update
Winning the Race: Maximizing the
Probability for Investment Success
What does it take to win a sailboat race?
Chief Investment Officer Rick Pitcairn
knows from experience that sailors must
analyze and anticipate a set of inputs –
including tides, currents, wind shifts,
etc. – and then position their vessel in
a way that maximizes the probability of
success. Similarly, investment professionals
take a set of inputs – economic growth,
earnings, etc. – and position portfolios
to maximize the probability of success.
At the 2014 Pitcairn Family Wealth &
Investment Forum, Mr. Pitcairn returned
to this apt metaphor to introduce a
discussion of “inputs” currently shaping the
investment landscape.
While offering his own insights, Mr.
Pitcairn guided a panel of industry leaders
as they considered five factors likely to
affect global investment markets in the
months ahead.
1.A global rise in capitalism and
consumerism
2.US elections and government action
3.Geopolitical events
4.Federal Reserve policy
5.Equity valuations and investor sentiment
Global Rise in Capitalism &
Consumerism Likely to Fuel
Global Growth
Mr. Pitcairn recently traveled to Asia along
with his fellow members of the Wigmore
Association, a group of chief investment
officers from eight family offices around
the globe. Their itinerary included visits
to Beijing and Singapore where they met
government officials, corporate leaders,
and investment professionals with keen
insight into the Asian region. The trip
Rick Pitcairn, 1989
J-22 North American Championship
provided substantial evidence of a massive
rise in consumerism and the expansion of
capitalism in China and other countries
within the Association of South East Asian
Nations (ASEAN).
As Mr. Pitcairn pointed out, the belief
that you can make your own decisions,
start your own businesses, and not have
to serve a feudal lord or an oppressive
government is a uniquely American
ideal. “Though emerging countries still
must solve problems with transparency
and corruption,” says Mr. Pitcairn, “in
general, these countries are moving toward
the American ideal, not away from it.”
“Capitalism is expanding to all corners of
the globe and will have a dramatic effect
on the investment markets. Seeing that
magnitude of economic activity in Asia
and the throngs of people combining hard
work with some variant of capitalism to
vastly improve their lives continues to fill
me with optimism.”
Jason Trennert, managing partner of
Strategas Research Partners, presented
data that support an optimistic view of
global economic activity. As plotted
in Chart 1, survey responses from
purchasing managers across the globe
showed favorable trends in economic
activity, based on indicators such as
new orders, production, and supplier
deliveries. Purchasing Manager Indexes
or PMI numbers, as they are commonly
called, suggest reason for optimism
around the world, not just in the US.
Mr. Pitcairn voiced his belief that the
current level of global consumption,
as well as projected consumption
trends in emerging market countries,
provide powerful support for global
equity exposure.
Mid-term Elections Open Door
for Change
Not surprisingly, the 2014 mid-term
election spurred lively debate among
political pundits and citizens on
both sides of the political aisle, as
Republicans gained control of both
Congressional houses. However, as Mr.
Pitcairn pointed out, this power shift
did not affect investment markets in
the short term. “Politics will always be
an important backdrop for the capital
markets, potentially affecting the country’s
mood and market direction, but we have
a bigger, more important election in
two years.”
Investment panel member and CNBC
Senior Contributor Larry Kudlow
expressed his belief that the mid-term
election results provide an opportunity
to move back toward a more free market
model of economic policy. He predicts
Republican leaders will send a flood of
new bills to the President’s desk, including
legislation on energy reform, tax reform,
and health care. Mr. Kudlow said he
expects President Obama to veto all of
these, though it’s possible some deals will
be made. Mr. Kudlow was optimistic that
congress will be able to pass a budget.
Mr. Kudlow also summarized the key
concerns of American voters as expressed
in Election Day exit polls. Voters were
concerned about economic issues, health
care, immigration, and foreign policy.
Geopolitical Events May Sway
Sentiment
Federal Reserve Monetary Policy
Is Key to US Market Outlook
So far in 2014, the range of noteworthy
geopolitical events has included the
Russia/Ukraine conflict, the rise of ISIS
extremists in the Middle East, and the
Ebola epidemic in Africa. Mr. Pitcairn
reminded the audience that even though
geopolitical concerns are often transitory
in nature, they can still have a significant
effect on market psychology. Earlier this
year, the escalating conflict between Russia
and Ukraine raised concerns about energy
prices and in October, news of US Ebola
patients had a notable, but thankfully
short-lived, emotional effect on investment
markets. In both cases, markets quickly
rebounded as fears abated.
Two years ago, the general consensus
was that investment markets would be
crushed as soon as the Federal Reserve
began winding down its quantitative easing
program. Surprise! Markets actually rose
when the Fed began easing. As of October
29, 2014, the Fed ended its bond buying
program (though it will continue to roll
over principle payments and maturing
securities, keeping its holdings at sizable
levels). Proving the bears wrong, the
broad US equity market (as represented
by the Russell 3000® Index) rose in
October and had a near 10% year-to-date
return through October month end. (US
equities maintained their upward trajectory
through the end of the year and ended
2014 up 12.6%.)
