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Market Update: July 2014

July 18, 2014

David Matias

If you’ve seen the news over the past two weeks, you’ll have noticed there is much joy in the U.S. financial picture. The Dow has reached an all-time high of 17,000, unemployment dropped again in June to 6.1% after 280,000 new jobs were created, and fear levels, as measured by the various “fear indices,” are at lows that have not been seen more than once a decade. Stocks are up another 8% for this year, on top of last year’s meteoric rise, and bonds, which were assumed to be poised for a significant decline, are, in fact, up this year by 4%. There is no shortage of good news when it comes to investing.

The risks and realities, however, are very different. The U.S. economy actually contracted, for the first part of this year; long-term unemployment is still at levels never seen in the modern U.S. economy; and the level of global conflict has risen to a level not seen since the 1970s. Globally, sustained growth is still in doubt: Europe has still failed to extract itself from a recession and risks deflation, Asia is looking for that “soft landing” of slowing the asset bubbles without cratering the economy, and wealth inequality is beyond comprehension.

We are in fact, looking at a tale of two minds. One mind believes in the ability of stocks to rise in any situation; the other mind is on constant alert for the next set of bad news that could impact the global balance.

If we stick to home, and take a closer look at the U.S. economy, we can get a better picture of how the goods news we are used to seeing in asset prices is still ahead of the good news we need about overall economic recovery.


All major asset classes have shown similar growth in 2014 thus far, indicating a “risk-on” market mentality as investors seek returns through greater risk taking.  While not matching last year’s performance in equities, the consistency of returns in unique.

All major asset classes have shown similar growth in 2014 thus far, indicating a “risk-on” market mentality as investors seek returns through greater risk taking. While not matching last year’s performance in equities, the consistency of returns in unique.


Markets – Equities

On the bright side, markets continue their rise after a rocky start to the year. Last year’s meteoric upswing in equities was quickly met with a harsh pause in January, as stock prices closed out that month down 6%. What could have been a further rout of markets was, it appears, a retesting of market levels and a chance for some to take risk off the table. With the market more than doubling since the lows of 2009, it is not unusual for an entire group of investors to take a breather and turn those gains into cash thereby protecting themselves again sudden declines.

By the end of Q1, the markets regained their equilibrium, and demonstrated a slight gain for the year. That gain of just a few percent was tenuous for the next few weeks until May and June, when equities reached new highs and are now posting 8% gains for the S&P 500.

Interestingly, in this rally, the gains have been in the larger valuation companies, not growth firms. Specifically, large and mid-cap value companies have gained 8% and 11% respectively, while small-caps are doing only a fraction of that at 2-4%. This difference reflects an interesting change from the dot-com rally of the 1990s – investors are looking for some substantiation of the company’s stock price, not just a whiff of promise that the firm might make enormous profits later. Although this is not a strict trend, it points to some sanity in the current rally.

Markets – Fixed Income

As opposed to stocks, whose rise was almost universally projected at the beginning of the year – albeit to varying degrees – bonds were supposed to fall. I did not read a single prediction that bonds would rise in 2014; naysayers pointed to the Fed’s reduction in quantitative easing and rising interest rates. Instead, rates have stayed level or gone down, with bonds up across the board.

While the average bond market return of 4% YTD (8% annualized) is impressive in any environment, the composition is even more interesting. High-yield bonds (non-investment grade corporates), have some of the lowest spreads to treasuries in recent history, posting a 5.5% gain for the year, while thirty-year U.S. treasuries posted a 14% gain this year. The compression of spreads on high-yield is an indicator of the continued economic recovery, amid predictions that corporate defaults will be extremely low. These phenomena are consistent with the complacency we have seen in the equity markets. The explanation I’ve heard on the treasuries is a little more complicated, but in short, there are simply not enough bonds to go around. Institutional investors, who need these risk-free bonds to hedge portfolios and meet investment mandates, demand them while the available supply dwindles.

All these dynamics are reflective of the accommodative monetary policies of our central bank, the Fed, as well as the global central banks. The Fed grew their balance sheet by $3.5 trillion from 2008 to today – all of that representing “new money” in the banking system. Around the globe, the figures are similar in size. From that new money, and the Fed’s use of it to purchase bonds in the market, we have seen rates down and prices up.

The downside of this stimulus is difficult to predict. The Fed will stop printing new money in the fall, as anticipated, yet we have not seen any of the market reaction that we might have expected. Notably, inflation has remained negligible. The fear four years ago was that inflation would run to extreme levels and hamper the recovery; now, we are now faced with the opposite problem. We need some inflation to stimulate consumption (encouraging buyers today, when things are less expensive), yet global developed markets have seen flat prices and the US inflation index is under 2%.

The immediate impact is on retirement planning. In effect, if you wish to invest your money risk- free for the next ten years, the spread between income and inflation is nearly zero. Your money, in terms of real dollars, will not grow. This can have a potentially devastating impact over the coming years as the economy returns to historical averages for these measures. Namely, some areas of price inflation hit ordinary people very hard – food prices, for example. In fact, food prices have risen steadily over the past few years with some basics, such as meats, seeing 15-20% annual price increases. Yet food is not counted in the inflation gauge (called non-core CPI), and hence we are left to feel the impact without acknowledging the problem.


The perverse dynamic of inflation is best understood in the context of the jobs market. As we continue to remind folks, the measure of jobs health used by the media is misleading. Unemployment does not reflect the jobs participation rate, ignoring those who have simply left the market. Instead, we look at total employment as a percent of the population, as you’ll see below. While the trend has been encouraging, it shows only marginal improvement from the end of the recession five years ago.

An equally disturbing trend is the long-term unemployed. As you can see from the chart below, those unemployed for 27 weeks or longer as a portion of the total unemployed population spiked to levels never seen before. And while the trend has brought that level down from 1-in-2 unemployed to 1-in-3, it is still well above historical levels.


Long-term unemployed (27 weeks or greater) as a percentage of total unemployed.  We reached levels (45%) double the long-term average, and have not employed most of these workers in the recovery thus far.  While the level has dropped to 33%, we still have an unprecedented problem.

Long-term unemployed (27 weeks or greater) as a percentage of total unemployed. We reached levels (45%) double the long-term average, and have not employed most of these workers in the recovery thus far. While the level has dropped to 33%, we still have an unprecedented problem.


The impact is devastating on the economy and on people. There has been a wave of forced retirees, folks who were at the prime of their career with vast experience and education who simply cannot find suitable work. This has also fed the inflation dynamic mentioned above – people are unwilling to switch jobs for fear of losing theirs. With fewer employed folks job-hunting, this puts a damper on wage increase and ultimately lowers the cost of labor for firms. Labor costs, being one of the major components of inflation, have helped to tamper inflation as measured by the government. Yet, while wages remain flat, basic costs such as food and fuel continue to rise, creating an impact on Americans’ daily lives.

As we look at the other aspects of the U.S. economy, the message is equally mixed. We are seeing a renaissance in energy, with U.S. reserves and production of natural gas and crude exceeding even the wildest estimates from just five years ago. Yet energy prices continue to climb as global conflict creates uncertainty and the cost of refining keeps prices high on gasoline and heating oil.

