Monday, December 07, 2009

The 'Are You Unemployed' Game Show

Justin here. The folks at have done it again. Here's a great video explaining real unemployment. Kinda makes you think that the "great" news last week wasn't all it was cracked up to be.

Thursday, November 26, 2009

Everything I Needed to Know . . .

Justin here. Everything I needed to know about fighting a recession, I learned from Tate Street Coffee House. I took this picture the other day while drinking my regular coffee (w/ half and half, spenda, and a packet of raw sugar); it says it all:

Innovate - See the bar there? TSCH is offering wine and beer now. Not just Keystone Light either, but an organic brew made from hops grown by owners Matt and Anne. Brilliant.

Do it Yourself - See that guy painting the ceiling during business hours? That's Matt, the owner. He does a bit here, a bit there. Never closes down business, never pays painters. And it gives the customers something to talk about and check in on. Two Birds/One Stone.

Know Your Customers - Again with Matt . . . he, Anne, and the other employees seem to know everyone by name and they ask about their interests and genuinely want to know their customers. I've rarely seen it done better.

Tuesday, November 24, 2009

Who Is Paying Taxes?

Justin here. We're getting near year-end and so taxes are on the brain. I ran across this graphic from They do some really great visual explanations (they recently did one on reverse mortgages) but, seeing as though my second language is "Charts and Graphs", they could probably make a diagram about paint drying and I'd be fascinated. Enjoy.

Personal FinanceSoftware –

Wednesday, November 04, 2009

Paul Krugman Thoughts

Justin here. I went with a friend last night to see Paul Krugman speak at the Guilford College Bryan Series. I've got a number of things on my plate today so my review/thoughts will be brief.

Best Quote: "We can no longer make money by selling each other houses that we bought with money we borrowed from the Chinese."

Second Best Quote: In talking about the similarity between the US and Japan he said something to the effect of "With the exception of our raw fish consumption, we're pretty similar. Both democracies, both have hard working intelligent citizens, both have politicians who aren't the best but aren't idiots."

Comment That Provoked a Slight Gasp from the Woman Beside Me: when answering a question about the N.C. furniture industry, Krugman said he couldn't imagine an industry that is so labor intensive lasting so long in a high wage country like the US. And he followed that up with something to the effect of "before you get too worked up about that, remember that it's only here because the high wage North East US forced the jobs south to cheaper labor." As if to say, this is only a pit stop on the way further south.

Cold Sweat Inducing Statistic: 55% of commercial loans that are to reset in 2014 are underwater. And that's considering that they started with an extremely low Loan/Value ratio that would certainly need to go up if they get rolled forward. Makes me think of a number of friends in the commercial real estate business as well and the impacts that has on other industries.

My Question That I Didn't Get To Ask: what do you do with your excess income (i.e. how do you invest)?

Overall message:
  • He talked about how we got into this mess ('shadow banking', poor regulation, leverage),
  • How this was/is a global crisis (Spain, UK, even countries without bubbles felt it because they were connected.)
  • What we did right (cut interest rates, stimulus, flexible fed),
  • How we get out this crisis quickly (no silver bullet that will save us like railroads, world wars, and IT did for recessions past . . . only remote quick fix could be green technology, but even that has a lot of barriers and lag time, and 10% unemployment is a HUGE number will take a lot of GDP growth to get over),
  • How, more likely, to get out of it slowly (possibly unions (which, to my surprise got a round of applause), possible further stimulus, cut interest rates if we could go any lower)
  • Final point was that Keynes said "the shortage of capital through use, decay and obsolescence causes a sufficiently obvious scarcity to increase the marginal efficiency" meaning that our ipods will break, our computers will become slow, and our tires will wear out. Although slow, this process will create demand and innovation.
Politics aside, it was a good talk. It reinforced our slow growth thesis and our propensity to seek quality dividend paying companies as well as opportunities outside the US and in fixed income.

Saturday, October 31, 2009

"If not for Veteran, I have no place to come to"

Some events are so enormous that history’s judgment erects a permanent monument; something that remains long after all the eye witnesses are gone. Last Saturday, I boarded US Airways Flight 9092 to Washington, DC as part of the Triad’s Flight of Honor to take 101 World War II Veterans to see such a monument, their monument: the World War II Memorial.

I was chosen to be one of thirty-six guardians, each of us assigned to accompany three of the Veterans (pictured, myself in red). Before the flight, knowing that seniors prize familiarity, I made an effort to both call and meet my 83, 86, and 91 year-old companions at the ‘pre-flight’ meeting. When the eldest couldn’t make the meeting because he was under the weather, I drove out to his home. I learned how much the last ten years have demanded of him, but I got to hear a lot of happy memories too, and I could see that the more we talked, the better he felt. The only problem, I learned, was that the t-shirt he’d been given for the trip was an XXL but he needed an L at most. Before I could reel back in my words, I told him I’d take care of it.

After finding out there were no more shirts available, I called the seamstress who has repaired my dress shirts over the years. “Could you take a size XXL and make it into a size large?” I asked. “Sure,” she said, in broken English, “You bring large t-shirt too when you come, ok? When you come?”

