Series: Blessings & Curses of Inherited Wealth – The Guide for Inheritors 

Introducing James E. Hughes, Jr., Esq. the author of Family Wealth: Keeping It in the Family, and of Family: The Compact Among Generations.

James E. Hughes, Jr., Esq. was the founder of a law partnership in New York City specializing in the representation of private clients throughout the world. He is now retired from the active practice of law. He is a frequent lecturer for and member of the Purposeful Planning Institute, an early member of the Family Firm Institute, and has spoken at a number of their annual gatherings. He is an advisor to SAFOX in Shanghai, whose mission is to advise Chinese families on how to nurture multi-generational success. He has frequently addressed international and domestic symposia on avoiding the “shirtsleeves to shirtsleeves” trap. Mr. Hughes’ focus is helping families flourish by promoting the growth of their “capital” in many areas: not only financial but also human, intellectual, social and spiritual. Mr. Hughes is a Fellow of Wise Counsel Research Foundation; co-author with its founders, Keith Whitaker and Susan Massenzio of “The Cycle of the Gift” and “The Voice of the Rising Generation”; and co-author, with Mr. Whitaker and Hartley Goldstone of “Family Trusts”.

Mr. Hughes’ wisdom fits perfectly into our series on the blessings and curses of inherited wealth. He emphasizes the long-term, patient vision a great family needs and the importance of recognizing that enduring multi-generational wealth requires more than mere money. We have an old saying in America: “shirtsleeves to shirtsleeves in three generations.” This refers to the cycle of earning and spending that depletes many a pool of family wealth over decades.

Mr. Hughes reminds us: “As it takes 150 years for a copper beech tree [ metaphorically, a great family] to mature, plant today because there is no time to waste.” He points out that “The vision underlying a system of family governance must be the enhancement of the pursuit of happiness of each individual family member as part of the enhancement of the family as a whole for the purpose of achieving the long-term preservation of the family’s wealth: its human, intellectual, and financial capital.”

While we at Sicart can be successful long-term investors and capital allocators, managing fortunes of families over generations, Mr. Hughes inspires us to look at the family’s prosperity and well-being in a broader, more holistic way.

We had the pleasure of discussing with Mr. Hughes a number of lessons he has shared with families over the decades. Here are some highlights:

The importance of family governance

In Family Wealth, he warns: “Without careful planning and stewardship, a hard-earned fortune can easily be dissipated within a generation or two.” Furthermore, “Wealth preservation is a dynamic process of group activity, or governance, that must be successfully re-energized in each successive generation to overcome the threat of entropy.”
Mr. Hughes explains: “If a family thinks it is in business to enhance the lives of its individual family members, it discovers the most powerful form of preservation thinking it can do.”
We are reminded of the importance of governance beyond financial capital alone: “Very few families have understood that their wealth consists of three forms of capital: human, intellectual and financial.”

Constant growth and renewal matter most: “Families fail to understand that wealth preservation is dynamic, not a static process, and that each generation of the family must be a first generation – a wealth-creating generation.”

There are three steps that we need to keep in mind:

1) “Once a family understands that joint decision making is a form of governance, its next step is to choose the system of governance that will serve the group of people who will be affected. To put it another way, the family must choose the system of governance that will cause the greatest number of family members affected to accept the decision as fair and to accept the individual consequences that flow from it.”
2) “The second step is adoption of a formal process for each successive generation to reaffirm its acceptance of the family’s system of governance.”
3) “The third step in achieving a successful system of family governance is the adoption of a process to amend its practices as the family evolves. “
Keeping the family narrative alive

In Family Wealth, we learn about the need to nurture each family’s identity: “Families fail to tell the family’s stories. These stories are the glue that binds together the individual members of the family. Family stories give members a sense of the unique history and values they share, their ‘differentness.’ A family that does not inoculate its young against childhood diseases would be risking its most precious assets. Failure to inoculate the family’s young against entropy with the vaccine of its history and the values that are contained in its stories is similarly risky.”
The importance of ritual in family’s long-term success

Mr. Hughes tells us: “Families who recognize with ritual the important passages in their members’ lives seem to fare better at overcoming the shirtsleeves proverb. This should not be surprising, since the creation and practice of rituals marking important developmental steps in the life of a human being are at the core of successful tribal life. Tribes are extended generations of an original family.” He mentions coming of age, arrival of a new member, and incorporation of new members from outside as some of the important life stages that the rituals could honor. He adds, “Ritual thus serves two purposes in the life of a family seeking to thrive for many generations. It helps individuals develop from one life stage to another, and it helps the family succeed by promoting the development of its members.”

The family balance sheet, income statement and the long-term investment horizon

In Family Wealth, we are introduced to a broader definition of a family balance sheet: “The family balance sheet and family income statement are key tools for measuring the health of a family’s long-term wealth preservation business.” Among the family’s assets, Mr. Hughes lists intellectual, financial, and social capital. Liabilities can range from failure of family governance, death, and divorce to inflation and income taxes. In Hughes’ view an income statement should measure the family’s annual performance in managing its human and intellectual capital.
Mr. Hughes extends the usual long-term investor horizon to 100 years (or three generations) for family capital. He reminds us: “Families often fail to apply the appropriate time frames for successful wealth preservation.”

The complexity of interwoven family relationships

In Family Wealth we find this suggestion on managing the complexity of family relationships: “One of the things that we recommend families do at their governance meetings is to make a diagram of the family as a whole, of all of their interwoven relationships, and then make a similar diagram of all the individual relationships each family member shares with all of the other family members.” He adds: “For family members and their advisers to understand the complexity of a family’s relationships and their unique character as a composite of those relationships helps the family to understand how it exists and how it functions.”

A family bank enhancing its intellectual and human capital

Mr. Hughes introduces the concept of a family bank with its unique role in strengthening the family: “The family bank provides a means for a family’s wealth to be leveraged by making loans available to family members on terms not available commercially. These are loans that would be considered high risk by commercial bankers but are low risk to the family because of their contribution to the family’s long-term wealth preservation plan. Loans from a family bank are usually for two purposes: investment, to increase the family’s financial and intellectual capital; or enhancement, to increase the family’s intellectual and human capital.”

Control without ownership

In Family Wealth, we find this valuable advice: “Control without ownership expresses a way of thinking, a philosophy. This concept, when practiced, powerfully assists a family to overcome the proverb ‘shirtsleeves to shirtsleeves in three generations.’ Control without ownership means that each family member adopts the idea that ‘I am the owner of something if I control it, even if I am not the legal owner of that thing.’”

Mr. Hughes further adds: “As the years have passed, I have discovered that people are in fact very willing to give up ownership, but not control of decision making. Fear of loss of control is often so profound that it continues to permeate some individuals’ planning processes after their deaths.”

Finally, we read: “Every plan for the long-term wealth preservation has to take the issue of control into account and find a way to deal with it positively.”
Beneficiaries and trustees

Mr. Hughes tells us “Two complex relationships are formed between a beneficiary and trustee when a trust is created. First is the legal relationship, and the resulting individual and joint responsibilities created by that relationship. Second is the behavioral dynamic between a beneficiary who is fully educated on what it means to be a beneficiary, and a trustee who understands that his or her role is to be the beneficiary’s representative.”

He adds, “When a beneficiary and a trustee fully appreciate each other’s roles and responsibilities in the governance of the trust, their understanding advances the family’s long-term wealth preservation plan by making joint governance of the trust a positive experience for both parties. “

The role of personne de confiance

In Mr. Hughes’ book Family: The Compact Among Generations, we are introduced to the role of personne de confiance. He explains how “Personne de confiance almost always begin their careers as personnes d’affaires” and how “for centuries, these devoted professionals sought to achieve the highest status that family could bestow: the personne de confiance.”
He further shares: “In my father’s explanation, there lies another clear way to distinguish between the personne d’affaires, the person offering advice or knowledge, from the personne de confiance, the person offering courage. The person offering knowledge fills a gap in client’s needs at a level that requires no ongoing lifelong relationship with the client.”
We also learn that: “The person offering courage asks very different questions of the client, often bearing on a transition in the life of a family member or in the life of the family as a whole. Courage is the defining word because the serving professional, as personne de confiance, will frequently be expected to provide the courage needed for decision at hand, when the client knows the right answer, but lacks the resolve to act on it.”

Personne de confiance plays a role of a confidante, intermediary, among others. We, at Sicart Associates, grew to appreciate the importance of personne de confiance in a long-term success and well-being of a great family.

Family philanthropy

Family philanthropy is a frequently recurring topic that we have discussed in earlier parts of our series. In Mr. Hughes’ book, we are reminded of its importance: “Philanthropy is first, perhaps, the fundamental parent expression of personal and family values. If the family mission statement is an expression of these values, philanthropy is often the best way to move them into practice. Philanthropy can often be a means for family members who are isolated from society by their wealth to connect with the larger issues of the world and to find an active and meaningful place in it.”

The roles of mentors in the family

In Family Wealth, we learn: “Mentor represents two roles: first, that of regent, a person of deep trustworthiness who can safely hold the space for another, while that other goes on a quest; second, that of the elder and teacher who can instill knowledge in another, particularly wisdom about the other person’s journey of self-discovery.”
The author concludes: “Successful mentoring is a dialogue in which both parties learn something essential.”

Grandparents and grandchildren - natural allies

Mr. Hughes highlights the importance of a unique relationship that grandparents have with their grandchildren: “History and literature, as well as my own personal experience, all indicate that a grandparent’s relationship with his or her grandchildren is filled with pure love. Grandparenting offers the
chance to teach the family positive virtues, stories, and myths without the parental obligation of being concerned with discipline and passing on by admonition the family’s negative experiences.”

In our conversations Mr. Hughes added: “Many surveys of Millennials and GenXers advise that these groups feel their grandparents are those they admire the most—not celebrities.”
Family inversions, a new phenomenon

Mr. Hughes also commented on an interesting demographic shift that affects planning across generations. Historically the field has assumed an ever-increasing number of family members as generations evolve. However, he says, “In every developed country of the world the birth rate is far below replacement and even lower when applied only to the 1%. Thus, the reality for almost all families in the developed world (and now rapidly in the developing world among the equivalent 1% populations), families are inverting. Clearly within the next two family generations many of these families, as demography predicts, will have branches go extinct if not the family itself. I believe the planning community has missed this completely and needs to understand that its statistics about families’ unfettered growth are not only wrong -- they are predicting the exact opposite of families’ realities. Helping families project their actual realities is critical to their planning realistically and fruitfully.”

Our highlights by no means cover all the great lessons from Mr. Hughes’ book – Family Wealth. We highly recommend exploring it in more detail, as well as his other publications including The Cycle of the Gift: Family Wealth and Wisdom, and Family: The Compact Among Generations.

Bogumil Baranowski – July 18th, 2017
Disclosure:

This article is not intended to be a client‐specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.

Photo: Badder Manaouch

Introducing Alexandre Mars, a New York City based, French-born serial entrepreneur, and engaged philanthropist who, in 2015, was named one of New York City’s top 20 philanthropists under 40 by the New York Observer.

In our series “Blessings & Curses of Inherited Wealth – The Guide for Inheritors”, we have had the pleasure to investigate inheritance with inheritors, experts and authors,with a variety of stories and experiences. The one topic that comes up very often is philanthropy. A lot of inheritors and first generation wealth creators find it very fulfilling to give back. It helps them find a fuller sense of purpose, and makes them feel part of the community.

As much as philanthropy is a worthwhile, inspiring pursuit, it can have its challenges. Alexandre Mars took upon himself making giving back easier, more efficient, and smarter by employing his skills, talents, and experience acquired in business, entrepreneurship and technology.

Mr. Mars’ Epic Foundation links wealthy young entrepreneurs with charities helping children and young people. Smartphones, apps, virtual reality headsets are the tools used by Epic to jumpstart a wave of innovation in philanthropy; I had the pleasure of attending their gala last year at the French Consulate in New York City. and I learned a lot about how connecting donors with those who benefit from their donations is changing.

Alexander Mars was kind enough to sit down with us and tells us more about his philanthropy.

What was the inspiration for the Epic idea?

I always knew I would use my success for good- it was embedded in me from a young age. Upon selling my fifth startup, I went on a journey to decide how exactly that would be. My wife and I pulled our kids out of school and spent months traveling the world- from Peru to Mongolia, Sydney to Moscow- sitting down with local people, philanthropists, policy makers and NGOs, asking “how does it work in your country, how do you think we can have an impact, what can be different in the near future?”

This period of market research revealed a major gap between charities that need funding and those who want to give: 1) The charitable sector has been slow to adopt technology for the purpose of donor engagement. 2) Non-profits are still communicating with their donors through traditional means (i.e. an annual report). 3) People are confounded by the number of organizations supporting each cause and lack the time, knowledge or trust in their work to contribute.

As an entrepreneur, I was able to identify these gaps and understand how I could use my two decades of skills and experiences to fill them in. Thus, Epic Foundation was born.
Your motto is: “give better, give smarter, give more” – could you elaborate on those three main goals.

Our tag line is aligned with the gaps we’re trying to fill- mainly the lack of knowledge, time and trust people have in their charity. We’re tapping into a wealth of resources available to us through innovation, design thinking, etc. to overcome the barriers people face when they’re giving. We’re allowing them to feel more confident in their donation which in turn makes them want to give more.

How does technology affect philanthropy?

The same way it is affecting every other industry today- it’s driving change. Philanthropy has been shifting for several years. On one hand, the conveniences of technology have allowed everyone to see the perils of the world more easily, so the perception of philanthropy as a hobby for wealthy retirees no longer applies. The narrative that you should wait until you have the wealth or the time to give back is no longer relevant.