Among the economic variables most
closely tied to geopolitical events, energy
prices are a recurring source of concern.
However, a meaningful shift in the world’s
energy situation may actually mute the
impact of geopolitical incidents. Mr.
Kudlow described how the global energy
picture has changed due to the significant
increase in US production; the US now
leads Saudi Arabia in oil output.
PMI Measures Show Solid US Growth
Global Manufacturing PMIs
CONTRACTING ACTIVITY
EXPANDING ACTIVITY
8
STRENGTHENING
4
SLIM Supplier Deliveries
There’s little doubt that interest rates
would be meaningfully higher if central
banks weren’t involved, but for investors,
the bottom line, according to Mr.
Trennert, is that “betting against risky
assets is very tough sledding right now
because all the powers that be (central
banks) are arrayed against you.”
Ireland
Italy
Euro Area Taiwan
Germany
Australia
Vietnam
Netherlands
US
Poland
UK
Switzerland
Global
Austria
Canada
India
Indonesia Norway
Japan Mexico
China
Singapore
S. Korea
Brazil
New Zealand
Denmark
Russia
Turkey
S. Africa
France
2
0
-2
-4
Spain
Greece
SLIM New Orders
WEAKENING
YTD Average vs. 2013 Average
6
46
48
50
52
54
56
58
Even as the Fed ended its bond buying,
central banks around the globe continue to
purposefully repress interest rates. Central
bank actions support Mr. Trennert’s
“TINA” principle and expand it into the
realm of global equities. As Mr. Trennert
has said for some time, “There Is No
Alternative to equities if families want to
earn meaningfully more than inflation and
institutions want to achieve their actuarial
targets.” As evidence, Mr. Trennert cited
Germany where a 10-year government
bond yields just 0.85%. “In the US,” says
Trennert, “we are lending money to the
government at 2.3% for the next 10 years.”
That level of return is not going to get
families where they need to be.
60
62
64
October 2014 PMI
Countries in the upper right quadrant of the chart show expanding economic activity.
Source: Strategas, 2014.
66
“How the market accepts impending
shifts in US Fed policy, as well as the
policy moves of central banks around
the world, will be critical going forward,”
said Mr. Pitcairn. He believes that further
fundamental improvement in the US
We will always be at the optimum
intersection of technology and sound
financial advice that serves the complex
needs of multi-generational families.
economy would put inflationary trends
in place, which would then give Fed
Chair Janet Yellen the perfect middle
ground to achieve her goal of returning
the US to a more normal monetary
environment. On the other hand, if Ms.
Yellen has to back off tightening and
institute more quantitative easing due
to economic slowing, that would rock
market confidence.
Mr. Pitcairn thinks “that two to three years
from now, we would be better off with
a Fed funds rate 2%-3% higher than it is
now, and I believe most corporate chief
executives and chief financial officers
feel the same way.” Under that scenario,
S&P 500 companies should continue to
deliver a decent earnings stream, which
would foster a favorable environment for
risk assets.
but it’s no bull market peak. That forecast
equates to a forward earnings yield of
6.25%, making equities a very attractive
alternative to AA corporates, Treasuries, or
any other low risk investments.”
Mr. Trennert pointed out that people just
won’t believe this is a real bull market and
persist in calling it a rally. “The S&P 500
is up 200% since its low. That’s not a rally,
that’s a bull market,” Mr. Trennert stated.
While the stock market is at all-time highs,
so are earnings. Mr. Trennert believes
people have been so scarred by the
financial crisis, they want to assume the
market is up for illicit reasons and not for
an obvious reason like earnings have risen.
trade deficit mainly due to higher US
oil production. Meanwhile, demand has
been bolstered by Fed bond purchases
and the US position as the world’s safe
haven. As demand for safety greatly
outstrips supply, bond yields remain low
and unattractive relative to equities.
• Reduced supply of stocks. There are
far fewer publicly-traded US companies
than at the turn of the millennium.
Increased regulation has raised the cost
of being a publicly-traded company and
the explosion in private equity has made
it easier for companies to obtain capital
without going public.
• Continued apathy from average
investors. In 2013, mutual fund owners
added only $17.9 billion to equity funds
in a year when the S&P 500 was up over
32%. “Bull markets generally don’t end
with this much apathy from the average
person,” says Mr. Trennert. “The end
comes in a period of over exuberance.”
Ray Nolte, chief investment officer of
SkyBridge Capital, added one note of
caution to the other panelists’ optimism.
