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How Investors Should Navigate The Recent Volatility

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After the stock market (as measured by the S&P 500) dropped by 3.55% yesterday, bringing the decline to nearly 13% in 2022 (and almost 17% for small-capitalization stocks), many investors are panicking.

Losing money is an awful experience and losing money for clients who have entrusted you with their hard-earned savings is even worse. However, there is a significant difference between a temporary loss on paper and a permanent loss of capital.

The past few years have had very little volatility (with the notable exception of March 2020), so this sharp reversal is especially difficult. However, in a typical year since 1980, the stock market has declined by an average of 14% from peak to trough, with midterm election years having historically produced large intrayear pullbacks (17% on average, according to LPL Financial). Midterm election years also tend to produce strong year-end rallies, although admittedly this year has been anything but typical.

Investor Worries

Today’s investors are worried about a host of things, from inflation and interest rates to COVID-19, lockdowns and an economic slowdown in China, and the war in Ukraine. Though I am not downplaying the seriousness of these issues, investors can always find reasons to sell equities. Since 1940 market participants have endured multiple wars, the assassination of a sitting U.S. president, the economic malaise of the 1970s, the September 11 attacks, the financial crisis and the Great Recession, and more recently the COVID-19 outbreak—but investors who have stayed the course and held on have been richly rewarded.

As mentioned above, one of investors’ biggest worries today is inflation. Inflation has been reasonably tame for the past 25 years or so but has recently soared to a 40-year high. Although historically stocks do poorly when inflation rises, they do quite well after it peaks. According to data from Bloomberg and Leuthold, since 1950 the S&P 500 index has increased an average of 13% over the 12-month period following each of the past 13 major inflation peaks. The question, then, is whether inflation has peaked. Of course, no one can know for certain, but signs do seem to indicate that runaway inflation may be ending relatively soon.

Staying the Course

In my opinion, the worst thing investors can do is sell during a panic. Since 2001 the S&P 500 has increased by ~7.5% per year, yet the average investor has received a return of only 2.9% per annum. Why? Because people buy and sell stocks based on emotional reasons and not fundamental ones, buying in when the outlook is rosy (and valuations are highest) and selling out when times are tough (and valuations are lowest).

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I have no idea how much longer this relentless selling will continue, but I do believe there are a whole host of high quality businesses that are positioned to do well over the medium to long term that are selling at significant discounts to what they are truly worth. The near term will likely be bumpy, but I’m optimistic about the future. In fact, now is when investors should be thinking about increasing their equity exposure: historically, the best time to invest is when you feel the worst. Even highly experienced and successful investors find taking this plunge difficult, particularly when prices keep falling, but buying great businesses at marked-down prices and holding them for the long-term is historically how the best returns are made.

Why Don’t You Sell Now, Then Buy When the Situation Stabilizes?

Clients sometimes ask us why we don’t sell in a downturn and wait for the situation to “stabilize.” As simple as it might sound, such an idea is impossible to implement and poses a serious risk to investors’ financial well-being. As famed investor Howard Marks pointed out in his recent memo, missing just a few days could significantly eat into your long-term return. According to data from JP Morgan, during the 20-year period 1999-2018, the S&P 500’s annual return was 5.6%, a figure that dropped to only 2.0% for investors who missed the 10 best trading days (roughly 0.4% of the total trading days during the period). Investors who were unfortunate enough to miss the best 20 trading days made no money at all. The market’s best days tend to follow its worst days, and investors who sell out at these times of maximum pessimism are likely to miss the rebound.

Reasons for Optimism

Today’s headlines are certainly frightening, but not everything is doom and gloom. U.S. consumers are in reasonably good shape with unemployment levels and debt levels at historic lows, major U.S. banks are well capitalized, and the worst of COVID-19 appears to be behind us. In fact, one of the most bullish signs is how negative the current sentiment is, with a recent American Association of Individual Investors survey the most bearish since March 2009 (the month the market bottomed and advanced 23% for the year).

Like everyone else, I am concerned about the recent stock market volatility. How could anyone not be? There’s no sugar-coating it—volatility is awful to go through. But corrections are an integral part of the investment process: Without them, stock pickers like us would have no chance to purchase stocks at deeply discounted levels. It is this volatility that gives us the potential opportunity to generate superior long-term returns compared with other types of investments.

This information is not a recommendation, or an offer to sell, or a solicitation of any offer to buy, an interest in any security, including an interest in any investment vehicle managed or advised by Boyar Asset Management (“Boyar”) or its affiliates. This material is as of the date indicated, is not complete, and is subject to change without notice. Additional information is available upon request. No representation is made with respect to the accuracy, completeness or timeliness of information and Boyar assumes no obligation to update or revise such information. Consult your financial adviser before making any investment decisions. Any opinions expressed herein represent current opinions only and no representation is made with respect to the accuracy, completeness or timeliness of information, and Boyar Asset Management and its affiliates assumes no obligation to update or revise such information. You should not assume that any investment discussed herein will be profitable or that any investment decisions in the future will be profitable. Past performance does not guarantee future results. Certain information has been provided by and/or is based on third party sources and, although believed to be reliable, has not been independently verified and Boyar Asset Management or any of its affiliates is not responsible for third-party errors. Any information that may be considered advice concerning a federal tax issue is not intended to be used, and cannot be used, for the purposes of (i) avoiding penalties imposed under the United States Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter discussed herein.