On the other hand, technology is facilitating the ways people are getting involved. One obstruction preventing people from giving is the lack of transparency in where their money is going. Technology is able to overcome this. As in the case of Epic, we enable our donors to track their social portfolio online– similar to how you can monitor a stock portfolio – to help people understand how their donation is creating impact.

The younger generation wants to give more, and start giving earlier – what’s your advice for them? How can Epic play a role in their pursuit?

It’s no surprise that, as the nature of philanthropy is changing, so are the types of people who are coming forward to give. The new generation of donors are tech savvy, hungry to get involved and make a powerful impact in the world today. They want to go beyond giving money and become more active in helping the causes they care about.

For this generation, the lines between philanthropy, consumption and work are blurring as young people seek to align different elements of their lives with their values. It’s a powerful movement and young people should recognize this strength. As the generation that will soon dominate the workforce, they can cover some serious ground in urging their employers and elders to get involved.

Epic is advocating for young workers’ involvement in philanthropy by helping businesses integrate ways for them to give to charity. For example, we have advised several entrepreneurs, family offices and even companies, from luxury retailers to blue-collar manufacturing corporations, on how they can institute payroll giving. It’s a simple option added to your paycheck that turns leftover change into impact. That sixty cents at the end of your paycheck may be meaningless to you, but when added to the pool of leftover change from 1,000+ other employees- that’s meaningful.

There are many causes, and many places in need. How do you choose your area of focus? What are they?
All of our organizations support children and youth. This focus acts as an umbrella with four targeted areas of impact directly beneath- rights & protection, health, education and economic empowerment.

Traveling the world with my own children has given me the privilege to meet and live with families around the world. It’s clear to me that the challenges we as parents and citizens are all so worried about, such as climate change, will be faced and fought in full by our children. To solve these big global challenges we have to invest in empowering the next generation of global leadership: our children and youth around the world.

You put a lot of emphasis on monitoring your impact. How do you accomplish it? Why is it so important?

This need has surfaced through the abilities of technology to finally allow us to tackle it in a simple and effective manner. Gone are the days people rely on end-of-the-year paper reports because that’s the only manner of engagement with a nonprofit that existed. If technology allows us to log on and check our investment portfolios, why shouldn’t the same platform exist to check our impact portfolios as well?

Money is money. The desire for consumers to know what their money is buying is no different from donors who want to know where their money is going. This has become even more important as the news of scandals and mismanagement of funds from a small number of NGOs splashed across page 6 have eroded people’s confidence in charities. Our monitoring team ensures that donors receive a true and fair assessment of organizations, enjoy transparency and accountability and significantly mitigate the risk of an underachieving philanthropic strategy.
Lastly, you allow donors to experience their impact? How do you do that? Why do you think it plays such an important role especially with younger donors?

For years, giving was seen as a one-sided action which is why we viewed those who don’t give as “selfish”- it’s an emphasis on the self. You can really see this has started to change with new terms such as “impact investing” or “corporate social responsibility” gaining momentum in recent years. An investment means you get something back, so it’s a clear shift from the previous narrative.

These terms run parallel to the needs of a new generation of donors who desire a two-way conversation around giving. We realized this early on, which is why it’s so heavily embedded into what we do, but we also saw growth in people focusing on new experiences. The younger generation is keen on showing what they’re engaged in. You don’t see their Instagram feeds with 10 pictures of their new sofa. Instead, you see them exploring new places, trying new things, volunteering, etc.

We organize on-site donor visits to some of the 30 (and counting!) organizations we support. There’s power in a simple site visit that can turn curiosity in stopping by the drop-off center from Ali Forney Center (one of our NYC-based organizations helping homeless LGBTQ youth), for example, into suggesting a new activity helping the beneficiaries, or identifying a way to donate your time to the cause you support as well.

For those who cannot physically visit the organizations, we’ve introduced virtual reality (VR) capabilities in a series of VR-based films providing a window into the work of the organizations we work with. People can step into a classroom in East Africa or a children’s hospice in the UK without ever stepping foot out of their living room. It’s pretty powerful stuff! I still get excited waiting for someone’s reaction about 5 seconds after I put a VR headset on them and start the video.

Thank you for taking the time to discuss with us new ways of giving back for the new generation of philanthropists.

Photo: Annie Spratt

Introducing Jeffrey Condon the Author of Beyond the Grave: The Right Way and
the Wrong Way of Leaving Money to Your Children (and Others).

There are many books about the challenges and dilemmas of inheritance planning, but very few are
written in a simple, easy-to-understand, relatable way. Beyond the Grave is full of examples, candid
advice, and straightforward answers to some very difficult questions.

We learn about the importance of having an inheritance plan, and the author explains that there is the
right, and the wrong way. We are reminded how crucial it is to treat beneficiaries equally. Among many
other lessons, we also find an interesting discussion of one of the most frequent questions when it comes
to inheritance – how much is too much?

With his late father, Gerald M. Condon, Jeffrey is the co-author of Beyond The Grave: The Right Way
and the Wrong Way of Leaving Money to Your Children (and Others). Published in 1996 and revised in
2001, it was updated in 2014. The Wall Street Journal has called Jeffrey’s first book “the best estate
planning book in America.” In 2008, Jeffrey authored The Living Trust Advisor: Everything You Need to
Know About Your Living Trust (John Wiley & Sons).

In this third part of our series on inherited wealth, we feature selected highlights from the book. We had
the pleasure of getting Mr. Condon’s feedback and discussing some very interesting aspects of estate
planning with him in the process.

Beyond the Grave takes away the mystery and confusion, and shines a bright light on some of the
dilemmas, explaining it all in a simple way. The book is full of “aha” moments, where Mr. Condon tell us
what he used to believe as a young attorney, what people’s intuition might suggest, and what has really
worked for his clients over the years.

What is an inheritance plan?

Mr. Condon provides a straightforward definition. He writes: “Whatever the form, an inheritance plan
boils down to one purpose: It is your instructions for who inherits your money and property, when they
inherit, and on what conditions they inherit.”

If you have ever been intimidated by the idea of establishing your own inheritance plan, now you know
that it’s an answer to three questions: who, when and how? Let’s begin.

The right way and the wrong way
Before we too quickly conclude that creating an appropriate inheritance plan is simple, Mr. Condon
shares with us: “I have learned the hard way that there is a right way and a wrong way of leaving money
and property to spouses, children, grandchildren, and other heirs. “He adds: “This book will open your
eyes to the panorama of potential family conflicts and problems that often occur in the inheritance area,
most of which you never before considered.”

Our perfect children
We read in the book: “In every literate society, there is this saying about inheriting wealth: If you really
want to know a person’s true character, share an inheritance with that person. This is sage advice. Having
observed what happens between children following their parents’ death, I have arrived at one indelible
conclusion: Your children may be perfect – but you really don’t know them until they divide your
money.”

As we later learn in the book, planning for a variety of scenarios (and some unexpected sources of
trouble) may help children divide parents’ money in a more orderly fashion without unnecessary
conflicts.

Equal or not

This is a question that seems to be on many people’s minds: how should I divide the inheritance? Do I
give more to the financially struggling kids and less to the more successful? How do I measure their
success anyway? Is there a way to be fair? Mr. Condon simply says – give to them equally. Always. Do
as much as you can to balance their inheritances, and do it before you die.

He writes: “If you care about maintaining family harmony after your death, leave your money and
property to your children equally, regardless of their economic circumstances or their beau geste
declarations.” He adds further: “Even the most seemingly harmless inequality can cause problems.”

When should the kids get the inheritance

Mr. Condon tells us that interval allocation doesn’t work. This is the idea of giving beneficiaries access to
their inheritance in installments at pre-determined ages. Condon states, “Although Interval Allocation
remains popular and is frequently used, I believe it is fatally flawed. Why? Because it simply does not
work! It may do little, if anything, to lead the financially immature child to maturity.”
He is in favor of “the wait and see program” where an inheritance plan provides that a Trustee controls
the inheritance and measures the beneficiary’s progress in terms of responsibility, stability, independent
earning power. The Trustee then adjusts the age when the legatee receives control. This leaves more
flexibility to the Trustee, and helps minimize unwelcome consequences of giving too much too early -- or
too little too late.

Motivating the inheritors

In Beyond the Grave, we hear that “there is no better incentive than money to motivate your child toward
gainful employment.” The author writes: “the dollar-for-dollar incentive is the best thing I’ve found to
‘coerce’ a child into getting a job.”

I found the dollar-for-dollar concept refreshing. In this situation, the Trustee matches what the beneficiary
earns on his or her own. Again, Mr. Condon’s advice is very blunt, and straightforward, and worth serious
consideration.

How much inheritance is too much

Inheritance itself should be more a blessing than a curse, as the title of our series discusses.
Mr. Condon shares with us: “Since Beyond the Grave was first published, this concern has become the
‘hot’ topic in family inheritance planning. Never before have I encountered more people who fear that a
large inheritance will lead their responsible children to become classic ne’er-do-wells who hang out at the
country club or who will acquire bad habits.”

He adds: “With the ‘New Economy’ having created more millionaires than ever before in American
history, this issue will undoubtedly be considered and addressed more than ever before. But one does not
have to be a Captain (of Industry) or a millionaire to share the concern that a significant inheritance can
lead a ‘good kid’ down the path of irresponsibility. It is simply a natural feeling to want our children to
make the most of their lives.”

Mr. Condon recommends his version of incentive-based planning, while informing us that the typical
“carrot-and-stick” methods do not work: “I prefer an incentive-based plan not built on reward but on cold,
hard reality of ‘that’s all you get.’ This is a no-strings-attached plan that states, in essence, as follows:
‘Child, when we die, your inheritance will be held by a Money Manager who, for the rest of your life, will
pay you an amount equal to the monthly support we have given you during our lifetime.’”
He adds: “This is more than an incentive-based plan – this is a reality check!”

Controlling child’s life from the grave

Mr. Condon quotes examples of parents who want their kids to follow certain rules or change their
behavior and try to use inheritance to steer their kids that way. He shares: “For them, the inheritance plan
is not just a way to transfer their wealth when they die. It is a tool to control their child’s life from the
grave.”

On one hand, he writes: “I am a firm believer in inheritance conditions when they are designed to prevent
the inheritance from being squandered due to the problems in your children’s lives – addiction, financial
immaturity, disability, marriage, and divorce problems, and the like.”

On the other hand, he adds: “You know that I am somewhat opposed to rewards-based inheritance
planning for children whose only addiction is avoiding a conventional lifestyle or whose only disability is
not being desirous of attaining education or employment. Not only do I instinctively react against parents
attempting to control their children too much from the grave, I believe these plans do not ensure that the
goals to be sought will be achieved.”

Child’s trustee

Mr. Condon talks about the importance of ensuring the execution of your wishes when it comes
inheritance. The Trustee plays a key role here. He shares in his book the three alternatives: a private
individual, a banking or other financial institution, or the child himself or herself.
There is no one-size-fits-all answer here, but one lesson resonated with me the most. Mr. Condon
counsels against naming one sibling as Trustee of the other. He writes: “There are sensible reasons that
make it seem right to appoint a child’s sibling a Trustee. Early in my practice, I invariably agreed with
this choice. But since then clients have died, and I have seen what happens when one child holds money
for another, inevitably, there will be stress on – or the destruction of – the sibling relationship. Why?
Because when one sibling holds money for another, the tie that binds is no longer only blood – it is blood
and money.”

Succession of the family business

With the majority of new wealth coming from new businesses, business succession becomes a frequent
challenge for successful wealth creators and their beneficiaries. Mr. Condon reminds us: “Statistically,
two out of three family businesses do not survive the death of the founding parents. The federal estate tax,
the death of key men, a lack of management skills, no child with desire to take over and carry on – all
these problems work against the family business surviving into the next generation.”
Here, Mr. Conon emphasizes again the importance of treating all siblings equally. If only one of them is
interested in the family concern, he suggests that child should inherit the business, while the other(s)
should receive assets of equal value or an insurance policy on the parent’s life (if insufficient assets are
available).

The author warns us about dividing a business, as when one sibling holds a majority interest. Conflicts
may arise with the minority-share sibling(s) receiving lesser distributions. These situations can lead to
litigation, putting the business at risk.

Thinking of grandchildren

In Beyond the Grave, we learn how all grandchildren should be treated equally as well. If grandparents
have fears about the use of money, Condon suggests urging grandchildren to account for the gifts they
have been given, and explain what they are doing with the gifts.

Mr. Condon draws our attention to an important challenge, though: “If your child is like most children,
his attitude about your lifetime gifts to your grandson is: ‘Dad and Mom, your gifts are great but don’t
give him too much. Leave your money to me and I will take care of my child.’ If you don’t follow this
thinking, your child may resent that you gave away some of his inheritance. The result is that you may
have created enmity between your child and your grandson. Before you make an appreciable gift to your
grandson, I urge you to be sensitive to this possibility.”

Leaving your money to charity

It’s a frequent question - how do we prepare for leaving some or all of our fortune to charity? Mr. Condon
tells us that there is no better way than both doing your research on a specific charity, and getting
personally involved before committing your fortune to the cause.

Cautionary tales

Towards the end of the book, Mr. Condon shares some really interesting cautionary tales. Not to give too
much away, we’ll mention two.

In the first tale: “Probate is the ‘Lawyers’ Retirement Fund,’” Mr. Condon introduces us to a couple who
own a house. It’s a second marriage for both, and both have children from their first marriage. Although
the husband left a will, the author points out that “this Will was self-executing. In order to carry out Mr.
Schultz’ wishes, the Will had to be submitted to court for ‘probate,’ which, in a nutshell, is the courtsupervised
process of transferring assets from the dead to the living. The probate process took about
thirteen months and about $12,000 in court costs and attorney’s fees… but she ultimately ended up with
the entire house.”

