Issue #30

June 2009

Many changes are coming to our society, and they are likely to have significant effects on capital allocation, risk and returns. I believe that over the next ten years investment returns will be modest in nominal terms and low in real (inflation-adjusted) terms. Demographic and generational change will dominate the directions and responses to events.

As an investor, I’m responsible for protecting private wealth; that’s always my focus. Lately, I have become very interested in some work from historian and social demographer, Neil Howe. Howe’s research on generations describes how the common experiences of each generation’s unique time and place in history create and determine a shared outlook.

Generational Archetypes
Howe describes four archetypes of generations, which are repeating in eighty-year cycles. Each archetype develops in the time and place in history during which that generation comes of age. Further, when one archetype generation is passing on, the new generation follows the collective patterns and character traits of the generation it is replacing, refilling that archetypes’ societal role.

Howe posits that the Millennials (born 1982-2002); share the archetype of the GI Generation (born 1901-1924), which Tom Brokaw dubbed “The Greatest Generation” in his 1998 book who fought not for fame or recognition, but because it was the “right thing to do.” Like the GI Generation, Howe expects the Millennials to be the force of change for our society in the coming decades “because they intuitively see what the right thing to do (Sic.)” is. Compared to the last few generations, they are civic-minded, political engaged and progressive. If these characterizations are accurate, they portend potential massive institutional change and structural.

Recently, that possibility has captured my attention.

Immigrant Roots
Like the GI Generation, the Millennials have a huge number immigrant roots. Forty percent of the Millennials generation is non-white or Latino. Twenty percent of them have at least one immigrant parent, ten percent have at least one parent who is not a U.S. citizen. Similarly, the GI generation’s parents were a part of the massive immigrations to the U.S. in the 1880s to 1910s from central, southern and Eastern Europe.

The pendulum of the social fabric is swinging. I am taking notice that the momentous changes that Howe predicts may have profound consequences on investment decisions. But before getting to some of the ways that we are preparing client portfolios to weather the oncoming storm of change, let’s jump into some of these issues of “Great Change” – and the beginning of the end of the world as we know it.

Great Change

We enter the next decade on the cusp of a magnificent tidal wave. And it feels to me like it’s beginning to crest. As the wave gathers strength, coming to envelop the wave riders, the only question that counts is “how skillful are they at surfing?”

Will they be able to ride the tidal wave without going over the falls?

I grew up in what was once a sleepy beach city in South Orange County. One of the scariest things for an adolescent beach kid is learning to ride the bigger waves without “going over the falls.” Literally, this means riding the wave – without simply being tossed from the top of the wave, face first into the sand, as often happens if you are poorly positioned when the wave breaks. Think of the fishing trawler with George Clooney at the helm in “Perfect Storm.” That boat was fine as long as it either rode the waves or went through them, but if it gets to the top, and goes over the falls or capsizes, it’s game over.

As wealth managers, we’ve got to navigate these awesome swells of societal transformation with skill in order to avoid “going over the falls.” Asset allocation is the name of the game. We need to decide how to invest money for something more than a government bond fixed return. We just experienced a rebound this year in stock and bond values. But that’s yesterday’s news. What concerns me is what the future looks like? How will this affect you, your parents, your kids?

How is will this wave break? How will it affect stock, bond and real estate values? While we can predict some of the issues that will provide the catalysts to social upheaval and institutional change (health care, pension changes, energy, global warming, war) we cannot predict the eventual outcomes.

Predicting Historical Outcomes

Think back historically. Nobody knew that when they dumped the tea into Boston Harbor it would lead to the founding of a new nation, one which ultimately would become a transcontinental hegomonial state.

No one imagined during the debates of the 1850s that the bloodiest of wars ever on this continent was about to break out, and that it would divide and then forge together a nation that would ascend past all others in the succeeding century.

No one imagined that the surviving kids of the depression era were about to take on the world. In the 1930s, America was an isolationist nation.

Consider the Obama election

Obama captured the energy and power of this emerging generation with a masterfully designed social networking campaign that he orchestrated while Boomers and Gen-Xers were still trying to figure out what social networking was.

Catalysts to Great Change

Howe believes the Millennial kids bring a community spirit, teamwork skills and a sense of “doing what’s right” that can and will empower change in the way we do things. He predicts changes in institutional structures on a global scale. If he’s right, then the investing game will become even more dicey and dynamic indeed. If the social and institutional structural order really is about to undergo transformational change, then we in the wealth preservation game ain’t seen nothing yet.

What type of generation has the will to take on the entire structure of health care, Social Security, energy and pension reform? Howe says it will be the pragmatic, hard-nosed Gen-X generation.  For Howe, Gen X is most characterized by their value of liberty, survival and honor. Gen-X is just now moving into positions of leadership and authority. But already, it has had its greatest impact by the innovative strong individuals who have distinguished themselves entrepreneurially and at a younger age, than previous generations. Examples of Generation include Jeff Bozos (Amazon.com), Michael Dell, Tim Geithner and Barack Obama (A Gen-Xer at heart, who was born in the last cusp of the Boomer Generation).