Ten minutes later, the owner of Alternation Studio, a petite Vietnamese woman and I were comparing a size L to the size XXL. The shirt had the Flight of Honor logo, which she asked about. “Honor Flight,” she said, “what this?” I offered the short answer. “This you wear?” she asked. “No, no, my 91 year-old Veteran friend will wear it when we go to see the World War II Memorial in Washington,” I answered. “Veteran,” she said, her mind working, “I do for him, yes,” and with a bigger smile, said this powerful truth, “If not for Veteran I have no place to come to.”

Two days later, as promised, she produced the transformed size L t-shirt. Knowing how no one likes to wait for something, I delivered the shirt on my way home. At first I had a little trouble explaining how a t-shirt labeled XXL was really a size L, but when he understood that it had been remade just for him, you would have thought he just made a hole-in-one.

Other than t-shirt alterations, the job description of guardian was to accompany the Veterans through airport security, help them board and disembark, sit, walk and talk with them, point out access ramps and restrooms, tote cameras and pill bottles, provide an arm to lean on, circle up chairs under a big tent, and secure our box lunches. But much more importantly, we were there to listen, offer strength, and stand by them as they, the heroes, gazed into the Memorial, reflected on their own thoughts, and opened up the history books of their lives to us on that magnificent day not one of us will ever forget.

I haven’t been able to get that day out of my mind. It was such a privilege and honor to be with those men on such a gift of a day. But I’ve also been thinking about how much my job that day mirrors our job here, as Financial Guardians. We listen and plan, we direct and monitor, we share highs and lows, and offer our support and strength through all the stages of life’s journey.

This year has been a journey indeed, and our job as guardians has never been harder or more needed. Seven short months ago, a media-dominated, worried nation wondered if this time the headlines might be right. Investors whose parents lost everything during the Great Depression told us so. Fear spiraled. Sellers sold, buyers backed away. Stocks skidded, hitting low levels not seen in many years. As advisors, we bore down to figure out what our investments were really worth and what was really driving the market. The answer: bad news begat fear begat selling begat more fear and so on. We remembered John Templeton saying, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” We clung to that, hung on to our positions, owning more stocks than we normally would, while strategically moving up the quality chain and diversifying away some risk. We waited for rationality to return, figuring it could be many quarters or years away.

Then out of nowhere, here we are today (written 10/6/2009): the S&P500 is up nearly 20% for the year (and up nearly 60% off the March lows), corporate bonds are up nearly 15% and 10 year treasuries are down 6% year to date. Again, we have to ask where we are, how we’ve gotten here, and most importantly what it means to be a guardian. Our short answer: the market has gone far past “fair value,” mostly on the backs of low-quality stocks, and caution is the order of the day.

A Low-Quality, Speculative Rally. Like a tightly coiled spring, the assets that were most depressed in 2008 and early 2009 let loose when the world did not, in fact, come to an end. Any way you slice it, this six-month rally has been driven by the lowest-quality assets (in both stocks and bonds). Small stocks have outperformed large stocks, Newspapers and Financials have outperformed Regulated Utilities, and, most telling, No Moat stocks have outperformed Wide Moat stocks (for more about moats, see our Q1 2009 commentary “What’s Really Important: Price, Moat and Uncertainty).

Instability in the Background. Throughout this rally, we’ve seen large improvements in the real economy, but we’re nowhere close to out of the woods. After shooting up to record levels, the personal savings rate has slowly drifted from 5% in June, to 4% in July, 3% in August and although September data is not yet available (written October 6, 2009), our best guess is that the trend continues. Unemployment has crept up to 9.8% (and even that number doesn’t capture the underemployed and discouraged who are no longer looking for work.) The government has promised a $1 trillion per year deficit for the next ten years. Housing and Consumer sales have been temporarily bolstered by government programs that are all but over.

Caution is the Order of the Day. The need for caution doesn’t just come from the gloomy statistics mentioned above, but it also seems that caution could provide very satisfactory absolute (not just in raw numbers, we see the market as a whole selling for approximately what it’s worth (102% of fair value, see above.) However, the businesses with Wide Moats are selling for 88% of fair value (a 12% discount!) in contrast to the No Moat businesses that are currently overvalued (109% of fair value). Using the same yardstick, the US stocks in our separately managed portfolios are selling for 74% of fair value, with a 3.4% dividend yield on top of that. We structure these investments along with foreign stocks, domestic and foreign bonds, commodities, and real estate to provide our clients with a diversified portfolio that delivers a large portion of its expected return in the form of interest and dividends (which can then be used for income needs or reinvested in the market.)

I have a good friend who could probably sleep through a jackhammer pounding in the next room, but if he heard a set of keys rattle in the middle of the night, he’d shoot straight out of bed. Why? He was a prisoner of war for a long, long time. Although he learned quite a lot during those solitary years, he never quite learned to like the sound of a jailer’s keys. As guardians, we’re constantly learning to ignore the sound of the jackhammer, however loud it gets, and listen for the keys that the average investor might miss. Seven short months ago that jackhammer was unmistakable: “sell now, get out, run for cover.” We mostly ignored the rumble of the pavement and thankfully went about our business. Today, the jackhammer is a little more subtle (mostly from uncertainty), encouraging the investor to “seek the highest risk, make up lost ground” without regard for what the investor can stomach financially or emotionally.