He adds: “I advised Mrs. Schultz that now that she owned the entire house, she should have a Living
Trust. With a Living Trust, she retains ownership and control of the house during her life. On her death,
the Living Trust then transfers the ownership of the house to her children without that probate court
nonsense.”

That’s not the end of the story, though. Mrs. Schultz didn’t act on the advice, and a year later, when she
passed away, her children had to face the probate process again, with all the time and money that it
consumes.

In the second tale, Mr. Condon shares a lesson: “You have to predict the future about the nature of the
relationship between Trustee and Beneficiary.” He writes: “Getting the right trustee to manage the family
money and property for the surviving spouse’s benefit is a very important choice. If the surviving spouse
and the trustee can’t get along, problems and unhappiness will arise.” We learn further: “My personal
preference is the professional trustee, which is contrary to most clients’ decisions. If a personality or
management-driven conflict arises between the beneficiary and the individual assigned by the bank or
other institutional trustee to interact with the beneficiary, a different person can be assigned.”
Final thought: should you tell your children about your inheritance plan?

Mr. Condon closes the book with one of the biggest questions – should you tell your children about your
inheritance plan? He writes: “I never cease to be amazed how often clients ask this question when
common sense dictates it is the right thing to do. Nevertheless, clients seem loath to discuss inheritance
issues with their children, leaving their children in a mystery as to the contents of their parents’
inheritance plan. “

He advises: “Even if discussing inheritance issues with your children goes against your grain, I strongly
encourage you to do it anyway. If you care enough, this is the true solution to potential conflicts and the
simplest way to their resolution.”

There is much more in the book than we have been able to cover in this article. The book discusses
further how a proper inheritance plan can help avoid probate, and allows you to take advantage of estate
tax exemption, and more. We hope you will enjoy it as much as we did.
Bogumil Baranowski – February 24th, 2017

Disclosure:

This report is not intended to be a client‐specific suitability analysis or recommendation, an offer to
participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report
as the sole basis for investment decisions. Do not select an asset class or investment product based on
performance alone. Consider all relevant information, including your existing portfolio, investment
objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general
informational purposes only and is not intended to predict or guarantee the future performance of any
individual security, market sector or the markets generally.

Photo: Miguel A Amutio

Our guest is Ann Perry, the author of The Wise Inheritor: A Guide to Managing,
Investing and Enjoying Your Inheritance.

It’s rare to see a book about inheritance written from the perspective of the heirs. Ms. Perry’s
grandmother popularized the first widely marketed Go Fish card game, helping lay the
foundation for Ms. Perry’s own inheritance.

She tells us that money is the last taboo, and inheritance a triple taboo. She also reminds us that
inherited money should be treated differently. We learn that with looming biggest ever wealth
transfer of tens of trillions of dollars, more of us than ever will be facing the dilemmas of
inheritance. What can we do to be better prepared?

Bogumil: Thank you for taking the time to talk to us. I really enjoyed reading your book. I’d
be curious to know what got you interested in the topic of inheritance, where did the
inspiration come from?

AP:
Thank you. My inspiration came from my own experience receiving a modest inheritance of
$500,000 in 1993 after my mother passed away. I was quite surprised that her estate was worth
as much as it was. After all, she was a grade-school teacher living on a fixed income. However,
she was frugal—and she had preserved most of what she had inherited from her family.
As an only child, I was also overwhelmed by the gift of these assets, a family home, a summer
home, an IRA account and various stock holdings.

At the time of her death, I was working as a syndicated personal finance writer and was
knowledgeable about such topics as investments and real estate, but I lacked confidence. I
realized that if I found it a challenge to manage my inheritance, other people were doubtless
feeling the same way.

Bogumil: You discuss the importance of treating inherited money differently. How should we
treat it, and why?

AP:
Inherited money IS different than other money. You didn’t receive it by working hard, saving
aggressively or taking a risk in the stock market. You most likely got it because someone died,
probably someone for whom you cared. Many heirs feel that these assets are not really theirs;
they rightfully belong to the deceased. For that reason, they can be reluctant to sell, divest or
manage the assets differently—even when that reluctance is not in their best financial interests.
Regarding your question of how to treat inherited money, I think that the first step for heirs
should be to acknowledge these emotional connections. With that understanding, they can then
learn more about the best approach for their own financial situations.

Bogumil: Your book reminds us that we are witnessing the biggest intergenerational wealth
transfer in the history. The topic has never been more relevant than today, and the challenges
of inheritance are affecting more people than ever before. Is that a problem or an opportunity
for many of us?

AP:
I think it can be both. Some heirs will be too paralyzed with guilt to manage their money well
while others will simply squander it.

However, a bequest can be a life-changing opportunity for many. Whether the estate is small or
large, heirs can put it to good use: making a career change, starting a business, paying for
college, establishing financial security or giving it to charitable causes.

Bogumil: You write how money is the last taboo, that people are much more willing to reveal
very intimate details about their lives than confessing their net worth. You call inheritance a
triple taboo—at the intersection of money, death and family relations. Is it something you
expect to change?

AP:
It won’t change until family members begin having open communications with one another. That
may mean starting the conversation by discussing your own financial situation and your estate
plans to draw out other family members.

It’s also important to try to improve family relationships by mending fences with estranged
siblings or other relatives. This can save much future heartache.

Bogumil: You emphasize the importance of talking to our parents about their wealth, their
plans and wishes. How do we start that conservation?

AP:
First, keep in mind that such a talk can make your parents feel vulnerable. They might find
discussing their own mortality an anathema or feel that you’re only interested in getting an
inheritance and not in their well-being.

To get started, consider some, or all, of these approaches: look for an appropriate time to talk
(not over the table at Thanksgiving dinner); suggest that your parents get a “financial checkup”
with an advisor (who will surely cover their estate planning); share relevant articles with them,
and gently remind them that lack of planning could mean emotional hardship for their heirs.

Bogumil: You share with your readers detailed checklists of what we should do when our
parents are still around. Without giving too much away, what’s the number one item, we need
to remember?

AP:
Encourage your parents to sign two types of documents, one giving you or another trusted person
the power to make healthcare decisions and one creating a power of attorney for financial
matters should they become incapacitated. While these might seem to be giving up too much
control, they can in fact do just the opposite—ensure that your parents’ wishes are carried out.
These documents can be tailored and designed to be used only in certain or limited
circumstances.

When my mother was terminally ill, I found both documents enormously helpful. I could help
manage her care with doctors and hospital staff in accordance with her wishes. Without the
financial document, I would have been unable to use her bank accounts to pay her bills, manage
her IRA accounts and file her tax returns.

Bogumil: In your book, you discuss the need for professional help, could you tell us what an
inheritor should look for in the right advisor?

AP:
First off, you must choose a financial advisor with whom you have a good rapport and who will
patiently answer all your questions. Your advisor should be willing to discuss how he or she will
be reimbursed, by commission, a flat fee for advice or a fee for ongoing money management.
You should be convinced that this person puts your interests ahead of their own.
Once you have a good financial advisor, that person should be able to direct you to trustworthy
CPAs, insurance brokers and appraisers, serving as a kind of quarterback for your finances.

Bogumil: Our readers find the topic of children and inheritance especially interesting. How do
children react to a parent’s sudden inheritance? What should we keep in mind?

AP:
Educate them, in age-appropriate ways, about managing money. Start with an allowance and
then slowly increase the amounts and types of saving and spending, permitting them to make
mistakes now that will help them cope in the future.

Children should have a sense of how well off the family is so that the amount of a bequest won’t
be a jarring surprise at a time of loss. You should also convey in general terms how you will
allocate your assets: to all to your children equally, more to one with special needs, or some to
charity as well.

They might find such discussions awkward or frightening. If they have questions, you can keep
them brief and matter-of-fact. The goal here is to avoid leaving them blind-sided. It’s also
important to impart your values and the need to be self-sufficient and create meaning in their
lives, so they don’t feel entitled.

Bogumil: Could you talk about the emotional rollercoaster that inheritors often experience?

AP:

I’ve identified Six Emotional Stages of Inheritance. Not everyone will experience all of them or
in this order:
1. Disbelief—Some heirs still feel like children, even though they’re adults. They may
think, “not this, not now.”
2. Anger—This feeling could stem from a sense of abandonment or a grievance that a
parent left the estate in a mess, with no instructions.
3. Euphoria—Once the reality of the bequest sets in, some heirs may feel exuberant because
they’ve never had so much money and they begin thinking of all that they can buy or do.
But most should realize that while they can do some things, they can’t and shouldn’t try
to do all of them, or they will spend it all.
4. Guilt—I’ve spoken with many heirs who feel guilty that they inherited only because
someone died. They may find it difficult to manage their money or to dedicate it to things
that their parents wouldn’t approve.
5. Paralysis—This may stem from reluctance to sell assets or use them differently from their
parents and from fear of making poor choices.
6. “Heirworthy”—After a period, when negative emotions have run their course, heirs will
begin to appreciate what they’ve received and the difference it can make in their lives.
They learn to preserve it and invest wisely to leave for their own children and deserving
charities.

Bogumil: Thank you so much for your time, we really appreciate it. We hope our readers will
find your book equally interesting and inspiring.
Ann Perry’s The Wise Inheritor is available on Amazon.

Bogumil Baranowski – January 20th, 2017

Disclosure:
This presentation and its content are for informational and educational purposes only and
should not be used as the basis for any investment decision. The information contained herein is
based on publicly available sources believed to be reliable but not a representation, expressed or
implied, as to its accuracy, completeness or correctness. No information available through this
communication is intended or should be construed as any advice, recommendation or
endorsement from us as to any legal, tax, investment or other matters, nor shall be considered a
solicitation or offer to buy or sell any security, future, option or other financial instrument or to
offer or provide any investment advice or service to any person in any jurisdiction. Nothing
contained in this communication constitutes investment advice or offers any opinion with respect
to the suitability of any security, and has no regard to the specific investment objectives,
financial situation and particular needs of any specific recipient.

