Charter Trust - Global Market Update

What is the Federal Reserve doing? In its statement yesterday, the Fed noted that they decided to wait for more economic data before tapering their asset purchase program. In his press conference afterwards, Chairman Bernanke blamed tightening financial conditions and a soft labor market—along with a shot at the Federal Budget sequester—for delaying the taper process. He counseled patience—patience with the Fed, patience with the economy, patience with the process—to markets that have been itching to move.The reaction was anything but. Bond yields dropped point-one-five percent, stocks hit all-time highs. Everyone had been expecting the Fed to start cutting purchases of Treasuries and MBS in September, and their statement yesterday even shaded economic growth higher. So now the whole thing’s on hold?After June’s meeting, Bernanke announced the Fed’s intentions and the market freaked out. Interest rates went up too far, too fast, and Fed officials got out and walked it back. Yesterday’s announcement continued that process. The Fed needs lower interest rates to keep the economy growing, especially in the housing sector.Formulating Fed policy is deliberative, messy, and fraught with uncertainty. Like sausage-making, the end product may be attractive, but the process can sure make you lose your appetite.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpddirect: 603-252-6509 reception: 603-224-1350www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Does anyone smoke anymore? The ‘90s were a decade of tech booms and S&L busts. Of budget surpluses and Monica Lewinski. And tobacco litigation. 46 states sued the major tobacco companies, claiming that smoking raised Medicare costs. Rather than fight it out, the parties agreed to settle. The states dropped their lawsuit, and the tobacco companies agreed to pay over $200 billion to the states over the next 25 years—the largest civil settlement ever.Many states didn’t just wait for the payments; instead, they securitized them, pledging the expected payment stream and borrowing against it. But increased state and federal cigarette taxes have pushed sales down, and most of these bonds are now junk-rated.In essence, too many people are quitting. Only 19%of Americans smoke now, significantly lower than the 25% who smoked at the time of the settlement. That’s good for their health, but bad for the health of these bonds.Recently cigarette bonds rallied, based on a new court ruling that frees up more cash for bond payments—but it’s only temporary. When a product kills off its customer-base, it’s usually a bad investment.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpddirect: 603-252-6509 reception: 603-224-1350www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Is America exceptional?Last week’s spectacle of Russia’s President writing an op-ed in the New York Times chiding Americans was surreal. Especially when he all but quoted the Declaration of Independence to admonish us for considering America as exceptional. What’s going on?Apart from the irony of seeing our former Cold War antagonist lecture Americans on American values, does he have a point? Is it truly dangerous to encourage people to see themselves as exceptional? I would submit that it depends on what the exception is. If a people see themselves as especially chosen to bring civilization or prosperity or purity or character to a benighted world, that can be dangerous. That view arguably led to all kinds of abuses during the  Age of Empires—and even World War I and the Russian Revolution.But if the exceptionalism is one of origins, of coming together rather than going out, of ideals rather than ideology, that’s different. And it can be measured. Just look at the number of people who want to move here: almost 140 million, by one estimate—over three times the next most popular destination, England. (And 25 times the number who would rather move to Russia.)That’s an exceptionalism that seeks to be a light, not a burden—that has a decent respect for all peoples. One based on choice and trust.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpddirect: 603-252-6509 reception: 603-224-1350www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

After five years, what have investors learned from Lehman?Lehman's bankruptcy and the pricking of the housing bubble created chaos, disruption, and market opportunities on a scale that hasn't been seen in the markets for decades. Indeed, not since 1974, with double-digit inflation at home and foreign policy failures abroad had the market been so cheap. The bear market of the '70s offered its own lessons to investors--inflation matters, price matters, government policies can change--which were incorporated into the bull market of the '80s. Does the financial crisis offer similar schooling?One clear instructional gem is that diversification works, but only if you let it. A portfolio of 25 banks is not diversified; a portfolio split between government bonds, muni bonds, large-cap stocks, and small-cap stocks is. Many all-stock portfolios went down 50% or more after Lehman failed; balanced portfolios declined about half as much. And that diversification served you well, if you had the stomach to rebalance during the Winter of Discontent in 2009.But that's another lesson: it's much easier to say "I'll be greedy when others are fearful" than to act on the principle. Almost everyone--including myself--should have been more aggressive when the market crashed. But it's hard: all those negative stories with fears of bank nationalization and Great Depression 2.0 were paralyzing for many. Just riding out the cycle was a white-knuckle experience.And five years on we're back to all-time highs in the market. That's the final lesson. Recessions happen. Bubbles happen. Keeping your head and viewing the market in perspective is hard, but if you did, you saw some outstanding bargains: excellent companies offered at excellent prices. There were also some value traps. But the opportunities created by the general panic were real, and level-headed investors bought in and then moved on.Investing is hard work. But if you can keep your head when everyone else is panicking,  the market is yours.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpddirect: 603-252-6509 reception: 603-224-1350www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