We recently met with a client who, while happy with her portfolio going back up, wondered if she’d ever get back to the high water mark. That’s the sound of the jackhammer. We reminded her that we were accomplishing her goals now: producing a dependable income stream that meets her needs, on the backs of high quality, diversified investments that still have plenty of potential to appreciate. Now, that’s the sound of the keys jiggling that many investors miss. She quickly recognized the difference and wanted to pursue meeting her real-life goals, rather than just a number.

And even though we’ve been financial guardians for nearly three decades, we never know what Mr. Market’s next move will be; that’s a fool’s errand anyway. But, we do know that businesses that tend to produce high returns on capital will increase in intrinsic value over time and that those companies will tend to outperform the market. We know that owning investments across a number of different asset classes smoothes out the volatility of returns. We know that we sleep better when a large portion of our expected return is being paid in the form of interest and dividends. And we know that we’ve never felt better positioned for a quickly changing and uncertain world.

Friday, October 16, 2009

Risk Appetite Hits Highest Level in Over Three Years

Warren Buffett said “Occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics is equally unpredictable, both as to duration and degree. Therefore we never try to anticipate the arrival or departure of either. We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”

Seems like the speedometer is going fro "Zero to Greedy" in 7 months.

Risk Appetite Hits Highest Level in Over Three Years

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Wednesday, September 02, 2009

Surprise Call From a Congressman

Justin here. Congressman Howard Coble has been in US House about as long as I've been out of preschool. He's on our quarterly mailing list and knows Jonathan fairly well (I don't think it's just because he requests a new flag every couple of years, but maybe.)

You can imagine my surprise today when he called asking for me. It went roughly like this:

Congressman Coble: "Well son, I got your press release with your recent commentary and was just calling to congratulate you on the CFA."

"Well, thank you sir."

Congressman Coble:
"Now that was pretty hard wasn't it? How long did it take?"

"About 3 years and a thousand hours."

Congressman Coble:
"Yes, I don't imagine they're just handing those CFA's out in the restroom stalls, now are they?"

"No sir, not in any of the restrooms I've been in."
What a surprise joy. Something happens in a phone call, letter, or meeting that just can't happen over facebook, twitter, LinkedIn, or even email. I'll try to remember that.

Tuesday, August 25, 2009

What's important Part II - Dividends, Diversification, and Safety

Jonathan here: One of the two best best ideas we've ever had is having an enduring investment process. The other is focusing more energy and resources on process than on outcome. In What’s Important Part II, we explore three ordinary but frequently underestimated components of an enduring investment process.  

Our part of the world gets, on average, 43 inches of rainfall each year. That’s too much to worry about the price of rain barrels going up, but not enough that your average gardener can really trust Mother Nature for all watering needs. It seems the popular and cost-effective solution of choice is Drip Irrigation. My introduction to it was nine years ago, in Sacramento, California. My son-in-law hooked up miniature hoses and nozzles, which sputtered, stuttered, and sprayed a fine water mist for three whole minutes twice a day, onto ferns, banana trees, morning glory, oleander, hibiscus, and bird of paradise. His “backyard” was literally a beautiful pool and a cement pool deck with huge terra cotta pots containing mammoth plants. I was astonished that the plants flourished in these conditions. Seriously convinced, once home I visited Lowes in search of all things drip irrigation. I threaded rubber hose no thicker than a pencil through a maze of rhododendron, yew, azaleas, hydrangeas, moon vines, morning glories, black eyed Susan, cardinal vines and impatiens. I attached, at various intervals, micro sprinklers and nozzles, balanced the water output with Y-splitters, and screwed into the nerve center of this hydroponic contraption, one battery operated Gilmour automatic water timer.

But not every gardener has it so easy (so to speak). Parts of California, Nevada and New Mexico, for instance, get between 8 and 16 inches of water per year. There’s a saying that farming is just gambling in slow motion – you have to wait nine months to find out if you’ve won. Recently, Morning Edition featured Zach Sheely, a farmer who can’t afford to place a bet on (or wait nine months to find out) whether he waters too much or too little. Sheely uses a system designed by PureSense (pictured right) to help him rebalance the moisture levels on his 10,000 acre, California vegetable farm. “Using probes, sensors, weather instruments and meters, PureSense calculates the moisture and nutrients in the soil; it uses the Internet to send the information to servers, and then uses software to analyze whether or not the crops are getting the right amount of water.” The data is then transmitted wirelessly to Sheely’s iPhone; he can literally make it rain on any section of his crops with the tap of a button.

The principles governing agriculture and investing are much the same. Plant the best seeds at the right time in good soil, then water, fertilize, weed, thin out, protect against threats, harvest, enjoy, repeat as often as necessary. Too much or too little of any of these activities can create undue risk. But, hit the right balance and you stack the odds of reaping a harvest in your favor. In our last commentary, we outlined six “prism tweaks” we’ve put in motion. We discussed, in detail, the importance of Price, Moat, and Uncertainty; this quarter, we’ll cover Dividends, Diversification, and Safety.