Equity Valuation & Investor
Sentiment
When will this market run end? Are stocks
valued too high? According to Mr. Pitcairn,
those are the questions he’s asked most
frequently. “I think there’s still room to
go higher in this market. If the bears
are complaining now, they may really
be screaming by the time this bull
market ends.”
Mr. Kudlow also expressed his bullishness
on the economy and stock market.
Based on the positively shaped Treasury
yield curve, he concludes there is no
recession in sight for two to three years.
Furthermore, based on the break-even
point for Treasury inflation-protected
bonds, there’s no sign of inflation either. “If
I use Mr. Trennert’s forecast for S&P 500
earnings of $125 per share for 2015, that
is roughly 16x earnings. That ain’t cheap,
Investment Roundtable from left to right: Rick Pitcairn, Jason Trennert, Ray Nolte, and Larry Kudlow.
Mr. Trennert pointed out that even as
average investors refuse to recognize
the bull market, multiple factors indicate
continued equity gains:
• Supply/Demand Keeps Treasury
Yields Low. Normally, 10-year
Treasuries trade about equal to nominal
GDP growth which is at 5%, but
10-year Treasuries now yield only 2.5%.
Supply is suppressed by the decline in
our federal budget deficit and a lower
“We should expect continued volatility
going forward because many shock
absorbers are out of the market. Before
the 2008 crisis, banks and large brokers
had significant stakes in stocks, bonds, and
other securities, which they actively traded
for their own accounts. For example, before
the crisis, market makers and proprietary
trading desks held 25% of the high-yield
market compared to 3% today. That
means that during rough patches, there
are significantly fewer buyers to shore up
the market.”
Conclusion
In his introduction and throughout the
Investment Roundtable, Mr. Pitcairn
reiterated Pitcairn’s role in helping clients
navigate changing economic and market
conditions. Comparing his current role as
Pitcairn’s chief investment officer to his
days as a sailboat racer, Mr. Pitcairn noted
that much is the same – he still observes
current conditions, pinpoints change,
and works to make sense of shifting
variables. He suggested that many in the
audience – family leaders and managers of
family businesses – are in the same boat,
peering forward into an ever-changing
environment, striving to make the right
moves for their families.
Mr. Pitcairn noted that technology plays
an ever present part in the decisions we
make and the way we live our lives. “The
world is changing at a record pace and
it’s incumbent on all of us to respond to it.
Continually evolving technology gives us
an opportunity to rethink our structures so
we can deliver the advice we need to deliver.
You have a pledge from this firm that we
will always be at the optimum intersection
of technology and sound financial advice
that serves the complex needs of multigenerational families.”
He concluded, “Our fundamental
recommendation for families is to work with
a firm like ours to find a plan that makes
sense for your families. Be sure that plan
stands the test of time. Inform the plan with
insight from other trusted advisors, populate
it with the best investment managers, keep
a careful eye on fees and taxes, and then
let that plan work for a long period of time.
That will lead you to success. We believed
this 20 years ago, we believed it five years
ago, and we believe it today.” P
©2015 Pitcairn
Harold F. “Rick”
Pitcairn, II, CFA is
Chief Investment Officer
of Pitcairn. One of the
chief architects behind
Pitcairn’s open architecture
investment platform, he
is a leading authority on the use of tax overlay
and Unified Managed Accounts (UMA) in trust
structures and for the ultra high net worth investor. In
addition, Rick is a founding member and Chairman
of the Wigmore Association, a global collaboration
of chief investment officers from seven family offices
from across North America, Europe, Australia
and South America. The group exchanges views,
research, and insight to enable members to enhance
their global perspectives and enrich their investment
processes. Rick is a frequent speaker and author on
investment topics including long-term investing for
families, due diligence, tax overlay, and global asset
allocations. He has contributed expertise to various
investment media outlets, including The Bloomberg
Advantage, Barron’s, The Wall Street Journal,
Investment News, and Family Office Review.
He was awarded MFO CIO of the Year at the
2013 Family Office Review Annual Awards.
About Pitcairn
Pitcairn is one of the world’s leading family offices. We are dedicated to helping families sustain and grow their
substantial, often complex financial assets and supporting the unique heritage of our clients across multiple
generations. Pitcairn works with families and single family offices filling one need or providing comprehensive
solutions. Since our founding as a family office in 1923, we have successfully transitioned wealth across
generations of families through a combination of effective planning, strong investment results, thoughtful
governance, and a commitment to education. Headquartered in Philadelphia, Pitcairn also has offices in New York
and Washington, DC as well as a network of resources around the world. You can learn more about our family
office services as well as find additional articles, news, and events on our website at www.pitcairn.com.
Pitcairn Update is a publication prepared by Pitcairn for the exclusive use of its clients. The information provided
should not be construed as imparting legal, tax, or financial advice on any specific matter. For more information,
please call us at 1-800-211-1745 or visit us on the web at www.pitcairn.com.
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