why asset-allocations fail

7/29/2019 Why Asset-Allocations Fail

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WhyWhy

Asset-AllocationsAsset-Allocations

FailFail


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A presentation of

Weather-Eye AdvisorsForward lookingRisk-controlled

Investing solutionsThis publication should not be construed by any reader as a Weather-Eye Advisor(WEA) solicitation to effect, or attempt to rendering of personalizedinvestment advice for compensation, over the Internet. WEA does not make any representations or warranties as to the accuracy, timeliness, suitability,completeness, or relevance of this information. Please remember that different types of investments involve varying degrees of risk, and there can be noassurance that the future performance of any specific investment or investment strategy, will be profitable or equal any historical performance level(s).Readers should seek appropriate guidance before making any investment decisions. WEA is a Michigan registered investment adviser. While the firm andits personnel are registered with the State of Michigan, it does not imply a certain level of skill or training on the part of the firm or its personnel.


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Allocation of What?

Most asset allocation areallocations of different

Asset Classes

You want to diversify your risk notyour assets


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Here's a typical diversified

allocationSmall Cap Stocks, Middle Cap Stocks, Large Cap Stocks, High Yield Bonds,Foreign Stocks and Real Estate

Do you notice anything? Different assets, but the same risk.


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What is going on?


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Crappy Diversification

If I sell you four types of crap

Small CrapMid CrapLarge CrapForeign Crap

It doesn't really matter. Rain. sun orsnow it will still behave like crap.


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It the same for stocks.For the most part stocks will

behave like stocks.

Small CapMid CapLarge Cap

When the market tanks theyall go Cap-put.


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Like This.


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So...What do you do?

You, follow the money.


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But, before you do that you needto know where money comes

from.

How does new money get into the

economy and eventually into themarkets?


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U.S. Currency comes from the USGovernment.

Some people think it comes fromChina, like coffee makers, but it

doesn't.


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When the government spendsmoney on anything, it is new

money in the economy.


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When the government taxes itremoves the money. The money

isn't re-spent it is destroyed.


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It works like this. New money is spent into theeconomy and old money is taxed. The government

doesn't spend your tax money, but people like to

believe it does.

The money pools in the economy as private sector liquidityThe private sector liquidity is what we spend, save or invest.


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Here is how it happens.(more or less)

Now, everything balances the government spent a million dollarsthat is deposited in a or many banks. The banks buy bondsand now the government has borrowed back its own money.So now there is a million dollars of new money and a milliondollars of government debt. Everything balances.

The governmentbuys a submarine fora million dollars.(They're on sale).

The submarinecompany depositsthe million in theirbank.

The bank wantingto get interest buys amillion dollartreasury bond


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Banks also create money the

same way.

Once again, everything balances the bank loaned 100,000 dollarsto the boat owner. Then it reserved the loan with the money it lent.So now there is a 100,000 dollars of new moneyand a 100,000 of bank debt. Everything balances.

You borrow $100,000from the bank tobuy a boat and pay itto the boat company.

That night the boatcompany deposits100,000 in theirbank.

Later in the month the Fedask the bank if they havethe money to coverthe loan and they say.

Yes, we have $100,000 in

new bank deposits.


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Banks and the Government

create and destroy money.Private Bank Lending

Government Spending

Private Sector Liquidity

Government Spending

Government TaxesLoan repaymentsand defaults


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So? what's this have to do with

investing?.


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To make money you investing you

have to catch the money as itflows through the system.


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To make money you investing you

have to catch the money as itflows through the system.


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Ask yourself where does the

money go inside the economy onits journey from creation to

destruction?

If it goes to bid up the price ofyour financial assets you'll

make money.


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People can only do three thingswith money.Save it

Spend it

Or, Invest it

I guess they could dothis, but its expensive


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In this model, money is save if it isput into a government-guaranteed

bond or bank account. Anythingelse is investing or spending.


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Let's look at investing it.


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Stocks

Real Estate

Private orLocal Bonds

Commodities

Money Supply

Money Supply

When it is invested it moves from buyer to sellerwithout being destroyed or removed from the economy


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Buyers money

When you buy a stockthe supply of money inthe economy doesn't

change it just goes frombuyer to seller. So howcan you make money?

