This article was originally published by the Financial Repression Authority on April 12th, 2017

In 1994, most investors had heard of the Internet but had no real idea of what it was or how it would impact their lives. An episode of The Today Show that year featured Katie Couric and Bryant Gumbel discussing the topic when Bryant Gumbel asked “What is the Internet anyway?”¹ By the time most investors truly figured that question out, fortunes had already been made and many other business models had been disrupted. The lesson: astute investors should take time to understand the technology that computer geeks are enthusiastic about. Today, that is Bitcoin and other cryptocurrencies.

Like the Internet back then, most investors have heard of Bitcoin, but few have a real grasp of the disruptive technology behind it – the blockchain. Blockchain technology has the potential to be as revolutionary and disruptive as the Internet itself.

What is Bitcoin?

Bitcoin was the first cryptocurrency, a virtual money and payment system. It is based on a revolutionary technology referred to as the blockchain. Understanding Bitcoin and other cryptocurrencies involves first understanding the blockchain itself, the genius behind all cryptocurrencies.

The blockchain is a digital accounting ledger. It is public, transparent, and includes the full history of all transactions on the system for all users to see and verify. Similar to a bank’s private banking records or ledger, the blockchain stores a registry of all user assets and transactions. This is done in a pseudo-anonymous way with users’ identifications only specified by a numeric address typically held in a “wallet.”

The “blocks” contain Bitcoin transactions. The most recent Bitcoin transactions are recorded on these blocks, which are verified with cryptography (an encryption system using advanced mathematics). Only a Bitcoin owner’s cryptographic keys can alter that segment of the blockchain. This prevents double-counting of or multiple claims to bitcoins. The blockchain is thus a “chain” of these many “blocks” registering ownership in one comprehensive and transparent accounting ledger. Bitcoin owners have access to their respective transactions within the blockchain available to them anytime, anywhere in the world.

Further, this requires no middleman’s trust or approval. It is as if each individual becomes their own bank and controls their own money. This bank is open 24 hours a day, seven days a week, and it can be accessed globally and transacted quickly with minimal transaction fees. It is portable beyond national borders with a value that is set globally.

Contrast this to an investor with money in the bank. An investor’s money is also an electronic entry, but this time on a private accounting ledger controlled by the bank. This requires dealing with the bank to get access to their own money. Worse, due to fractional-reserve banking, money in the bank is actually largely lent out (depositors are creditors to the bank). Transaction costs may also be high or it may simply be impossible to do certain global transactions.

Who maintains the system?

It is a global peer-to-peer system, managed by its members and not reliant on any centralized governing body, corporation, or government to function. In this sense, it is a pure free-market model where members maintain the system in a way that supports their own economic interests. Essentially, the system is run by the majority of its most active participants referred to as “miners.” These miners are a global community of individuals who keep the blockchain updated by authenticating transactions. As a reward, they earn new bitcoins. In this regard, they are given the name “miners” in reference to gold miners who are rewarded for their mining efforts with newfound gold.

Is Bitcoin secure?

The ledger is replicated across the entire network of users such that no centralized institution or server controls the blockchain data. Since the data is replicated thousands of times over on computers globally, hacking would require massive computing power. In any such attempt, the offending computers will be identified as corrupted by the tens of thousands of uncorrupted copies of the blockchain. For this reason, bitcoin and the blockchain are likely much more secure than most centralized systems we rely on today.

Although the blockchain has never been hacked, certain online accounts holding bitcoin have been hacked which created some negative publicity. However, it is critical to differentiate between the security of the blockchain itself and where a user chooses to store their bitcoin. Related to the security of each transaction, the miners help audit and confirm the validity of every transaction on the blockchain many times over, such that hacking and fraud of the bitcoin are highly unlikely. Imagine a dozen accounting firms auditing every transaction of a business and only approving them if all accounting firms agree.

Why is the blockchain concept so revolutionary?

Blockchain’s disruptive potential is most heavily influenced by its key attribute – that it allows for a trustless system. It is a peer-to-peer system with no middleman. Users rely on the integrity of the blockchain itself and thus have no need to know the identities or reputations of a counterparty or place any trust in them. The integrity of the system itself is all that needs to be trusted. The mysterious founder of Bitcoin, Satoshi Nakamoto, wrote: “we have proposed a system for electronic transactions without relying on trust.”³

What is the value of Bitcoin?

The value of Bitcoin or any cryptocurrency can be hard to grasp, although it has a price that is set globally and trades 24 hours a day. Thus, a global network of buyers and sellers act to set the price at every moment. At its core, bitcoin is a digital currency that can be used to transact, act as a store of value, or held as a speculative investment. Overstock.com was an early adopter to accept Bitcoin, but Bitcoin can now be used at over 100,000 merchants including household names like Starbucks, Walmart, Home Depot, Tesla, and Subway.⁴

The value is contingent on supply and demand. For Bitcoin, the supply is programmed to grow from approximately 16 million bitcoins today to 21 million bitcoins in the future.5 It has a finite supply (unlike fiat currencies today), supporting its longer-term value. Demand drivers include the utility or benefit users get from using Bitcoin. These include a trustless blockchain technology allowing individuals to become their own bank, an ability to transact or transfer value globally at any time to anyone at minimal costs, and the capability for micro-transactions (more on this below). With a market capitalization (or total value) of $18 billion, bitcoin is similar to the concept of owning a piece of other payment systems like PayPal ($52 billion market capitalization) or MasterCard ($120 billion market capitalization).

Micro-transactions today are totally uneconomical with financial institution fees, but Bitcoin can be transacted in any fractional amount. For example, imagine someone needing to do a transaction in a poorer region of the world. Today, they could transfer 0.0012 bitcoin or approximately $1.44 (based on a bitcoin price of $1,200). Transferring dollars would be cost-prohibitive with any normal level of financial fees. Applying this technology to regions of the world needing money in small denominations and lacking access to traditional banking could unleash the power of Bitcoin as the money of the internet.

There has been some debate about whether cryptocurrencies like Bitcoin represent money. Money is a medium of exchange and, as such, presupposes the ability to act as a store of value. Over two thousand years ago, Aristotle noted the primary qualities exhibited by money: portability, durability, homogeneity and divisibility. Bitcoin meets these criteria. Today, as most currencies are increasing their supply dramatically, bitcoin offers a unique alternative due to its finite supply. Interestingly, the price of bitcoin surpassed the price of gold for the first time ever on March 3, 2017.

Why do investors own Bitcoin or other cryptocurrencies?

Many owners of Bitcoin are using it for transactions. However, some view it as a store of value or speculative investment. This former view is a hedge against the risks of a future global currency crisis as most governments today have debt levels which can only be repaid by massive monetary printing. Bitcoin may be a hedge against monetary instability or capital controls as it allows individuals to be their own bank and control their money outside of the fractional reserve banking system. For speculators, it is an opportunity to be part of a vibrant and mushrooming industry where the value of Bitcoin may grow as more users enter its network.

What are the risks?

Technology is always evolving and its path is far from certain. In social media, early winners like Myspace gave way to Facebook, so the future of leading cryptocurrencies could change. Miners can also have disagreements leading to splitting a cryptocurrency in two separate coins, referred to as a “hard fork.” For example, there is currently a debate in the Bitcoin community about block size as it relates to speed and cost of transactions. If a hard fork occurred, current Bitcoin owners would get coins in each new currency that they could trade. Prices of any cryptocurrencies can be extremely volatile.