Photo: Natalya Zaritskay

Inheriting a fortune – or being lucky enough to leave one to your children – can be
a mixed blessing. As the largest-ever intergenerational wealth transfer is upon us,
it’s important to realize that how we give may matter more than how much.
We at Sicart Associates have spent our careers as investment advisors to families, and lifelong
students of wealth growth & preservation. These are complex concerns. Every family is different,
and the financial world does not do us the favor of staying the same through time. Strategies that
have worked for one family may be inappropriate for a later generation; earners and inheritors
have different approaches to life. Our goal, always, is the financial well-being and prosperity of
families for generations.
This concern is urgent as we have already started to experience the great wealth transfer of $12
trillion from the generation born in the 1920s and 1930s to their children, the baby boomers. Over
the next few decades will come the unprecedented wealth transfer of $30 trillion from baby
boomers to their heirs. (1) Two-thirds of the world’s wealth is currently in the hands of firstgeneration
wealth creators with limited experience in wealth succession planning.
It’s a worldwide phenomenon. The US, with expected average inheritance of $177,000, ranks only
6th in the world, with Australia ($500,000), Singapore ($371,000), the United Kingdom, France
and Taiwan leading the pack (2).
This massive shift creates obvious challenges for the families involved. In a multi-part series of
articles, we would like to explore the topic of inherited wealth – its blessings, curses, and
dilemmas. As investment advisors, we are frequently asked how to help inheritors make career
decisions or when to inform young people about their future wealth. We are happy to present here
a resource for families with similar questions.
Part 1 – Introducing Barbara Blouin’s publications of the Inheritance Project
Not many books discuss the emotional journeys of inheritors, and few of those have been written
from an insider’s perspective. That’s what makes Barbara Blouin’s numerous publications so
unique and interesting. In 1992, together with two other inheritors, Mrs. Blouin founded The
Inheritance Project. Its goal was to explore the emotional and social impact of inherited wealth,
and to show heirs how to claim their personal power and use it to bring meaning to their lives and
benefit others.
The Legacy of Inherited Wealth is a good starting point. Here you’ll find a collection of frank and
lively first-person interviews with inheritors. They discuss the challenges and opportunities that
inherited wealth can bring.
Mrs. Blouin has published other works that cover specific aspects of inheriting wealth such as
finding a meaningful career and passing wealth along to one’s own children. I had the pleasure of
talking to Mrs. Blouin and exchanging many emails with her about this project. She graciously
gave me a lot of feedback, and guided me in writing this piece featuring her work. Thank you!
Below you will find some highlights from a number of Inheritance Project publications that I found
especially relevant. Given the depth and the volume of examples, advice, and life stories shared,
it’s hard to give them justice in a brief article.
List of Inheritance Project Publications available at http://inheritance-project.com/
Including the Children
(Here I would expand the discussion to not just children, but to any inheritors who may receive a
significant bequest at a young age.)
Emotional dimension
In Passing Wealth Along to our Children, authors Margaret Kiersted, Barbara Blouin & Katherine
Gibson discuss the emotionally charged decisions of estate planning. We see how conventional
planning focuses on tax and financial priorities, minimizing how parents feel about passing on
their wealth. The experts quoted in the book remind us that we might be wrong thinking that we
can talk about money in a factual, dispassionate way. It’s easy to overlook the emotional dimension
of wealth transfer on both sides, those giving as well as those receiving.
Be positive when you talk about money
In Coming into Money – Preparing Your Children for an Inheritance, Mrs. Blouin writes: “One
way to protect your children from misplaced guilt, embarrassment and shame is to teach them —
if you feel comfortable doing it — that you are proud of your family heritage. Almost everyone
wants to feel that they are part of a family culture and a family tradition. If you feel mostly positive
about the wealth your father or great-grandfather created, you can teach your children about your
family’s history — how the money was made and the good things that have been done with it.”
It’s not enough to appreciate the emotional dimension of passing wealth along; it helps to focus
on the positive side of money – the good it can bring and the family history around it.
The issue of control
We further read in Passing Wealth Along: “Control, or the lack of it, is one of the central issues
for many parents in creating their estate plans. On the one hand, they want to help their children
by leaving them money. On the other hand, they fear that their largesse could be misused, the
wealth could be squandered, and their children could become people of whom they would
disapprove.”
Is there a happy middle ground, where we give them enough freedom, yet help them avoid making
the biggest mistakes?
Baby steps, allowing for some mistakes
We further learn: “The way children are raised has great impact on how well they cope with their
wealth. The more we discuss wealth and its implications with our children while they are growing
up, the better they will be equipped to handle their inheritances. If we can afford to, distributing at
least some of our wealth before our death gives children the opportunity to make some mistakes
and develop some skills.”
Avoiding all mistakes is impossible. Having early, gradual, and open conversations with children
may help immensely, but we might need to leave children room to make their own mistakes. These
can be learning opportunities.
Work ethic – being a good role model
In Coming into Money – Preparing Your Children for an Inheritance, Mrs. Blouin writes:
“Whether you give your children money earlier or later, and whether you give them more money
or less, there are things you can do that will be helpful. Modeling a work ethic for your children is
essential. […] But it isn’t necessary for you to spend forty or more hours a week earning money
at an office in order to be a good role model. It may not even be necessary that you make money.
Woody’s [one of the inheritors featured in the book] mother did volunteer work; what he admired
was not whether she made money but that her work had intrinsic value. She demonstrated how a
person of wealth can serve others.”
It’s quite a feat to be a role model, but given the long-term benefits it can bring, it might be worth
the extra effort.
Rethinking the secrecy
In the same publication, we learn more about the need to inform the kids about the inheritance: “In
the past, wills were often kept secret. The man of the house, who usually had full legal control of
the family assets, did not discuss the terms of his estate, sometimes not even with his wife. Children
who wanted to know the terms of their inheritances were seen as greedy and grasping, waiting to
benefit from a parent's death. By the same token, parents who kept their children in the dark were
able to use the threat of disinheritance as a tool to manipulate their offspring.”
Again, the manner of giving is more important than the amount, and openness is generally
beneficial.
Surprise inheritance may backfire
In Coming into Money – Preparing Your Children for an Inheritance, Mrs. Blouin writes:
Responses to a sudden announcement vary widely — from paralysis to anger, from spending
sprees to deciding on the spot to give away the entire inheritance. Others respond by leaving their
money alone, not spending any of it, and just pretending it isn’t there.”
A large inheritance is a life-changing event, and can take considerable time to process. For that
reason it’s often wiser to prepare inheritors with a more gradual revelation of their expectations.
No perfect plan
The authors remind us: “Even if parents plan their estate with the precision of a space launch, life
remains unpredictable. There are so many variables involved that it is impossible to create a
flawless estate plan.”
As investors, we can’t predict the future. As parents and grandparents, we can’t outguess all
possible outcomes either. No plan can cover every eventuality, but it is essential to have a strategy
to pass along wealth.
Career Implications: Looking for purpose and autonomy, while facing high expectations and
doubts
Most young adults look for work that is both meaningful and satisfying. This can be harder to
achieve with the prospect of a large inheritance in the future.
A freedom we all crave, but a complex one
In Labors of Love Mrs. Blouin writes: “Not needing to work for money opens up vast possibilities,
unbelievable freedom of choice. Doesn’t everyone, after all, crave that kind of freedom and all the
other perks that come with money? What choices do people make when they have so many options
from which to choose? Why do some find ways to live full, satisfying, and productive lives? And
why do others drift aimlessly and joylessly, without taking hold of anything that sustains them?
As an heir, I have been haunted by these questions for many years.”
So how can we lead a full, satisfying, and productive live, and take advantage of the variety of
choices we have, instead of drifting aimlessly and joylessly? Perhaps there is no easy answer, but
asking the question at least starts the conversation.
Purpose is all there is
In Inheritors and Work: the Search for Purpose Barbara Blouin quotes a young inheritor: “When
you don’t need to work for survival, purpose is all there is. And when you're twenty-one and you
don't have the necessity to get out there, it’s an enormous thing to struggle with at a young age.
What do I need to do? I don’t need to do anything! I feel the money I inherited is a muting force—
like right after a snowstorm, when everything is white and quiet and sort of neutralized. I feel like
I’ve been subdued. Nothing stands out more than anything else.”
When earning money is a necessity, the true purpose becomes secondary. Without that financial
pressure, the search for purpose becomes the main goal.
In search of autonomy, self-esteem, and identity
We read in the same publication: “The first job that pays a living wage is a rite of passage into
autonomy. But when young adults start getting hefty incomes from parents or grandparents, they
are likely to question whether or not they could stand on their own.” And further we hear:
“Inheritors who have not yet taken the leap into their first job often feel ashamed and inadequate.
And their sense of identity may be tenuous.”
We realize how fragile autonomy, self-esteem, even identity may be when young adults are
overwhelmed with gracious gifts from the family.
Great expectations and great doubts
The author shares with us that: “Whether young adults have parents who are inheritors or
entrepreneurs, they may inherit the considerable baggage of high expectations along with the gift
of wealth. Whether such expectations are external or whether they become internalized, or both,
the consequences are the same. Sometimes great expectations work well for inheritors. More often,
though, heirs either fail to measure up, or they believe they haven't measured up.”
The advantages of inherited wealth may be accompanied by outsized expectations for inheritors to
achieve at the level of their parents or forebears. Failure to do so is naturally very painful.
Do what you love
Later in the book we read: “Some heirs use their unearned income as a springboard to do what
they love: to join work with play, to be creative. Doing what you love has an infinite variety of
possible shapes. It can mean wedding fulfilling work with money making, or it can mean devoting
your time to painting or writing poetry or theater.”
In the most positive scenario, inherited wealth can liberate its recipients to do whatever they love.
Learning to be self-reliant
In Coming into Money – Preparing Your Children for an Inheritance, Mrs. Blouin quotes an
inheritor, who shares the family wisdom: “Another family tenet is that money comes and money
goes. So, although we were prosperous, we have been educated with the knowledge that war,
revolution, depression, inflation and government policies can wipe out funds in the twinkling of
an eye. Therefore, it is up to us to educate ourselves and our children in the understanding that we
have to be self-reliant.”
Freeing a family from the sense of dependence on inherited wealth is not easy, but self-reliance
can be achieved, and is immensely liberating.
Long journey and its turning points
In Labors of love Mrs. Blouin tell us: “As you read this book, I encourage you to pay close attention
to the turning points in the lives of these people, for it is in the turning points that the heart of the
matter lies. What are those turning points, and what changes did they bring about? Because my
purpose is to encourage and inspire by example, my hope is that you will say to yourself, " If these
people could do what they have done, so can I.”
Mrs. Blouin’s publications help us to see that there are many who face the dilemmas of inheritance.
Better yet, they inspire to see paths for ourselves, as others have done.
Inheritance can be a blessing
We read in Inheritors and Work: “For those who have found satisfying work they care about, an
inheritance is truly a gift and a blessing. This is not to say that all the difficult aspects of being an
heir can be neatly disposed of. These individuals still have plenty to contend with. One thing they
all share, however, is a history of personal growth. They have committed themselves to the intense
‘inner work’ (3) that theologian Matthew Fox encourages. And the fruition of their inner work
manifests in their ability to connect with some form of outer work that benefits not only them but
also others. By so doing, their work—whatever it may be—connects them to others and to
community. Thus they are able to go beyond their isolation and become whole human beings.”
Through personal growth, satisfying work, connecting with the community, we may realize that
inheritance could be a gift, and a blessing allowing us to accomplish more than we could have
imagined.
Conclusion
To sum up, there is no single way to prepare our children or descendants for inheriting wealth, but
the emotions must be considered as much as the finances. Further, it is a good idea to gradually
introduce the next generation to the responsibility, challenges and advantages that come with
inheritance. When money is not an issue, career choices may prove to be a search for a true calling
which helps earn our autonomy and self-esteem. And finally, many future inheritors will discover
giving back as a fulfilling, rewarding part of their journey.
Bogumil Baranowski - January 1st, 2017
Reference:
(1) “We're On The Verge Of The Greatest Transfer Of Wealth In The History Of The World,”
Matma Badkar (Business Insider, June 12, 2014)
(2) “The United States is lagging behind other parts of the world when it comes to leaving
inheritances for future generations,” (CNN Money, December 13, 2013)
(3) Matthew Fox, The Reinvention o f Work: A New Vision o f Livelihood in Our Time
(SanFrancisco: HarperSanFrancisco, 1994
Disclosure:
This presentation and its content are for informational and educational purposes only and should
not be used as the basis for any investment decision. The information contained herein is based on
publicly available sources believed to be reliable but not a representation, expressed or implied,
as to its accuracy, completeness or correctness. No information available through this
communication is intended or should be construed as any advice, recommendation or endorsement
from us as to any legal, tax, investment or other matters, nor shall be considered a solicitation or
offer to buy or sell any security, future, option or other financial instrument or to offer or provide
any investment advice or service to any person in any jurisdiction. Nothing contained in this
communication constitutes investment advice or offers any opinion with respect to the suitability
of any security, and has no regard to the specific investment objectives, financial situation and
particular needs of any specific recipient.

Photo Larry Li

We have forgotten what it’s like to experience a shrinking economy. The economic tailwinds we’ve enjoyed for decades, however, are beginning to turn into headwinds: demographics, consumer behavior and most of all --- the debt mega-cycle. What has worked so well in the investment world for the last few decades may not only work poorly in the future, but also could get many investors into real trouble. Making and keeping money may become a lot more difficult than what we’ve gotten used to.

Thinking long-term

We at Sicart Associates don’t claim to have discovered a formula to predict the market’s direction for any particular span of time. Moreover, if we did have one, it would not be that helpful to our strategy and goals – wealth preservation over many generations. We believe that our job is to worry so that our clients have less to worry about. We think in terms of decades. So, this is a moment when we are looking backward at the last half century to assess where we might be headed to next. Fundamentally, we couldn’t be bigger optimists… but do we have some concerns about the near-term future.

The best 40 years behind us

The developed world has seen smooth financial sailing for dozens of years now, so long that many of us in the industry have known nothing else. So, let’s look at the special circumstances that brought about this halcyon period:
--we’ve had healthy population growth
--baby boomers have spent big, compensating for their parents’ post-Depression thrift
--productivity increased as technology not only became more prevalent but also lowered costs
--as a result, consumption increased, boosting GDP growth
In addition, fiscal policy has cooperated. We’ve ridden the biggest wave of constantly growing debt ever recorded. When we ran out of capital to lend, we’ve just printed fresh money to extend the “prosperity.” Last, but not least, so much private, corporate, and public debt would not have been possible without an accommodating monetary policy which in my lifetime has cut interest rates from 20% to zero.

Could anyone have asked for easier times? What amazes us is how long they have lasted.
Now, however, we see these trends as increasingly unsustainable. We expect rates to normalize. We expect deleveraging to take its toll, consumption shrinking, population growth slowing, and productivity flat-lining.

Double the debt, cut the rates, double the debt, cut the rates…
There have been economic hiccups in this prosperous period, of course: 1987, 2000, 2008, and smaller bumps in the road. Each time we could count on the government’s generous helping hand - they religiously doubled down on the debt, and cut rates in half to keep the party going. Dr. Greenspan put his gold standard beliefs aside for the time of his tenure as the Fed chairman, then a student of the Great Depression Dr. Bernanke picked up where his predecessor left off. Dr. Yellen not only promised us no crisis in our lifetime, but followed in the footsteps of Dr. Bernanke, keeping the rates very low, and only

raising them (slightly). We understand - it’s almost impossible to disrupt institutional inertia. Or, for that matter, to propose alternatives to received wisdom that everyone accepts.
Why look back and learn something?

Nevertheless, if history teaches us anything, it is that every period of growth, expansion, and eventual credit bubble is followed by a major contraction. We saw it in the US between 1929 and 1932 when the economy shrank by 1/3, the stock market collapsed by 90%, and deflation cut prices by 18% (through 1936). It took the Dow a quarter of a century to recover – a whole new generation was born, raised, and educated, before the market reached its previous high.
So, we wonder: How would have today’s passive investors fared in a turbulent period like that?

Maybe we can’t agree on the remedy, but we can agree on the cause.
No one doubts that there’s a great deal to learn from the Great Depression, but there’s some politically-generated confusion about just what those lessons are. Some claim the government did too much, some say too little. Some believe the wrong policies were put in place while others think the market would have self-corrected in time. Perhaps the more the government tries to “help,” the bigger the problems down the road. The one clear lesson from the past seems to be what conditions usually lead to an economic crisis:
– cheap and easy credit. It seems to have been a no-fail formula over decades, and centuries if not millennia. Looking for examples? How about:
--the Greek Debt Crisis
--Japan’s 1980s Bubble
--the Weimar Republic (Germany, 1920s)
--the South Sea Bubble (England, 1720s)
--the Mississippi Company Bubble (France, 1720s)
--late Roman Empire.

By debasing our currency and racking up a lot of debt in the last 40 years we haven’t invented anything new, but we did it take it to the next level.