Any results mentioned, do not necessarily represent the results of any of the accounts managed by Boyar Asset Management Inc., and the results of Boyar Asset Management Inc. accounts could and do differ materially from any of the results presented. While the results presented show profits, there was the real possibility of a permanent loss of capital. This information is for illustration and discussion purposes only and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Boyar Asset Management Inc. is an investment adviser registered with the Securities and Exchange Commission. Registration of an Investment Advisor does not imply any level of skill or training. A copy of current Form ADV Part 2A is available upon request or at https://adviserinfo.sec.gov Please contact Boyar Asset Management Inc. at (212) 995-8300 with any questions.

Finance

Teacher, Police And Firefighter Pensions Are Being Secretly Looted By Wall Street

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America’s severely underfunded public pensions are allocating ever-greater assets to the highest cost, highest risk, most secretive investments ever devised by Wall Street, such private equity, hedge funds, real estate, and commodities—all in a desperate search for higher net returns that, not surprisingly (given the outlandish fees and risks), fail to materialize. Transparency—public scrutiny and accountability—has been abandoned, as pensions agree to Wall Street secrecy schemes that eviscerate public records laws.

Our nation’s state and federal securities laws are premised upon full disclosure of all material risks and fees to investors: “Read the prospectus before you invest,” is the oft-cited warning by securities regulators. Nevertheless, teachers, police, firefighters and other government workers today are not allowed to see how their retirement savings are managed or, more likely, mismanaged by Wall Street.

For nearly a decade, the United States Securities and Exchange Commision has warned investors that malfeasance and bogus fees are commonplace in so-called “alternative” investments and, more recently, Chairman Gary Gensler has called for greater transparency to increase competition and lower fees.

Gensler has asked the agency’s staff to consider recommendations on ways to bring greater transparency to fee arrangements in private markets. “More competition and transparency could potentially bring greater efficiencies to this important part of the capital markets,” he said. “This could help lower the cost of capital for businesses raising money. This could raise the returns for the pensions and endowments behind the limited partner investors. This ultimately could help workers preparing for retirement and families paying for their college educations.”

Gensler has stated he would like to see a reduction in the fees these investments charge and has also commented on industry abuses such as ”side letters” which permit private funds to secretly give preferences to certain investors—preferences which harm public pensions.

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But that’s not good enough to protect public pension stakeholders.

No one—including the pensions themselves—seems to care that the government workers whose retirement security is at risk are being kept in the dark.

The SEC needs to do more—actually alert public pensioners as to those abuses the Commission knows full well are rampant, at a minumum. Advise them, Chairman Gensler, to demand to see and read prospectuses and other offering documents related to their hard-earned savings.

Does the SEC think it’s kosher for Wall Street to conspire with public pension officials to withhold this information from investors—any investors?

Since my 2013 forensic investigation of the Rhode Island state pension exposing gross mismanagement by then General Treasurer Gina Raimondo which I accurately predicted would cost workers dearly; my 2014 North Carolina state pension investigation exposing that $30 billion in assets had been moved into secretive, offshore accounts and, most recently, my investigation of the State Teachers Retirement System of Ohio, I have provided my expert findings to the SEC staff for their review. Each and every public pension forensic investigation I have undertaken has extensively discussed Wall Street secrecy schemes that enable looting. In my book, How To Steal A Lot Money—Legally, I quote disclosures from SEC filings that detail industry abuses.

Join me, Chairman Gensler, in giving government workers a clue, a glimpse, a peek, at the alternative investment abusive industry practices that are carefully guarded by Wall Street and being hidden from them.

Teachers, police and firefighters deserve a fighting chance to protect their retirement savings.

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Finance

It Is Time To Buy Bonds

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US 10-year note prices are likely to rise through August. The monthly histogram below shows that July and August have been the two strongest months for the note price.

Monthly Return- US 10-Year Notes

Blue: Average Percentage Change

Red: Probability of a rise on that day

Green: Expected Return (Product of the first 2)

These numbers are static in the sense that they change little over the years. This is only one cycle, the one-year cycle, whereas there are many cycles operative at any one time. In order to get a reading on such other rhythms, a scan is run to identify other profitable price cycles. The graph below reveals the most valuable cycles that are operative at any one time.

