person what should be done that’s in their interests is the very essence of what advice is, in the first place! On the other hand, the suitability standard is about offering a product for sale that is suitable – or at least, not unsuitable – given the client’s circumstances. The latter, simply put, is not a standard for advice; it’s not actually about advice at all, but simply determining whether a product being sold is so unsuitable that it’s unconscionable to allow it to be bought at all. Advice, as Merriam-Webster makes clear, it about telling someone what actually should be done, not merely what would be “not unsuitable” to buy. In fact, the existing securities regulations (Section 202(a)(11)(C)) have already stated that any advice delivered in a product sales context should be “solely incidental” to the sale of the product; if the primary focus of the relationship is about the delivery of advice and/or special compensation is received for advice, the fiduciary standard already applies!

I think it’s better if I just re-print Kitces entire post below – his eloquence on the subject is convincing.

In the ongoing debate for the fiduciary standard, supporters of fiduciary have suggested that everyone in financial services should be subject to the standard, while those opposing have responded that consumers deserve a choice between fiduciary and suitability; in essence, they simply suggest that we should let consumers choose whatever method of financial services they prefer, and may be the best model win. But to me, the choice presented is a false one: the real choice is not between fiduciary advice and suitable advice, the difference is between fiduciary advice and suitable product sales. In other words, the real choice we should present to consumers is between advice and product sales, and the real goal of the planning profession should be to focus on who is and is not qualified to deliver advice.

The inspiration for today’s blog post comes from several recent Twitter debates that I’ve had about the fact that I believe the focus on fiduciary is the wrong message to send to the public. As I’ve noted previously on this blog, consumers already believe that advisors have their best interests at heart, so promoting fiduciary isn’t really about saying “you can trust me” – it’s just about bashing your competition and saying THEY can’t be trusted. And a negative advertising campaign that bashes the competition is a terrible way to advance the profession, and your own financial planning practice.

But the real point here is that fiduciary advice vs suitability advice is a false dichotomy; the only kind of advice is fiduciary advice, delivered in the best interests of the person receiving the advice. Merriam-Webster defines the act of advising as “to give (someone) a recommendation about what should be done” (emphasis mine); in other words, telling the person what should be done that’s in their interests is the very essence of what advice is, in the first place! On the other hand, the suitability standard is about offering a product for sale that is suitable – or at least, not unsuitable – given the client’s circumstances. The latter, simply put, is not a standard for advice; it’s not actually about advice at all, but simply determining whether a product being sold is so unsuitable that it’s unconscionable to allow it to be bought at all. Advice, as Merriam-Webster makes clear, it about telling someone what actually should be done, not merely what would be “not unsuitable” to buy. In fact, the existing securities regulations (Section 202(a)(11)(C)) have already stated that any advice delivered in a product sales context should be “solely incidental” to the sale of the product; if the primary focus of the relationship is about the delivery of advice and/or special compensation is received for advice, the fiduciary standard already applies!

Accordingly, the real debate is not about whether consumers should have a choice between fiduciary or suitability; the real choice is between working with an advisor who delivers advice and working with asalesperson who sells a product. Notably, the latter is not intended in a derogatory or pejorative manner; it is simply to make the distinction between someone who offers bona fide advice – which, by definition, is in the interests of the person receiving the advice to get a recommendation about what should be done – versus someone who offers a product for sale, which is implicitly in the interests of the person or company offering the product for sale but should only be offered when it is not unsuitable to do so.

Why is this distinction of advice versus sales more important than fiduciary versus suitability? Because, cast in the context of advice versus sales, the solutions quickly become more readily apparently. The goal of fiduciary advisors should not be to subject everyone to the fiduciary standard; it should be to subject everyone offering advice to the fiduciary standard. If you don’t want to be treated as a fiduciary, that’s fine; just don’t offer advice, and don’t hold yourself out as offering advice. People who offer securities or insurance products for sale eliminate the words “financial advisor” or “financial consultant” from their business cards, and simply hold themselves out for doing what they do: registered representative, stockbroker, or insurance agent. Those who offer advice hold themselves out as advisors, and subject themselves to the appropriate standard.

In this framework, then, it’s not about whether consumers deserve a choice between fiduciary and suitability standards; it’s a choice about whether they want to buy their products from a salesperson, or receive advice from an advisor. It’s a much clearer choice. Eventually, we might even see a world where a prospective buyer of an insurance policy, after being told about the policy’s benefits and features, asks the question “But is this policy right for me?” to which the insurance agent responds “Oh, I’m sorry, I can’t give you advice on that; you’d have to ask your financial planner.” The agent responds this way because he/she doesn’t want to be held to a fiduciary advice standard if he/she isn’t giving advice. And the consumer receives a genuinely clear distinction about what role the insurance agent does, and does not, serve.

In fact, arguably consumer clarity itself is a major benefit of shifting the dialogue in this manner. While consumers have made it clear they don’t understand the different between a fiduciary and suitability standards very clearly, the difference between “is this person giving me advice, or not” is much clearer. In fact, it highlights the problem, as noted in the RAND study itself: “most investors believe that the financial intermediary is acting in the investor’s best interest [regardless of whether delivered from a broker-dealer or investment adviser].” Perhaps the best target for advocacy is not to expand the fiduciary standard to all, but instead to remove the “solely incidental” exception for advice delivered by registered representatives, and simply make all advice subject to fiduciary.

But the bottom line is this: debating about the fiduciary versus suitability standards is a lost cause. The public doesn’t understand the distinction, in no small part because they simply cannot conceive of anyadvice that isn’t in their best interests, since that contravenes the very definition of advice. The real issue to the consumer is whether they are receiving advice at all, or whether they are simply being pitched a product for sale. By creating a distinction between product sales and advice, consumers can have a clear choice about which they want, and each can be regulated in its own appropriate framework. And if a product salesperson doesn’t want to be held to the standards of advice – client-centric fiduciary, with the necessary competence including education, training, experience, and ethics – that’s fine; just make it crystal clear to the buyer that no advice is being delivered. Just as so many advisors are already quick to emphasize that they are not tax advisors and cannot/do not give tax advice, so too would they make it clear they are not financial planners and cannot/do not give financial advice, unless they truly wish to deliver such advice and be held to the associated standard. (emphasis mine)

So what do you think? Is “advice vs product sales” a better distinction than “fiduciary vs suitability”? Does it make a clearer distinction for the public? How could we shift our advocacy, lobbying, and discussions with the public if we focused the debate on separating advice from product sales, instead of fiduciary from suitability?