Today

Businesses are doing great

During 40 years of tailwinds that are both unprecedented and perhaps unrepeatable, business has prospered greatly. High spending and consumption boosted revenues to ever higher levels, productivity and globalization lowered costs, which led to record profitability. The drop in the cost of debt, dramatic increase in leverage, and stock repurchases funded a one-time boost for earnings and stock prices in the last decade. General exhilaration helped expand valuations to record levels. In equities, these valuations are expressed as record high earnings multiples while for real estate and fixed income they’re record low yields. Many private equity deals and real estate projects have been made possible by sustained economic growth, higher prices and ever cheaper credit. At the same time, never-ending rounds of drastically low-cost debt financing have kept alive many otherwise bankrupt companies (zombies).

Consumers would rather go big than go home

Consumers enjoyed the ride as much as business people. The cost to borrow fell and we have been encouraged to borrow more to buy anything and everything. We’ve also been discouraged from saving. Now, we’ve not only recovered from the last correction in 2008, we hold more credit card, student, car, and mortgage debt than ever. Our investments and retirement accounts have been boosted by easy monetary policy, bidding up asset prices all around. We are richer than ever, and we’ve been able to buy more with less money down, and lower payments than ever. Just one outstanding example:
--record car sales (recently finally correcting)
--with record average car prices,
--record percentage of financed cars
-- record percentage of leased cars thanks to customers who want to buy big but can’t handle the monthly payments.
The US government has never been richer
The US government at every level, right down to localities, has also benefited from the last 40 years. Not only did it get easier and cheaper to borrow your way to “prosperity;” but also with all the economic growth, and asset inflation these governmental bodies have enjoyed record tax revenues. Extrapolating all those rosy assumptions into the future makes all promised obligations and benefits seem almost reasonable. We are currently hearing once again about the nervous dance around the federal debt ceiling, and attempts to raise it one more time. The concept of “fiscal discipline” seems to have disappeared from political and economic dictionaries for good.
The trends are shifting though

More with less

More cars, more homes, more things -- the mantra of the last few decades -- resonates less with the younger generation. They are not big buyers, and spenders. Millennials prefer transportation-sharing apps to possessing cars. Access matters more to them than ownership. They’d rather use vacation home-sharing apps rather than owning a second home or staying in hotels. Younger generation has also less disposable income due to both the student debt burden and the limited availability of well-paid jobs which would allow for mortgage, car, or second home payments. Since there are at least as many Millennials as Baby Boomers, they may eventually step up to the plate, and mature into consumers, but still probably not to the same extent as their parents.

Demographics tell the truth

The biggest consumer generation in history is retiring now. They are still in debt, they don’t have enough saved for retirement. Many will have to rethink spending habits and start tapping into savings as income starts to shrink. Overall US population growth is the slowest it’s been since 1937. The current childbearing generation tends to have fewer kids, and to have them later in life. Immigration won’t help our economy as much as it did in the past, either: on one hand, fewer people are coming and on the other, the current administration is less immigration-friendly than previous ones, ignoring the demographic realities.

End of easy, cheap credit

Credit plays a crucial role in the economy. Short-term credit helps companies manage their working capital and helps households get through brief monthly cash flow shortfalls. Long-term credit enables big investments in new productive assets, offices, warehouses, and homes. The economy can grow faster than population and productivity growth would normally permit – but only if we can continue to expand the overall leverage in the system. We are basically spending future savings (in other words, we will have to save in the future to pay off what we borrowed today), unless the central bank buys government debt, mortgage-backed secured and other debt obligations, then we are spending money that does not actually exist. The consequences of such an experiment are unknown, but unlikely to be positive.

Either way, we at Sicart Associates argue that there is a limit to how much debt any economy can maintain. If a free market in interest rates existed, current excessive public debt would have already pushed the cost of money higher. Thus, the general cost of debt would have risen and quickly put an end to the credit expansion. As Richard Ebeling, in his refreshing book Monetary Central Planning and the State, reminds us: “Monetary central planning is one of the last vestiges of generally accepted out-and-out socialist central planning in the world.” He adds “Government can no more correctly plan for the ‘optimal’ quantity of money or the properly ‘stabilized’ general scale of prices than it can properly plan for the optimal supply and pricing of shoes, cigars, soap or scissors.”

Eventually though, the total outstanding debt will not only stop growing; it will start shrinking (paid off, defaulted or not-rolled over), and rising rates will accelerate the process. Our consumption, spending, and financial engineering will correct themselves automatically.

When trends collide

What happens when decelerating population growth and productivity improvement run up against shrinking and more expensive debt and lower spending?
Asset bubbles burst
With consumers spending less and the cost of debt rising, revenues, margins, and cash flow will all come under pressure. Many assets will become less attractive, many businesses unprofitable, and perhaps even unsustainable. Valuation will compress, leading to meaningful correction in prevailing prices. We might see lower profits, lower prices, and higher cost of debt.

It’s a triple whammy for businesses and investors.

Government with emptier pockets and growing obligations
If tax revenue shrinks due to falling profits and incomes, deficits will expand unless the government cuts spending. That would require cutting welfare programs, pension fund benefits, etc. which maintain the livelihoods of an ever-growing senior citizen population. All the long-term assumptions of all pension funds at all levels would need to be rethought, and the gap between what they need and what they can actually earn will widen. Cuts, which may turn out to be unavoidable and necessary, would further undermine consumption, which spills over to businesses. They would suffer from even deeper profit cuts, and resort to even bigger employee layoffs. The result? More pressure on tax revenue on one side, and greater need for unemployment benefits on the other. We might see higher spending needs, lower tax collection, and higher cost of debt.

It’s a triple whammy for the government policies.

Living standards adjustment
The macro correction could lead to higher unemployment, lower income, lower ability of the government to help, failing pension funds and asset price declines – homes, stocks, bonds all re-establishing values at substantially lower levels. We would both feel poorer, and have less disposable income that could be taxed at higher rates to offset a tax revenue drop. The Great Depression was an era of the biggest tax hikes in the U.S. history, with margin rate going from 25% to 94% by 1945. As demand weakened, prices would have to fall, creating a softer landing for those with sustainable income. Lower incomes, lost investments, higher cost of debt.
It’s a triple whammy for individuals.

Seeing and acting on it

It’s not hard to imagine how the last 40 years’ upward spiral driven by debt, demographics and productivity could easily become a death spiral. We at Sicart Associates are not the only ones who perceive the problem, but we are among the few who act on it. We see complacency and paralysis - cash levels among investors are at record low, short positions as well, and passive investing has never been more popular. Even investment professionals choose to either ignore the danger or take a “cautiously cautious” stand.

Buy and hold approach

We are big proponents of a “buy and hold” strategy: one-decision stocks. We buy them right, and hopefully don’t ever have to sell them. We see how that approach has done a magnificent job for us and many long-term investors, Warren Buffett among them. We do believe that times have changed. It’s not only dangerous to remain fully invested, and especially to be a passive investor; it’s also dangerous to stay blindly committed to the “buy and hold” approach. We are under the impression that we’re reaching the end of a huge cycle with peak levels of public, consumer, and corporate debt, ultra-low interest rates prolonging the cycle, and ultra-high asset prices and valuation temporarily masking the problem.
Today, successful investing is less about chasing the tail of a tired bull market, and more about preserving the capital.
Our clients are families, and our job is to take good care of their fortunes for generations to come. Today, our best course is to:
Hold only "highest conviction" stocks
Maintain excess cash positions
Keep fixed-income durations short given interest rate uncertainty
Consider some small gold exposure.

(We are more concerned about deflation hitting us first before inflation catches us by surprise later; thus, the possible role for gold.) Finally, to benefit from a potential market drop, we'd consider a very gradual use of an inverse ETF tracking a broad market index, and preferably one that is not leveraged. Additional leverage can give us a boost if we are absolutely right about the timing of the sell-off, but that's hard to guarantee.
Abundance of investment ideas ahead, the US remains the favorite market
We expect to see some remarkable opportunities ahead, possibly even a true revival of Benjamin Graham- style fundamental equity research. In that situation, we’d probably have more ideas than money -- our favorite time for stock picking.

We make it a practice to look anywhere and everywhere for ideas: among small and big companies, domestic, and foreign. We are exceptionally excited about the US market, though, given its size, diversity, and depth, backed by the 300M+ American population full of hard-working, smart, creative people and a vast, rich economy. It’s been a true talent magnet for a few centuries. We’ve been through ups and downs before. The point is to acknowledge that they happen, and to be prepared.

Bogumil Baranowski August 21st, 2017
Disclosure:

This article is not intended to be a client‐specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.

Photo: Sarah Lachise

With stock markets at new highs, we take a careful look at our cautious, contrarian stand

When we analyze an individual stock or the market as whole, we wonder how our conclusions can be wrong. Lately, we think the current market offers extremely low reward at an extremely high risk. How can it keep going up forever? Only if it finds buyers.

Since the last financial crisis, debt-funded corporate share repurchases have amounted to almost 20% of market capitalization, and they offset net selling across most other investor types. The best example of current times is Restoration Hardware which recently executed a huge and speedy buyback, loading up with debt and propelling its stock 170%+ creating a major short squeeze -- while its peers remained flat, and its business fundamentals have been underwhelming.

Will anyone replace those buyers? And do they have the capital to do so?

Wealth preservation vs. chasing the next hot thing

Many financial advisors will tell you that they are in the business of making money for you. Our practice, on the other hand, calls for preserving and growing family fortunes over generations. The two mindsets couldn’t be more different. We remain loyal to the same clients for many decades, and we care for their

financial well-being the same way we do for our own. More conventional money-management firms, if they fail to deliver on their promises, can find new clients and new success with a novel investment idea.

We, however, understand that a disciplined, calm, deliberate contrarian approach serves us best in our endeavor. We may not always beat all asset classes or all indexes, but our top priority is preserving capital, and that we do very well. We are not complacent, however: we always question received wisdom, including our own.
Red flags all around

For a while now, we’ve been pointing out red flags in the investment world:
--record public, private, and corporate debt
--record valuations
--slowing economic growth
--staggering central bank-funded asset inflation
--record-low volatility
--record-high passive investing.

These disturbing phenomena are generally viewed with indifference in the world of finance, but we suspect they foreshadow the end of an unprecedented bubble. In other words, we are operating in an increasingly risky investment environment that offers decreasingly attractive rewards.

The most prosperous decade

On paper, the last 8 years have been a period of the biggest wealth creation in history. In the US alone, total net worth peaked at $68 trillion in late 2007, then dropped to $55 trillion in 2009. From there it soared to reach almost $95 trillion most recently. In a similar scenario, US homeowner equity got cut in half in 2009/10. Since then, in an unprecedented $7 trillion swing, it has doubled. Those are remarkable growth curves considering current weaknesses in economic recovery and productivity improvement, along with the slowest population growth in decades.

Our fear is that the most recent boom could be followed by a corresponding destruction of wealth, with potentially disastrous effects on the record number of individuals who will soon reach retirement age. Would their life savings survive a market bust?

Pain now, pain later, or the illusion of no pain at all

The world’s governments and central banks are currently faced with three corrective options. They may take actions that produce pain now or later, or actions to prolong the illusion that pain can be infinitely deferred. (Another term for this might be “kicking the can down the road.”) If you were sitting in the dentist’s chair you’d probably choose the last strategy. That’s human nature. But as professionals, we at Sicart are wary of illusion. If our leaders truly normalize fiscal and monetary policy, we’ll see major deflation and explosion of the asset price bubble, followed by a severe depression and massive unemployment. Unfortunately, all that pain might be required to shape a sounder economy for generations to come.
The big illusion persists

If our leaders choose to continue postponing financial pain, we’ll see more weak growth and more market distortions in asset prices, feeding further illusion.
Central banks will further expand their mandate beyond inflation and employment targets, and officially start to do all that is in their power to never allow any asset price to fall. This will only take the current absurdity to a whole new level.

Unfortunately, a great deal can go wrong with that attempt to defy market and economic cycles by riding the wave of ever cheaper credit and ever more debt. We may think we have escaped the pain of a serious market correction, but it will catch up with us eventually.

The Federal Reserve is already a big holder of mortgage-backed securities, propping up assets ranging from our home prices to government bonds. The European Central Bank (ECB) is equally active in government bonds, and has been a big buyer of corporate bonds. In addition the Swiss National Bank (SNB) has been shopping globally, snapping up mega caps in the US (Apple, Microsoft, Amazon, Facebook, and Alphabet, for instance). Meanwhile the Bank of Japan (BOJ) has become the biggest holder of local ETFs (71% of the nation’s ETF market as of July 2017).

Unlimited buying power and no accountability

Propping up the market is nothing new. Conceptually that’s what banker John Pierpont Morgan did in 1907, that’s what was attempted in 1929. However, Morgan’s capital was limited and private.

In 2017, we have central banks with unlimited buying power and unlimited options. The ECB took 12 months to even disclose what they’ve been buying in the corporate bond market, and did so only under pressure.

If we count the assets of the 10 largest central banks, Bloomberg reports, the total amounts to $21 trillion in central bank assets or 30% of the world economy; or 1/3 of the world market capitalization; or 1/3 of official world public debt, or the total value of the US stock market. How much is too much?

The other difference between the present and the era of J.P. Morgan’s intervention in the market is the duration. In 1907, it was brief. Today, however, the central banks’ involvement in markets can prop up prices for almost a decade, and there is still no end to it. Needless to say, such a long period of market distortion only creates an ever-bigger gap between the reality of market forces and the illusion created by monetary and fiscal wizardry.