Also, cryptocurrencies pose a risk to governments as a store of value outside of the banking system. Since banks are reliant on depositors to keep a leveraged system afloat, governments could crack down on Bitcoin or tax it excessively. Today, most governments have accepted Bitcoin and, in the U.S., it is given favorable tax treatment under the capital gain tax laws.

What areas will be impacted by blockchain technology?

We see three branches emerging. First, money and banking as bitcoin and other cryptocurrencies gain acceptance as a store of value and payment system.

Second, titling and document retention. A group of open-architecture platforms, such as Ethereum, are creating smart contracts for many business applications to eliminate the need for a middleman due to the trustless nature of the blockchain. Ownership of their “coin” is somewhat akin to owning stock in their ultimate platform. This area is likely to disrupt many businesses as their platform allows developers to create business applications that act as smart contracts with a traceable system documenting all records, management, and transactions. This has the potential to disrupt any businesses that serve as a middleman to ensure trust amongst the transacting parties including title companies in real estate and even global stock exchanges.

Ultimately, we foresee many private and government applications built around the blockchain technology. Private uses of blockchain may be back office systems for banks and financial firms. We are even seeing disruptive social media sites like Steemit that reward key users and contributors with value in the social media network (akin to ownership) instead of these benefits only accruing to corporate owners (such as Facebook’s model). Securely storing and validating records (health, education, legal, etc.) and even authenticating voting remain likely possibilities.

This blockchain revolution is much bigger than Bitcoin alone, but Bitcoin remains the leader in payments and as an alternative store of value. While many of us may feel as lost about cryptocurrencies today as Bryant Gumbel was about the Internet, investors ignoring the potential of the blockchain may miss out on an equally lucrative opportunity.

About the Author: Brett K. Rentmeester, CFA®, CAIA®, MBA, is the President and Chief Investment Officer of WindRock Wealth Management. Mr. Rentmeester founded the company to bring tailored investment solutions to investors seeking an edge in an increasingly uncertain world.

He can be reached at 312-650-9593 or brett.rentmeester@windrockwealth.com .

WindRock Wealth Management is an independent investment management firm founded on the belief that investment success in today’s increasingly uncertain world requires a focus on the macroeconomic “big picture” combined with an entrepreneurial mindset to seize on unique investment opportunities. We serve as the trusted voice to a select group of high net worth individuals, family offices, foundations and retirement plans.

Endnotes:

1 “What is the Internet, Anyway?” Today Show. 1994.  YouTube. 28 January 2015. https://www.youtube.com/watch?v=UlJku_CSyNg

2 The Financial Times Ltd.

3 Nakamoto, Satoshi. Bitcoin: A Peer-to-Peer Electronic Cash System. 24 May 2009 http://bitcoin.org/bitcoin.pdf

4 SpendBitcoins. http://spendbitcoins.com/

5 Bitcoin: A Peer-to-Peer Electronic Cash System

All content and matters discussed are for information purposes only. Opinions expressed are solely those of WindRock Wealth Management LLC and our staff. Material presented is believed to be from reliable sources; however, we make no representations as to its accuracy or completeness. All information and ideas should be discussed in detail with your individual adviser prior to implementation. Fee-based investment advisory services are offered by WindRock Wealth Management LLC, an SEC-Registered Investment Advisor. The presence of the information contained herein shall in no way be construed or interpreted as a solicitation to sell or offer to sell investment advisory services except, where applicable, in states where we are registered or where an exemption or exclusion from such registration exists. WindRock Wealth Management may have a material interest in some or all of the investment topics discussed. Nothing should be interpreted to state or imply that past results are an indication of future performance. There are no warranties, expresses or implied, as to accuracy, completeness or results obtained from any information contained herein. You may not modify this content for any other purposes without express written consent.

Christopher P. Casey

Question: Although WindRock Wealth Management is a U.S.-based Registered Investment Advisor which manages money for wealthy individuals, you certainly seem different from other firms out there. One of those differences is your macroeconomic viewpoints. Why is that important to WindRock?

WindRock: It is amazing but true, many wealth advisory firms have no view on the economy! I cannot tell you how many times I have asked Chief Investment Officers of major wealth advisory firms what causes recessions, and their response is either “we don’t know” or “we’re agnostic as to the economy” – whatever that means. If any firms hold any views on the economy, they typically adhere to Keynesian economics – they basically just parrot what the Federal Reserve and other mainstream organizations predict. And the Federal Reserve in particular has a horrific track record in this regard – having not only completely missed the 2008 recession and the 2007 housing crisis, but also by initially dismissing the impact of Covid on the economy.

So, we think having a well-thought-out view on the economy is a tremendous advantage. We think it’s important in designing portfolios. In particular, we favor the Austrian school of economics which is an alternative to Keynesian philosophy. Austrian economists, unlike the mainstream Keynesian economists, understand what truly causes inflation and recessions – the artificial expansion of the money supply by central banks.  Since these are the two greatest threats to anyone’s investment portfolio, this understanding is critical. This is why many wealth advisory firms herded their clients right over the cliff with the crash in technology stocks and later with all equities in 2008 – which we can see repeating in the future. They could not foresee these events because those events don’t comport to their flawed models and theories. For the same reason, they do not foresee any danger with today’s overvalued U.S. stock and bond markets. By using Austrian economics, we have a time-tested tool to guide our decisions.

Question: Recessions pop asset valuations, and are thus a threat to anyone’s portfolio, but what about inflation? What do you see going forward and how do you position clients accordingly?

WindRock: The actions of the Federal Reserve since August 2008 – and especially since March 2020 – are truly unprecedented. Depending on how you measure it, the U.S. money supply has increased over 75% since the lockdowns were initiated. We’re at historically high year-over-year growth rates – and we have been since March 2020. Increasing the money supply to this degree will inevitably cause significant inflation. It may not show up soon, it may even be preceded by some brief deflation – although I doubt that, but it will develop. When this happens, stocks will, at best, be flat in real terms. And bonds will be decimated. The only way to protect one’s wealth is to invest in such thing as precious metals, cryptocurrencies like bitcoin, and certain types of real estate – mainly farmland and rental residential real estate in the Sun Belt states. Positioning one’s portfolio as such will not only offer protection, but great profit. And this isn’t just based in theory, but in experience. The historical performance of these investments in the 1970’s in America offers great guidance – while the price index more than doubled in 10 years, farmland and gold provided tremendous appreciation.

Question: How do you design portfolios?

WindRock: Our clients’ risk profiles and liquidity needs are integrated with our projections of real economic growth and price levels over the next twelve months. We then combine this with our judgment as to overall asset valuations in the equity and debt markets to determine the allocation between stocks, bonds, and hard assets such as real estate and precious metals. After determining these broad allocations, those same assessments dictate the constituent parts of each allocation. For example, if we are in equities, how much is in emerging markets versus the developed world? How much is defensive versus aggressive, etc.?

