Monthly Archives: January 2016

Extreme Caution – Brokers At Work


January 25, 2016

Will we ever learn? I was looking at the Wall Street Journal on Thursday this past week and was surprised to see the headline “UBS Redeems Two Energy Products”. Since energy is one of the hot button topics in the market I was curious to find out what had been “redeemed”. It quickly became apparent that this was yet another story about a complex product designed by a brokerage firm. These engineered products have long been a staple of Wall Street brokers. The desire to “manufacture” products for sale to investors is just as strong today as ever, but it seems that investors never learn from the mistakes of the past. Sure enough these UBS energy products had cost investors a huge portion of their investment.

Financial engineering is a polite term for creating products which make fairly specific bets in the markets. The bet in this case of redeemed energy products was a security tied to the stock price movement for oil and gas master limited partnerships (MLPs) involved in the energy pipeline business. If the pipeline companies did well, the product developed would do well. In fact the leverage in the product meant that it was designed to do twice as well as the underlying market. On the other hand the product would do twice as badly if prices fell.

So when oil prices crashed, and the stock prices of MLPs plummeted, these UBS products fell twice as far. The two products both dropped by 20% on Wednesday alone, and are down 50% in value since the start of the year! UBS then made the decision to stop the carnage and announced they would redeem the two securities on February 1 for a currently undetermined price.

The formal name of the security was a 2X monthly Leveraged S&P MLP Index ETN. This is a lot of inscrutable letters and abbreviations for something which turned so toxic, so fast, that the sponsoring brokerage firm felt compelled to redeem just to try to make the problem go away.

The lesson to be learned here goes back to the basic blocking and tackling of investing. What are the investment rules violated by this investment product? Two come to mind very quickly. First, understand the risks of a product before you invest. Second, respect the power of leverage. This instrument had been levered by a factor of two, which meant the return exposure on both the up and downside was doubled.

We do not know if the investors in this case fully understood the risks they were getting into at the outset, but the desperate actions of the sponsors suggest that even they might not have really appreciated the perilous nature of their products . By the end of the week another firm that had issued a similar type of security, was warning investors to exercise extreme caution when buying and selling these securities. Such “advice” is of little help to those investors already holding the product. Let’s hope those investors can still afford to make more considered investment decisions in the future.

Carl Gambrell


Phone Calls From The 1%


January 19, 2016

The sluggish US markets of 2015 have been quickly followed by pessimism and volatility.  Based on how my phone was ringing following last week’s pathetic market move, anxiety levels are starting to rise.  In last week’s Weekly I reiterated some of the basic rules that many financial and advisory firms espouse for long-term investors.  Trying to maintain a 30-year horizon is difficult when the last 30 minutes in the market have been turbulent to the downside.  Based on Friday’s close the year-to-date return of the S&P 500 is down 8% and the emerging markets are down 10.7%.  The price of oil continues to free fall, and by the close on Friday it had already fallen by 22.3% in January.

There is a lot of 2016 left but the bold prediction of volatility just a few weeks ago has certainly been the major market trend for the start of the year.  This is all occurring as the “wealth gap” in the world now stands at the largest that it has ever been in modern history.  Last week it was reported that the richest 1% of the global population is worth more than the remaining 99% of the population.  The statistic that is truly hard to comprehend is that the combined wealth of the top 62 families in the world is greater than the poorest 50% or 3.6 billion people.  Who worries about these markets the most?  Those with the most to lose, and especially the “1 per centers”.

To make the top 1% in global earnings you need to have an annual income of $32,400, and from a net worth stand point you need to have assets of $770,000.  If you are an American living in the most prosperous country in the world (sounds like I’m running for office), then the income hurdle to be in the top 1% is $434,000, and the net worth hurdle is $7,000,000.

Who picks up the phone for advice when the market drops?  Those people who have substantial assets.  As you worry about a decline in the market I would challenge us to think about the impact on the average global consumer.  Wealth is concentrated but spending is universal.  I worry more about the spending habits of the 99% than those of the 1%.  The 1% may be calling to seek advice on what they should do in a crazy market, but it’s what the 99% will do that matters when it comes to global growth and spending.

As many of you know, we believe in maintaining three years worth of cash or cash flow available for spending needs.  This will allow an investor to weather the storm of short-term volatility.  With a 3-year cash buffer you might find you can worry less about the next three days of market volatility.

Carl Gambrell