April Newsletter 2023
April 3, 2023
“Cracks Beneath the Surface”
It’s been a long, hard winter, but “Spring is in the Air”. Jeannie was in New York City last week with a college classmate getting her “Broadway fix” and she enjoyed some beautiful Cherry blossoms in Central Park. Also Jeannie and I saw "Annie" in Tucson recently and I was reminded that "The Sun will come out, Tomorrow."
In February and March, Mother Nature dealt many devastating blows to the meager earthlings struggling to take care of our fragile planet. A partial list includes earthquakes in the Middle East and New Zealand; forest fires in Chile; flash floods in Australia; avalanches in Central Asia; heavy rains in Brazil; atmospheric rivers of snow and rain across the entire United States; and just last week tornados in the Deep South. Ultimately, these challenging events have economic impacts across the globe and affect the economies and companies included in our diverse portfolio of investments. It will take years for a full recovery and for people to overcome the effects these events have had on their lives.
The two agricultural funds included in our managed portfolio were not completely immune to the effects of the heavy snows, rains and eventual flooding of farmland across California. Both Gladstone Land (LAND) and Farmland Properties (FPI) were nominally impacted by the flooding. Downed fences and damaged structures have been reported; with the damages covered by insurance and/or tenant obligations. Planting seasons will need to be adjusted, the excess water will produce larger fruit crops and the flooding will restore the drought-stricken groundwater levels. In the scheme of things, both funds should continue to produce meaningful returns in the portfolio; all in spite of the recent stock value hits that were felt across the entire agriculture industry. We continue to be impressed with both funds and their management and will use the temporary value declines to add to both positions to maintain the relative portfolio positions across all managed portfolios.
Our portfolio and the securities industry were also hit hard in March by the collapse of Silicon Valley Bank, marking the second largest shutdown of a bank in US history (second only to the collapse of Lehman Brothers precipitating the 2008 financial crisis). To settle the nerves of both depositors and investors, the Fed and the FDIC have since stepped in to assure that bank depositors will not lose their money in the failure. Several other banks, both here and abroad, have since failed and have now been taken over by other banks in the multi-bank financial system on which we rely.
The banking tremors have sent shockwaves through the global financial markets. Even the smaller regional banks we all use for our daily banking business have felt the pain.
All-in-all, depositors and investors are keeping a sharp eye on the banking industry. The fact is that the Fed’s continued raising of interest rates could not be absorbed without the cracks beneath the surface negatively impacting banks of all sizes with inadequate reserves and/or portfolios of low interest rate investments in otherwise seemingly “safe” US Treasury securities. The well-managed banks will survive without current financial losses; but the entire banking system will need to work hard to regain creditability with depositors and investors. Our managed portfolio includes a ladder of serially maturing CDs, notes and bonds which will continue to be held to maturity without loss of principal. We are continuing to add new fixed income positions of the highest quality to the portfolio at the current higher rates of interest. The aggregate managed income portfolio now reflects a cash flow yield of over five percent; with many new issues paying more than that.
Expectedly, Charles Schwab and its stock value has been caught-up in negative news about the banking sector. To be clear, Schwab as a financial institution is significantly different from the many banks being impacted by what happened at the failed banks. As reported to you previously, we believe that you do not need to worry about the ability of Schwab to hold custody of your portfolio investments. Please read the updated letter from Charles Schwab and Walt Bettinger wherein they describe in great detail the many differences between Schwab and the effected banks. Link:https://www.aboutschwab.com/updated-our-most-recent-perspective-on-industry-events
The market sell-off from the collapse sent the S&P 500 negative for the year. Most sectors are now recovering as the quarter ended on a “bang”; but the financial sector still needs some time to sort out the damage to the system. It too, will recover on the back of an otherwise resilient economy. The Fed’s efforts to rein in inflation with higher interest rates will cycle through the economy and the “fit will survive”. Our portfolio of well-managed funds will come out on the other side stronger than before the downward slide; mainly on the strength of gradually lower inflation rates and employment numbers that continue to impress us all.
The graph below prepared by Laura shows the ever-upward trend of the managed Equity Portfolio, going back to 2010. We believe that the downward endpoint reflecting the bank instability will again regain upward movement as the economy cycles through the current phase; much as it has in the past after a whole variety of downturns. It could very well be 2024 before the Fed has finished dishing out its pain; but in the end, the equity markets will be stronger.
The second graph reflects the trajectory of the Income Portfolio, also back to 2010. Different from the equity portfolio, the returns on the income portfolio are directly related to the interest rates on the pieces of the CD/Bond Ladder included in all client portfolios. Until the individual issues have matured and the invested principal received, the market values will be based on the lesser interest rates of the older positions in the portfolio. New issues with the current higher interest rates will help buoy the overall portfolio, but it will take a combination of higher rates and maturities to get the income portfolio results to return to their pre-Covid trajectory.
Our aggregate managed Equity Portfolio returned over seventy percent for the ten-year period. The aggregate managed Income Portfolio returned over forty percent for the same ten-year period. Each client’s overall portfolio return reflects the combination of equity and income returns based on the allocation dictated by their Individual Investment Policy Statement. The aggregate return for all combined managed portfolios was just over forty percent. As previously noted, the returns are negatively impacted by the depressed value of the bond ladder positions, even though the positions will be held until maturity for full invested principal returned to the investor/client. Putting the ten-year returns in perspective, the cash inflows from interest and dividends were five times more than the value declines over the same period.
All reported returns for the one, five and ten-year periods have been affected by the Covid and post-Covid attempts to stabilize the economy (not always successfully). We all are looking forward to the historic portfolio returns reflected in the two graphs, where pre-Covid long-term annualized equity returns came in at eight-to-ten percent and the income returns came in at four-to-six percent, on the same basis. The economists we follow are of the opinion that a “return to normal” is on the horizon. In the meantime, the aggregate portfolio is currently projected to produce annual cash flows from interest and dividends at a rate above five percent. And it bears repeating that all planned for distributions are currently either “in the bank” in bond ladder maturities or projected current cash inflows.
From news about transitioning to Charles Schwab, we are still looking at account conversions to take place over Labor Day weekend 2023. As we learn more details, we will keep you posted. The one detail we know now is that periodic distributions will be controlled to certain days of the month and quarter. For example, monthly will be on the last day of the month. We will review each account in distribution and evaluate how this might affect all clients.
In honor of Women’s history month in March, here is a fact to ponder: fewer women invest than men do. Recent surveys of American women report that only 52 percent say they hold stocks and only 23 percent say they invest in financial markets. If you know any women who would benefit from our Intelligent Investment service, please introduce them to us so we can start a conversation.
Sincerely,
Intelligent Investment Management, LLP