One additional item I should note about portfolio construction, we do not believe in “putting all of your chips on red” and waiting for the big payoff. By that I mean we select investments we expect to do very well when the economy plays out the way we expect, but they will also do well in the interim due to the compelling risk and return profile the investment itself offers. As an example, we believe multi-family rental real estate will do quite well in the U.S. when a housing decline unfolds due to rising interest rates and/or inflation hits. Our play has been to focus on new construction neighborhoods that rent like apartments but look and feel like single family homes. We did not go out and buy a publicly traded rental real estate vehicle – they are currently overvalued – which may do well in a housing decline and/or with inflation – we found an investment which believe will do well regardless since it is building a new type of multi-family housing community.

Question: What else differentiates WindRock from other wealth advisory firms?

WindRock: It’s not just about having a different view on how economies work. It’s about what you do with that knowledge. It’s about having an entrepreneurial mindset to act on these opportunities – to seek out and vet investment vehicles which the mainstream wealth advisory industry won’t touch. I think we describe this well on our website where we wrote:

Conventional wisdom associates the word “entrepreneur” with the assumption of risk. While risk can never be fully avoided, what actually makes entrepreneurs unique is their understanding of risk. Our unique insight of the risks posed by governmental interference in the economy serves to protect our clients’ wealth. As entrepreneurial-minded advisors, we emphasize independent and creative thought to boldly seize opportunities while minimizing key risks.

Farmland is a great example. There are very few public farmland vehicles – Real Estate Investment Trusts – or REITs, in the U.S. Accordingly, there are no investment benchmarks for farmland to be considered by mainstream wealth advisors (because the sample size is too small). Therefore, mainstream wealth advisory firms will not consider an investment in farmland. Mind you, it’s not because the investment opportunity isn’t there, but because they cannot be viewed as performing out of sync with the commonly used real estate investment benchmarks. To do otherwise will entail risking their careers. This is a real problem in the wealth advisory industry – advisors are worried about losing clients, not with losing clients’ money. The mainstream wealth advisors are happy tracking what everyone else is doing – because in so doing, they believe they are preventing their clients from switching to another firm. This “career risk” syndrome forces wealth advisors into short-term outlooks with a herd-like mentality.

This is a real problem in the wealth advisory industry – advisors are worried about losing clients, not with losing clients’ money.

Question: Besides the lack of an economic viewpoint (or an incorrect one), besides the “career risk” mentality, what other problems exist within the wealth advisory industry?

WindRock: Misaligned incentives. Many firms lack independence, meaning they create and market their own investment vehicles. So oftentimes they’re not just advising clients to own a particular type of investment – they’re advising clients to own their investment. Which certainly means additional fees and probably a sub- performing investment vehicle. I cannot tell you how many times I have reviewed a prospective client’s investments only to find they are heavily invested in their advisor’s funds. Is it really that likely that the best emerging market equity fund just happens to be owned and run by the advisor’s firm? That the very same advisory firm has the top currency fund? What are the odds?

Question: So, the XYZ Wealth Management firm owns the XYZ funds . . .

WindRock: I think common sense and anecdotal evidence suggests that if you examined client statements from all wealth advisory firms, you will not find the ownership dispersion you would expect if wealth advisors truly provided independent advice. This Wall Street sales culture permeates many firms. Unfortunately, the more wealth advisors serve as salesmen, the less they act as a trusted advisor.

Question: With all of these problems in the industry, why should investors even consider using a wealth advisor?

Unfortunately, the more wealth advisors serve as salesmen, the less they act as a trusted advisor.  

WindRock: Doing it yourself can be an option. And perhaps a fairly viable one when compared to the alternative of using many of these firms. But there are still compelling reasons to use a wealth advisory firm. For example, since wealth advisors possess buying power by representing numerous clients, we can have access to certain investment vehicles which may simply be unavailable to the individual investor. In addition, we can negotiate lower fees and minimum investments with the funds we utilize. But in a greater context, maximizing returns and minimizing risks for any investment portfolio requires time, research, money, judgement, and knowledge. It’s a full-time job, especially in today’s world of massive government intervention in the economy and the financial markets, to manage a portfolio. This is why we created WindRock, because wealth advisory has its place – it just needs a different economic viewpoint, a unique investing mindset, and greater independence.

Question: How can anyone interested contact you to learn more about WindRock’s services?

WindRock: Of far greater importance than what we do is what we believe. All of our marketing is driven by thought-leadership, so I encourage any interested parties to visit our webpage at www.windrockwealth.com to read about our philosophy as well as our regularly posted research and analysis. I also suggest interested parties to sign up for our mailing list.

About WindRock

WindRock Wealth Management is an independent investment management firm founded on the belief that investment success in today’s increasingly uncertain world requires a focus on the macroeconomic “big picture” combined with an entrepreneurial mindset to seize on unique investment opportunities. We serve as the trusted voice to a select group of high-net-worth individuals, family offices, foundations and retirement plans.

www.windrockwealth.com

312-650-9602

assistant@windrockwealth.com

This article was originally published by the Mises Institute on August 29, 2018

Fans of HBO’s hit series, Game of Thrones, know well the motto of House Stark: “Winter is Coming.” This motto warns of impending doom, whether brought on by the Starks themselves, devastating multi-year, cold weather, or something far more ominous north of the Wall.

At least since Soviet economist Nikolai Kondratieff wrote The Major Economic Cycles in 1925, recessions have been associated with winter weather.1 Although Kondratieff’s theories contained as much fantasy as Game of Thrones, using seasons as an analogy for the stages of a business cycle is intuitive. If spring represents recovery, and summer the peak of economic growth, then the U.S. economy may well be in autumn. All should be as wary as the subjects of Westeros (the realm of focus in Game of Thrones).

Why Winter is Coming

Few mainstream economists currently foresee a recession. They cite “strong” (a new-found, favorite term in Federal Open Market Committee minutes) economic statistics, a “healthy” stock market (despite gains highly concentrated in the so-called “FANG” stocks), and few warning signs among the “leading indicators.”^{2 3} But the same exact sentiment existed before the last recession. Most infamously, then-Federal Reserve Chairman Ben Bernanke stated in January 2008 – exactly one month after the recession technically began: “the Federal Reserve is not currently forecasting a recession.”⁴

How could Chairman Bernanke have been so wrong then, and why may mainstream economists be likewise wrong today? The answer lies in their erroneous business cycle theories. Without a theory which accurately describes recessions, watching leading indicators or other signs of a slowdown are as effective as reading tea leaves. One can only predict by first understanding causality.

The Austrian school of economics explains business cycles, for it describes their phenomena (e.g., the “cluster of error” exhibited by businesses and economic actors), why they are recurring, and why they first repeatedly appeared in the 19th century (with fractional-reserve banking and/or central banks). In short, when the money supply is artificially increased, interest rates are decreased and distorted. As interest rates are a universal market signal to all businesses and economic actors, investments and purchases which previously appeared unprofitable or untenable now seem economically profitable or reasonable.

However, these expenditures are actually “malinvested” relative to the natural level of interest rates. When interest rates revert to their natural level and structure, a recession ensues. Recessions are an inevitable condition which corrects malinvestments by returning capital to rightful purpose.