The biggest leveraged buyout (LBO) in history? Biggest market rally ahead?

Could central banks buy another $50 or $100 trillion of anything they want at whatever price they want? Of course, they could. If they did, asset prices could continue to climb. Could the central bankers take all public markets in all securities private? Interest rates are set at zero, credit is free, risk premium is a forgotten concept, printing presses are allowed to run full speed. What’s more, central banks can buy and hold almost everything: government bonds, mortgage-backed securities, corporate bonds and equities, on top of what John Maynard Keynes referred to as – “barbarous relic” – gold.

Thought experiment

If you extrapolate this market intervention to the limits of imagination, central banks could eventually own all corporate and public debt, all banks, all formerly publicly traded equities, and all real estate: any asset with a price tag. When you go through that thought experiment, we end up in some really silly world…
Blast from the past

In fact, we are transported to the last days of the failing centrally-planned economies of Central and Eastern Europe. Back in the late 1980s local currency had no credibility as a store of value so people’s savings were in US dollars (referred to as “hard currency” and treated with the utmost respect). There were no public equities, no bond market, and real estate was most often leased rather than owned. Is that where we are headed? What will be our hard currency this time?

Haven’t we learned anything?

If central banks eventually own all assets, any former asset-holder will be sitting on a lot of newly printed cash with nothing to spend it on. What do you call a time when too much paper money is chasing too few goods? Hyper-inflation.

The IMF, studying the early-1990s policies in Central Europe concluded that “cheap credit, fiscal deficits financed by central banks had led to near hyper-inflation.” Having witnessed that economic experiment at first hand, I sincerely hope we are not headed that way.

To undo the damage of the centrally planned economy in Central Europe almost 30 years ago, the IMF set a fundamental rule for the governments - it forbade the national central banks to finance government budget deficits and forbade the issue of new currency. Isn’t this the very rule that all major “free market” countries violate so openly these days? Is it time to reinstate that old rule?

No normalization in sight

Year-to-date, despite the supposedly improving economy and inflation picking up, central banks bought $1.5 trillion in assets with BOJ and ECB leading the race. If they keep up the same pace throughout the rest of the year, this will be the biggest buying spree in a decade. Something tells us that new highs for the stock market may have something to do with it.
Lately, the Fed has alarmed some observers with talk of tightening and balance-sheet shrinking, but we wouldn’t bet on policies normalizing anytime soon. In our definition, that means the Fed going back to its original role – lender of last resort, allowing the market to freely set interest rates reflecting true investment risks across the full spectrum of assets.
Revolutionary idea? Hardly. The same way the market sets prices of thousands if not millions of goods and services every day without the help of a dozen wizards secretly contemplating the next price change and communicating in codes causing the markets to whipsaw as central bankers “recalibrate the message” each time.

Reading the tea leaves

Recently the famous motivational speaker Tony Robbins asked Former Fed Chairman Alan Greenspan: “So, in this world of intense volatility and insane central banking policies around the globe, what is the one thing you would do if you were still the Fed chairman today?” Greenspan paused for a while. Finally, he leaned forward and said: “Resign!”
It was probably the clearest, and shortest answer anyone has ever gotten from Dr. Greenspan, who once famously said: “I know you think you understand what you thought I said but I'm not sure you realize that what you heard is not what I meant”. We know what he meant this time. It’s never been more difficult to be a central banker - never the stakes have been higher, never the dilemmas bigger.

We’ll take Dr. Greenspan’s frank response over recent Dr. Yellen’s comforting assurance of no financial crisis in our lifetimes. Those kinds of declarations seem to be usually very poorly timed, like Dr. Bernanke’s 2007 calming commentary or the words of the legend himself – John Maynard Keynes who told us in 1927: “We will not have any more crashes in our time”.
The bottom line: yes, central banks can become buyers of last resort, but in the long run, you can’t borrow or print your way to prosperity
The current misguided monetary and fiscal policy can last for a long-time, and central bank can establish themselves as buyers of last resort vs. lenders of last resort which was the intended role at their inception. This economic experiment will eventually have to end though.

The lesson here is not that capitalism or the free market economy has failed us. it’s that statism, government interventionism, and central bank manipulation always eventually fail as they have done too many times before. The free market and capitalism haven’t had a chance to breathe in a while.

No one can tell just when the stock market will peak, but this is not a good time for complacency, passivity or paralysis. We wish smart decisions, good luck, and patience to everyone with a small or large fortune at stake. The next 40 years will be very different than the last 40, and likely the next 5 won’t be like the last 5.
We recommend acting accordingly.

Bogumil Baranowski – July 31st, 2017

Disclosure:
This article is not intended to be a client‐specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.

Photo: Jamie Street

A lesson from Hans Christian Andersen

Sometimes I think that we learn all we need to know in life as children, and then somehow forget it all as adults. On my frequent walks through Central Park, I pass the statue of the famous Danish writer Hans Christian Andersen, famous for his fairy tales. One of his stories has made a lasting impression on me. It’s the tale of two enterprising weavers who promise a vain emperor new clothes which will be invisible to those who are unfit for their positions at court. As you may remember, when the emperor chooses to parade his new attire, only a child in the crowd dares to say he is not wearing anything at all. Let us, for a moment, look at the financial world through the eyes of that child. (1)

New market highs in the land of make-believe

Around the globe equity, bond, and real estate markets hover at all-time highs. Valuations are extended to the limits, growth languishes, and we are beginning to question the quality of the weavers’ work -- no matter how embellished their fairy tale has become. The weavers’ fabric turns out to be the ballooning debts, the threads are zero interest rates, and it’s all beautifully colored with relentless money printing.

Free market and its invisible hand vs. state interventionism and its firm visible grip
We recognize the free market’s ability to establish prices for goods, services and assets, through the natural forces of supply and demand. However, we also acknowledge the power and the extent of market manipulation through massive state interventionism, which passes today as “counter-cyclical pro-growth policies. “(2) Increasingly, we worry that this may be a failing strategy inspired by John Maynard Keynes’ faith that the state apparatus, and its ruling elite, will always save the day. (3)

Laws of economics: a quick refresher

Most of us got our grounding in economics some time after we heard fairy tales like “The Emperor’s New Clothes.” No matter when you took Economics 101, the three basic precepts are the same:
1) in order to invest or consume we are always spending our or other people’s savings, and we must repay those funds. Thus, there is a limit to what we can afford.
2) when countries have a trade imbalance, the country with a surplus accumulates the currency, and the country with a deficit eventually runs out of money. Then the exchange rate gets adjusted, and the trade is rebalanced – eventually you can’t buy what you can’t afford, can you?
3) if a government wants to borrow more money, the formula is simple: the more it borrows, the higher the rate it has to pay. Eventually it has to stop borrowing because it can’t afford to keep up payments.

You can see how there is a series of natural checks in this system. (4)

Where are the limits in our brave new world?

Over the years, these fundamental laws have been suspended. The situation resembles that of a builder constructing an ever-higher dam with ever-weaker material. “Look, I stopped the river for good!” he declares. We are smarter than that – aren’t we?

One factor that contributes to our illusions is the effect of fractional reserve banking, which permits creating more credit out of the same amount of deposits. It helps us enjoy economic booms, but also brings us regular busts, when the credit shrinks. As much as we appreciate the benefits of fractional reserve banking in good times, we need to remember the risks it carries, when the tide turns. Contrary to a growing popular belief, more and more credit is not the remedy for each and every downturn.

Secondly, trade imbalances can be maintained and extended – but not indefinitely. The printing presses of our trade partners’ central banks play a key role. Their newly printed money buys our currency, which they use to buy our public debt, which we provide with on-going, never-ending budget deficits. Again, the limit to what we can “afford” gets extended, maybe even becomes unlimited – at least for the time being. Eventually, we would need to adjust our consumption.

Thirdly, what happens when the government wants to borrow more and more? Anyone who has studied economics might have heard of the crowding-out effect. When government spending drives down private spending, and the government absorbs all the available lending capacity in the economy, the interest rates (the cost to borrow) go UP. These are simple laws of supply and demand. Free market interest rates go up, when the demand for capital goes up. This is the normal cause and effect.

But what happens if the government doesn’t need to rely on savings or the limited lending capacity of the economy? What if the central bank buys government debt with newly created money? Interest rates will likely stay unchanged or even fall, especially if they are controlled by an all-powerful central bank. That’s something we’ve experienced around the world over the last ten years. There is no limit on what the government can afford to borrow, and the prevailing belief is that more debt is a cure for any temporary weakness in the economy.

Back to the basics: capital

The foundation of a free market capitalistic economy is capital, i.e., the accumulated savings of all market participants. Capital is needed to finance our investments and our consumption. There should be a free market for that capital for those who have it (supply) as well as for those who want it to invest or spend (demand) – price discovery at its best!

Who is wearing invisible clothes now?

In our real-life parable, the savers are the last ones wearing real clothes, and instead of being praised for it, they are despised. Invisible clothes are proudly worn by everyone else. Governments spend money they don’t have and make promises they can’t possibly keep. Corporations borrow to buy businesses, pay dividends, and repurchase shares, which they can’t really afford. Consumer drive cars, wear suits and live in homes, none of which are really theirs.

War on savers won at last?

The outcome of recent trends and the evolution of contemporary economics put us in a peculiar position where the very foundation of the system – savers and investors -- is under attack. The artificial zero rate environment established by central banks pumping an unprecedented supply of money into the system has made savers’ and investors’ capital almost irrelevant. Legitimately-earned ready-to-invest capital is commingled with legally-counterfeited freshly-printed money. Thus, the praise of spending beyond one’s means and seeing credit as an ultimate remedy puts rational, responsible savers in an unfavorable position. Finally, we see emerging support for eliminating cash (5) to improve the effectiveness of a monetary policy. That’s the same policy which has brought us both real and increasingly often nominal negative interest rates, which is yet another assault on savers. As a result, savers are enticed to spend, and borrow rather than invest.

This recent phenomenon brings not so fond memories of some questionable ideas of the past. Karl Marx shared his disapproval of savers calling them “hoarders”, and John Maynard Keynes argued for “euthanasia of a rentier” expressing his dislike for thrift, and farsightedness. Lastly, Ben Bernanke not long ago blamed alleged “savings glut” for economic trouble, and challenges facing monetary policy.

New peaks of experimental economics

As a civilization with at least 5,000 years of experience with money, finance, and credit (6), we have never before reached the current levels of financial fantasy that bring us back to the vision of an unclothed emperor parading before his subjects who support his illusion so as not to be considered “hopelessly stupid.”
The correct incentives that lead to prosperity are temporarily out of favor. If history offers any guidance, the natural laws of economics can be suspended only for so long. We have to admit that sometimes we feel like characters in Samuel Beckett’s famous tragicomedy – “Waiting for Godot”. We’ll wait.

Having the courage of a child in the crowd

As contrarian investors, we often risk being considered “hopelessly stupid.” Yet we have no choice – we must find the courage of that little child in the crowd who speaks his mind.

In our role as investment managers taking good care of family fortunes over generations, we have to take steps to position our clients’ portfolios in these perilous times, where shortsightedness, complacency and passivity can prove exceptionally dangerous to wealth preservation. Blind faith and trust in the weavers’ words may get us in trouble.
The procession must go on!

This is how Hans Christian Andersen ends the tale:
“’But he doesn't have anything on!’ said a small child.
‘Good Lord, let us hear the voice of an innocent child!’ said the father, and whispered to another what the child had said. ‘A small child said that he doesn't have anything on!’
Finally, everyone was saying, ‘He doesn't have anything on!’
The emperor shuddered, for he knew that they were right, but he thought, ‘The procession must go on!’ He carried himself even more proudly, and the chamberlains walked along behind carrying the train that wasn't there.”
Maybe the procession must go on, but we choose not to follow an emperor wearing nothing.
Bogumil Baranowski – June 20th, 2017
References:

1. “The Emperor’s New Clothes” – Hans Christian Andersen, 1837
2. The Great Deformation: The Corruption of Capitalism in America – David Stockman, 2014
3. The General Theory of Employment, Interest and Money – John Maynard Keynes, 1936
4. The New Depression: The Breakdown of the Paper Money Economy – Richard Duncan, 2012
5. The Curse of Cash – Kenneth S. Rogoff, 2016
6. Money Changes Everything: How Finance Made Civilization Possible -- William N. Goetzmann, 2016

Disclosure: This report is not intended to be a client‐specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.

Photo: Pana Vasquez

The transition from one to the other is less intuitive than it seems

As we work with more and more entrepreneurs around the world, we find a number of key differences between them and portfolio investors.

By nature, entrepreneurs feel that they can succeed at anything if they put their minds to it, so they do not initially see any obstacle to taking on new responsibilities as their family’s steward of capital. But in fact, we believe that the qualities that made them successful entrepreneurs are seldom the same ones that make successful stock market investors. The two have overlapping talents, of course, but we observe that each would often benefit from focusing on the activity that best fits their personality.

Furthermore, since entrepreneurs have had most of their net worth tied up in one business, and they have often limited investing experience beyond that, the anticipation of becoming responsible for a patrimony made up of diverse assets over which they have no management control will create anxiety, even if it is not always acknowledged at first.

It is well-known that the stock market is driven by greed on the one end and fear on the other, and the stock market investor’s skill consists of navigating between these two emotions with a clear head. There is a distinct risk that the former entrepreneurs’ anxiety may cloud their judgment, but once they realize that making money and keeping money require two very different skill sets, we may be able to help.