 What are the lessons of Lehman's failure?It's important to look at the failure in context--in the context of the economy at that time, and also in relation to other financial institutions. Bear Stearns had been bought by JP Morgan in a Fed-engineered takeover in March; mortgage giants Fannie Mae and Freddie Mac were put into a Federal conservatorship the week before. On Friday, September 12th, 2008 many market participants thought the same fate awaited Lehman. The stock might be wiped out, but the bondholders would be made whole.But that's not what happened. The next Monday the company filed for Chapter 11, its senior bonds traded down to 30 cents on the dollar, and a financial panic ensued, with the market falling over 30% within a few weeks. How did otherwise free-market advocates come to expect federal intervention and support?One culprit is the culture of bailouts that had been growing since the early '90s. Mexico received US support in '94; Long Term Capital was taken over in a Fed-supported bailout in '98; investors had been discussing the "Greenspan Put" for years: the belief that if the market traded down, the Fed would lower interest rates to support asset prices. The expectation of government support led to widespread moral hazard--where firms take on risk believing that if it works out they make money, but if the venture fails, they'll get government support. This didn't happen with Lehman; try as they might, Federal officials couldn't find an excuse--or deep-pocketed partner--to bail them out.Government support can make a crisis worse when it leads them to take risks they otherwise would leave alone. In 2008, what should have been a moderate recession almost became another Great Depression because financial intermediaries doubled down. Instead of reducing risk, the entire financial system became more fragile.There are not atheists in foxholes, and no conservatives when bailouts are at hand. Beware of governments bearing gifts.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpddirect: 603-252-6509 reception: 603-224-1350www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Is the US power grid doomed?The electric utility industry is facing a revolution. Rooftop solar cells, gas-powered micro-turbines, and software-based switching technology are allowing some electric utility customers to go off the grid and still keep the lights on. They just use traditional power lines as a backup.Distributed generation is becoming more and more common. Rooftop installation is especially popular in the southwest, and it's not just homes any more. Wal-Mart President Bill Simon recently remarked that solar is often cheaper than grid power, and Wal-Mart has a lot of roofs. And because there's little advantage to having a large, centralized arrays, individual homes and businesses can generate their own power and feed their excess back into the grid.But because line charges are built into the kilowatt-hour rate, these folks aren't paying for the infrastructure that brings this power to their homes. Rate increases on non-generators can make up the difference, but only for a while. Eventually you get into a death spiral: higher rates kick more folks off the grid, which leads to higher rates for those remaining, and so on.Technology costs fall; utility costs rise. Eventually, those lines cross. When that happens, watch out. And put on your sunglasses.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpddirect: 603-252-6509 reception: 603-224-1350www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Are we addicted to being right?Research shows that when we get into stressful discussions, our hormones kick in. Cortisol hits the body, and we default to a fight-or-flight response. If we stay engaged, our voices might get louder. We begin to talk over each other; our pulse and blood pressure rise. It feels like an out-of-body experience.If others back down, our brains are flooded with adrenaline and dopamine. We feel dominant and invincible. It's a feeling we like, and it becomes physically addictive. The next time the tension rises, we fight again. And again. We want to get that buzz.But this power trip can be poisonous. Investing, like many things in life, is a team sport. After a decision, lots of players are part of making it work. If they're just going along to get along, we won't get the outcome we need.Fortunately, there's a team-building hormone as well: oxytocin. It comes into play when we create human connections, and it helps create interdependence and sharing. By trying to empathize and understand--rather than to dominate--we can build  trust and make our decisions more effective.Sometimes it's wrong to be right. The best way to communicate just might be to listen.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpddirect: 603-252-6509 reception: 603-224-1350www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Will technology cost us our jobs? For centuries people have worried that technological progress will create unemployment. I've written before how the factory of the future will have a bunch of robots, a person, and a dog: the person is there to feed the dog, and the dog is there to make sure the person doesn't touch the machines. But it's not just manufacturing anymore: massive online computer courses threaten university professors; automated trading algorithms have eliminated many floor exchange jobs; there are even automated burger-flippers. James Joyce observed this when he wrote Ulysses: Leopold Bloom observes how hard it is to steer a tramway, and imagines an invention to make it easier. Of course, Bloom notes, the operator would lose his job, but then another fellow would get a job making the new invention. Technology makes us more efficient, but it displaces workers in the process. Technological progress is inevitable. It makes all of us better off collectively but makes some of us worse off in the process. The key is to help those displaced by the process--through retraining or pensions--without stifling the incentives for growth. Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all! Follow me on Twitter @GlobalMarketUpd direct: 603-252-6509 reception: 603-224-1350 www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Are we going into another round of political brinksmanship?It sure looks like it. With Congress divided and the debt-ceiling deadline, government funding deadline, Fed taper target, and new Fed Chair decision all coming due, it seems like we're headed for volatile times. To be sure, these are important issues: monetary policy helps determine interest rates, which in turn are key to the value to all financial assets. Government spending constitutes over 20% of the economy; shutting it off suddenly would be highly disruptive. And if we don't expand the debt ceiling, the US could default--a disastrous possibility that no one really wants to contemplate.But we've seen this movie before, and it's a snoozer. The difference between Larry Summers and Janet Yellen is one of style, not substance. The institution of the Fed Chair is far bigger than any man or woman who sits there. Fed policy is dependent on the economy, which is gradually strengthening. And fiscal and financial policy have been in flux ever since the Republicans took the House in 2010. Divided government is something Americans do--like eating hot dogs or buying junk food. It may not be good for us, but it won't kill us right away, either.So don't get all lathered up over the latest Congressional brouhaha. Chances are, it's just some politician hoping for a headline.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpddirect: 603-252-6509 reception: 603-224-1350www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Why does the economy grow? When we look at the natural world we see cycles of growth and decline. Gardens sprout in the spring, bear fruit in the summer, and die back in the fall. Populations of rabbits and deer grow until they're everywhere and then collapse.  Rivers go into flood, then slow to a trickle. Only with economies do we see steady, long-term growth. A generation ago cars only went 100 thousand miles or so, and you had to wait for weeks to get parts to repair them. Several generations ago people were just getting indoor plumbing. We're a lot better off now. Why is this? It's been said that the economy is more productive now because we're smarter than we used to be. That's not exactly true--human nature hasn't changed. Conflict and war is still common; leaders are still felled by hubris and overreach; education and study are still hard work. But living standards have been rising steadily for 200 to 300 years. Why? Two centuries of economic research have shown that economies grow because they accumulate capital-- human, physical, or financial--and the more flexible that capital is, the more steady that growth will be. That is, if you can shift a railroad from shipping coal to shipping oil, the line won't go unused (and jobs lost) when the price of oil declines dramatically. That's why the natural world is an imperfect model for understanding the economy. And the faster the economy grows, the better-off everyone is. Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all! Follow me on Twitter @GlobalMarketUpd direct: 603-252-6509 reception: 603-224-1350 www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