Seller's money


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So if in an imaginary world wediverted all of our money to stocks

they could never go up in value

because there is only so muchmoney. (assuming our money

supply is unchanged)


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If there is only $100 dollars in the

money supply that is the most youcan sell your stock for.


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For stocks to increase,investment money has to be

diverted from elsewhere in theeconomy from savingsor consumption.


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If you want the to spend more on

the investment you have to spendless on the other two things.

Less savingLess spending

More investing


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That's why we usually don't havegoods and service inflation at thesame time we have a bull market

and economic growth (spendinggrowth). Think about the 1990's.Good market low inflation. Or the

1970's high inflation lousy market.


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If the money gets saved in agovernment bond instead then thecurrency disappears out of system until

the bond matures.This is because a dollar

is a type of bond a billof credit that's why wecall them bills. If youbuy a bond with aanother bond from thesame issuer one iscanceled out. Thecurrency disappears forthe length of the bond.


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When the money is spent oninvestment and consumption it is

recycled from buyer to seller.But when it is saved it is take outof the system.

It is benched.

It is out of the race.


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So things look like this.Private Bank LendingPrivate dis-savingGovernment Spending

Private Sector Liquidity

Government Spending

Government Taxes,bond sales,and personal savings

Loan repaymentsand defaults


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When money flows to stocks it is recycled back intothe economy. When it goes to government bonds it is

not.


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When currency flows increase into

government-insured savings instead ofconsumption we get

DEFLATIONDEFLATION


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Deflation occurs when the price of assets,wages, goods, or services decrease. Thisusually bad for the economy because theprice of assets goes down but the level of

debt remains constant. .

This is what happened during the financialcrisis.


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Deflation occurs when the flow of money goes into government-guaranteed savings. This money cannot be recycled into debt

repayment and makes it difficult to pay down the debt.

As the flow of money isredirected the price ofstocks decrease and theprice of government bonds

increases.


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When this happens the interest rate

decreases

Like this.


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To combat deflation with Quantitative Easingthe Fed buys government bonds to create a

shortage and make it harder to save.

Fed buysGov. bondscreating ashortage

The money flows to other places


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When the money flows into consumption

instead of savings we can sometimes get

INFLATIONINFLATION


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General or goods and service inflation

occurs when the prices of wages, goods andservices increase.

It isn't always bad. It is good if your wages

increase and you owe a lot of debt. You canpay off the debt with cheaper dollars. This

happened in the 1960s and 1970s.











Inflation occurs when the flow of money


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Inflation occurs when the flow of moneygoes into consumer goods, fuel and food.

This leaves less money for savings, stocksand bonds

The price of stockstends to decreaseand the price of

government bondsincreases.


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To combat inflation in the early 80s the Fedsold government bonds to create a surplus

and make it easier to save.

Fed sellsGov. bondscreating a

surplus

The money flows from otherplaces

Money isremovefrom thereeconomy


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Or sometimes the consumption causes

inflation of capacity orECONOMIC EXPANSIONECONOMIC EXPANSION


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When money flows into investmentsinstead of consumption or savings we

usually get

ASSETASSET INFLATIONINFLATION


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Investors like inflation that increasesthe value of their investments.

Most allocations focus solely on thiseconomic outcome.

Asset Inflation. But if assets don'tinflate neither does your portfolio value.


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Most standard allocations relypredominately on asset inflation.

If financial asset prices don't inflate then

the allocations perform poorly.


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A risk allocation doesn't allocate betweentypes of assets it allocates between

economic outcomes

DEFLATIONDEFLATIONINFLATIONINFLATION

EXPANSIONEXPANSIONASSETASSET INFLATIONINFLATION

AND NO OUTCOMEAND NO OUTCOME

MUDDLING ALONGMUDDLING ALONG


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Here is a simple portfolio composed of investments

allocated to the four economic outcomes.

Notice how much more diversified the investments behave.

This portfolio is comprise of Treasury Inflation Protected Bonds to protect against inflation,An S&P index to capture asset-inflation, Long term government bonds to protect against deflationand Government Mortgage Backed Securities to provide steady income in slow economies,


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Find out more about moneyflows and risk -managedallocations in the book.

why asset-allocations fail

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