Generation X is filled with impatient, pragmatic, ruthless problem-solvers, and we (I was born in 1968, which puts me in among early Gen Xers) will be the generation in the leadership positions during the coming transformational era.  Perhaps the simplest way of thinking about the character differences between Generation X and the Millennials is their influence on the development of the Internet. Generation X made Google, which is brutally all about finding what you need and finding it fast. The Millennials are Facebook, which is gabby; and all about creating communities and socializing.

Generation X and Millennials – A One-Two Punch
Extrapolating from Howe’s ideas, I can imagine that the hard-nosed practicality of the leadership generation today, which Obama embodies, paired with the iron will of community-focused, do-the-right-thing, Millennials, all 95 million of them, may be a one-two punch that can change our society faster than we suspect possible.

The Millennials won’t be in positions of leadership anytime soon, but they will be the dynamic force of the equation, the body politic. Howe believes they have the political will to take on pretty much any issue. As dictators know, you can only do what the army supports. The Millennials are the army, which is why Obama has been empowered to take on the biggest issues like healthcare.

My prediction: We will probably bear witness to more structural change in the next 20 years, than we have seen in the last 50 years.

This is a big and scary thought for money managers. What does it mean to bond allocations? What does it mean for the stock market? What about alternative assets? Here are some of our assumptions and the investment conclusions that we draw from them on managing client wealth and creating investment policy.

1. The energy crisis will be massive. We will invest tens of trillions globally in energy solutions over the next few decades. We want to overweight our exposure to energy companies.
2. The dollar will decline gradually. We want some investments, which are not directly dollar sensitive.
3. Multinational companies will continue to be profitable, and have less dollar exposure than other investments. We want a significant percentage of our equity holdings invested in multinational companies.
4. Taxes will go up. We want to buy municipal bonds when they sell at good values.
5. Inflation will go up. We want exposure to assets that will appreciate with inflation
6. Deficits will go up for quite awhile. We want to avoid an over allocation to growth investments because most classical “growth” investments will not turn out to be “growth investments due to transformational institutional change.
7. Scientific breakthroughs will improve the economics of different businesses. We don’t know when they will occur so we avoid non-dividend paying emerging businesses due to their low returns on capital.
8. Opportunities will appear.  Liquidity is important. We are less interested in hedge funds, and other investments that tie up or commit capital for a long period of time.
9. The standard of living will be a struggle maintain. We are wary of consumer discretionary companies.
10. Volatility and fear will dominate the investment climate. We want to convert capital gains into income streams, when possible.

Concluding Thoughts
In the midst of the social discourse of a rapidly changing society, stock, bond, real estate and other asset prices are unlikely to be stable (i.e. they will be volatile). We want to remain opportunistic. We prefer capital preservation and income strategies to growth strategies. As soon as the economic global recovery picks up steam the next Energy Crisis will be upon us. The transformation to non-carbon based energy economy will likely take at least 50 years, similar to the transition from a wood-based energy society to a coal-based one in the 19th century and the coal to petroleum transformation of the 20th century.

The western world can only compete in the new information economy if it relies on its strategic advantage in services and its creative innovation in new technologies and industries. Production-focused education curricula must be transformed into an environment supportive of creative and critical thought. The social debate that will ensue, commencing in the next decade will be massive. The Millennial Generation, with their penchant for teamwork and their belief in building a new and better world may demand that education move from preparing children for an industrial economy, to preparing them for a knowledge-based economy.

So that’s some food for thought today and this quarter. Our business has flourished in 2009 as our investments in gold, municipal and corporate bonds have led our portfolios to better than market returns with much lower overall risk. Our income-focused capital preservation strategies are designed for retirees and affluent investors seeking to protect their accumulated assets through the commencing Great Changes.

“Second-Look” Service
We offer a “Second Look” service. This is a complimentary review of your existing portfolio allocation with no cost, obligation or pressure. If you are concerned about making the best choices to achieve your life goals in a safe way, call us to schedule a 30-minute “Second-Look” review meeting at our new office location in La Fiesta Square.

Publishing Foci for Barnes Capital Insight
Going forward, BCI will be produced quarterly. The January issue will continue as the Review & Forecast Issue. The July issue will be a mid-year update to the Review and Forecast Issue. The Spring and Fall issues will highlight whatever I am really interested in at that moment. My best English teachers used to tell me to write about what I know and am passionate about. BCI will follow that advice.

Incidentally, you may want to take a look at our newly designed website, and our articles in Lafayette Today. In March I began writing a column in this local monthly paper with a circulation of 11,000. These articles are short and snappy.

Barnes Capital is a Registered Investment Advisor located at in downtown Lafayette. With RB Capital Management, Barnes Capital develops custom tailored portfolios for its clients. Specialized in retirement income portfolios, financial planning in an integral part of our process. Call 925-284-3503.

This entry was posted on Wednesday, July 1st, 2009 at 1:56 pm and is filed under Insight Newsletter. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.