Another paradoxical phenomenon is general economic growth. Consumer confidence, the general measure of how likely people are going to spend, is back to its long-term average and touching levels not seen since the Great Recession began. Yet, GDP, the measure of production, and by inference, consumption, contracted in the first quarter by -2.9%, again the first time since the Great Recession ended. Although much of that contraction has been blamed on the bitter winter, it is still a reduction in the economy that requires a steep recovery.


GDP quarter-over-quarter annualized change from 2000-2014.  While we have shown steady growth since 2009, Q1 saw a -3% decline.  Q2 numbers, due out shortly, will test the assumption of a sustained economic recovery.

GDP quarter-over-quarter annualized change from 2000-2014. While we have shown steady growth since 2009, Q1 saw a -3% decline. Q2 numbers, due out shortly, will test the assumption of a sustained economic recovery.


Global Conflict and Perception

One of my earliest lessons learned as a student of international relations was the damning relationship between the economy and global conflict. As discussed in the Wall Street Journal (“An Arc of Instability Unseen Since the ‘70s,” July 14, 2014), we are facing the most challenging set of circumstances we have witnessed since the late 1970s and the height of the Cold War. There are two civil wars that have the potential to spill over into U.S. interests (Syria and Iraq); Afghanistan is facing an electoral crisis; Russia is promoting ethnic strife in Ukraine after invading Crimea; the Israeli-Palestinian conflict is heating up with little signs of easing. In short, we are seeing some of the worst conflicts of our generation peak at roughly the same time.

[Note: This article was being finalized as a Malaysian Airlines passenger jet was shot down over the Ukraine, emphasizing just how volatile these conflicts have become]

I am loathe to make any sort of political commentary, but each and every one of these conflicts has the potential to draw the U.S. back into an armed conflict, even during a time when the US has resoundingly shown little interest in engagement. This perception – that the U.S. will not engage to resolve conflict – has created the adverse effect of increasing the belligerence of rogue actors. It is a perverse situation that echoes through the history of nation-state politics: perceived weakness breeds conflict, while the threat of might promotes peace. The impact on our economy is unmistakable. Put succinctly, what happens abroad can destroy our recovery at home.

These conflicts are developing rapidly against a backdrop of pressing global issues that are damaging our ability to grow. From climate change and viral outbreaks to food scarcity, we are facing a growing global series of challenges that will require a coordinated and intelligent response. Yet the denial is palpable. For instance, rising sea levels have put major roads in Miami under water during regular tide surges, a trend that will continue to engulf the city in sea water in the coming years. Yet real estate prices continue to climb in the city, development is robust, and elected politicians continue to deny there is a problem.

The math is undeniable: the economy will suffer and our quality of life will be threatened. To combat the rising tides in South Beach, the city of Miami has already committed $1.4 billion to shoring up the roads. That is money spent to stem a problem, money that could have been better used to invest in a technology or build up our educational system. We are increasingly short sighted as a society as the world quite literally “heats up.”

As a parting thought, I offer this last chart, which shows the fear gauge on the S&P 500, a broad measure taken from the futures market that shows how stock traders view the short-term future. A lower number indicates a perception of calm and rising markets, a higher number indicates rocky or down markets. For reference, the index bottoms out at 10 during strong bull markets, and peaks at 80 during market calamities such as 2008, with an average level of 20. In the past two weeks, VIX has hovered between 10 and 12. Perception of financial risk, at this moment in time, is the lowest it has ever been. Are we putting our heads in the sand? And what will the consequences of our denial be?


VIX from 1990 to 2014.  At only three times in the past 24 years has the VIX reached a low of 10 – a level that shows perception of financial risk is at its lowest possible.  Once in 1993, another in early 2007, and today.

VIX from 1990 to 2014. At only three times in the past 24 years has the VIX reached a low of 10 – a level that shows perception of financial risk is at its lowest possible. Once in 1993, another in early 2007, and today.


As I am fond of saying, perception is reality. Today, the markets perceive low risk and rising assets ahead. That perception, however, will be fragile as broader issues take root in daily life. And as perception changes, so will the financial risks that we all face.

I want investors to be aware that although some things are stabilizing, we live in destabilizing times. It is this balancing act of perception against reality that drives our portfolio composition. We have seen that managed volatility in our portfolios, while capturing growth from a variety of asset classes and strategies, leads to stable returns over the long haul. Put another way, these portfolios are designed as an all-weather strategy, a welcome approach when the line between perception and reality becomes blurred.

Rest assured that we at Vodia are keeping abreast of current issues in order to keep our investors informed and our assets as protected as possible. We remain optimistic, and realistic.

It is our job to monitor the world and manage the portfolios. It is your job to enjoy the summer.


David B. Matias, CPA
Managing Principal

Curing Hepatitis

June 24, 2014

Hepatitis C virus, artwork

       HCV Cell                                                        © Mehau Kulyk/Science Photo Library/Corbis

Hepatitis C Virus (HCV)

There has been much discussion and news lately about a new breakthrough in therapy for people with hepatitis C (HCV).   This is a relatively recent development and its ramifications represent a major breakthrough for human health as well as a significant investment opportunity.

First identified in the early 1980s, HCV is a small (55 – 65 nm) single-stranded RNA virus that causes inflammation of the liver in humans. It is contracted through blood exchange from blood transfusions, needle sharing (IV drug use), and tattoos and is considered the most serious of hepatitis viruses. The virus primarily uses hepatocytes (liver cells) for replication. HCV causes cirrhosis (scarring) and if left untreated, hepatic carcinoma and eventual death. It has also been established that it uses elements of the central nervous system for replication as well. Neurological manifestations of untreated HCV involve autoimmune disorders such as Sjogren’s syndrome, cryoglobulinemia, general neuropathies and cognitive impairment, to name just a few.

Vodia Mandate

As the world population continues to grow and pressure on global resources, public health and economic stability mounts we look for investment opportunities that address our biggest challenges and span multiple disciplines. Part of our mandate is to seek value that is created from companies that build sustainable business models in health, technology, timber, housing, food and water to solve some of our most pressing problems. The development of antiviral therapies for treatment of hepatitis C is of particular interest because of its vast potential for improving human health – and consequently, its commensurately large market potential. In addition, some of our brightest scientists and best companies are investing large amounts of human, intellectual, and monetary capital towards combating viruses. Companies like Johnson & Johnson, Merck, AbbVie and Bristol-Meyers Squibb are dedicated to creating cures and are making progress in the development of antiviral medications for hepatitis.

HCV: U.S. and Worldwide

  • Estimated number of people in the US with chronic HCV: 2.7 to 3.9 million [1]
  • Estimated number of people worldwide to have chronic HCV: 170 to 200 million [2]

(These estimates exclude the homeless and the prison population. It is estimated that 1 in 3 incarcerated individuals in the US are HCV positive.)[3]

  • Estimated number of recorded deaths each year from HCV-related liver disease: 350,000 – 500,000 [4]
  • Tattoos are now a leading cause in the spread of HCV. [5]

(These estimates are likely to be very low because people with chronic HCV can live for decades without any symptoms and therefore never know they have it.)


