CyberSecurity—It’s a People Problem

Most companies have had a cyber hack—or if they haven’t yet, they soon will, according to a panel of experts at the January 31, 2017 European American Chamber of Commerce’s symposium on The Shifting Paradigm of Data Security. It’s not a question of if it will occur, but rather, when. And when it does, it’s expensive.  According to Stewart Rose, President of ThreatReady Resources, a Boston-based cyber security awareness training firm serving top corporations in the US, "The average cost a company incurs is $6.5 Million, including expenses associated with brand, reputation, and litigation."

We’re all too familiar with the more common ways hackers grab our data:  phishing, rogue emails, and links containing embedded malware or ransomware.  What we’re not prepared for is how hackers are using human behavior to penetrate security, pointing to the need to “think diabolically, just like hackers do,” says Philip Kibler, who was a Global Partner in IBM’s Cyber Security Practice and now heads Cyber Risk Consulting at AIG. For example, social media outlets, such as LinkedIn and Facebook, are easy entry points for hackers to obtain email addresses, and they’re learning how to bypass even the most sophisticated spam folders.

Cyber hackers are growing more savvy, often targeting third parties as a way to access company data.  Companies mistakenly assume their third-party business partners have strong controls, only to discover that's not the case, leaving them vulnerable.  Global regulations are still in flux (after all, the cyber industry is somewhat nascent—only 30 years old), making compliance challenging.

One trend that is gaining hacker traction is acquisition targets.  These companies may have lax defenses as they focus on getting the deal done and containing expenses, with employees scurrying to find new jobs, which can leave the organization exposed.

A solution that could help is for companies to have the equivalent of a cyber FICO score—with a defined road map outlining what must be done to improve it. Also, recognizing that most times, cyber hacks can be traced back to failure at the human level.  “No router is malicious, but people can be foolish and careless when it comes to how they handle data,” says Joseph DeMarco, partner at DeVore &DeMarco LLP, a litigation and counseling boutique law firm dedicated to the protection of intellectual property, emerging e-commerce, and Internet law

Vendors have culpability, too.  According to one statistic, 30% of breaches in a major US government organization could be traced directly to the products it purchased to guard against vulnerability, shining a spotlight on the need to prove these products are secure before they're installed.   

Most software companies issue patches to fix problems, but the problems they address are often the direct result of having discovered a vulnerability, tantamount to locking the barn after the proverbial horse is stolen. Instead, patching should be rigorous and diligent, driven by guarding against potential susceptibility, rather than by corporations' drive to save money and improve the bottom line.

There is no magic bullet to prevent a hack, but training employees how not to make silly mistakes can make a company less vulnerable. As Rose explains, most employees don’t sit at their desks planning how they can hack their companies’ data. But these same people may nonchalantly plug a thumb drive into a corporate computer’s USB port—a simple act that can have disastrous consequences. ThreatReady Resources employs instinctive, active learning techniques designed to change human behavior permanently.

And if your company does get hacked?  “Your first call should be to your lawyer, so he or she can guide you on your legal rights and obligations as to the protection of your systems and sensitive data, says DeMarco.

Investing in the World of Trump

No matter whom you voted for in November,few can argue that the election result has been a bonanza for the stock market. As it continues posting a 19,000-plus close, pundits are out in full force to opine on where we go from here.  Some say a further climb is in store—others predict financial Armageddon.  What should investors do? It may be wise to revisit investing 101.

Attempting to predict the market’s move can be a fool’s game—witness what happened after Brexit, and more recently, on November 9.  What does make sense is having a long-term strategy and sticking with it.  That means a diversified portfolio weighted according to your own risk profile and time horizon.
 

It also means dusting off some basic tenets of successful investing, starting with being smart about managing gains. As the old adage goes, ‘No one has ever gone broke taking profits.’  Many traders have a different view, but they aren’t long-term investors, and that’s an important difference.  Being invested for the long haul means taking gains when a stock position has appreciated—selling half to protect the profit and letting the remainder continue to grow is one strategy—thus generating liquidity to purchase new investments or having cash on hand to take advantage of lower prices when the market turns (and it always does—but we never know precisely when).

And it includes watching investment costs, something the sage of Omaha, Warren Buffet touts.With the proliferation of index funds, ETFs, and on-line trading platforms, investors can keep transaction costs to a minimum.  Knowing when to quit is another one of his rules—the sell decision is often the hardest one for an investor to make.