It's been a mild hurricane season so far. Will it stay that way? At this time of year people watch a storm center in the Caribbean to see how tropical storms develop. In the same way, observers can watch storm centers in the global economy to see if financial problems might be headed our way. For the past several years we've kept an eye on Southern Europe, but recently South and Southeast Asia has become a new global storm center. The Indian Rupee is down 12%; the Indonesian Rupiah 10%; and the Malaysian currency 8%, and their stock markets have fallen 10-20%. Capital is leaving the region and financing costs are increasing. For many, this is reminiscent of the "Asian Contagion" of some 15 years ago. Are we headed there again? Probably not. Back then, a major issue was the fixed exchange rates that many countries maintained against the dollar. When capital fled, they had to use up their hard-currency reserves to support the fixed rate. Now their currencies float. Also, the most vulnerable countries--Indonesia and India--are much less levered than Thailand and Singapore were in the late '90s. And the region is more diversified and flexible than it was before 1997. This means that while foreign lenders to these countries will likely feel some pain, there aren't that many, and their currency exposure is probably hedged in some way. The hurricane season isn't over, and economic issues in Asia could still organize themselves into a major gale. For now, however, it just looks like a hard blow. Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all! Follow me on Twitter @GlobalMarketUpd direct: 603-252-6509 reception: 603-224-1350 www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