Table1 6.23.14





*Actual acute cases estimated to be 13.4 times the number of reported cases in any year. [6]

Gilead Sciences

Until very recently, people with hepatitis C were faced with the prospect of living with and managing the disease because there was a low probability of a cure and the treatments that were available caused serious medical problems. There were very few – if any – good options. This is no longer the case since Gilead Sciences has come to market with a cure.

Gilead Sciences (GILD) is a research-based biopharmaceutical company that discovers, develops and commercializes innovative medicines in areas of unmet medical need. GILD has an impressive portfolio of antiviral therapies that address HIV/AIDS, liver diseases, respiratory and cardiovascular conditions, cancer and inflammation. They have achieved a number of “firsts”: most notably, they were first to market with a complete treatment regimen for HIV infection available in a once-daily single pill. The bulk of GILD’s revenues come from its market-leading HIV franchise of therapies, Atripula and Truvada. Gilead has now expanded to antiviral therapies for hepatitis and achieved another first on December 6, 2014 when they received FDA approval for their new HCV antiviral, Sofosbuvir. Sofosbuvir is a polymerase inhibitor. In simple terms, the drug finds the protein (NS5b) that is responsible for viral RNA replication and blocks it. The result is the termination of the replication process, which leads to cure. The brand name of the drug is Sovaldi and the administration of therapy lasts from 12 to 24 weeks. Taken in combination with Ribavirin, Solvaldi has demonstrated a >90% cure rate in HCV genotypes 1, 2 and 3. [7] Solvadi may be the most successful and fastest drug launch on record.

The launch of Sovaldi propelled Gilead’s earnings to one billion dollars over analysts’ estimates in the first quarter of 2014. The following chart shows the increase in all antiviral sales from Q1 2013 to Q1 2014.

Table2 6.23.14

Price Wars and Protest

Sovaldi’s price tag for 12 weeks of therapy is $84,000. Despite protests from pharmacy benefit managers, such as Express Scripts, insurance companies are approving and paying for it. Express Scripts threatened to start a price war between Gilead and upcoming competitors such as AbbVie, J&J and Merck. Gilead’s competitors, who have also made substantial investments into HCV antiviral therapies, have suggested that they are not interested in a price war. Even the US Senate has joined the discussion and held hearings in March 2014 asking Gilead to explain Solvaldi pricing. The cost of any treatment regimen, however, must be evaluated in the context of probable outcomes and the costs associated with them. While the price may seem high, Sovaldi was priced so that the total cost of treatment is comparable to the prior regimen protocols. Prior treatment protocols were to engage in a 48 – 52 week regimen of a combination therapy of Peginterferon and Ribavirin. The side effects of this therapy are so severe that patients often delay starting treatment or are forced to terminate prematurely. Additionally, the efficacy across HCV genotypes (GT) 1, 2 and 3 of the Peginterferon/Ribavirin treatment is mixed and falls short of the Gilead regimens by wide margins.

Peginterferon/Ribavirin                                                    Sovaldi/Ribavirin

GT 1: 31%-54% sustained viral response (SVR)         >90% cure rate in HCV genotypes 1, 2 and 3 [10]
GT 2-3: 64-80% SVR [9]

Failure of treatment leads to other very costly medical problems such as cirrhosis, cancer and liver transplantation. When evaluated in this context, Sovaldi is less expensive than prior regimens.


Gilead offers guidance for 2014 sales of all of its products at a range of $11.3 to $11.5 billion. Importantly, Sovaldi sales are not included in Gilead’s 2014 guidance. Meeting these estimates (excluding Sovaldi sales) would bring Gilead’s price-to-earnings (P/E) ratio from 29.5 down to 13. Considering the industry P/E average of 69, this suggests the company is undervalued relative to its peers. Sovaldi sales were $2.3 billion in the first quarter of 2014 and the consensus view is that Gilead’s HCV therapy sales could reach $12 billion in 2015[11]. Even if the consensus is wrong, three million Americans have Hepatitiis C. It would cost $250 billion to provide treatment to them all.   Add in the WHO’s estimate of 170 million with HCV, and it’s clear the market is extremely large.


Increasing competition from Bristol-Meyers Squibb, J&J, AbbVie, and Merck (by acquisition) along with pricing pressure from payors such as governments in Europe and pharmacy benefits managers in the U.S. are risks for Gilead. Austerity measures in Europe as well as increasing health care costs in the US will continue to exert downward pressure on pricing.

We believe Gilead’s leverage lies in the unprecedented safety and efficacy of Sovaldi and that they are significantly ahead of their competition in terms of timing. We also believe that since there is no longer a reason to delay or avoid treatment the market is very likely to reveal itself to be much larger than currently understood (consider the prevalence of tattoos). This would likely absorb any future reduction in price if Gilead were forced to negotiate. In addition, Medicare recently decided to cover screening costs for hepatitis C. This will facilitate Medicare payment for hepatitis C treatment. [12] Finally, the diversification and strength of Gilead’s total antiviral portfolio forms a solid foundation for potential growth.

What’s Next?

The next advancement of Gilead’s HCV treatment is finishing phase three clinical trials. This is a single-dose combination therapy of Ledipasvir and Sofosbuvir. While Sofosbuvir blocks NS5B, the non-structural protein essential for replication, Ledipasvir blocks NS5A, a protein that plays a more complex role in the life cycle of a HCV viral cell but is also important to the replication process. The combination of Sofosbuvir and Ledipsavir could represent the final eradication of HCV across all genotypes.

Lead by CEO John Martin, PhD and COO John Milligan, PhD the management team has demonstrated exemplary stewardship of the company. Gilead’s concentration on infectious diseases, relatively low overhead, continued development of next generation therapies and strong intellectual property portfolio have helped Gilead establish the dominant position in the marketplace.

Disclosure:  Vodia Capital has established a long position in GILD for some clients.

© Dwight Davenport 2014
Dwight Davenport may be contacted at



[1] Center for Disease Control and Prevention (CDC). Viral Hepatitis statistics and surveillance, accessed May, 2014 at

[2] World Health Organization (WHO), Hepatitis C fact sheet, accessed May, 2014 at

[3] – CDC publication # 21-1306, HepCIncarcerationFactSheet-BW.pdf

[4] Personal interviews of gastroenterologists and hematologists

[5] World Health Organization (WHO), Hepatitis C fact sheet, accessed May, 2014 at

[6] CDC, accessed May, 2014

[7] US Government, accessed June, 2014. See also Gilead Sciences, Sovaldi prescription information fact sheet

[8] Gilead Sciences,, accessed June, 2014

[9] The Alfred 2002. accessed June, 2014, fact sheet Ribavirin/Pegylated Interferon Combination Therapy for People with HCV

[10] US Government, accessed June, 2014. See also Gilead Sciences, Sovaldi prescription information fact sheet

[11], accessed June, 2014

[12] Centers for Medicare and Medicaid services,, accessed June, 2014

Efficacy of treatment using Sovaldi (sofosbuvir)

Response Rates in Study POSITRON*

GT 1: > 90% SVR

GT 2 & 3: 61 – 93% SVR

( – See also Fact sheet on Solvadi,

*POSITRON was a randomized, double-blinded, placebo-controlled trial that evaluated 12 weeks of treatment with SOVALDI and ribavirin (N=207) compared to placebo (N=71) in subjects who are interferon intolerant, ineligible or unwilling. Subjects were randomized in 3:1 ratio and stratified by cirrhosis (presence vs. absence). Treated subjects (N=278) had a median age of 54 years (range: 21 to 75); 54% of the subjects were male; 91% were White, 5% were Black; 11% were Hispanic or Latino; mean body mass index was 28 kg/m2(range: 18 to 53 kg/m2); 70% had baseline HCV RNA levels greater than 6 log10 IU per mL; 16% had cirrhosis; 49% had HCV genotype 3. The proportions of subjects who were interferon intolerant, ineligible, or unwilling were 9%, 44%, and 47%, respectively. Most subjects had no prior HCV treatment (81%). Table 12 presents the response rates for the treatment groups of SOVALDI + Ribavirin and placebo.