Dividends. Sometimes it helps us to think about investing in terms of being a gardener who sells vegetables, whole vegetable plants, and potted flowers at the local farmers’ market. On any given Saturday, she can decide to sell her hand picked vegetables (which, in investing, is similar to collecting dividends), or she can sell a whole plant (selling a dividend paying stock), or she can also sell her potted flowers (selling a non-dividend paying stock). The problem the gardener faces with buying and selling too many potted flowers (buying non-dividend paying stocks) is that the only way to make a profit is if her buyers think the flowers are worth more than she paid for them. That’s all well and good if her time horizon is long enough or the market for plants is stable. But what if (like many investors today) her time horizon is shorter and the market for plant buyers isn’t especially stable? Or what if the price of soil skyrockets or news reports circulate that recreational gardening is a health risk? People won’t want to plant in their gardens and prices of these plants will drop. If our gardener is depending on selling her plants (vegetable or flowering) for her income, she would have to sell them at an inopportune time. As advisors, we aim to set up our clients’ gardens (portfolios) in such a way that their vegetables (dividends) provide for the majority of their income needs and they aren’t dependent on the price of their plants (stocks) on the day they need income. There’s much more to dividends than finding the highest yield (for example, determining a company’s ability to keep paying it, management’s commitment to upholding it, and what we can expect in terms of its growth) but that’s for another commentary.

Diversification. Suppose our gardener needs to choose between planting squash, cucumbers, or both. She figures each will produce approximately the same amount of income for her and will need the same amount of sunlight, water, and care. The only difference: squash are susceptible to squash bugs while cucumbers are vulnerable to cucumber beetles. With an equal chance of either insect showing up hungry and harming a crop; it makes sense to plant both squash and cucumbers while still trying to ward off both insects. This is the case not only for stock diversification (owning more than just a handful of stocks), but even more so for asset class diversification (owning more than just a couple asset classes such as US Stocks, Bonds, Foreign Stocks, Commodities or Real Estate.) While it does get more complex meshing multiple asset classes, the outcome is still the same. An investor can take a number of inherently risky assets and combine them in a portfolio that delivers the highest expected return for a given level of volatility (determined by what the investor can stomach both financially and emotionally.)

Safety. Sometimes, what could seem safe (taking shelter in a storm under a tree or taking money out of stocks last March) can actually be the most dangerous option possible (both “lightning” and “missing a 30% rally” can really knock the wind out of someone). As portfolio managers, we want to make sure we’re always learning from our mistakes . . . but just not learning too much. We’re conscious to look at the important data points, not the prevailing perception that might say seeking sustainable dividends, wide moats, and low uncertainty is being too “safe” to provide any meaningful returns. We might normally agree, however today is far from normal. We’re in a market where companies with the widest moats are selling for the largest discounts (78% of their worth) while the companies without moats, see chart, are trading for no discount (100% of their value).

Author Annie Dillard says “Danger is the safest thing in the world if you go about it right.” While investing is and will continue to be “dangerous” in terms of uncertainty and volatility, we’re confident that we’re “going about it right.” As we said last quarter, we’re doing that by: concentrating on buying undervalued assets (Price), owning businesses with sustainable competitive advantages (Moat), and investing in areas where we have a narrower range of outcomes (Uncertainty). By adding to those the areas we’ve covered this quarter, we’re able to take calculated risks that line up with our clients’ ability and willingness to take those risks.

Monday, August 17, 2009

Justin W. Smith, CFA, Earns Prestigious Chartered Financial Analyst Designation

Greensboro, NC, August 14, 2009 − Justin W. Smith, CFA, a Financial Advisor at Jonathan Smith & Co., Investment Counsel in Greensboro, NC has earned the prestigious Chartered Financial Analyst® (CFA®) designation.

The CFA charter is a globally recognized credential for investment analysis and management. The CFA Program sets a globally recognized standard for measuring the competence and integrity of financial analysts, portfolio managers, and investment advisers. Currently, more than 82,800 investment professionals in 128 countries and territories hold the CFA charter.

Recipients of the CFA charter have successfully completed a graduate-level, self-study curriculum and series of three intensive examinations taken sequentially over at least two years. It is recommended that candidates prepare a minimum of 250 hours per exam, with substantially more recommended for individual circumstances.

Since the inception of the CFA Program 45 years ago, pass rates at each of the three exam levels have averaged about 50 percent. Because of the rigor of the program, only about one in five candidates who enter the program pass all three exams and successfully complete all the requirements to earn the charter.

Administered exclusively in English, the international language of business, the three six-hour exams cover ethical and professional standards, securities analysis and valuation, financial statement analysis, quantitative methods, economics, corporate finance, portfolio management, and performance measurement.

“This isn’t about adding three letters to the end of my name,” Smith pointed out. “At a time in the market where there is so much uncertainty, I’m happy to be able to do something that not only makes me a better advisor, but also gives our clients some added confidence in who they are trusting to get them safely home.”

“Five months ago, you could have picked a portfolio by throwing darts at the Wall Street Journal and had a great return,” Smith said. “But today, we think we’re looking at just the opposite. That’s an almost inconceivable shift in such a short amount of time. The CFA program has given me the knowledge, insight, and persistence to tackle this ever-changing investment landscape.”

And if his day job weren’t enough, he’s got a full load on his hands at home. “I’ve got a 115 year-old house, one toddler and another due soon, and a honey-do list that, due to the CFA exams, has been three years in the making,” Smith noted. “All that CFA work is going to seem like a breeze compared with what I have in store for me at home.”

Robert R. Johnson, Ph.D., CFA, deputy CEO, explained what motivates candidates to make such a significant investment of their time and energy to seek to earn the CFA designation.