What causes the artificial boom to end and the winter to begin? Ludwig von Mises offered a succinct explanation:

The boom can last only as long as the credit expansion progresses at an ever-accelerated pace. The boom comes to an end as soon as additional quantities of fiduciary media are no longer thrown upon the loan market.⁵

In the U.S., the growth rate of “additional quantities of fiduciary media” has flatlined (as represented by the red line below). The most relevant monetary metric to analyze is the Austrian definition of the money supply known as “True Money Supply” (“TMS”). Developed by Murray Rothbard and Joseph Salerno (and frequently commented upon by Ryan McMaken of the Mises Institute), TMS more accurately captures Federal Reserve activity than traditional measures such as M2. Since March 2017, it has averaged a mere expansion rate of just over 4%.⁶

Since Austrian business cycle theory describes the impact of monetary expansion and contraction upon interest rates which, in turn, impacts the economy, are interest rates likewise signaling a possible end to the current, artificial economic expansion?

When Winter is Coming

Interest rates have certainly risen. Since breaking below 1.4% just over two years ago, the 10-year Treasury has traded with a yield close to 3.0% for the majority of 2018.⁷ But in forecasting a recession, timing and probability are better served by analyzing the structure of interest rates (known as the yield currve) rather than the overall interest rate level.

The yield curve represents a graphical depiction of fixed-interest rate security yields plotted against the amount of time until their maturity. Various methods of measuring the “flatness” of the yield curve exist, but one of the most popular is the yield on a long-dated bond (e.g., the 10-year Treasury) minus the yield on a shorter-term bond (e.g., the 2-year Treasury). Based on this methodology, the yield curve has flattened extensively over the last several years to levels last observed just prior to the Great Recession.

Historically, a yield curve which flattens enough to become inverted; that is, when short-term interest rates are higher than longer-term interest rates, a recession typically follows. An inverted yield curve possesses a unique power of predictability.

As explained by economist Robert Murphy, in foreshadowing every recession since 1950:

Not only has there only been one false positive (which even here was still associated with a slowdown), but every actual recession in this timeframe has had an inverted (or nearly inverted) yield curve precede it. In other words, there are no false negatives either when it comes to the yield curve’s predictive powers in the postwar period.⁷

The acknowledgement of the yield curve’s prognosticative capability extends beyond Austrian school economists such as Dr. Murphy, for numerous studies – many by Federal Reserve economists – cite this phenomenon. The Federal Reserve Bank of New York, in introducing some of this research, recognizes “the empirical regularity that the slope of the yield curve is a reliable predictor of future real economic activity.”⁸

Recognition is different from understanding as mainstream economists are largely unable to offer an explanation. However, yield curve recession signals adhere well to Austrian business cycle theory which demonstrates the importance of banks in creating money and lowering interest rates (which steepens the yield curve as most of their influence resides with shorter maturities). It is the reversal of money creation – and the impact of banks on interest rates – which causes shorter-term interest rates to rise disproportionately (the typical fashion by which the yield curve flattens).

In addition, if the artificial boom ends when interest rates are no longer artificially depressed, then it stands to reason the structure of interest rates will also revert to its natural state. A flatter yield curve comports with the natural structure of interest rates expected in a free market. The Austrian-economist Jesús Huerta de Soto described the underlying reason free markets generate flatter yield curves:

. . . the market rate of interest tends to be the same throughout the entire time market or productive structure in society, not only intratemporally, i.e., in different areas of the market, but also intertemporally . . . the entrepreneurial force itself, drive by a desire for profit, will lead people to disinvest in stages in which the interest rate . . . is lower, relatively speaking, and to invest in stages in which the expected interest rate . . . is higher.⁹

In short, the predictive power of the yield curve is matched only by the explanatory power of Austrian business cycle theory. If it continues to flatten and invert, a recession will likely follow as the previously created malinvestments are exposed.

But rather than wholeheartedly embrace yield curve analysis, high-ranking Federal Reserve officials consistently waffle at its utilization. Like Westerosi maesters in conclave to determine the advent of winter, they frequently recognize recessions only after their onset.¹⁰

Conclusion

The similarities between the climate in Game of Thrones and the state of the U.S. economy are eerily similar. Prior to the recent beginning of winter, Westeros experienced an unusually long time since the last winter. Likewise, according to the National Bureau of Economic Research, the current U.S. expansion is the second longest ever at just over nine years (110 months).¹¹

Also, just as recessions are not phenomena endogenous to free markets (but rather, as discussed above, caused by an artificial expansion of the money supply typically produced/coordinated by central banks), so too the winters in Westeros appear to be generated from an artificial, exogeneous source. As protagonist John Snow explained in describing the supernatural White Walkers: “the true enemy won’t wait out the storm. He brings the storm.” The Night King is the Westerosi version of the Chairman of the Federal Reserve (with the primary difference being the Night King purposely brings about winter).

Finally, like the next winter in Westeros, the next U.S. recession may prove unusually severe by historical standards. In Game of Thrones, many characters (at least the peasants) believe this winter will be the worst in 1,000 years. Given the Federal Reserve’s unprecedented monetary machinations since 2008, the next recession may well prove worse than the last one, and potentially as devastating as the Long Night.

Approximately one year ago, speaking as confidently as a Red Priestess of R’hllor, then-Federal Reserve Chair Janet Yellen believed the next recession-driven financial crisis may be averted for at least a generation or so:

Would I say there will never, ever be another financial crisis? . . . Probably that would be going too far. But I do think we’re much safer . . . and I hope that it will not be in our lifetimes, and I don’t believe it will be [emphasis added].¹²

You know nothing, Janet Yellen. Winter is coming.

About the Author: Christopher P. Casey is a Managing Director with WindRock Wealth Management. Mr. Casey advises clients on their investment portfolios in today’s world of significant economic and financial intervention. He can be reached at 312-650- 9602 or chris.casey@windrockwealth.com.

WindRock Wealth Management is an independent investment management firm founded on the belief that investment success in today’s increasingly uncertain world requires a focus on the macroeconomic “big picture” combined with an entrepreneurial mindset to seize on unique investment opportunities. We serve as the trusted voice to a select group of high net worth individuals, family offices, foundations and retirement plans.

All content and matters discussed are for information purposes only. Opinions expressed are solely those of WindRock Wealth Management LLC and our staff. Material presented is believed to be from reliable sources; however, we make no representations as to its accuracy or completeness. All information and ideas should be discussed in detail with your individual adviser prior to implementation. Fee-based investment advisory services are offered by WindRock Wealth Management LLC, an SEC-Registered Investment Advisor. The presence of the information contained herein shall in no way be construed or interpreted as a solicitation to sell or offer to sell investment advisory services except, where applicable, in states where we are registered or where an exemption or exclusion from such registration exists. WindRock Wealth Management may have a material interest in some or all of the investment topics discussed. Nothing should be interpreted to state or imply that past results are an indication of future performance. There are no warranties, expresses or implied, as to accuracy, completeness or results obtained from any information contained herein. You may not modify this content for any other purposes without express written consent.

CASEY: When did you first see the potential in cryptocurrencies, and what in particular did you find so compelling?

JOHNSON: I first started looking at cryptocurrencies back in the second half of 2013. We were watching what was going on with the banking crisis in Cypress. In December of that month, our founder and CEO, Patrick Byrne, made kind of an off-handed comment to a reporter saying: “we’ll start accepting cryptocurrency sometime in the second half of 2014.” That created a lot of buzz both outside and inside the company. We then had a group of developers approach management saying: “we should get this done more quickly, there’s no reason to wait six-to-eight months.” So, during the following weekend, a couple of teams of developers locked themselves in a room and started working on this project. On January 9, 2014, Overstock.com  became the first billion-dollar retailer to accept bitcoin or any cryptocurrency. We like it for lots of reasons. We like it because it’s not a government-issued fiat currency which can be printed ad nauseum. We like it because it makes it easier for customers to buy things on Overstock.com’s website. We like it because we think it promotes freedom. I guess that last one is ultimately the best reason for bitcoin and other cryptocurrencies.