Finding good businesses at good prices will pay off over time (the operative word), something Buffet advocates.  “It is far better to buy a wonderful business at a fair price than a fair business at a wonderful price.”

Energy and infrastructure are hot investment areas because the new administration is committed to both.  And so long as people drive cars and need heat and electricity, energy companies will provide them.  But energy can be fickle—and prices to a large extent are a function of global supply, which is beyond our control. Yes, OPEC has agreed to cut production to stabilize the market, but getting member countries to comply is a different story.  Domestic producers, on the other hand, are taking advantage of higher oil prices to increase rig count, so may represent shorter-term investment opportunities.

Infrastructure will likely be funded by bonds, and now that interest rates have finally begun to rise, the returns are at least palatable, although no one could argue with a straight face that even a prospective 5% coupon holds a candle to the potential profits of the stock market.

But therein lies the rub—bonds stabilize a portfolio against the volatility of stocks. As the stock market moves higher, the FOMO trade—fear of missing out—picks up steam.  The market always has and always will be driven by fear and greed. And sometimes both at the same time.

Long-term growth in the stock market is grounded in a healthy outlook for corporate earnings.  As of January 20, 12% of S&P companies had reported, and of those, 61% beat average estimates.  Sam Stovall, Chief Investment Strategist at CFRA, makes the case that 4Q 2016 earnings could be up by 8%.

If that trend continues, we may see even more positive momentum in the stock market. Buying companies with solid earnings performance has always been a good strategy, along with a suitable allocation to bonds as a buffer.

Rather than attempting to invest by figuring out the new administration’s investment plans, paying attention to basic investing principles may be a better path.

What Lies Ahead—and What It May Mean For Your Portfolio

As the stock market has recovered from its February 11 low (and posted a modest gain for the year), many of us wonder what lies ahead.  Given the Federal Reserve’s recent decision not to hike interest rates now, low-risk investors are looking elsewhere for return, and many are questioning whether the stock market is their only option.

At a recent economic forecast presentation hosted by Denver-based AMG National Trust Bank, insights were offered that could be a guideline.  Themed, “growth with a speed bump”, the speakers were careful to point out both the positives and negatives that may be in store.  On the plus side, consumer spending, which accounts for around 67% of our country’s Gross Domestic Product (GDP), looks to be running in the range of 3%.  Add to that figures for rising home prices, low energy costs, an improved labor market, and expectations for GDP growth ranging from 1.5% to 3.2%.  (Although that figure may be a tad optimistic:  Other analysts put it at 2%-2.5%).

On the other side of the ledger is declining business investment, particularly capital spending in the energy industry, which has seen sharp declines.  A few other risks could cloud the picture:  high domestic inventories, an increase in foreign imports, and weakening credit standards.  High inventories mean that businesses won’t produce goods while they are drawing down inventories.  Increased foreign imports mean we are buying more from other countries than from our own US manufacturing base. Deteriorating credit standards are reflected in troubled real estate and construction loans, which may compress banks’ interest income and margins.  These things combined make for a somewhat murky outlook.

The credit picture is further complicated by high-yield debt, currently yielding around 7%.  Although improved from the higher rates seen in December and January (primarily because of a better outlook for oil prices that caused those bonds to rally), the spread between these rates and the risk-free rate of the US 10-Year Treasury remains fairly wide compared to a couple of years ago.

So what does this mean for investors?  First, valuations for stocks are high:  A current price/earnings ratio of 17 (versus the long-term average of 15) for our stock market suggests that it may be tough for the market to have a significant rise.  According to another analyst, Vinny Catalano, President of Blue Marble Research, either interest rates need to drop or earnings have to accelerate for stocks to rise much more.  Interest rates can’t drop much (they are already low: just .50%), and first quarter earnings for 2016 are expected to decline by more than -7% over last year, and fall another -2% for the second quarter versus a year ago, before turning positive for the third and fourth quarters.  These forecasts amount to a projected overall increase of a mere 1.49% for the year.  Not exactly a rosy scenario. 