Research Note, Thailand – June 4, 2014

June 4, 2014
David Matias

You have possibly heard about the military coup that occurred in Thailand on May 22, 2014. In brief, the military imposed martial law and has dissolved much of the elected government. They are establishing a new economic plan, and have temporarily installed the head of the military as the prime minister. In short, democracy in one of the world’s strongest economies is now dead.

Like most news events, this is a story that requires a far deeper understanding to appreciate all of the ramifications. While an objective assessment would be prudent, I am clearly biased by my connections and friendships in the country. What I see is a logical progression that started many years ago with the dismantling of their democracy when Thaksin Shinawatra’s political party (Thai Rak Thai) was elected into power – the man whom this is all about.

A quick history of recent developments in Thai politics begins with Thaksin, a former policeman-turned business leader who was elected prime minister in 2001 through the support of the mostly rural and poor farmers of Thailand. Thaksin did some good for the country in the form of rural development programs. But the downside was corruption – he is a deeply corrupt politician who used his control of the elected bodies to neuter the country’s enforcement agencies and anti-corruption safeguards. In the end, he fled Thailand for Dubai with billions in illegal wealth, escaping a two-year prison term.

In the next act of this drama his sister, Yingluck Shinawatra, who was elected prime minister in his wake on essentially the same platform as her brother, brought further economic revival to the countryside. Her method was far cruder than her brother’s. She promised and delivered on artificial price supports for rice farmers by raising the price that the Thai government would pay per ton of rice. The effect was devastating for the government. Farmers benefitted, but the government incurred at least $4.4 billion in losses (WSJ, June 17, 2013) as the rice they bought rotted in warehouses while rice prices continued to decline due to global overproduction.

This might all have been put under the rubric of bad economic policy if it were not for her last significant move as prime minister – to propose amnesty for her brother to return to Thailand and Bangkok politics. It was this last straw that led to protests, riots, and various forms of political maneuvering, rendering the current government ineffective with no clear path for bringing in a newly elected government.

While it is still not clear what precisely triggered the military’s move at this point in the drama, it is not unexpected. Thailand has a long history of military coups, the vast majority of which are without violence or bloodshed. The military is loyal to the King and only acts when there is a significant threat to the royalist nature of the country. If things go as hoped, the military rule will eventually give way to a political body that is largely in line with the King and a pro-economic ruling party. The issues of corruption still exist, and it will be quite some time until truly elected bodies will be able to function as a democracy, but this is a positive step forward.

From an investor’s perspective, this is welcome news. The market value of our holding, an ETF based on the Thai SET 50 Index (THD), moved in a narrow range immediately following the coup and is now up 4%. The larger volatility in the related index occurred many months ago when uncertainty around the Yingluck government arose and the prospect of Thaksin’s return was real. That was when we first entered the position – after a 20% drop in the Thai index on the fears of a political upheaval.


Chart 1 – The Thai SET 50 has suffered tremendous volatility in the past year as the political situation deteriorated in the country. The Amnesty Bill, allowing Thaksin to return, was the trigger that eventually led to the current coup. The market abhorred the Amnesty Bill, yet welcomed the coup.

Chart 1 – The Thai SET 50 has suffered tremendous volatility in the past year as the political situation deteriorated in the country. The Amnesty Bill, allowing Thaksin to return, was the trigger that eventually led to the current coup. The market abhorred the Amnesty Bill, yet welcomed the coup.


Our focus now will be on how the military stabilizes the economy and sets a path for the transition to an elected government. The real damage has already occurred – Thailand’s economy contracted last quarter due to the turmoil and poor economic policies during Yingluck’s tenure. Nicknamed the “Teflon economy,” Thailand has one of the most resilient economies in the region, capable of strong growth based in Southeast Asia’s global expansion. With the elected government’s dysfunction out of the way, the country can return to stable growth as the civil administrators, business leaders and foreign investors are again able to return to the business of doing business.

All the best for an enjoyable summer.

David B. Matias, CPA

Managing Principal

Market Update: January 2014

January 30, 2014
David Matias

It is a little tough to believe that it is 2014 and already a new year. But in a sense I am quite relieved that 2013 is done and behind us. It was a defining year in the modern era of finance. This time, the disparity between developed market stocks (US, EU and Japan) and the rest of the asset world (emerging markets, bonds, and commodities) was the largest ever. In fact, there has never been a time when developed stocks surged, surpassing all other asset classes. There was a period in the late 1990s when there was a strong divergence, but even in those markets, the other asset classes posted modest gains.

The history books on finance are being rewritten as we speak, because financial stimulus in the developed markets has been unprecedented while global economic growth has been anemic. This massive flow of capital into specific markets caused those markets to bolt ahead, while giving impetus for economic growth. Some of that growth is just from folks feeling safe to spend again; some of it is from further wealth concentration and investment by an ever-smaller segment of the population. Until the economic growth is diverse and stable, however, markets will be at risk. Witness the events of Friday, January 24th, when the Dow lost over 300 points over concerns of the impact of Fed stimulus tapering on emerging market currencies.S


Chart 1: Major Asset Class Returns in 2013. While the US and International Developed Markets (the EU and Japan, namely) surged in 2013, the remaining asset classes had losses for the year. At no other time in modern finance has such a disparity existed. [Notes: within fixed income, junk bonds posted a modest gain. The modern era covers 1980 forward, when the advent of IT and derivative markets changed market fundamentals.] Source: Bloomberg

Chart 1: Major Asset Class Returns in 2013. While the US and International Developed Markets (the EU and Japan, namely) surged in 2013, the remaining asset classes had losses for the year. At no other time in modern finance has such a disparity existed. [Notes: within fixed income, junk bonds posted a modest gain. The modern era covers 1980 forward, when the advent of IT and derivative markets changed market fundamentals.] Source: Bloomberg


We have Ben Bernanke and his leadership to thank for both this blessing and curse. The blessing is the remarkable recovery we have seen from the Great Recession – a period which could have become much worse had the Fed not engineering a global life preserver. Now that Bernanke is stepping down next month as Chairman of the Fed, it is worth examining this legacy.

Bernanke and His Legacy

Ben Bernanke effectively navigated the US economy through a financial crisis that had the potential to tear down our entire economy and recreate another Great Depression. We came very close to true economic devastation. Bernanke, in all his academic prescience, saw what could happen and in the absence of solid fiscal measures because of political dysfunction, he used the Fed’s balance sheet to pump trillions into the financial system. Frankly, he saved our economy.