ROSENBERG: I was involved with cryptography and currency prior to bitcoin by over a decade, so I’ve been interested, but I finally really started paying attention to bitcoin in 2010. I saw this as just a brilliant combination of peer-to-peer networking and cryptography: the way they are doing hashes and proof of work and essentially making timestamp chunks of data which we call blockchain. I saw how this establishes trust between people who don’t know or trust each other. I thought: “wait a minute, this is a big deal.” So, I knew from 2011 or so that it was looking very promising. But you never truly know if these things are going to catch on.

RENTMEESTER: We first became aware of bitcoin in 2011 and found it to be an interesting free-market movement as a store-of-value and payment system outside of traditional banking. This was against the backdrop of a world that had come out of the financial crisis of 2008 by printing massive amounts of fiat currency to bail out Wall Street and the banks, taking on huge debt to do so. It seemed like a grass-roots uprising or “people’s money” fighting against our debt-based monetary system. In 2013, we began to better understand the true revolutionary nature of blockchain technology behind bitcoin and began to talk to investors about the potential for cryptocurrencies in a portfolio. This new system takes control away from central banks and governments, who are overspending and printing money carelessly, and gives power back to individuals. With bitcoin, you don’t need banks as a middleman and transactions can occur anywhere at a low cost. As former President Obama correctly described it, it was like a “Swiss bank account in your pocket.” From an investment perspective, we saw cryptocurrencies as potentially offering investors a very unique spectrum of outcomes. On one hand, it was a play on the upside of a new and disruptive technology: blockchain. On the other hand, it could possibly represent a hedge against a dangerously indebted global financial system.

CASEY: What, if anything, has surprised you about the growth in cryptocurrencies and their use over the last several years?

RENTMEESTER: Like many technological trends, it initially progressed slower than we would have thought at the time, but is now accelerating faster. It took people a long time to understand the disruptive nature of blockchain technology. They had to wait and see it proven by bitcoin as the prime mover and it’s now nine-years old. This was phase one of the rise in cryptocurrencies. Phase two is likely to be driven by liquidity and money entering this space. Since many, but not all, cryptocurrencies like bitcoin have limited supply, a big influx of capital is likely to drive prices higher. Phase three may well be an Internet-like crash followed by phase four, a building out of concepts in every industry disrupting incumbent industry leaders with blockchain solutions.

In hindsight, cryptocurrencies and blockchain technology are following a traditional technology adoption curve. In 1995, there were an estimated 16 million Internet users worldwide, representing less than 0.5% of the global population.¹ Today, there are an estimated 20 million bitcoin wallets with at least $1, but only an estimated eight million wallets with $100 of more.² This represents less than 0.5% of the global population and appears to us to be at a very similar juncture to where the Internet was in the mid-1990’s. Therefore, we are very early in this story. That said, we expect this cycle to be quicker than the Internet wave as recent technology adoption curves have been much quicker with a scalable technology.

ROSENBERG: The thing that pleased me and in fact surprised me were the number of people who became involved. All of a sudden, there were hundreds, then thousands of people who were really into this thing. Where did they come from? No one really has the numbers on this, but I bet you there are easily a hundred thousand people involved right now. Maybe two or three hundred thousand, who get up every morning and are trying to do something with cryptocurrencies. To me, the technology is really important, but even more important is this active, involved, and large group of motivated people.

JOHNSON: After we first started accepting bitcoin, there was obviously an initial surge of interest and a lot of crypto-bugs and enthusiasts were purchasing things on Overstock.com. Then it fell off to a fairly steady, small state of people using bitcoin to buy stuff on Overstock.com. But in 2017, we saw a steady increase in our cryptocurrency revenue. So much so that last summer we went from just accepting bitcoin to now accepting about 50 different cryptocurrencies. I guess what I would say is most surprising is that other retailers and service providers have been slow to accept cryptocurrency. For us, it made sense. We’re in the business of making it easy for customers to purchase goods from us. If they want to do is with American Express or PayPal or bitcoin, we’re going to accommodate them. I’m surprised that other retailers haven’t followed suit. Particularly during 2017 when cryptocurrencies have become all the buzz and all the rage. Last week there was an article on the front page of the Wall Street Journal. It said: “even your grandma cares about cryptocurrency.” Well if grandmas care about cryptocurrency, we think service providers and retailers ought to be accepting it.

CASEY: As an early adopter of bitcoin, how did that lead you to explore blockchain technology in general?

JOHNSON: It wasn’t soon after we began accepting bitcoin at Overstock.com that we realized that bitcoin is just the first killer application of blockchain technology. Underlying blockchain technology is really valuable. Email was the first killer app on the Internet, but the Internet became so much more than just a tool for delivering email. It now permeates our lives in so many ways. We think blockchain technology will be the same. What the Internet did for the transfer of information, we think blockchain technology will do for the transfer of value or assets. Back in 2014, we put together a division called Medici – now formalized as a wholly owned subsidiary of Overstock.com called Medici Ventures – which is investing in companies that advance blockchain technology. Today, we are principally focused on five different industries: capital markets, money and banking, property and land, voting, and identity. We think that in each of those industries people are transferring an asset; whether that’s their vote, a stock certificate, or some kind of property right – and it should be transferred through blockchain technology.

CASEY: Would you mind highlighting two or three of those underlying portfolio companies? What are they doing in their respective spaces and how disruptive they may be to their industries?

JOHNSON: We’ve invested in a company called Bitt which is working to bank the unbanked and the underbanked by providing a digital wallet while working with the Caribbean central banks. Today in the Caribbean, roughly 40% of the population is unbanked. That’s not because they don’t have jobs, or they don’t have an address, or they’re not paying utility bills – they’re doing all three of those things. But the banking regulations have become so strict that many people around the world are simply shut out of the banking economy. It is difficult for a cash-only citizen of the world to transact. A digital wallet dealing in a digital currency helps solve this issue. Given that cell phone penetration is around 140% in the Caribbean, it’s a place for the unbanked to store money and gain access to digital currency.

Another is in the capital markets area and it’s called tZERO. Typically, when people are buying and selling stocks or bonds, that transaction settles three days after the trade, or what the industry calls T+3. But with blockchain technology, people can buy and sell stocks, buy and sell bonds, and have the trade be the settlement. So, you get rid of your broker, the prime broker, the depository trust and clearing corporation, etc. Part of what we think is so great about blockchain technology is it eliminates middlemen. Middlemen are by definition inefficient and rent-seeking. They add time, they add cost, and they add the opportunity for fraud in a transaction. We have them in place because, historically, we’ve needed them to allow people who don’t know each other to engage in commerce. Blockchain provides trust through technology. You and I, whether we know each other or not, can now trust each other because blockchain technology says that we can. That’s a great way to do two things: eliminate inefficient middlemen and re-humanize commerce so that you and I, through an electronic handshake, can do business person-to-person. We really think the re-humanization of commerce is something that’s a social good of blockchain.