10-Year Note Monthly Cycle

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These cycles reinforce the seasonal tendency for notes to rise. Prices have risen in 60% to 65% of the time in these summer months. With the dynamic cycle also in ascent, the probabilities rise to about 65% to over 70%. There are similar and supportive developments in the Japanese and German fixed income markets.

The cycle projection must be confirmed by market activity. The daily graph reveals that price broke through a downtrend line.

10-Year Notes Broke Through Resistance

Here is a helpful sentiment indicator that supports the bullish view. The cover page of this week’s Barron’s points to much higher rates. Applying contrary opinion, this suggests lower rates and higher note and bond prices. The first objective is 123.0.

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Finance

Will There Be War Over Taiwan – The Next Spy Thriller

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I usually go through a rhythm of reading one or two serious books, followed by a few works of fiction and with summer on the way I wanted to highlight a few of both. In that regard I have just finished Laurence Durrell’s ‘White Eagles in Serbia’, an old-fashioned espionage thriller where the hero Colonel Methuen is dropped behind enemy lines in post war Serbia (he speaks excellent Serbo-Croat) and becomes embroiled in a violent plot to overthrow Tito.

The book is a warm-up to reading Durrell’s ‘The Alexandria Quartet’, a work that nearly won him the Nobel Prize. Durrell was part of an interesting Anglo-Irish family, who largely considered themselves Indian – his brother Gerald, the naturalist and writer, touches on this in ‘My Family and Other Animals’.

Thrillers

Though I am not an expert on these matters, I found ‘White Eagles’ a more realistic account of espionage than much of what we see in the media today (Mick Herron’s ‘Slow Horses’ is good), and overall it is a tale of derring-do that is more in keeping with the work of the founding fathers of the genre – Eric Ambler, John Buchan, Erskine Childers and Ted Allebury for example.

It also made opportune reading given what seems to be an epidemic of espionage – with reports of the Chinese hacking group APT40 using graduates to infiltrate Western corporates and notably the admission by the head of Switzerland’s intelligence that Russian espionage is rife in that country (notably in Geneva – for which readers should consult Somerset Maugham’s ‘Ashenden’ as background material).

These and other trends – such as the outbreak of a heavy cyber battle last week (against Lithuania and Norway for instance) and the increasingly public ‘clandestine’ war between Israel and Iran (they have just sacked their spy chief) point to a world that is ever more contested and complex.

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Secret World

One of the new trends in the space is cyber espionage – both in the sense of stealing state and industrial/corporate secrets, influencing actors (such as the manipulation of the 2016 US Presidential election) and outright acts of hostility such as the hacking of public databases and utilities (i.e. healthcare systems). Here, if readers are looking for some serious literature I can recommend two excellent books – Nicole Perlroth’s ‘This is how they tell me the world ends’ and ‘Secret World’ by Christopher Andrew.

I am personally more intrigued by the difference between a spy and a strategist. A spy’s work could well be described as the pursuit of information about someone who is acting with a specific intent, as well as a sense of their reaction function. There are plenty of examples – from Christine Joncourt (‘La Putain de la Republique’) to Richard Sorge (see Owen Matthews’ ‘An Impeccable Spy’).

In contrast a strategist may try to plot trends and the opportunities, spillovers and damage they may cause. The US National Intelligence department is good in this regard, becoming the first major intelligence agency to publish detailed warnings on the side effects of climate damage.

Spies and strategists might work together, but history is full of examples (LC Moyzisch’s ‘Operation Cicero’) where intelligence fails to make it through the strategic process or is simply ignored for political reasons (might the early warnings on the invasion of Ukraine be an example).

Asia next?

In the spirit of the Durrells and Flemings of the world, what issues might be of interest in terms of digging into unknown knowns and unknown unknowns. Here are a few ideas, most of which are Asia focused (we might see an uptick in Asia focused thrillers).

On the diplomatic front, an interesting recent development was the visit of Indonesian president Joko Widodo to Ukraine, and then Moscow. It was a rare visit to Ukraine by an Asian leader and potentially marks the emergence or at least aspiration of Indonesia (population 273 million) as an emerging world diplomatic player. What has intrigued me so far is that there has been little coordination by the populous emerging (largely Muslim) nations (Nigeria, Indonesia, Pakistan) in the face of high energy and food prices, and that potentially Widodo could play a unifying role here.

Then, still in Asia, but on a more deadly footing, if the Western commentariat is to be believed, China is preparing an assault on Taiwan, and looking to learn from Russia’s military errors in this regard. Other countries are reacting, and I suspect that there will be much intrigue around Taiwan’s ability to acquire sufficiently powerful ballistic missiles that could strike the coastal cities of China, and relatedly how long might it take Japan to produce nuclear missiles (my sources say they could very ambitiously do it in five months!).

So, whilst the espionage literature of the 20th century has tended to be focused on Geneva, Berlin and London in the 21st century we may find ourselves reading about ‘behind the lines’ exploits in Jakarta and Tanegashima.

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