What we don’t know as of today is how that legacy will bear out. As we saw with Alan Greenspan in the 1990s, what was then viewed as pristine policy turned out to be irresponsible stimulus that helped create the dotcom bubble and trillions of lost asset value. The most relevant impact of this stimulus has been the explosion of consumption in the US driving much of our economic growth at the expense of exports. Where consumption used to be 50% of our GDP in the 1950s, it has grown to 70% today. This increase was the impact of the easy money policies of the 1990s and 2000s, where we saw capital flood the equity markets and then the real estate markets, creating paper wealth for millions. Unfortunately, that vanished in just weeks and months.


Chart 2: The S&P 500: 1990 to 2013. In the chart to the right, we see how market volatility has changed dramatically since the mid- 1990s. Highs are far higher during bubbles, and the drops are extreme, averaging 50% during recessions. Loose monetary policy and the resulting dependence on consumption for GDP growth is a primary underlying cause of these extremes. Source: Bloomberg

Chart 2: The S&P 500: 1990 to 2013. In the chart to the right, we see how market volatility has changed dramatically since the mid- 1990s. Highs are far higher during bubbles, and the drops are extreme, averaging 50% during recessions. Loose monetary policy and the resulting dependence on consumption for GDP growth is a primary underlying cause of these extremes. Source: Bloomberg


For Bernanke, the final test will be future inflation. If this recovery does in fact hold, then the challenge will be removing the vast liquidity from the market in time to head off excessive inflation while maintaining the base level needed for economic growth. As we witnessed in the 1970s, inflation can create a vastly damaging problem that is tamed only through high restrictive monetary policy, followed by recession. The counter to that scenario is deflation – an equally devastating situation of falling prices which throttles growth that has begun to shape the global debate on emerging economic threats.

The US Economy and The World

Another recession would be devastating given the current state of our economy. The employment picture is the key to this concern. Bernanke, in comments he made on January 3, 2014 at the annual meeting of the American Economic Association, cited the 7.5 million new jobs since 2010 as evidence of a stabilizing economy. The dark side of that statistic is that since 2010, the US population has grown by just as much through a mix of immigration and births. Accounting for work force participation rates, we have created only enough jobs to support new workers, the preponderance of which is in low wage jobs. We lost 8.5 million jobs in the recession – that loss has yet to be addressed. A new recession would push down employment levels down to a place not seen since the 1930s.


Chart 3: Percentage of Americans with Jobs: 1945-2013. We lost 8.5 million jobs in the recession, and while we have gained 7.5 million jobs since then, the US population has grown by almost 10 million people. The effects of the recession are still with us, limiting the spending power of the broad worker base and accentuating the wealth disparity of the recovery. Source: Bloomberg

Chart 3: Percentage of Americans with Jobs: 1945-2013. We lost 8.5 million jobs in the recession, and while we have gained 7.5 million jobs since then, the US population has grown by almost 10 million people. The effects of the recession are still with us, limiting the spending power of the broad worker base and accentuating the wealth disparity of the recovery. Source: Bloomberg


We do not yet know how successful Bernanke has been. We can see the evidence right now – the stock market raged ahead to new levels that even the most optimistic economists did not predict – but the legacy will be written over the next few years as we see either economic dividends or carnage from this policy.

The unanswered question is whether the stock market rise is anticipating a return to stable growth. Thus far, the news has been encouraging. GDP growth in the US surged ahead in the 3rd quarter of 2013, to 4% – a level that we have not seen sustained in quite a while and would be necessary to justify further market gains. Globally, economic growth is also beginning to creep up as the World Bank and the International Monetary Fund in the past two weeks have both increased their estimates for growth, something that hasn’t happened in several years.

These revisions are critical to the state of our economy in the coming year. For the equity market levels to be sustained and increased, we need companies to continue to increase their global revenues and not just depend on the American consumer. As the employment picture illustrates, the recovery in the US has been spotty and erratic. A further reliance on consumption domestically could work to push us ahead, but that is a risky bet right now. Exports will have to be a part of longer, sustained US recovery.

To whom we would export however, is a question. Right now, the EU counties and the broader European region have the largest global economy, but that economy has been shrinking, not growing. Part of the encouraging news from the IMF and World Bank is a belief that Europe might actually grow again in 2014. That in itself would be an enormous boost for the US and the other economies that supply Europe.

China is the other economy that can dramatically impact our recovery. At their growth rate and the size of the economy (7.6% growth on a $9 trillion economy, as compared to 2.2% growth on a $16 trillion economy in the US) largely dictates the health of global consumption. While China consumes about half of what we do for every dollar of GDP, the central government has pinned the hopes of sustainable growth on the Chinese consumer. Should that model bear out, it presents tremendous opportunity for US companies. Should it fail, global assets will see another correction in prices with ensuing volatility.


Chart 4: Comparing the major global economies: Using 2013 figures, actual and estimate, we see the world’s dependence on Chinese growth. Their annual incremental economic growth (Growth Dollars) is double the US. [Growth/Capita shows incremental consumption dollars per individual in that economy]. Sources: Bloomberg, IMF, World Bank, US Census Bureau

Chart 4: Comparing the major global economies: Using 2013 figures, actual and estimate, we see the world’s dependence on Chinese growth. Their annual incremental economic growth (Growth Dollars) is double the US. [Growth/Capita shows incremental consumption dollars per individual in that economy]. Sources: Bloomberg, IMF, World Bank, US Census Bureau

For economic growth to continue for several more years, we need to see the dual support from increased exports and increased domestic consumption. The first part – exports – is being tremendously aided by the energy boom we are experiencing in the US. With the benefits of shale oil and fracking (long-term environmental destruction aside), we are both a cheap energy source for manufacturing and an exporter to the world. For instance, gas exports have increase 3x in the past five years – a mind-blowing change that will have an impact on both economics and global politics.

The silver lining for domestic consumption is housing. We have seen only modest recovery in this sector – existing house prices have recovered just a third of their decline from the recession, and new home construction is still at half the level of long-term needs. With every new home, there is both job creation and increased demand for the goods and services that fill the home. There is room to double the sector in a stable economy, resulting in increased jobs and economic growth, not just for the US but the countries who export to the US. There is enormous potential in the housing sector, but only if Americans feel confident to invest in a new home and have the job stability to do so while the banks continue to lend at low rates.

Markets and Psychology for 2014

As we have seen in the last two growth economies, the equity markets get well ahead of themselves and collapse in a fury. A simple measure to assess this exuberance is the price-to- earnings ratio (P/E) on the market, as well as some key stocks. Right now, the P/E on the S&P 500 sits around 17x, a good clip above its long-term average of 15x. A simple analysis says that if earnings do grow this year by at least 15%, then the stock prices are justified. If not, prices are high.

But is it really so simple? Google has been trading at 25x for many months now, well outside a sustainable range. And the price keeps going up. Retail stores are trading at 30x; some large pharmaceuticals trade at even higher ratios.

Historically, the P/E will continue to climb well past these levels before investors notice that the punch bowl has been drained. During the last two bubble markets, the S&P 500 reached 25x and 30x, both well above where we stand today. This doesn’t imply that the market will go up without some further developments to sustain investor’s excessive optimism, but don’t be surprised if there are new predictions in the coming months about how we are again seeing a “new economy” in which fundamentals are worth ignoring. History will repeat itself.