We have another one called Factom that’s doing something both in banking and in land. It’s working with big banks which are issuing mortgages to help them ease their compliance burden through blockchain technology. The volume of mortgages on a dollar basis issued today versus right before the 2008 crisis is about the same, but the compliance costs for those mortgages have skyrocketed. Factom’s view is if mortgage banks can put all of that paperwork on blockchain, then it’s easily auditable and it can’t be changed. The compliance costs go way down, lessening friction, and making the cost of accessing capital much easier. It’s blockchain technology helping the average person. What we see going forward is that blockchain technology is going to begin affecting each of us. We may not know how or when it’s being used, just like we don’t always know how and when the Internet is being used, but we know it makes our life easier and we know it makes it better. It will be with same with blockchain.

CASEY: How well do you think the current cryptocurrencies are working? That is, are the various forks proving they work or do you see them as a negative?

ROSENBERG: I do see problems with it. Not that it’s going to destroy anything, but it’s just that some of it is pretty juvenile. There are particular people who were in bitcoin really early and who are very rich as a result. To their credit, they’re keeping very active in the community and sponsoring new things and helping people. They are doing what’s basically the right thing. But some of these guys are battling for their version of what bitcoin should be, and they are getting very emotionally involved in it. And the beauty of bitcoin, the incredible thing about bitcoin, is that it’s surviving its enemies and it’s surviving its friends. And it’s surviving them very well. So, the forking doesn’t bother me from a general standpoint. If you like your way better, then it should be fine – split off and prove your better way – but don’t get into big arguments.

RENTMEESTER: Overall, they are working extremely well given that this was simply an idea back in 2008. The bitcoin blockchain has never been hacked or compromised to our knowledge, making it one of the most secure methods for storing and transmitting information in the world. Sure, there are growing pains, with network congestion as demand accelerates beyond the current ability to handle it. Again, this reminds us of the early days of the Internet when it could take 30 seconds to download a webpage. Those issues will resolve themselves now as they did then. In many ways, this is the most important free-market experiment in the world. Can a peer-to-peer system function and adapt without a centralized middleman, corporation, or CEO running things? So far, the answer appears to be “yes.” That is why I see forks, or splits of a blockchain, as a positive. Those that didn’t like bitcoin’s path split off to Bitcoin Cash and Bitcoin Gold. It’s pure capitalism – almost like natural selection – may the best fork win.

CASEY: What future applications of cryptocurrencies do you foresee which have yet to be fully developed?

RENTMEESTER: The Initial Coin Offering phenomenon is allowing whole new business models to spring up almost overnight as challengers to incumbents in almost every industry. ICOs represent the chosen path of raising money for many tech entrepreneurs using blockchain versus a traditional Wall Street fundraising approach. In fact, ICOs raised an estimated $3.6 billion in 2017 according to Coinschedule. Thus, the first disruption is the old way of fundraising that Wall Street has controlled for so long. Along those same lines, stock markets may be disrupted. There is a wave of decentralized exchanges in cryptocurrencies that don’t have centralized exchange providers taking fees, instead allowing investors to trade shares directly with other investors, or “wallet to wallet,” in a decentralized exchange.

However, the applications go well beyond banking and Wall Street. Imagine a world where all sensitive private data transmits through the blockchain. Such as securing identities on the blockchain or transferring secure medical records. Or a world where people without a banking account can use cryptocurrencies to process micro- transactions made possible by the ability to transact at low costs in fractions of a dollar. Or social media sites where value-added content providers and users own the system and are directly compensated instead of corporations like Facebook and Google.

We are entering a global peer-to-peer world where we will interact with others without the need to pay a middleman to secure trust. That was Satoshi Nakamoto’s key premise when he launched bitcoin – to build a “trustless” system. Suffice it to say that we believe blockchain technology will impact almost every human on the planet.

ROSENBERG: Well, there’s a couple of things that spring to mind. The first thing that hasn’t been quite solved yet is replacing credit cards systems. I think credit card systems today process about fifty or sixty thousand transactions per second. Bitcoin can’t do that. It just won’t. Now I have been hearing stories of other new cryptocurrencies that are designed differently and are approaching Visa-type speed right now. So that’s a big area, if that works as well as they are saying it does, because all of a sudden, we’ll have a technology that can compete with Visa and Mastercard. Now Visa and Mastercard have immense inertia and a lot of people are making a lot of money with it. Every time you use your credit card, Visa gets two or three percent. That’s sixty thousand transactions per minute. That’s a lot of money. They have immense market share, so cryptocurrencies not going to take them over right away, but they will eventually. If cryptocurrencies reach comparable speeds, then it’s simply a better way to transact: you don’t have to pay these high fees and if you’re a merchant, you don’t have to deal with charge backs. It’s simply a better way to do it.

It’s amazing how many different niches have applicability for cryptocurrencies. For example, I read about one which was working on dental insurance. You buy your token and then you buy them in advance or trade for them however you like, and then a token is good for one third of a root canal, or for three fillings, it you takes two tokens to buy a bridge or whatever it is, but they’ve got this, and it’s kind of a replacement for dental insurance.

You get your tokens and they’re good for dentistry for anybody in this network. You can just cash your tokens in and get the dental work you need. Right now, if you can get dental insurance, it is very expensive. These guys are solving the problem. There’s all kinds of things that you can do with these new tokens. People are using them for giveaways for business similar to how people used to give away coupons for something.  The other area that I think is really interesting, but it’s still in development to an extent, is smart contracts, Ethereum in particular. This is a really interesting idea, it actually came out in the early 1990’s. You set it up and the contract executes itself. There are immense areas of application in business: you could automate certain businesses or you could automate departments inside of businesses. This is a really a big deal.

JOHNSON: Voting is a very promising area. When I think of all the times I’ve voted in an election in my life, I’ve never known for sure that my vote was counted as cast. There’s no way to verify that. I rely on a lot of trust institutions between my casting the vote, and it being counted. If you’re living in an area like me where you vote by mail, then you trust the county clerk to get you a ballot. You trust the county clerk to send the ballot to the right people. You trust the post office to get you the ballot and return it to the country clerk after you fill it out. You trust the county clerk to record that vote as a secret ballot – that is, without looking to see that it was you. You expect the voting machine to read it as you’ve cast it. That’s too many trust institutions and not enough knowledge for the voter. We think blockchain technology will allow people to vote remotely, by phone, perhaps using biometrics for identity confirmation. I can then confirm that my vote was counted for the person for whom I cast it. We think this has tremendous ability to increase participation in voting and to increase trust in our elected officials and institutions. It could really be monumental, particularly as voting participation has been on the decline. It’s time we reverse that pendulum and get going the other way.

CASEY: What is the greatest risk to the growth and value of cryptocurrencies?

RENTMEESTER: Government regulation is number one. However, we’ve long said that you can’t kill cryptocurrencies unless all world governments work to simultaneously ban them. That is to say, if you ban them in China, they prosper in the U.S. Kill them in the U.S. and they thrive in South America. Since there is no central location to cryptocurrencies, you can’t simply kill them in one country, fine a company, or fire a CEO. You are dealing with millions of decentralized users that make up the network. Any country turning their back on cryptocurrencies will soon find that they are lagging behind in technology in this key area.

Another risk is that with so many ICOs, there will be plenty of investment scams which could scare investors away. It truly is the Wild West out there. Expect more regulatory measures in the year ahead.