The big transformation

The challenge of morphing from entrepreneur to steward of capital lies in the dual influence on the stock market of psychology vs. fundamentals. It has been said that, in investment markets, price is driven by sentiment, whereas value is driven by fundamentals. As a result, price and value often diverge widely. Thus decision methods and criteria native to business often do not work as well in the stock market.

To create wealth you start a business with little financial capital and demanding, high-stakes timetables. But at least fortune seems potentially around the corner. To preserve existing wealth, you start with a larger financial capital and no time pressure. But the growth of your fortune will have to await the miracle of compounding over many years. The time factor gives you a major advantage, but it also requires you to take on a different role: to turn from fortune maker to steward of fortune.

Optimistic entrepreneur vs. skeptical investor

The biggest difference between entrepreneurs and investors lies in their nature and view of the world. Entrepreneurs tend to be optimists, while investors tend to look at the world with a healthy dose of skepticism.

Entrepreneurs are not only optimists; they are stubborn optimists. One reason for many entrepreneurs’ success has been creativity -- turning ideas into businesses or, at least, into a competitive edge. They will naturally spend a good part of their time on the offensive, devising aggressive ways to gain market share from competitors, often without bothering to calculate if they are properly compensated for the risks they are taking – first, because they are inveterate optimists and second, because they are confident that they are the masters of their business’s destiny.

Good stock market investors are more likely to seek visible value over imaginary gains. They tend to focus more on the defensive because most of them know that even successful investing is fraught with occasional missteps. In contrast to the entrepreneur -- constantly betting that he or she will win by making the right decision -- the stock market investor aims first for fewer costly mistakes. He seeks proper diversification and, in the end, a good overall batting average. Warren Buffett, arguably the world’s most successful stock market investor says it best:
“Rule No. 1: Never lose money. Rule No. 2: Never forget rule No.1”

One big leap vs. a lifetime of compounding

Entrepreneurs’ wealth creation often happens in a relatively quick leap. In the stock market, wealth is more likely to arrive stealthily, the result of a long-lasting, repetitive, reliable investment process. The latter leads to compounding wealth at a relatively steady rate in the long run. To quote Warren Buffett again:
“My wealth has come from a combination of living in America, some lucky genes...
… and compound interest.”

The daily quote challenge and market folly

Recently an entrepreneur-turned venture capitalist told me how he tried to “dabble” in stock investing, and failed. His returns weren’t terrible, but he couldn’t handle one key aspect of it – the daily price quotes. When he started businesses or invested in companies, he didn’t rely on price quotes as the indicator of success. Instead he worked with regular reports, meetings with management, and a continuous flow of information about how the business was actually doing. This fundamental information gave him comfort and peace of mind about his investments. In contrast, stock market investors’ judgment is constantly challenged by short-term price fluctuations that seem to temporarily contradict their long-term, fundamental analysis.

This conversation made me appreciate even more the unique emotional make-up needed to be a successful stock investor. To some extent it requires a split personality: thinking like a fundamental investor while taking advantage of price fluctuations that the market folly has to offer.

Dangers and rewards of contrarianism

Contrarianism consists of taking positions that are radically different from those of the crowd. In financial investment, I find this approach to be extremely valuable. Buying something that the crowd does not like will, at the very least, insure that you are not overpaying drastically. If your idea and analysis are basically correct but your timing is not perfect (as is often the case for value investors) you also have a good chance of being bailed out by time and successive business cycles. And if the stock has declined in the meantime, you are given an opportunity to buy more shares at a cheaper price.

In contrast, being a contrarian in business could prove fatal. If, at the beginning of a down cycle, you accumulated too much time-sensitive or fashion-oriented inventory, or invested in too much new equipment, then losses, and possibly a severe liquidity squeeze, are likely to follow. In business, time seldom bails you out.

Some successful CEOs are long-term planners, but most are more nimble. They are prompt to recognize new trends for their businesses and quick to adapt when necessary, or to identify and seize new opportunities. For this reason, despite their theoretically longer-term time commitment, business owners/executives tend to have better instincts for trading than for stock market investing. Unfortunately, in our team’s long stock market experience, we have seen few sustainable fortunes made by short-term trading.

Good understanding of the business vs. poor understanding of the markets’ perception of it

Long-term successful investing may require more than recognizing a good business. These are usually well recognized, widely understood, followed by many analysts and, through the auction system of financial markets, they are often hugely overvalued.

Overpaying for a great business can lead to poor investment returns, as the market perception gets corrected over time and the price/earnings ratio shrinks along with the overly optimistic expectations. It is not unusual, as a result, for a stock price to fall despite still-satisfactory business performance. History is replete with examples of companies that transformed the world (think railroads, airlines, or radio) and yet failed to profit their early investors.

Managing a portfolio of ideas vs. one single business

Technological change offers immense wealth creation opportunities, but it is also responsible for wealth destruction.

Once omnipresent, Kodak vanished not long ago due to the proliferation of digital photography. (1)
Yahoo was once a $100B+ company, while its core assets were acquired for less than $5B this year. (2). AOL peaked at over $200B+ and ended up at $3B. Looking a bit further back in time, Radio Corporation of America (RCA) was once just as hot as many of the later technology favorites. It went public at $1.50 a share in 1920, rose to $114, only to fall to $2.50 by 1929. Excessive market valuations can turn many into millionaires and billionaires, but mean reversion eventually catches up with inflated expectations.

It might have taken the successful entrepreneur one brilliant idea, or one smart career move to create significant new wealth, but preserving that wealth requires a different strategy. Instead of putting all eggs in one basket -- a reasonable tactic for an entrepreneur -- the new investor needs to start thinking beyond one business to building a portfolio of investments.

There are two reasons for this:

--First, with age and the new responsibility of substantial capital to protect, investors will naturally becomes more risk averse. Diversification tends to reduce risk.
--Second, the entrepreneur-turned-investor will relinquish considerable control. When something fails to develop according to plan in your enterprise, you can react and fix it. With your portfolio companies, your only recourse is to bail out by selling. The consolation is that the shares of listed companies are relatively liquid and you don’t have to spend months looking for an elusive buyer.

Warren Buffett says “I’m a better investor because I’m a businessman, and I’m a better businessman because I’m an investor.” (3) As an entrepreneur you already have a higher, healthier risk tolerance than most stock market investors. You are also more aware and curious about new opportunities and, especially if you have negotiated the sale of your venture(s), you understand that realizing value requires a willing buyer.

All those qualities prepare you better for including wise investing among your wealth preservation strategies. The real question is whether you will put them to better use as a budding stock market investor or as the astute client of a professional portfolio manager.

Bogumil Baranowski
September 5th, 2016

Sources:
1. Eastman Kodak Files for Bankruptcy by Michael J. De La Merced (The New York Times, January 19, 2012)
2. Yahoo Sells To Verizon In Saddest $5 Billion Deal In Tech History by Brian Solomon (Forbes July 25, 2016)
3. Buffett: The Making of an American Capitalist by Roger Lowenstein (Random House, 2008)

Disclosure: This report is not intended to be a client‐specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.

Photo: Nolan Issac

It’s obvious to us that the US equity market is overheated, and that we are due for what may prove to be one of the biggest corrections ever recorded. We don’t claim to know when exactly it will happen, how much stocks will decline, and for how long. We are no prognosticators, we are just trying to make an intelligent interpretation of the familiar facts.
We consider ourselves value contrarian long-term focused investors. We like to buy good companies when they are down, cheap or out of favor. Even today's market's tech darlings had their long spells in the doghouse not that long ago.

We don’t usually bother to make market forecasts. We enjoy learning about businesses, distinguishing good ones from bad ones, and maintaining discipline in buying them. For us at Sicart this is more satisfying than analysis of the big-picture macro backdrop. Normally we find that to be a futile endeavor. Nevertheless, from time to time it’s the big picture that matters more than stock picking. This is one of those times.

What do we see?
-- markets hovering at all-time highs
-- valuations at record levels
-- fiscal and monetary stimuli unleashed to the limits of imagination
-- more of the same being offered as a recipe for lackluster growth
Yet there is a dwindling conviction that even with these measures, growth could be swift and orderly.
Thus, we choose capital preservation over near term growth at a record high risk.

As we are reminded by the past and by observations credited to such financial masterminds as Baron Rothschild, J.P. Morgan, and Bernard Baruch, fortunes are made by selling too early. Seeing a problem is one thing; acknowledging and speaking up about it is another. Acting on that conclusion is a whole different thing.
From the big picture, top-down point of view, we see a lot of red flags; from the bottom-up point of view, we see little (if anything) that we really like.
If you just look at the price chart of any major US or global index or for that matter, you’ll see an all-time high. Momentum investors might get excited about it, though they get easily bruised in this flattening market. We, on the other hand, are curious as to how much further can this go on, and what will follow.

No matter which metric you like to use -- trailing 12-month price-to-earning, cyclically adjusted
price-to-earnings, PEG ratio to account for meager growth -- the conclusion is self-evident; the
market is very expensive. According to many metrics, it’s the most expensive it has ever been,
going back to the foundation of modern stock markets.

We would have no issue with a chart climbing to the sky, and valuations on a similar trajectory, if
we held only stocks characterized by accelerating growth and improving margins. However, that
does not reflect the broader market. GDP growth and underlying earnings growth have been
decelerating.

S&P 500 companies are enjoying peak margins mostly because of the artificially low cost of
borrowing, which is responsible for the majority of margin improvement since the 2009 market
low. If that wasn’t enough, S&P 500 companies (excluding financials) almost doubled their
leverage (debt-to-EBITDA), which helped grow earnings per share through record high buy-backs,
and top-line through acquisitions. That one-time tactic has its limits.

Some pundits argue that during the internet bubble some valuation metrics were even higher. This,
they claim, creates more headroom. They forget to mention that the last 5 years do not compare at
all to the late 1990s. Back then the GDP was growing at twice the current rate while productivity
grew at three times the current rate. What’s more, 5- and 10-year average EPS growth was in high
single-digit percentage vs. less than 1% for the same periods today.

Let’s prime the pump!

With fragile growth, one might hope for more counter-cyclical monetary and fiscal stimulus from
Washington. How much dry powder is left, though? Interest rates are close to zero. The Fed’s
balance sheet hasn’t been this big since the Great Depression. US government debt hasn’t been
this high since funding the world’s biggest war (WW2). Meanwhile total US debt --including
corporate and consumer --has also peaked. These conditions would usually prompt easy money
policies and more fiscal stimulus to “prime the pump” when the growth stalls. However, those
tools have already been used extensively. What’s more, they have their limits. The record shows
they haven’t been very effective. If anything, they’ve helped inflate asse pricess even beyond the
peaks the market reached prior to the Great Recession.

The broad economic picture is only one side of the current situation. Looking at it another way,
very few individual stocks meet our strict contrarian criteria. Yet a high concentration of all stocks
hovers close to 52-week or even multi-year highs. That reminds us of a store where everything is
priced the same, regardless of quality.

At the same time, very few stocks trade at comparably low prices: 52-week or multi-year lows,
our usual hunting ground. The majority of companies that happen to be down have been tarnished
by fraud, litigation, or questionable business practices.

Given the macro and micro backdrops, you’d think this supposedly efficient market would
price the risks and rewards properly.

Unfortunately, the market sometimes operates like someone who boldly runs out of the house with
no umbrella because it’s not raining -- only to get drenched 5 minutes later. So, who is making
calls in this so-called efficient market? With an unprecedented expansion of passive index
investing, there’s less independent thinking and more blind following. This is a worrisome
development.

More and more debt is not a sustainable solution.

Human civilization offers over 5,000 years of recorded history of debt. Bubbles go back as far as
the Babylonians, Ancient Greeks and Romans over-expanded with the help of easy credit and
debased currency. These cycles have been repeated throughout history. We have nothing against
the use of credit but there is such a thing as excess leverage, as mankind has learned and forgotten
over and over again.
Deleveraging is usually disruptive to the economy, society, markets, asset prices, and asset
allocation.

There are at least four possible scenarios: 1) initial deflation followed by an over-large stimulus,
leading to hyperinflation (example: the Weimar Republic in the 1920s) 2) just enough stimulus to
keep the economy alive while escaping deflation for decades (example: contemporary Japan) 3)
we miraculously grow our way out of trouble (historical example: none) 4) governments and
central banks step aside, and let the free market correct itself, resulting in deflation, temporary
recession, subsequent honest debt repayment through higher taxes, followed by interest rate
normalization.

In more detail:

1) A likely scenario would lead to stalled growth, increased unemployment, and deflationary
pressures – massively unpopular results. The Fed and the government would follow their
Pavlovian response and cut the rates to zero. Unleashed asset buying would swell the Fed’s
balance sheet with more air. Meanwhile the government would augment the stimulus with
higher spending and lower taxes. Debt levels would balloon further. Eventually creditors
would have doubts about the government’s, consumers’, and corporations’ ability to pay
their debts. As faith in the currency wavers, inflation would finally kick in.

2) Or: just enough fiscal and monetary stimuli would keep growth above zero, teetering
between deflation and hyperinflation. (Imagine a tightrope walker on a windy day with a
bit of rain and hail.) Government could keep this up for as long as possible, as Japan did
for almost 30 years while a dramatic asset deflation eroded wealth (stocks and real estate
lost 80%+ of their value over time). It’s a path of slow, almost invisible nationalization,
where private market participants are gradually replaced by the government.

3) We would like to be wrong about the near-term challenges. We would love to see growth
accelerate at unprecedented levels so we can grow our way out of public, consumer, and
corporate debt while the level of interest rates normalizes. However, history offers no
examples of this.