“For more than 40 years, candidates have sought to earn the CFA charter for two chief reasons,” Johnson said, “one, to expand and test their knowledge of current practice across a broad range of investment topics, and two, to demonstrate to clients, employers, and peers their mastery of a demanding body of knowledge."

CFA Institute
CFA Institute is the global association for investment professionals. It administers the CFA and CIPM curriculum and exam programs worldwide; publishes research; conducts professional development programs; and sets voluntary, ethics-based professional and performance-reporting standards for the investment industry. CFA Institute has more than 96,000 members, who include the world’s 82,800 CFA charterholders, in 133 countries and territories, as well as 136 affiliated professional societies in 57 countries and territories. More information may be found at

Jonathan Smith & Co., Investment Counsel
Jonathan Smith & Co. is a Registered Investment Advisor providing investment counsel and financial planning for individuals, trusts, estates, corporations, investment trusts, employee benefit trusts, and institutions. Aware that each engagement’s wealth management needs are unique and often complex, they craft individualized solutions and simplify life's financial aspects for their clients. Their mission is to build, protect and manage each client's wealth through every stage of life. More information may be found at

Monday, August 03, 2009

I Probably Won't Be Dessert . . .

Justin here. Professor Jeremy Seigel recently pointed out the difference between the fear of unemployment vs the reality of unemployment here:

"The June unemployment rate touched 9.5%, and it is quite possible that that rate will eventually exceed the 10.8% rate reached in November 1982. But even if it does, unemployment will rise, at most, 2 percentage points, far less than the reported 30% to 40% of workers who fear they will be laid off. And as the economy mends, the fear of being unemployed will subside, and consumption will rise."

Professor Seigel has forgotten more than I'll ever know about economics, but I have to (very respectfully) disagree. I think it’s unrealistic to think that Joe Consumer could have 10-20% more friends, family, and co-workers lose their jobs and then somehow he'll then breathe a sign of relief and start spending because some economists think that unemployment is already far above normal. I think Joe is going to pretty scared for a pretty good while.

It’s like being in a pit of lions that, on average, will eat no more than one human in a sitting. I don’t know about you, but if I’m stuck in there and two of my buddies were just eaten (mind you that's 100% above the average), mean reversion and bell curves won’t make me any less likely to need a clean pair of underwear.

Wednesday, July 15, 2009

What’s Really Important: Price, Moat, and Uncertainty

Jonathan here.  Been a busy quarter migrating to our new investment platform.  Been meaning to post our 1st quarter Market Commentary since April when we wrote it.  2nd quarter Market Commentary in the queue. 

I have a pair of Skyline 16x50 binoculars that belonged to my father-in-law, Conley. They feel great hanging around my neck or in my hands (certainly due more to my fond memories of their former owner than the superior design of their manufacturer.) Even though they are decades old, the magnification and width of field are superb. There’s just this one tiny problem: they create just enough double vision that you have to close one eye when you look through them. I still remember having to use them as a monocular so I could see Sam Snead lay up close to the pin on the 18th green at Sedgefield Country Club when Conley and I went to the Greater Greensboro Open years ago.

A while back I tried fixing my binoculars’ cockeyed view. Perhaps an objective lens or eye piece was cross threaded. Nope, they were screwed in fine. Asking myself “What’s the worst that could happen?” I took them all the way apart. Four tiny screws later, cover plates removed, I saw the problem: there were four prisms, seemingly held tight with little set screws, until one prism jiggled loose. Just one misaligned prism resulted in the distorted view.

I was reminded of my binoculars after an attorney friend of mine told me about a presentation he’s been giving to area banks. He’s committed to helping them work through this financial crisis and see the future of banking. When he talks, he holds a prism up high. He tells the bankers, “If you look straight ahead, where you’re accustomed to looking, you won’t see what’s straight ahead. If you want to accurately see what’s ahead, you need to turn the prism.”

Many of the troubles we’re experiencing in our economy are due to our nation’s tendency to look straight ahead and miss it. For example, we saw that Lehman Brothers was leveraged 25 to 1 while many investors and talking heads didn’t blink an eye because that’s how investment banks have always operated. And for years consumers shunned saving, but rather lived on their home equity and credit cards because their home values always went up and cheap credit was always available. And in the last year, we saw that a bank could combine a few BBB issues into a new CDO and the rating agencies would suddenly call it AAA because it was now a new security that was “relatively” safe. On the surface, these examples might look like instances of hindsight being 20/20, but they are really instances of past foresight being more like 20/180.

I wish we could say that, as advisors, our vision has always been stellar, but we can also be guilty of “looking straight ahead and missing it.” What is more important, though, is that we’re willing to open up the binoculars, adjust the appropriate screws, and go on viewing the golf match. We think the only thing worse that looking through a broken pair of binoculars would be to think either: a) we’ll get lucky and the golf ball might just roll into view or b) the binoculars are going to fix themselves.

So, what prism tweaks have we set into motion? They can be summed up in six areas: Price, Moat, Uncertainty, Dividends, Diversification and Safety. We’ll give some details of the first three in this commentary and the next three in the following commentary. If you can’t wait until next quarter to read about them, let us know and we’ll send you our thoughts ahead of time, or we can sit down and talk about them face to face.