But the outlook for European stocks may be better, given their lower market valuations.  The European Central Bank (ECB) also recently expanded (and extended) its quantitative easing program, by which it will purchase more bonds, thereby putting more money in circulation.  The ECB also introduced negative interest rates (that encourage savers to spend), and the Eurozone is enjoying a strengthening currency.

The outlook for oil is not clear.  Although its price peaked at $41 per barrel before retreating slightly to around $36, it still represents around a substantial increase from the $26-per-barrel low reached in February.  As a commodity, oil prices are determined by supply and demand, and several factors have affected both sides of the equation.  Demand from emerging markets (China, among others), has contracted, and at the same time, we have more supply from US oil producers.  As low prices prompted domestic producers to cut back production, Saudi Arabia and other global producers continued to pump to preserve their market share.  In addition, now that we have an agreement with them to remove sanctions in return for their adopting a more acceptable nuclear policy, Iran is now a factor, and is expected to add sizable production to the supply.  Given these facts, oil may trade between $40 and $60 per barrel—higher than the rock-bottom low we saw earlier this year, but still a far cry from the $82-per- barrel-price of 2014.

For the time being, talk of recession seems muted, given the improving economic data and how well the stock market is performing.  But economists do draw some interesting parallels.  According to their findings, recessions that occurred during a bear market (defined as a drop of 20% or more), typically lasted 500 days. Contrast that scenario with historical trends for recessions that occur outside a bear market lasting around 136 days. 

So how can we use this data to our advantage?  Most professional investors view market timing to be a fool’s game, because it demands making two correct decisions:  when to sell out, and when to buy back in.  A more prudent stance is to have a well-diversified portfolio that is in line with your comfort level with risk.  In the short term, it is tough to get meaningful return in bonds, as the US 10-Year Treasury yields under 2%, and once interest rates begin to rise, capital will be risk (as bonds with higher rates are more attractive to an investor).  That reality has spawned much ink in the financial press about how standard equity/fixed income asset allocations for conservative investors and retirees may be passé.  It also has pushed many investors to invest in the stock market without adequately understanding, much less being comfortable with, the added risk. 

Risk has many connotations, among which are the degree to which you can “sleep at night”; the likelihood that your portfolio will lose value; and the possibility that you may need to make withdrawals to cover retirement living expenses at a time when the market is in decline. Depending on the severity of the decline, you may have insufficient time for your portfolio to recover, meaning your assets could be substantially depleted while you still need income. That degree of equity exposure may be uncharted territory for you, and you should understand the risk. One study showed disastrous results for a portfolio that was invested entirely in stocks for the 15-year period 2000-2015.

Building a portfolio with a mix of different types of equities, including those in international developed countries, along with some exposure to bonds for stability, may be a more acceptable strategy.  Stocks with dividends are one option, as typically—but not always—dividend-paying stocks do not suffer as much during a market selloff.  Another option is to select a balanced fund with a mix of both equities and bonds.  Although investors generally purchase bonds for their income characteristics, fixed income investments also stabilize a portfolio, as the underlying capital is a loan to the corporate issuer.  An issuer with solid credit is unlikely to default on the obligation.  Having bonds in your portfolio will help preserve your capital should the market suffer a decline.

You also should realize that in an election year, fiscal policy and market behavior can have an impact on how your portfolio performs.  When election campaign rhetoric is leading the charge, the outcome may be beyond your control.  But you can control how you react, and having a properly diversified portfolio is one way to counter the chaos.

Reading the Tea Leaves

Anyone invested in the market since pre-March 2009 has to be ecstatic - we've recouped our losses, and then some, on the Dow, and the S&P is not far behind. The bulls think it could go even higher, and bears, well, there will always be bears.

While the economy is improving, as witnessed by the surprisingly high number for retail sales released this week and consumer sentiment on the rise, a high stock market doesn't necessarily signal strength.  We maintain that investors seeking yield cannot get it in traditionally risk-averse areas like bonds, and are being forced to increase their portfolio's risk by chasing higher-performing stocks. 

Having drunk the Black Swan Kool-aid, and forever on the lookout for what could trigger another one, I recently saw a piece on Briefing.com that suggests we may want to monitor margin activity, particularly as it pertains to managing risk.  After all, if you see the black swan circling, you have time to duck for cover.