With this in mind, and all of the economic realities outlined thus far, we remain cautiously optimistic in our asset allocations. We continue to maintain our equity exposure at levels to reflect the risks, but have made incremental changes to capture the market psychology (called “risk-on”) and expectations of better global growth. We are also very active in the management of the bond side, keeping durations rather tight, using bond ladders and actively trading some positions to manage total return rather than allow market movements to dictate returns.

Commodities were a challenge for us in 2013, with metals and agriculture taking a beating while partially offset by timber and energy. Given our global view, commodities could do quite well in the coming year with increased demand for many raw materials. Housing may start driving up timber prices, and food prices may be impacted by continued meteorological and demographic disruptions (who knows how the Polar Vortex that has held the nation in a frozen grip will affect food production and sales?). We will continue to maintain these exposures with some adjustments to reflect our core values at Vodia.

All in all, we are again facing challenging times. The global economy is shifting in ways that are impossible to predict, with secondary and tertiary effects that reverberate throughout all asset classes. There are many positives to embrace in the short term, and many disturbing issues that must be resolved in the long term. Our approach – to reassess every quarter and step forward with caution – will continue to be our mandate as we continue to be thoughtful while we observe the world around us.

Best of luck with this winter and the Polar Vortices!


David B. Matias, CPA

Managing Principal

Market Update: October 2013

October 11, 2013
David Matias

From Tapering to Teetering

As has been the pattern of the past six years, the summer always brings an interesting set of challenges for the financial markets.  This summer was no exception, from continued uncertainty in the financial markets soothed over by unprecedented Fed stimulus to geopolitical developments that are still unfolding.  Unfortunately, the political dysfunction that has riddled the nation for the past fews years has reached a stage that will only continue to harm the economy and the country.

The positives, however, are fairly obvious: the US continues to pump $85 billion of newly printed money into the system on a monthly basis, with the stock market as the primary beneficiary.  While the numbers vary week to week, the S&P500 is up around 15% year-to-date.  The other bits of good news are real estate prices, which are on a remarkable recovery, a nominally growing US economy, solid corporate profits, and the recent changes in our energy dependence.

Unfortunately, each of those positives are countered by negatives:  the stock market went apoplectic when Ben Bernanke suggested tapering of the stimulus, growth from the emerging markets has faltered, US overall employment levels are the same as five years ago (mid-recession), and the economic growth in the US is significantly below the long-term average needed to insulate us from negative shocks.

The employment picture is perhaps the best place to find reasons for caution.  Although the unemployment figure we so often read about is significantly down from the high of ten percent, the employment picture is a bifurcated situation.  In the recession, we lost nearly 10 million jobs in the span of just a few quarters.  And while we have created 7 million jobs since then, our labor force has grown in those five years by roughly the same number.  So in short, the labor participation rate among Americans is at a 30-year low.  The following chart shows this fairly well.

Chart 1 Image

Chart 1: Data from the Bureau of Labor Statistics shows the percentage of people employed between the ages of 16 and 65. This chart covers 1981 to present, and shows that the labor rate has not changed since 2009. With a labor rate equivalent to the 1980s, we are creating only enough jobs to satisfy the growing population base, but not replacing those lost in the recession.

The anecdotal evidence suggests the jobs we’ve created in the past five years are of far lesser value than the jobs lost.  Most are at minimum wage, there is a tremendous underemployment problem, and the divisions among social classes continues to widen.  These issues only make the next conundrum even more challenging.

Market behavior continues to indicate that we are in a cycle of bubble markets driven by consumption economics.  The next chart shows the movement of the S&P 500 over the past 30 years, in which the market is pushed to new highs in each cycle.  The driving force behind these peaks is external stimulus leading to bubble asset valuations (dotcom in the 90s, real estate in the 00s, and Fed stimulus in the 10s).  In the collapse of the two prior bubbles, the damage to the financial condition of the broader society was extensive – far greater than the benefits from those bubbles.

Chart 2 Image

Chart 2: The US stock market over the past 20 years (S&P500) has shown a broad trend of asset inflation followed by steep drops as the economic growth falters. These asset bubbles have been extraordinarily damaging, with the potential that we have formed another one. Corporate profits will ultimately determine the breath and depth of the rise and fall.

For the current market rise to continue (as opposed to correcting by 20%-50%), we need corporate revenues to grow.  Thus far, corporate profitability has backfilled the market as price-to-earnings ratios remain at or below historical averages (16x).  This has been primarily achieved through layoffs and productivity increases with some revenue increase.  With the internal measures largely exhausted, revenue growth is going to be front and center for the next several quarters.

This picture could work but demand needs to come from a mixture of domestic and global consumers.  The global scene is dominated by Europe – still struggling to get out of a recession – and Emerging Markets.  As we have seen in China and elsewhere, the massive boom in the emerging markets over the past decade has created disruptive air pockets that make predictable growth elusive.  Hence, the need for the American consumer to find additional disposable income or a willingness to once again increase personal debt levels.  With such a stagnant US employment situation, neither are likely soon.

Chart 3 Image

Chart 3. As the US equity markets surged ahead (S&P 500 shown in red) in the first two quarters, Q3 saw the Emerging Markets (shown in green) stage a partial recovery while Europe & Japan (shown in blue) also posted stronger gains.

It is for these reasons that we at Vodia Capital maintain a diversified asset allocation strategy for our portfolios.  Relying on just equities to drive gains would subject portfolios to far too much volatility and uncertainly.  While markets have shown an ability to recover in the past, these gyrations eat away at long-term returns and ultimately underperform when compared to a diversified strategy.  In response, we continue to use fixed income, commodities and derivates to both stabilize portfolios from global uncertainty and generate predictable growth.


The biggest challenge to backfilling the equity asset bubble is global conflict.  Domestic issues are important and bleak, but with enough time and some basic legislation, our current situation will ameliorate or the domestic economy will simply adapt.  But until that happens, we do not have enough consistent economic growth to withstand a shock to the system and not enter another recession.

The global issues are less predictable, although we seem to have hit a moment of pause.  Despite my wildest expectations, the situation in Syria seems to have found a multi-lateral solution with Russia participating and China consenting.  While I have my doubts on the ability for the global community to truly disarm Syria’s WMD capabilities in the long-term, it is a relief to see it handled through cooperative diplomacy and through the UN.

On a separate but related front, Iran has consistently posed the greatest threat to global stability in the past few years.  Compared to Syria, Iran’s pursuit of WMD’s is a real problem with real ramifications.  Not to overstate the situation, but by many accounts this region was on the brink war if something was not done soon.  And while I also have serious doubts as to the authenticity of Iran’s overtures, we have taken steps to open a dialogue that has been closed for decades.  That is progress.

Where we do not have progress is in our own political structure.  As of this writing, we have a partial shutdown of our government, with another looming prospect of defaulting on our debt in another three weeks.  By some estimates, a complete shutdown of a few weeks could wipe out our economic growth for the quarter and possibly the year.  And defaulting on our debt is simply a non-starter – the financial ramifications are just too vast to play with.  While cooler heads will prevail, the damage to the economy through continued uncertainty has already taken a toll on lower economic growth.

