Robert W. Baird & Co. Private Wealth Management The Harkins Starr Group

FIRE SUPPRESSION By David Starr

“Truly, the real black swan problem of stock market busts is not about a remote event that is considered unforeseeable; rather it is about a foreseeable event that is considered remote. The vast majority of market participants fail to expect what should be, in reality, perfectly expected events.”

THE DAO of CAPITAL by Mark Spitznagel

"In 1988, Yellowstone National Park went wildfire as a crucial natural process and up in flames. In the worst catastrophe in called for it to be reintroduced into the the history of U.S. National Parks, nearly ecosystem...Central bankers, too, could 800,000 acres of forest and surrounding learn a thing or two from their forestry areas were scarred by the uncontrollable brethren."1 blaze." In recent years, every market retreat has "The spread of fire-suppression mentality prompted central bankers to wriggle forth can be linked to the establishment of with fresh promises of suppressed interest forest management in the , rates and . Jim and I such that by the early 1900's forests remain convinced that the great 'policy became viewed as resources that needed error' of the Federal Reserve doesn't lie in to be protected- in other words, burning the future. No, the great policy error of was no longer allowed. The danger of this the Federal Reserve is long behind us; in approach became tragically apparent in the misguided insistence on sustaining Yellowstone, which was recognized by the yield-seeking speculation, overvalued late 1980's as being overdue for fire; yet financial markets, and dramatic expansion smaller blazes were not allowed to burn of low-grade debt. The third speculative because of what were perceived to be bubble in 16 years is already well- risks that were too high given the dry developed, and the consequences are conditions. And so smaller fires were put baked in the cake. out, but in the end could not be controlled and converged into the largest The danger of constant fire suppression is conflagration in the history of Yellowstone. that it fosters the illusion that the entire Not only did the fire wipe out more than forest is a controllable object, while 30 times the acreage of any previously actually weakening its capacity for recorded fire, it also destroyed summer resilience. Likewise, the danger of and winter grazing grounds for elk and relentless Fed intervention is that it bison herds, further altering the fosters the illusion that the financial ecosystem. Because of fire suppression, markets are under the tight control of the trees had no opportunity or reason to , while encouraging ever replace each other, and the forest malinvestment that amplifies the severity thus grew feeble and prone to of the ultimate consequences. Nothing has destruction...in 1995, Federal Wildland been learned from 2000-2002 and 2007- Fire Management policy recognized 2009, when even persistent and The Harkins Starr Group

aggressive easing was incapable of vote may have been short-lived but is an holding back the inevitable collapse of example of what I believe is a growing investment bubbles. The market plunges crisis of confidence in government. that completed those market cycles Markets do not like uncertainty and as essentially represented the mass investors we should remain cautious as recognition by investors that they had the potential economic impact of this shift badly miscalculated. Each successive has not been fully determined. bubble encourages them to forget that lesson. Jim and I don’t doubt that central The cause of populism and nationalism in bankers will continue their recklessness; world politics may be due to increased rather, what investors should understand globalization, a rise in automation in is that easy money only supports the manufacturing as well as the continuation market when investors are already of sluggish economic growth around the inclined toward speculation. world which has led to poor economic policies creating a highly levered global To summarize, our near-term market environment. The political result becomes outlook remains skeptical, though a an evaporation of the political center and speculative rally continuing to feed on moves to the extreme right or left. yield seeking investors may continue. Still, we can’t envision any upside While the causes of the political upheavals scenario in which it would be appropriate are similar in Europe and the U.S., they to operate without a or safety-net. aren’t identical. Many middle-class In no case would near-term market Americans are upset because they think strength improve long-term prospects of recovery from the global financial crisis of the market. 2007-08 has been uneven, benefiting mostly those at the top of the income 1The Dao of Capital by Mark Spitznagel ladder. In parts of Europe the feeling is more that recovery has never come at all. In South America the sudden drop in oil and commodity prices has led to increased political instability and social unrest. I will Rise in Populism be watching to see what takes place at the conclusion of the Olympics in Brazil across the Globe this summer. By Jim Harkins Meanwhile nationalism is on the rise in both China and Russia as well. China has The recent passing of the BREXIT steadily devalued their currency in the referendum in the UK could be a preview wake of the BREXIT vote to protect their not only for our upcoming US elections trade with the world and continues to but in politics around the world. I believe have territorial disputes in the South we have been experiencing a recent shift China Sea. Russia continues to expand its in the political pendulum toward populism presence in world whether it’s in the Baltic and nationalism across the world which Sea over oil rights or their growing investors need to pay attention to. influence in the Syrian crisis. Market volatility that followed the BREXIT The Harkins Starr Group

Q2 Portfolio Notes mutual funds and exchange traded funds in most client models for asset allocation. We regularly reevaluate and monitor our As we closed out the first half of 2016 we equity and mutual fund positions continue to see the rotation from growth rebalancing where we feel prudent. Using to value stocks in the US markets which the Baird platform we have created model we have been anticipating and prefer. For groups for our discretionary portfolios as the first half of 2016 Large Cap Value well as personalized models to fit your continues to outperform Large Cap Growth investment goals. For clients with smaller by nearly 4% with the Russell 1000 Value portfolios we will also use mutual fund index up 4.6% vs the Russell 1000 Growth specific portfolios that may own a few Index only 0.6%. Also of note has been individual equities. the upside in Small Cap Value with the Russell 2000 Value Index up over 6% year to date. Although the broad US markets -Jim Harkins have moved off of their recent lows in February David and I both urge caution Past performance is no guarantee of future results. with this recent rally and continue to All investments carry some level of risk. Indices are unmanaged and direct investment is not possible. recommend a higher than normal position The opinions expressed are those of the author and in cash. We continue to recommend not necessarily those of Robert W. Baird & Co. holding small positions in gold and precious metals which has surged year to date with Gold up over 24%. This may be due to the political economic issues I have mentioned as well as the growing doubt in global currencies. Areas of opportunity become more difficult to find with current market highs and low interest rates but we continue to research areas such as agriculture and other sectors and asset classes to deploy our cash when we feel it is prudent.

How we manage your funds:

As our investors know, our goal is to achieve solid, risk-adjusted returns over a full market cycle. Our discretionary managed accounts are segregated by a client’s personal risk profile and your instructions to us. David and I have typically used individual equities with a The Harkins Starr Group focus on companies we think have Private Wealth Management enduring franchises in good times and 925 Fourth Avenue bad, hoping to purchase them at Suite 3600 attractive valuations. We also use no load Seattle, WA 98104