4) The most rational scenario is like an unpleasant dose of medicine, i.e. allowing free market
forces to take over after decades of counter-cyclical fiscal and monetary interventionism.
Deflation would take its toll across services, goods, and assets, while we deleverage the
economy. Taxes would rise to pay off the excess debt we’ve accumulated over many
decades. (Not only unpleasant, but difficult to execute politically.) Once this is
accomplished we can grow from a new, healthier base. This process was carried out in the
US in early 1920s and again after WW2, when fiscal discipline and responsible monetary
policy were still virtues. This path could be self-imposed or enforced by creditors.
Clearly, the only two options are tightening and deleveraging now, or deleveraging later. The order
of steps the economy follows will determine which assets will prove safe havens, and which ones
eventually offer satisfactory returns.

The global GDP grows in two ways – population growth and productivity growth. Every other
kind of growth is borrowed (or stolen) from the future, through the use of debt. Given current
demographics and the immigration stance of today’s administration, population growth cannot
provide a sufficient boost for the US economy. Meanwhile productivity plateaued a while ago.
Apparently sharing selfies, lining up to buy electric sportscars, and binge-watching streamed TV
shows have not been incremental enough to our economic output - hence our obvious doubts about
the rosy scenario.
Neither excessive public debt or attempts to turn them into success stories are a 21-st century
invention. In the early 18th century, Mississippi Company was a vehicle set up to help consolidate
and reduce the cost of a massive national debt in France, and South Sea Company was a similar
attempt in the UK, we all know that both led to infamous bubbles that fooled such brilliant minds
as Sir Isaac Newton himself.
Today, successful investing is less about chasing the tail of a tired bull market, and more
about preserving the capital.
Our clients are families, and our job is to take good care of their fortunes for generations to come.
Today, our best course is
--to hold only “highest conviction” stocks
--maintain excess cash positions
--keep fixed-income durations short given interest rate uncertainty
--consider some small gold exposure.

(We are more concerned about deflation hitting us first before inflation catches us by surprise later;
thus, the possible role for gold.) Finally, to benefit from a potential market drop, we’d consider a
very gradual use of an inverse ETF tracking a broad market index, and preferably one that is not
leveraged. Additional leverage can give us a boost if we are absolutely right about the timing of
the sell-off, but that’s hard to guarantee.
Why are we optimistic despite such a gloomy backdrop?

We are big believers in the strength and resilience of a free market capitalist economy with its
natural business cycles. We are highly skeptical of the efficiency and lasting success of countercyclical
fiscal and monetary state interventionism. What gets us excited is the prospect of bargains
across all asset classes that will follow the current effort to overrule inevitable forces of the free
market.

We are playing the very long term game. We can wait. Today investing may feel like shopping in
a crowded department store at the peak of pre-holiday frenzy, but we all know what happens after
New Year’s Day -- fewer shoppers, better selection, better prices. It only takes some patience.
Bogumil Baranowski, Sicart Associates, LLC – 5/19/2017

Disclosure: This report is not intended to be a client‐specific suitability analysis or
recommendation, an offer to participate in any investment, or a recommendation to buy, hold or
sell securities. Do not use this report as the sole basis for investment decisions. Do not select an
asset class or investment product based on performance alone. Consider all relevant information,
including your existing portfolio, investment objectives, risk tolerance, liquidity needs and
investment time horizon. This report is for general informational purposes only and is not intended
to predict or guarantee the future performance of any individual security, market sector or the
markets generally.

Photo: Samuel Zeller

It might have been the least exciting, and the hardest-to-beat bull market, and its crash couldn’t be more anticipated.

Our current, highly durable bull market is characterized by three qualities: it might be the least exciting bull market in history, it’s been possibly one of the hardest to beat, and when it ends, the resultant crash will have been anticipated for months if not years.

We used to have fun

To look at a comparable example it’s not necessary to go back to the days of Tulip Mania in the 17th century. Investment bubbles are always driven by excitement and novelty. The vibrant stories of the roaring 1920s are still very much alive: we can almost hear the jazz, see the dancing, admire the big, powerful cars. It was an era of sudden success that inspired such notable books as The Great Gatsby.

Some thirty years later, we had the Nifty Fifty, when the most popular large-cap stocks on the New York Stock Exchange captured people’s imaginations. Among them were Eastman Kodak, Polaroid, Xerox, and Sears. For a while, you couldn’t go wrong buying those companies: they offered never-ending growth perspectives provided by exciting technological and consumer trends.  

More of us remember the internet bubble of the late 1990s.  Companies with no revenue, no profit, no real business plan, consisting of little more than an exciting web domain, were reaching billion-dollar valuations. These were the fastest, the most successful IPOs. A short-lived phenomenon, that bubble nevertheless sparked investors’ imaginations. New waves of entrepreneurs got rich overnight, and online trading spread that wealth among day traders who swapped the security of salaries to turn their hard-earned savings into fortunes. A nationwide, even worldwide frenzy took over.

Even more recently came the 2000s housing bubble. You could make an instant fortune flipping homes, condos that could be bought with no money down and no discernible credit. Once again, people quit their jobs to pursue the latest strategy to get rich quick.

What all of those exciting bubbles had in common is the jealous neighbor mentality. It really doesn’t matter what the stocks or homes sell for until your neighbor starts bragging about making a fortune overnight while you are still punching the clock and counting your change carefully at the supermarket.

It’s different this time

But this bubble is not like the previous ones. First of all, the current equity, bond, and real estate bull market -- in the US as well as globally -- has lasted a good deal longer than most. What’s more, while Europe suffered from the debt crisis spreading across Southern Europe, and emerging markets have been buffeted by weak prices in the commodity markets, the US market has had a relatively smooth ride to ever higher highs.

Second of all, because it’s been slow in making, this bull market didn’t create overnight fortunes for many investors, as previous bubbles did. While we’ve experienced one of the biggest dollar and percentage increase in our nation’s net worth, it has gone mostly to those who were already “sitting” on assets: their homes, stocks, retirement accounts, bond portfolios. Obviously, there were those who took advantage of cheap credit and boosted their returns over the last decade, but most of the spoils went to truly passive investors.

Here at Sicart we can’t say we haven’t enjoyed the ride. Many investments that we expected to double in 5 years tripled in 3 instead. We won’t complain – but we can’t take full credit either. The bottom line is that those who held assets and did nothing benefited the most. There was no need to day trade or flip homes. What’s more the process took almost a decade, so the excitement of overnight fortunes never occurred.

Let’s keep the training wheels on

Most of us know how to ride a bicycle, and we learned using “training wheels.” I remember the day and the moment when mine came off. They helped you balance until you knew what you are doing, and soon  you were shouting, “Dad, Dad, look! No hands!”  

The American and global economy experienced one of the most dramatic recessions in history less than ten years ago. There’s been much discussion about the causes and possible prevention of future events. Our take is simple: if money gets too cheap because of generous monetary policy, and if lending standards are relaxed for political reasons, there is trouble ahead.

To avoid a 1930s-style Great Depression, and taking advantage of all monetary and fiscal might that paper money, central banking, and fractional reserve banking allows for, this country avoided the worst damage by making money even cheaper, and relaxing lending standards even further. Ben Bernanke played the father-figure role: stern but finally relenting. He wasn’t the only one. The federal government played a major role, and so did central banks and governments around the world.

We can look at our economy as that kid learning to ride a bike. But, if I can extend the metaphor, our training wheels are still in place. Mr. Bernanke, as Dad, never got to see the economy free-wheeling on its own. Unfortunately, neither has Janet Yellen, who succeeded Mr. Bernanke. The same experience was shared by almost all key central bankers of the world. Neil Irwin named them appropriately in the title of his book: The Alchemists: Three Central Bankers and a World on Fire. One of the three, Mervyn King took this designation to heart, and called his own book The End of Alchemy: Money, Banking, and the Future of the Global Economy. It is a little bit disturbing to some of us to hear banking compared to magic.

As I wrote this article on September 20th, everyone was holding their breath before Ms.Yellen’s press conference. We all want to know if the training wheels will stay on! A few days later, I think we are still confused about the next steps, and their consequences.

We might be grateful to our wizards for avoiding the next Great Depression, but it is that very assistance that has produced the least exciting bull market on record. And while their policies which might have fixed one problem they have clearly created another.

When is it going to burst?

 It’s not only been the most boring bull market, but also the most questioned. As early as mid-April of 2009, the US equity market hit bottom, and hope was seeping back while the huge monetary and fiscal stimulus was underway. At that moment, famous market guru Jim Rogers told Barron’s that he didn’t believe in a U.S. stock recovery.

Shortly afterward, when the European debt crisis sent shock waves across all markets in 2011, a new wave of skeptics surfaced. John Mauldin published Endgame: The End of the Debt Super Cycle and How It Changes Everything. As the title implies, more debt is not a solution, and may cause a massive crisis in the near future.

In 2013, John Mauldin followed up with another great book: Code Red: How to Protect Your Savings From the Coming Crisis. I greatly enjoyed both books and many others published around the time, in part since I share Mauldin’s views. More and cheaper debt will not solve the economy’s problems. Instead it will eventually catch up with us in some ugly way.

Mauldin is far from the only author to take this position. In 2010, A. Gary Shilling authored The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation. In 2012, Richard Duncan wrote The New Depression: The Breakdown of the Paper Money Economy. In 2013, James Turk & John Rubino published The Money Bubble. In 2014, Willem Middelkoop released The Big Reset – War on Gold and the Financial Endgame.

Are we there yet?

The last six months have produced an even wider range of skeptics. Now even the major banks like Goldman Sachs, JP Morgan, Deutsche Bank, and major investors like Howard Marks, Paul Singer, George Soros, Jeffrey Gundlach, Carl Icahn, David Tepper among others, have shared their concerns with the public. Even the legendary Julian Robertson had to join the choir.

What I find most convincing about their opinions is that they are based on their worries about their own fortunes. Thanks to their success, they themselves have become the biggest clients of their own firms.

Actions speak louder than words, and Warren Buffett – who has been cautious about identifying a market  “bubble” in recent interviews – has begun accumulating a significant position of uninvested cash. If we’re not in a bubble, why the caution?

Being right and making money

All of the doomsday scenarios, from 2009 until the most recent, are correct. In a world where 2+2=4, we should already have a had a major market crash, and probably a major global recession. The economy would have cleansed itself from excess debt, and we would have started fresh in a more sustainable economic position. It would have been a painful experience to all, no doubt about it. But if the world must choose between less pain earlier or more pain later, there can be no doubt which is the better option. The one unavailable option is total escape.

Nevertheless, for the last decade the logic and common sense that normally undergird the market have been suspended. Monetary policy and fiscal stimulus (which have become intertwined in the last decade) are re-writing the rules and shaping a brave new world --

without risks without economic, market, business, or credit cycles where capital can be created by printing presses where central banks become huge unfair competitors to private capital, distorting the natural pricing mechanism

Active investors can fall into a trap in a market like this. Benjamin Graham, the father of value investing, famously said, “In the long run the stock market is a weighing machine. In the short run, it is a voting machine.” Active investors (and we count ourselves among them) assume that the market can be irrational at times, but rational in the long run. What if the questionable rationality lasts a decade?

When the math doesn’t work

This least exciting bull market might be also the hardest to beat. Active investors are being outperformed and even the smart, well-funded hedge fund world has struggled in the last few years.

Some reports claim that hedge funds haven’t generated alpha since 2011: a date that coincides with the wave of doomsday-scenario books cited above. In 2016, hedge fund managers as a group earned the least since 2005, which is remarkable in a bull market.

Many big hedge fund managers are shutting down their funds, shrinking their operations or stepping down. Among those falling from hedge fund stardom is John Paulson who brilliantly predicted and benefited from the housing bubble crash. The world’s largest hedge fund, Bridgewater, seems to be also out of sync with the current market.

Sicart won’t try to time this market

We are more of a tortoise than a hare in our investing approach. We build and trim our positions slowly, and take the same approach when it comes to portfolio construction.

Accordingly, at least three steps are necessary in this climate:

First, an honest, diligent, and thorough review of all holdings, followed by the sale of the overleveraged, weakest, or riskiest securities.

Second, a higher-than-usual cash ( or equivalent) position – the US dollar may not be a great store of value over the next hundred years but in the near term, $100 is likely to remain $100.

Third, look into diversifying away from overpriced, overvalued assets through both inverse ETFs (which go up when the specific asset class goes down), and/or precious metal exposure. Gold has been considered a store of value for 5,000 years.

We’d rather err on the side of caution. As Meb Faber in Global Asset Allocation reminds us, most individuals do not have a sufficiently long time to recover from large drawdowns from any one risky asset class. What if they are ALL at all-time highs?

We have focused too much on the last 40 years as a model of what the markets can deliver in the long run. Yet if we expand the study to the last 200 years, passive investing has a very mixed record.

Our leaders want to convince us that they have the power to defy business cycles, outlaw recessions, and wipe out risk premiums. They’d like us to believe we live now in a risk-free, recession-free, ever-growing financial world. We have our doubts.

At Sicart we have a different mandate than risk-seeking, alpha-generating hedge fund investors. They try to maximize returns in the shortest of times, we want to minimize losses in the longest of times. We take care of family fortunes.

Hedge funds open and close, lose all the money, find new clients and start over. In contrast, we are in the business of nurturing family fortunes over generations. We must remain vigilant, disciplined, and conservative.

We are not in the business of making fortunes overnight. Instead, we are in the business of preserving them for as long as possible.

Bogumil Baranowski, September 22nd, 2017

 MUSIC: Bensound: A New Beginning.

Disclosure:

This article is not intended to be a client‐specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. This report is for general informational purposes only and is not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally.

Photo: Hans Eiskonen