Price. For years, price was our (and many other value investors’) end-all, be-all. We’ve been intent on buying “dollar bills for 50 cents.” The focus in this approach is more heavily on the stock and less so on the business. The problem is that this approach alone can lead to casualties if the investment’s time horizon and risk tolerance isn’t aligned with the investor’s time horizon and risk tolerance. We are still like a budget conscious grocery shopper: we know that it makes sense to buy cheap produce that has a few bruises on it, but we’re also conscious of some other factors that should get equal weight.

Moat. Moving up our chain of importance is a focus on a business’ economic moat. Warren Buffet said that a moat protects a “valuable and much sought after business castle.” Moats can come in many forms such as a well-known brand name, superior pricing power, or a large portion of market demand. While they come in many forms, all moats contribute to a common result: a company that is more likely to be in control of its own destiny. We recognize that there is plenty of money to be made in businesses without moats (many of us have built our livelihoods working for “no moat” companies). However, in this environment where the rules seem to change daily and confidence is here one day and gone the next, we believe it is wise to limit the number of factors that are outside of a business’ control.

Uncertainty. Another area garnering more weight in our process, is our level of uncertainty regarding the potential value of an investment. When I took up softball in my early forties, having never played baseball as a kid, my batting philosophy was this: close your eyes and swing, repeat if necessary. In investing, we have more control over the certainty of outcomes than I did in the batter’s box. Before we invest, we can choose to swing for either “homeruns and strike outs” or “singles and doubles”. Granted, sometimes swinging for singles and doubles will end up in a homerun and sometimes it will end up in a strikeout, but most of the time it’ll turn out just as intended: singles and doubles. Since our primary job is to help our clients sleep well at night, we are inclined to invest where we have a lower degree of uncertainty about the potential outcomes.

The most frequent question we’ve fielded after talking about any tweaks to our investment strategy is “isn’t this like shutting the barn door after the horse is already out?” It’s a great question; one we’ve thought through extensively. Our best answer is this: if someone would ring a bell today and announce with 100% certainty that the stock market can’t go any lower and we’ll have full recovery within months, then we would invest differently. The reality is that we haven’t heard any such bells announcing anything of the sort and, frankly, we could still see more unnerving news on the horizon.

We still think today is a great time to own U.S. equities, particularly companies with the qualities mentioned above (historically low prices, sizeable moats, and low uncertainty.) The potential returns we could see over the next ten years could be at levels not seen in generations. The problem is that we don’t all have ten year time horizons, and even if we do, the volatility is hard to stomach. This brings us back to the other three “prism tweaks” we’ve already put in place and we’ll cover next quarter: Dividends, Diversification, and Safety. These three allow us to (respectively): get paid to wait, smooth out the bumpy ride, and seek superior risk-adjusted returns. Again, our primary job is to help our clients sleep well at night and now, more than ever, that means investing for the upside and protecting against the downside.

Monday, March 30, 2009

Two Wrongs Don't Make a Right - Pension Insurance

Pension insurer shifted to stocks - The Boston Globe
Posted using ShareThis

The article above gives me a pit in my stomach on a number of levels, but one in particular. I think most people would get sick thinking of the money already "lost" . . . I get sick thinking about the money that might not be gained.

I'd like to think that the Pension Benefit Guarantee Corp would operate under some pretty standard advice: if you need money in the next 5 years, maybe you shouldn't have it in stocks. I do think they need to be proactive and estimate if they'll have an onslaught of pensions to back and see if that changes their time horizon, but they also need to be able to face reality. With valuations where they are, it might very well make sense to "stay put" and not have Congress reallocate your portfolio.

As we say here: "Two wrongs don't make a right." From this observer's point of view, it seems like shift back to the old strategy right now might be wrong #2.

Note: The author recognizes that he does not possess the right mix of qualifications, connections, and unconfessed past sins that is required to work for the PBGC, the Government Accountability Office, or the Congressional Budget Office. Therefore, his opinions are merely that and should not be applied to your investment strategy or the government's investment strategy for that matter and frankly he's surprised you're reading this fine print.

Wednesday, March 18, 2009

Feeling Like the Dryer Ate My Socks AND My Stocks

[UPDATED: I originally posted the entire article from investopedia here, but after brushing up on my copyright rules and regs (thanks to a couple colleagues) I've removed the article and just linked to it. Oops. Better safe than sorry.]

Justin here. I ran across a great article on
(you can find the original here) that talks about where all our stock value "went".

The take-home is this: when so much of a company's stock price is determined by perception, there is real value and security in investing in companies that will pay you a dividend. People can argue all day long whether a stock is worth $5 or $50, but it is impossible to argue about the real value of the dividends that just landed in your account.

Once you start focusing on dividends, the main question becomes: "is this company (stock) able and inclined to pay a stable, meaningful, and growing dividend?"

We think that's a whole lot more productive and easier to determine than the non-dividend approach where the sole question is: "is this company going to be worth substantially more on the day I need to sell it?"