Changing Energy Dynamics

The most promising development is the changing energy dynamic in the US.  The past six years have seen a dramatic and unprecedented change in our energy dependence.  Despite the mild economic recover, our use of oil has actually decreased by 10% from a combination of better vehicle fuel economy and alternative sources.  During this same time, our oil production has doubled from technological advances.  The net impact is to decrease our reliance on oil imports by half, to less than 10% of global production.

Combined with our natural gas boom, this is an incredibly positive development for the economy.  Much of our economic growth over the past decades has depended on cheap energy, creating a political structure and international presence that went to extreme lengths to protect the dynamic.  As net exporters or natural gas and coal, along with a far lighter dependence on the global oil market, untold resources will be freed up and could generate a new form of a “peace dividend” that we experienced post-Cold War.

The medium-term impact of our energy production and consumption is still of grave concern – from global climate change to the damage we are doing to our drinking water.  The shift to alternative sources, whether they be truly green or simply move us away from oil, is of paramount importance and must continue.  But the ability to shift a focus away from deeply disruptive policies to protect a bad oil dynamic is a start.  Where we take it next will determine just how much of a global leader we can be in the coming decades as the forces of economics increasingly determine our actions as a country.

All the best for an enjoyable fall.


David B. Matias, CPA

Managing Principal

Market Update: June 2013

June 28, 2013
David Matias

What is NORMAL?

Normal is a much-overused but complex word. It can refer to societal values that reflect one group’s preferences to the exclusion of another. In a statistical sense, it refers to a baseline expectation drawn from reams of data. When you combine the two, you create statistical measures that can be used to determine behavior in certain situations, such as IQ tests. You see how this gets tricky, and fast.

Now let’s discuss the “normal” of economics. The financial markets are permeated with the statistical use of “normal” – without some idea of what “normal” looks like all of risk management and portfolio construction would fall apart. But now economists are trying to assess this current economic period as either a “new normal” or a return to the “old normal.” But what exactly does that mean?

As you will have gathered from my blog entries and market updates, I often point out where the statistical use of “normal” in the financial markets is broken. Whether it is the price movement on gold or the stock market collapse of 2008/2009, “events” have happened that simply should not have – they seem, to us, to be statistically impossible and “abnormal.” As an asset manager, it is terrifying at times that the statistical “normal” of the past 50 years is no longer valid.

Somewhere along the way, someone decided that the word “normal” will make it easier for people to understand a complex topic. We live in a world of mass media and shortened attention spans, where messages need to be simple and short or else they are ignored (think Twitter). Hence, the word “normal” has been redeployed in our current world without people stopping to think about what it really means, much as they don’t think about the incessant sound bites of recent political campaigns. Unfortunately, the word “normal” captures very little of reality, and leads to a misguided sense of safety for investors.

In the broadest sense, there is nothing normal about the economy today. We have a world population that now exceeds seven billion people and a method of supporting those lives through consumption-based wealth creation. That is not normal – it has never happened before and we don’t know if it can be sustained.

Yet here in the US, we are supported by an economic model that has been proven over decades. We have a population that grows at 187,500 people per month, and an economy that is just generating roughly that same number of jobs. We have been the center of innovation and entrepreneurship for the globe for a century, and combined with a tremendous level of investment over that period, we have an economic base that supports the wealthiest nation today.

The challenges here, however, are vast.

  • Job growth is able to support the current population growth, but does not replace any of the jobs lost in 2008 and 2009. Today, we have the same relative number of jobs as the 1970s – when most households had a single wage earner. To replace those jobs, however, we need to consume at a level consistent with dual-income households.
  • The economic growth necessary to build back those jobs might not be attainable – that is the core of the current economic debate. We need 4% annual growth – we’ve been lucky to see half that over the past fifteen years.
  • Wealth is more concentrated now than in the past 100 years. Middle income families have been decimated by the financial turmoil (retirement and real estate assets), while the top income groups have seen their wealth explode.
  • Our political structure is largely paralyzed in guiding the nation’s resources and regulations in a way that invests for the future – whether it be in education, transportation, or conservation of natural resources.
  • The explosion of the digital age has created large potholes in the road to certainty. Whether it be financial calamities from computerized trading systems, social unrest, or the leaking of state secrets, these changes are redefining expectations.
To reframe what “normal” means , I might like to suggest instead that we think about expectations. People, for the most part, like to know what will happen next – whether it be the length of a commute or the length of a retirement. In today’s world, those expectations are increasingly altered, erased, or shattered. And with it comes a deep sense of uncertainty – the bane of stable financial assets.


With that introduction, I would like to say there is in fact good news to discuss. Last week’s dismal market performance masks one very important bit of news – the Fed believes that the economy is improving, so much so, in fact, that they might start to “taper” back on their historical stimulus program within a year or so.

Rather than treat this news with excitement, the market plunged. And it wasn’t just stocks – it was everything. (For those who wonder if this might be “normal” or part of the “new normal,” , let me point out that this 1.0 correlation broke all normal statistical expectations). It parallels the market behavior of this year – bad news is good for the markets, good news is bad for the markets.

People are saying that the US markets are up strictly because of all the stimulus. Without that stimulus, things will go back to “normal” – positive real bond yields, stock prices that follow company profits, and commodities prices that reflect demand. In other words, markets will have to reflect “normal” values for things, as opposed to the central bank inflation created by trillions in new money. That is not really a bad thing – in fact it is astoundingly good. The printing of money cannot continue without there being some serious damage to the global financial system in the form of currency devaluation and price inflation.

But like every aberration we have seen in the past five years, change is not taken well by the financial markets, even if the change in this case is a change in expectations about something that might happen a year from now.

Our role as investment managers is to determine what assets will be worth, based on their intrinsic value today and growth potential for tomorrow. To review the major asset classes and our perspective going forward:

Domestic Equities: US stocks have taken a beating, but only just so much. They were down 6% from their highs, but up 18% before the sell-off (for a net gain of 14% for the year as of right now). Whether we continue down or up from here is well beyond anyone’s control or foresight right now.

Our investment perspective on equities is essentially to stay steady – we have already kept a lower equity exposure precisely because of the inherent volatility, but do not believe that the recent volatility is reason to change that position. Instead, we are viewing this as an opportunity to increase investments in those individual equities that have the fundamental value and growth prospects to benefit from a growing US economy.

Valuations on the broad market are reasonable (S&P500 is around 15x earnings) and balance sheet structure of these companies is remarkably strong, thanks to years of cheap corporate borrowing. US companies have also shown further strength in their global customer base – as the world grows, so do the markets for many of the best US companies. If it is true that the economy is showing further signs of strength – as signaled by the Fed this week – then US companies are extremely well positioned to benefit.

The risk is a host of geo-political troubles that could trigger a global recession. There is no immediate indication that such a situation will arise imminently, but until we have see resolution in a couple of situations, we are going to maintain these equity levels as a buffer.

Foreign Equities: Here the story in remarkable contrast to the US. In short, the global stimulus from the central banks – not just the US – has propped up these markets for the past two years. Under the surface, however, the economic growth is weak. Europe has been in a recession for quite some time, Japan was on life support until recently and the emerging markets cannot support their economic growth through internal consumption.