So what caused the financial crisis? Now that we understand the four types of causation, we can apply them to what happened in 2008. Because if we understand how it all happened, we can apply these lessons to today. The efficient cause of the crisis was the sub-prime mortgage market. That's what blew up in 2007 and wiped out trillions in capital.The material cause was what made up that capital--the monetary system that underlies our financial system. It's why some people want to reestablish the gold standard. Change the material of the financial system and you change how the system works.The formal cause is the structure of the financial system itself. This structure creates vulnerabilities. Change the structure, and you may become less vulnerable. It's why there have been such changes in financial regulation and ongoing monitoring recently.The final cause--or goal--of any economic setback is to rebalance the underlying economic system. In 2002 through 2006--for many reasons--we built way too many homes. During the recession, homebuilding went down to levels not seen since the '50s. That allowed the economy to work off the excess inventory. Because economic needs change, we'll always have recessions. It's the only way that a system can adjust to new circumstances.By looking at the crisis through the lens of classical causation, we can see how and why some changes in the system might help us become less vulnerable during the next crisis. Because be assured, another crisis will come. As someone once said, we are born to trouble as the sparks fly upward. Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpddirect: 603-252-6509 reception: 603-224-1350www.chartertrust.com  •  www.moneybasicsradio.com   •   www.globalmarketupdate.net

In order to understand what caused the Financial Crisis, we need first to understand what it means to cause something.Classically, causation can be classified four ways. We looked at material and efficient causes yesterday. Today we will examine formal and final causes. The formal cause of a table is the plan for a table--a horizontal plane supported by several legs. Think of it as the blueprint, or ideal structure. The formal cause of a chemical reaction would be periodic table and electro-chemical potential of various molecules.The final cause is the purpose it serves. The final cause of a table is to lift stuff up so someone can get at it. The final cause of a car is transportation. It's what the thing or event accomplishes.So when we ask what caused the Financial Crisis, we should look at it classically, using the four causes. The efficient cause of the crisis was the subprime mortgage market; the material cause was monetary and financial flows; the formal cause was the structure of the financial system; and the final cause was to correct the imbalances and distortions that had developed in the economy.We need to look at the crisis as fully as possible in order to understand it. Because if we don't understand history we'll just go through it again. We sure don't need that.Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpddirect: 603-252-6509 reception: 603-224-1350www.chartertrust.com  •  www.moneybasicsradio.com  •  www.globalmarketupdate.net

What caused the Financial Crisis of 2008? On the face of it, that's a simple question. But it really depends what you mean by "cause." This isn't a word game. Classically, we can look at causation in one of four ways: material cause, efficient cause, formal cause, and final cause. We've largely forgotten Aristotle's notion of the four types of causation, but that doesn't make them any less practical. If we don't want something to repeat itself, we'd better understand what brought it about in the first place. To understand Aristotle's delineation of causation, it helps to think about a table, and what caused a table to be sitting in your kitchen. The material cause of a table's presence is the wood or metal that the table is made of. It's a pretty simple notion--material causes are created by the material something is made of. In the same way, the material cause of genetic trait would be the DNA-sequence in the cell-nucleus. The efficient cause for a table's presence would be the carpenter who build's it. Efficient causes are the action or process that created something. We don't want to fall into the "post hoc" fallacy--after this therefore because of this--but in order to cause something, it has to come before it. In order for a red billiard ball to cause a blue ball to move, the red one has to be moving first. The post hoc fallacy just mistakes sequence for causation. These two types of causes are what people usually think of when they think of causation, but the other two are helpful as well. We'll look at them tomorrow. Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all! Follow me on Twitter @GlobalMarketUpd direct: 603-252-6509 reception: 603-224-1350 www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Is college worth it?That's a reasonable question, and it's what's behind the Administration's recent effort to reign in college costs. The value of getting a college education has been an article of faith for so long (buttressed by study-after-study about lifetime earnings and unemployment) that questioning the value of a college education is like questioning the value of happiness. But it's important: college costs have eclipsed home prices for many as the single biggest expense of their adult lives.And it's unclear what we're paying for: education or the degree. Students in college can acquire valuable skills--advanced math, lab science, critical reading and writing--but they also receive a sheepskin. If it were just the skills that were important, cheating wouldn't happen. And we wouldn't bother to punish it.Between 1992 and 2008, the number of BAs awarded annually rose from 1.1 to 1.6 million. Around 60% of those additional graduates end up in jobs that don't really need a degree: electricians, waiters, mail carriers. So now we're seen an explosion in graduate degrees. Where will it end?Right now we're on a cost merry-go-round, where high prices lead to more federal aid which requires increased administration which pushes up costs and prices--lather, rinse, repeat. Maybe the President's proposal of online scorecards and regulatory waivers--combined with massive online courses--will help. For now, though, we're using subsidized debt to purchase an asset of questionable economic value that everyone claims will only go up in price. Have we seen this movie before? And how did it end?Douglas R. Tengdin, CFA Chief Investment Officer Hit reply if you have any questions—I read them all!Follow me on Twitter @GlobalMarketUpddirect: 603-252-6509 reception: 603-224-1350www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net