Monday, February 23, 2009

I lost the toss

Jonathan here. My February 3 post, Will the Dow Set a New low in 2009, is the most stupid post I've ever written. Not because my thesis was wrong (it was), but in our line of work, focusing on process over outcome is what it's all about, and in the clarity of hindsight, I was focusing on outcome not process. So now that I've had my whipping, eaten crow, and been avoided at the water cooler by my colleagues, I wanted to share just a bit about what we know and think about market sentiment, or more precisely, investor sentiment. Sage investors know investors become buyers when the consensus gets cheerful. Warren Buffett said "you pay a high price for a cheerful consensus." Ben Graham, Buffett's mentor and teacher, urged his apprentice to "buy when there's blood in the streets", or words to that effect.

Clearly, anybody who's followed that kind of advice has had his head handed to him on a platter. For going on a year now, it seems like the crowd has been right and buyers or holders of stocks have gotten it all wrong. "Will this persist?" (like it looks like it will) is the wrong question to be asking. "How long will it last?" is, I believe, the right question.

We've heard that history repeats itself. With all the focus on what's happening now in the stock market, it seems that investors have, once again, pretty much discounted what's happened long, long ago. But that's not unusual; we're all prone to a bout with Outcome Bias every now and again. "It's different this time," we hear, ad nauseam. Yes, events are different this time. But human nature hasn't changed one whit in the last 1,000 years, and I seriously doubt it will before 2009 rolls to a close.

To that end, we've poured a lot of time into studying bullish and bearish sentiment and investor pain. Believing that investors really are predictably irrational, we want to learn what happened when investors sold stocks when everything was dismal and when they bought stocks when everything was rosy. I'm far from ready to offer any conclusions, but I'm happy to share our initial findings here.

If these charts pique your interest, your comments are welcome. Similarly, if you drop us a line, we'd be happy to chat.

If these charts pique your interest, your comments are welcome.  Similarly, if you drop us a line, we'd be happy to chat.

Tuesday, February 03, 2009

Will the Dow set a new low in 2009?

Call me old fashioned, but I think there are safer and surer ways to get paid while waiting than to own a contract, valued at approximately 79 cents on 2/3/2009, betting that the Dow will set a low that is lower than 7,449.38 sometime between now and year end. 

With stocks at multi-year lows and investor pain at multi-year highs, I'm pretty sure that going long the Intrade contract is not a bet I'd want to take...but that's what makes a market.  If I understand the value proposition correctly, the buyer who's willing to pay ~ 80 cents to own this contract, now believes that there's an 80% chance that he'll see lower lows than 7,449.38 sometime this year.  Conversely the seller who's willing to sell this contract for ~ 80 cents now believes that there's a 20% chance that he'll see lower lows than 7,449.39 this year.  See Disclosure and more beneath chart.  

Price for Dow to Trade at New Low in 2009 at

[Disclosure - Jonathan Smith doesn't own this, or any, contract on Intrade (or any other prediction market) and isn' making any recommendations, bets, conjectures, whatsoever. For the record, his dowsing stick isn't any better than anybody else's. is a prediction market, and much ado has been made by the media about prediction markets. In case you're wondering what sort of payoff the buyer of the aforesaid contract gets for his ~ 80 cent investment if he wins. The answer is $1.00. On the other side of the transaction, the seller who sold the contract got ~ 80 cents for being willing to pay a buck if he loses. After he subtracts the ~ 80 cents he gets to keep from the buck he might have to pay out, he'll be out ~ 20 cents, and so you could say he thinks there's a 20% chance the Dow will go south of 7,449.38 in '09.]

By the way, this chart used with permission by

Thursday, January 22, 2009

"The Worst Quarter Since 1931" - Q4 2008 Commentary

The tremors that began over a year and a half ago in the mortgage market came to fruition in the stock and bond markets this past fall. The fourth quarter of 2008 was the worst quarter for the stock market in the 308 calendar quarters since 1931. Diversification, that friend of investors through thick or thin, did little to avert the damage. Even uncorrelated investments moved lockstep in one direction: down.

During the quarter, panicked investors fled any investment perceived to have risk. Prices of stocks and corporate bonds, under more pressure from sellers than from buyers, dropped to valuation levels not seen in decades. By November, under the weight of perpetual political campaigns, shorter days, and longer lists of bailouts, investor panic heightened. An index that tracks stock price volatility reached a new high last quarter, a level not seen since October 1987. Even money market funds were perceived as risky.

And then, at 8:30 am on December 11th, two weeks before Christmas, the world was stunned by the news of the arrest of Bernard L. Madoff on charges of running the largest investor fraud ever committed by a single individual. “The Madoff affair,” wrote Thomas L. Friedman, “is the cherry on top of a national breakdown in financial propriety, regulations and common sense.”

So if you’re looking for the recipe for that pit in the stomach of the average investor, it goes something like this: add once in a lifetime stock and bond market losses, throw in an investor scam of mammoth proportions, mix it with unprecedented government intervention, add a dash of a bleak economic outlook and a pinch of bank failures, top it all off with a depressed housing market and serve it up on CNBC. That’s more than enough to make us sick, and we haven’t even discussed foreign markets yet!

Given all that has transpired we keep going back to the basics, our research, and our calculators. At the forefront of our research we remember that in the best and worst of economic times emotions, not fundamentals, determine stock market prices. In contrast, during ordinary times, the underlying business values determine stock market prices.