According to the report published March 11, 2013, January's margin debt was the highest since January 2007, and we all know how that year ended.   Also, there is a $77.2 Billion deficit in the margin account credit balance, suggesting that meeting margin calls could be dicey.  Further, the last time there was such a significant margin deficit was in the spring of 2011, just prior to a 19% correction.

All of this suggests strong speculation in the market, fueled in part by increased confidence in the economy, but also signaling that there is a significant increase in market risk.  Should there be something that comes out of left field that induces selling, then forced liquidation of stocks to meet margin calls (since cash is not available) could cause a sell off.

Black swans don't come around all the time, but when they do, they can be deadly.  Protecting your portfolio from that kind of shock means being willing to settle for lack-luster yields in what seems like a boring bond market.  But it won't be so boring should the market suffer a correction.  At the very least, some exposure to bonds will give you a safety net, and placing the equity portion of your portfolio in relatively safer dividend-yielding stocks is a smart way to position yourself for what could be a bumpy ride. 

You can read the full report at:

http://www.briefing.com/investor/our-view/the-big-picture/margin-debt-rises-into-thin-air.htm

FrackNation

While lunching recently with an old boyfriend (one of the few liberals with whom I can engage in friendly political sparring), we were discussing the ailing economy (on which we both agreed) and debating the merits of more stimulus for the economy (on which we did not).  He made, however, what I thought was a poignant observation, that our country needs another “new thing” to get things moving again. While he and I are destined to stay on opposite sides of the aisle, his comment resonated.

Harking back through our economic history, America has experienced booms and busts throughout.  The railroads, the roaring twenties, the influx of returning World War II veterans and the demand for housing, products and services, the oil boom, the dot.com rush, and the credit-fueled real estate market are but a few examples. Each of these made millionaires out of mere minions (as well as fattened corporate coffers).  And each was followed by a severe bust.  We still are suffering from the last one, leaving an overhang that we cannot seem to shake.  

What does this have to do with finance you may ask (since this blog deals with financial issues)?  If we can unharness the gas companies and let them drill safely, it could be as meaningful as the gold rush.  Being the low-cost producer in any business is an important advantage.  The US has the potential to produce and export natural gas, with untold benefits for the global marketplace, and potentially rich returns for investors.  Reducing our dependence on foreign oil is one natural outgrowth.  Slashing the cost of energy is another, as families struggle to pay heating bills.  Stories abound about the economic boom in Williston, North Dakota, where jobs are plentiful and housing scarce.  There is even news for single women:  the ratio of available guys to gals is 95:1.  You go girl!

While I have no intention of moving to North Dakota, I believe, as do others, that the burst in natural gas exploration and production could be our “next best thing” and  make the mid-west the next emerging market (according to Jason Trennert, of Strategas Research Partners LLP), with untold opportunities for global investment, trading and profits. 

But not everyone agrees.  Many media outlets have exposed the problems—primarily, water contamination-- and the recently produced Gasland documentary is an example. Like any hot debate, tempers flare on both sides.  Fracking is the enemy of all who seek pure water and cancer-free health.  At dinner parties country wide, lively discussions ensue on the need to curb corporate excesses caused by irresponsible fracking.

There are others, however, who have a different opinion.  FrackNation, a new documentary which I just saw in Manhattan last night, depicts a distinctively opposite view, and every responsible American should take the time to see it.  While no one can deny, with a straight face, that corporations have not always acted responsibly when it comes to the environment, it is also true that having their collective feet held to the fire has forced necessary changes in regulation and responsibility, with demonstrable, concomitant changes in behavior.  

(Remember the Hudson River, anyone?)  One of the funnier scenes in the film shows the mound of required tests and studies that are required before a single drill bit can enter the ground.  

Currently playing at The Quad Theatre on 13^th Street in Manhattan, FrackNation also airs next week on local TV.  If, indeed, natural gas holds the potential for helping us out of the economic doldrums, we all need to be informed. In evaluating any investment, it’s imperative to calculate both the risks and rewards.  Go see FrackNation.  It is rare to be given a chance to view both sides of a hotly contested issue, and it’s a compelling antidote to the hysteria surrounding the issue of fracking.  Funded not with corporate dollars, but with Kickstarter, a grass-roots funding program for creative projects, the less-than-$300,000 production price tag was financed with investments of sometimes just a dollar by those interested in getting out their side of the story.  Go to http://fracknation.com/ for more information and to check local TV listings.