The resulting equity performance is rough. Global markets have shown just a few percentage points of gain this year (if not a small loss right now). Emerging markets on their own are down 12% on average, with some markets taking a 25% beating.

As investment managers, we have avoided Europe almost completely but still maintain a modest exposure to the emerging markets. We’ve done this mainly through positions in US companies that sell heavily into those markets, and whose future profitability will depend on growth in those regions. We are still very positive for the growth prospects for the emerging markets and view the current swoon as a market psychology driven movement. Especially as the US slowly pulls into a higher growth mode, these regions will benefit significantly.

Domestic Fixed Income: This market has received an enormous amount of attention of late in the form of interest rate movements of historical proportions. Rates on the 10-year Treasury note have move from 1.6% to 2.6% in a matter of weeks, and the 30-year rates have gone from 2.8% to 3.6% in that period. Again – “normal” of any sort doesn’t compute.

The impact on bond prices is tremendous – market price move down as yields go up. But from the perspective of an investor holding bonds to maturity, it is good news. As long as your maturities are relatively short, you will get to reinvest your cash at higher rates down the road, once your bonds mature at par. There is no impairment of value in this situation – a fact that is often overlooked.

Commodities: Again, this market has taken a beating this year, although far less so than some of the global equities. As emerging markets are perceived as slowing down, so does the thinking for the commodities consumed by growth.

Our perspective is quite to the contrary. The slowdown in emerging markets growth is only temporary. The US is pulling out of its malaise, and population growth in developing regions will continue to fuel demand. China, for instance, is planning to urbanize 250 million people in the next decade. To put that into perspective, that is the same population of all the major cities around the world – combined.

In addition to the global demand for construction resources, we are holding a notable position in grains and agriculture. The dynamic is a simple one: populations are growing and the global middle class is consuming more meats and high value foods. Production is keeping up – but just as long as there are reliable and predictable methods. Climate change is for real, however, and creates mayhem in the production cycles through drought, flood, and changing weather patterns. As we saw last summer, with these disruptions comes significant supply constraints and rising prices.

The area that is least “normal” is metals. Gold and silver, the two metals that we use for hedging purposes have seen historic declines. The price of silver has been cut in half with all the reactivity to the central banks, gold is off a third. More disconcerting is the daily movement, which is down under every market condition – whether there is good news in the world or bad.

Seeing these risks, we exited our silver position many months ago, just at the high. We kept the gold, however, as a hedge against some of the events we have recently witnesses. But in the break from any form of “normal” that hedge has failed and the position has been a drag. Under the perspective that this is a market dislocation unrelated to the value of metals, we continue to monitor that market and the timing for when it may make sense to restore the positions to their original allocation.


In summary, it has been an unusual year. The markets went straight up for four months, creating a buzz reminiscent of the late 1990s. During that period, stocks went up at a blistering pace and there seemed to be no end in sight for the dotcom stocks. The buzz was a simple, yet persistent demand to be in the stock market. If you were not fully invested, then you were “missing out.” Unfortunately, those who did go full into the market saw a remarkable event – a -70% loss in their portfolio values.

That buzz has ended now, as we are reminded of the vast uncertainty in the equity markets. In the last month, we have begun to witness volatility across disparate asset classes, from US Treasuries to Japanese equities. During late May and early June, the Nikkei had five trading days of 3-7% losses. Then just three weeks ago, it saw a 5% gain in one day. Like the movement in gold just two months ago and again now, that volatility is well outside “normal” volatility. And it is happening in US equities, to a smaller but notable degree.

To make this point, for the months of May and June (since the Fed started to talk about “tapering”), we have had 24 days of 100+ point movements in the Dow Industrials average: thirteen times it was up, eleven times it was down. That contrasts to the first three months of the year in which there were just nine such days, only two of which were down. Volatility came back with a vengeance, and when it did losses ensued.

As reported by the financial website Seeking Alpha and others, May saw the highest equity weighting among individual investors since September 2007. As a reminder, September 2007 was the beginning of the equity decline that lasted 18 months and 50% down. In the parlance of market psychology, it is not unusual for individual investors to be the last to the party.

And this lack of “normal” is creating havoc for the institutional managers as well. Hedge funds, the massively concentrated pools of capital that supposedly can time these events, have done no better. With gains of roughly 2.7% for the year, they haven’t solved this problem – no one is immune.

Our view is that we are seeing the shift to an investment environment based in old-fashioned fundamentals as the US economy pulls forward and artificial drivers fade out. It could take years, but ultimately that is a good thing. In the process, there will be uncertainty and wild volatility.

In the end, there is nothing normal about these markets – old or new. We are going through changes on historic scales, and as we continue to remind folks, we are all sorting through the events and the data to find the best places to invest assets for the future.

All the best for an enjoyable summer.


David B. Matias, CPA

Managing Principal

Market Minute – April 24, 2013

April 24, 2013
David Matias

Apple Earnings Release

It is impressive how the market can fixate on a single stock.  Apple has been that focus for a few years now – on the way up and on the way down.  And while I rarely focus on a single company given the diverse nature of our investment strategy, Apple is as much a mainstream news event as American Idol.

Last night Apple released their earnings from the past quarter (their Q2), and gave some guidance for the next quarter.  While there has been a tremendous focus on Apple’s “lost mojo,” they actually did extraordinarily well – selling 37.4 million iPhones in the quarter – a small gain over the same quarter last year.

That fact is huge.  Despite the bad press, the cratering stock price, and the onslaught of competition from Samsung, HTC and others, people still want Apple products in record numbers.  The distorted market perception ignores the global diversification that Apple accomplished last year.  Now two-thirds of their revenue comes from abroad, attributable to the fact that they expanded into over 100 new phone markets in 2012.  To emphasize the appeal of their products, iPad sales increased by 65% over the same period.  Not a small feat – and one done extremely well.

To give you a little context, iPhone and iPad sales combined to roughly 57 million units for the three-month quarter.  That translates to roughly 26,000 sold every hour of every day, or 440 units per minute.  Given an average selling price of $612 for the iPhone and $449 for the iPad, that is stunning demand for a premium product.

The downside is that Apple will not have any new phones, pads or game-changing products for at least another four months – an eternity in the minds of stock traders.  But in my opinion, that is fine.  What Apple has done thus far in logistics and supply-chain in unprecedented.  To wait and build that supply-chain for the next wave of products over the following year is perfectly acceptable for a long-term view of maintaining the world’s most valuable brand.

Consistent with this philosophy, and solidifying the slow-growth nature of such a large market footprint, Apple is radically changing their balance sheet structure to be more friendly to value-based investors.  It is well overdue – this should have been done last year and created a wicked backlash from investors – but the changes are good ones. First, they boosted the dividend to a 3% yield.  Second, they increased their stock buyback by $50 billion, reducing the stock float by 15%.  And third, they will bring debt onto the balance sheet for the first time in decades.  All of these changes have the net result of increasing the value per share, flowing cash to stockholders, and lowering the stock volatility in the long term.  In short, they will now be a value stock.

Unfortunately, Tim Cook and Apple’s culture took many missteps before getting to this point, and the stock has suffered mightily.  Some of those missteps were addressed last night.  Next is execution on the business strategy and the ability to create new and exciting products – and that again is where time will tell.


David B. Matias, CPA

Managing Principal


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