What’s an investor to do? Follow his heart? By no means! Regular readers of this commentary know that we often write about our admiration for Warren Buffett. His investment approach has proven successful in good markets and in bad. He recently made headlines for writing an essay in the New York Times encouraging investors to “Buy American.” He said:

“The financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary. So ... I’ve been buying American stocks.”
Buffett is no cheerleader. A dispassionate investor whose primary job is allocating capital, Buffett has made serious comments about the market only four times in his career. The chart below demonstrates both his ability and his patience.

We agree with Buffett. We have seen businesses selling for less than the cash in the company – yet there are few buyers because buyers are fearful. When Wachovia Bank, an institution that did not close during the great depression, teeters on the brink of collapse and virtually eliminates their cash dividend, it’s hard to know whom or what to trust.

World governments have taken steps to improve liquidity and credit markets are beginning to function rationally. There is evidence the crisis is beginning to subside but the financial system is still fragile and the economic news is likely to be pretty grim for the next few quarters.

The question we have to answer is this: do we have the time horizon and patience necessary to hold a company’s stock until that company’s value is realized? When stock prices move up or down 25% in one day or even several days, it’s quite apparent that underlying business values aren’t driving those price changes; confused people are driving those price changes. At some point, panic will subside and investors will begin (again) to pay attention to asset values, and when they do, share prices will adjust. So far in 2009 we’ve already seen a number of stocks that have risen over 75% in just the first three trading days. This is a sign that panic is subsiding.

Going forward, we’re keeping in front of us the words of Nick Murray:

“Less than 5% of an investor’s lifetime total return will come from what his investments did versus other, similar investments. The other 95% will come from how the investor behaved, and the primary determinant of that behavior will be the quality of advice he got, or didn't get.”
We take seriously our responsibility to our clients and our responsibility for how we behave in the midst of a period of tumult. All of our research, experience, and instinct tell us that today is a day to be invested and not sitting on the sidelines. As Mr. Buffett said in the same op-ed piece, “A simple rule dictates my buying, be fearful when others are greedy, and be greedy when others are fearful.”

To read more commentaries and learn more about Jonathan Smith & Co., visit

Monday, January 12, 2009

Sign of the times

Jonathan here. This week the recession hit home. It’s official. We know this because the copper lights on our company sign were wrenched off their mounting posts this weekend. I guess when the price for recycled copper cratered from over $4 in June to just a little over a buck now, the copper poachers figured it’s not worth straining too hard for salvage copper when there’s plenty of low hanging fruit easy reach.

Another sign of the times, more reliable than my copper sign light index caught my eye.

The email invited me to check out's year-end book deals. “Save big on the books you love,” the teaser read. So I did.

I remember years ago checking out Amazon’s book deals. Once, I recall, Amazon was peddling John Bogle’s book, “Bogle on Investing," for something like 70% off.

Bogle the value investor had then just published a book about his first 50 years in the business (Bogle, you may know, was founder and CEO of the Vanguard family of mutual funds, and was, is, and forever will be impervious to any urge whatsoever to time the stock market.) With dot-com stocks then flying high, I guess Amazon figured who in their right mind would want to read a book about value investing of all things, which is probably why the cut the price and this little gem of a book wound up the bargain table.

In thirty-two years in the investment business I've never heard anyone ring a bell when we've reached the “top” or the “bottom” of a market cycle. What I was about to see made me wonder if Bogle’s “value investing” book (on sale for 30% of “fair value”) was as good as any “bell” I would ever hear. After all, that little priced book just happened to coincide with what history would recognize as the peak of the dot-com bubble.

“Save big on the books you love,” read the recent flyer. Drawn by the sidebar featuring bargain books in the very category I was sure to like (cooking), I bit.  And there it was, just like (well, almost like) the one my mother in law gave us 37 ½ years ago: a Rival Crock pot and a copy of Rival Crock Pot: 3 books in 1, the most popular selling book in the bargain book cooking category, the 3rd most popular selling book in the cooking appliances category, and the 500th most popular selling book in the whole universe.

If Bogle’s book on the bargain counter signaled the bursting of the dot-com bubble, could the reawakening of stocks be too far behind the Rival Recession Index?
I was over at my favorite Sears store this weekend in the tool department in pursuit of a 21/64ths black oxide drill bit to finish drilling a light sign I made for Anne. Whenever I can't find what I’m looking for, an affable and able salesman named Jim is available to help me. Jim, I am sure, knows everything there is to know about tools and a thing or two besides. It's obvious he likes helping people, 3) works because, in his own words, “I’d go crazy if he had to sit around all day doing nothing,” 4) knows a heck of a lot about stocks and stock market valuations. He should. He’s 80!

If I’m lucky and Jim’s not too busy, I can usually pull a nugget or two of wisdom out of him, wisdom beyond that of the tool realm. And so I slipped my crock-pot theory on him, recounting how back in 2000, had slashed the price of John Bogle’s value investing book because, after all, nobody wanted it and now, Rival’s Crock Pot, paired with a three in one blockbuster book, was setting the slow-cooking woods on fire.  “Jim,” I said, “How's the old the crock pot selling these days?” He cocked his head and looked at me as if I had read his mind. “Son,” he said, “we sold so many Crock Pots this Christmas we just about quit putting them up on the shelves and let the customers go outside and pick ‘em up off the truck.” He added that for a little while, he was pretty sure no one Sear’s customer was going to get a chance to get near a crock pot, on account of all of Sear’s employees snapping them up before they were released to the public.