ROSENBERG: I agree that the negative repercussions of investment scams or heists are a risk, but I think this is lessening. There used to be nothing but negative stories on bitcoin. Now only half of them are negative. The real potential problem is regulatory. You always have to worry what the government is going to do. Although cryptocurrencies are not to their benefit, the reaction has been a bit mixed at the moment. For example, Japan has embraced them to an extent. I’m under no impression that regulatory agencies are ever going to be friends to the cryptocurrency community, but I certainly don’t want them to be our enemies. I’d rather they just left us alone. But maybe we’ve seen the worst of it.

The only thing that could really be a problem is if somebody could break the encryption, which is at this point really, really doubtful. The difference in difficulty between encrypting and decrypting is something like two to the one-hundredth power. I mean, engineers fight about this number, but let’s just say it’s somewhere in that range which approximates the number of molecules in the universe. So, I’m not too worried about it even with quantum computing. I mean we already have quantum-computing proof encryption, so we would just adapt the cryptocurrency program.

JOHNSON: The biggest risk is overregulation. When I think of humanity’s ability to adapt to new technology, the biggest boat anchor has always been overregulation. When I visit Washington, I’m frequently asked by agencies and staffers in Congress: “how do we get jurisdiction over bitcoin or how do we get jurisdiction over blockchain technology?” They want jurisdiction, in my mind, for one reason: to regulate. One of the reasons that the Internet flourished as much as it did and has was that, in 1996, President Clinton signed a telecommunications law which allowed the Internet to grow free and unfettered from state and federal regulation. I think we need to do the same with blockchain.

CASEY: What do you think is needed for cryptocurrencies to go mainstream?

RENTMEESTER: We are likely entering what’s known as the Early Adopter Stage in 2018. Less than 0.5% of the world’s population are in cryptos today, but we expect 2018 to be a transformative year where businesses and investors alike clamor to get involved. This stage is a key stepping stone toward mainstream adoption.³

We already hit a feverish pace in the second half of 2017 with governments, companies, and public figures discussing it. Of course, some were wildly in favor with others suggesting it was a fad or scam. Again, to us, it is very reminiscent of the early days of the Internet. Back then, many perceived the Internet to little more than a college chat room for techies with little real-life applicability. Two decades later, the Internet changed how the world communicates and shares information. We see cryptocurrencies and blockchain as a similarly powerful force which enables a new era of a global, peer-to-peer economy. This peer-to-peer nature means the middleman is no longer needed. They’ll be essentially extinct. We expect massive disruption in almost every major industry with middlemen.

Endnotes:

1 Statista, Inc. The Rapid Rise of the

Internet. https://www.statista.com/chart/2007/inte rnet-adoption-in-the-us/.

² BitInfoCharts. https://bitinfocharts.com/top-100- richest-bitcoin-addresses.html

³ Rogers, Everett (16 August 2003). Diffusion of Innovations, 5th Edition. Simon and Schuster

Disclosures

All content and matters discussed are for information purposes only. Opinions expressed by Christopher Casey and Brett Rentmeester are solely those of WindRock Wealth Management LLC, a Registered Investment Advisor (RIA), and our staff. Material presented is believed to be from reliable sources; however, we make no representations as to its accuracy or completeness. All information and ideas should be discussed in detail with your individual adviser prior to implementation. All activities of CryptoX Advisory are directed by WindRock Wealth Management LLC doing business as CryptoX Advisory.

Fee-based investment advisory services are offered by WindRock Wealth Management LLC, an SEC-Registered Investment Advisor. The presence of the information contained herein shall in no way be construed or interpreted as a solicitation to sell or offer to sell investment advisory services.

Cryptocurrencies are a new and unproven investment, are largely unregulated, and may have account or “wallet” security issues or other technical computer concerns that impact an investment. Cryptocurrencies are an extremely volatile investment category that could lose all of their value. Specific investments and securities mentioned by WindRock Wealth Management personnel may be owned personally or for the benefit of said personnel and/or clients of WindRock Wealth Managmemt.

WindRock Wealth Management personnel may have a material interest in some or all of the investment topics discussed. Nothing should be interpreted to state or imply that past results are an indication of future performance. There are no warranties, expresses or implied, as to accuracy, completeness or results obtained from any information contained herein. The presence of the information contained herein shall in no way be construed or interpreted as a solicitation to sell or offer to sell investment advisory services except, where applicable, in states where we are registered or where an exemption or exclusion from such registration exists.

“Unfiltered Tobacco”

The U.S. stock markets are precariously at or near record valuation levels. As of this writing, the Shiller Price-to-Earnings ratio (a.k.a. Cyclically Adjusted PE Ratio, or CAPE ratio) for the S&P500 stood well north of 30 and was historically surpassed solely by the technology bubble of the late 1990s.¹ Combined with an extremely uncertain and potentially deteriorating economic situation, current equity valuations suggest this stock market is one of the most overvalued – and therefore potentially dangerous – in history.

While many techniques can decrease the risk for an investor’s equity position, perhaps one of the simplest and effective consists of overweighting sustainable, high-divided yielding stocks. In a bear market, such stocks should theoretically decrease less than the market overall since any fall in prices would increase dividend yields which would attract attention, generate investor demand, and increase the stock price.

Surprisingly, despite the U.S. stock market’s current valuation levels, several industries appear to offer sustainable, high-dividend-yielding stocks. Perhaps the most compelling of these are tobacco stocks.

Why Tobacco Stocks Exhibit High-Dividend Yields

While tobacco stocks have long been shunned by many retail investors due to social distaste and opprobrium, their neglect by institutional investors has been bolstered by the incredible acceptance and growth of the ESG (“environmental, social, and governance”) movement.

The term itself was only coined in a 2005 landmark study entitled “Who Cares Wins”.² Current estimates anticipate continued exponential growth in ESG-mandated assets. In the United States, it is expected that half of all professionally managed investing will be ESG-mandated by 2025.³

One could argue tobacco stocks do not conflict with ESG investing per se, but many consider them to violate the “social” requirement. In support, ESG advocates cite the third item on the United Nation’s Sustainable Development Goals which promotes universal “good health and well-being” in addition to other ethical and moral criteria.⁴ As such, ESG investing typically eschews tobacco stocks.

Many also avoid tobacco stocks due to their “low growth” revenue prospects. This bias has been heightened in recent years by investors’ strong demand for “growth” over “value” stocks.

In developed countries, smoking is certainly a low-growth business. According to a weekly Gallup poll, the percentage of those having smoked a cigarette within the last week dropped from almost half of Americans in the 1950s to just 15% today.⁵ Many other developed countries exhibit similarly significant trends.

In general, the investment world either ignores tobacco or views it as a dying industry. This creates an opportunity –

Smoking may kill, but it is not dying. At least not as quickly as the annual Gallup poll suggests. First, while the percentage of the smoking population in the U.S. has certainly decreased, in absolute numbers, the decline is far less dramatic:⁶

Second, while smoking in the developed world has been decreasing worldwide, such decreases have been historically offset and surpassed by growth in developing countries.⁷ While such growth has moderated in recent years, the overall volume of cigarette consumption has plateaued and demonstrates, at best, an overall slowly declining trend.

Low or slowly declining revenue growth can actually act as a benefit to the sustainability of dividends. Growing companies must often fuel expansion with significant capital expenditures and working capital needs which can create liquidity issues. Low or slowly declining revenue growth conceptually requires very little cash outlays for such expenditures, and in the case of working capital, liquidating current assets (e.g., reduced receivables, inventory, etc.) can actually contribute to operating cash flow.

Tobacco is more than a cash crop; it is a cash cow. To wit, the three largest publicly traded tobacco companies in the world produce an average dividend yield of almost 7.0% – with some companies yielding far higher. This is well above the S&P500’s dividend yield of 1.6%.⁸

Operating cash flow, along with an analysis of solvency and debt service, is a key metric in determining the sustainability of cash flows. Tobacco companies’ capabilities to sustain such dividends appear strong.

In addition, today’s world requires sustainable business models from the perspective of future lockdowns. Unlike many industries, the production and distribution (e.g., convenience stores, gas stations, supermarkets, etc.) of tobacco products were largely unaffected by either Covid-19 or related containment efforts.

Finally, decreased revenues from cigarette smoking may be negated by increased revenue from non-smoking tobacco products (e.g., electronic cigarettes and vaporizers) and cannabis. Many major tobacco companies have already invested in such businesses: Altria bought both e-cigarette company Juul and a 45% stake in the cannabis company Cronos Group in 2018, while Imperial Brands bought Auxly Cannabis that same year.

These trends should continue, as cannabis production and distribution fit naturally well with current tobacco company business models. Such companies are well positioned as the cannabis industry’s future low-cost producers given their scalability potential from extensive farming networks, manufacturing prowess, marketing expertise, and established distribution system. Given the House of Representatives’ recent vote to remove marijuana from the federal Controlled Substances Act, this future may be fast approaching.⁹

When ESG-compliant stock screeners automatically filter out tobacco stocks, an opportunity for investors exists with unfiltered tobacco.

About WindRock

WindRock Wealth Management is an independent investment management firm founded on the belief that investment success in today’s increasingly uncertain world requires a focus on the macroeconomic “big picture” combined with an entrepreneurial mindset to seize on unique investment opportunities. We serve as the trusted voice to a select group of high-net-worth individuals, family offices, foundations and retirement plans.

www.windrockwealth.com

312-650-9822

assistant@windrockwealth.com

Endnotes:

1. Shiller PE Ratio. https://www.multpl.com/shiller-pe
2. Kell, George.    “The Remarkable Rise of ESG”      Forbes.    11 July 2018. https://www.forbes.com/sites/georgkell/2018/07/11/the- remarkable-rise-of-esg/?sh=452198fd1695
3. Collins, Sean. Sullivan, Kristen. “Advancing Environmental, Social, and Governance Investing” Deloitte Insights. 20 February 2020. https://www2.deloitte.com/us/en/insights/industry/financial-services/esg-investing performance.html#:~:text=The%20sustainability%20movement%20is%20growing,- Social%20consciousness%20has&text=Globally%2C%20the%20percentage%20of%20both,to%2075%20percent%20in%202019
4. United Nations. Sustainable Development Goals. https://www.un.org/sustainabledevelopment/health/
5. Gallup. “Tobacco and Smoking” https://news.gallup.com/poll/1717/tobacco-smoking.aspx
6. Our World in Data. “Smoking” https://ourworldindata.org/smoking and Centers for Disease Control and Prevention. “Current Cigarette Smoking Among  Adults in the United States” https://www.cdc.gov/tobacco/data_statistics/fact_sheets/adult_data/cig_smoking/index.htm#:~:text=In%202019%2C%20nearly%2014%2 0of,with%20a%20smoking%2Drelated%20disease
7. Statista. “Global Cigarette Consumption from 1880 to 2017” https://www.statista.com/statistics/279577/global-consumption-of- cigarettes-since- 1880/#:~:text=World%20consumption%20of%20cigarettes%201880%2D2017&text=This%20statistic%20shows%20the%20historical,tri llion%20cigarettes%20were%20consumed%20worldwide
8. Charles Schwab & Co., Inc. as of December 17, 2020 with market capitalizations provided by CompaniesMarketCap.com.
9. ABC News. “House Passes Historic Bill to Decriminalize Cannabis” 4 December 2020.

https://www.nbcnews.com/politics/congress/congress-takes-historic-bill-decriminalize-cannabis-n1249905

All content and matters discussed are for information purposes only. Opinions expressed are solely those of WindRock Wealth Management LLC and our staff. Material presented is believed to be from reliable sources; however, we make no representations as to its accuracy or completeness. All information and ideas presented do not constitute investment advice and investors should discuss any ideas with their registered investment advisor. Fee-based investment advisory services are offered by WindRock Wealth Management LLC, an SEC-Registered Investment Advisor. The presence of the information contained herein shall in no way be construed or interpreted as a solicitation to sell or offer to sell investment advisory services. WindRock Wealth Management may have a material interest in some or all of the investment topics discussed. Nothing should be interpreted to state or imply that past results are an indication of future performance. There are no warranties, expresses or implied, as to accuracy, completeness or results obtained from any information contained herein. You may not modify this content for any other purposes without express written consent.

https://www.nbcnews.com/politics/congress/congress-takes-historic-bill-decriminalize-cannabis-n1249905

U.S. farmland values have been growing. Since 2009, the nationwide per-acre value has risen almost 40% while prime farmland properties have sold for record prices. This appreciation derives from legitimate supply and demand trends in agricultural commodities. These developments include an increasing world population, continued limitations on arable land, fresh-water constraints, declining growth in crop yields, and increasing caloric consumption in developing countries. These trends are powerful, likely to continue and carry a worldwide impact. But there is a far more important reason to invest in farmland today – one that is not reflected in current values.

Farmland is an inflation hedge. Allocating part of one’s investment portfolio to farmland (particularly farmland in nations that will experience relatively high inflation) will not only protect investors but will allow them to profit – perhaps immensely.

Why farmland and not some other real estate asset class? Why not own a Real Estate Investment Trust (REIT) which holds office buildings, hotels, retail shopping malls, or the like? All things being equal, it is true that all real estate should perform relatively well in an inflationary environment. Unfortunately, in the next two to ten years, investors will also likely have to contend with severe economic downtowns interrupted by weak “recoveries.” Picture the U.S. in the 1970s, but potentially far worse. In such situations, the office building cannot attract tenants, the hotel goes vacant, and the retail shopping mall loses its anchor stores. Farmland has no vacancy issues.

In an inflationary recession, farmland values should thrive. Unlike other real estate asset classes, farmland sells its products to an international marketplace. Corn, soybeans, and wheat will fetch a similar price in any market. Accordingly, as a nation’s currency depreciates relative to other currencies, its exports become cheaper. Devastating inflation in the U.S. will hurt American consumers at the grocery store, yet whet the appetite of foreigners. As demonstrated in the following graphs, the impact of the 1970’s U.S. inflation provides some precedent. Grain exports rose significantly not only in absolute volume but also relative to global exports.¹

Perversely, this provided a double-whammy for American consumers. As the law of demand dictates, more demand generates higher prices. So agricultural products rose not just in nominal terms, but also in real terms. In fact, the 1970s experienced some of the highest prices ever for U.S. agricultural commodities after accounting for inflation.²

Rising crop prices increased farm revenue which directly translated into higher farmland values. For the ten-year period ending in 1981, U.S. farmland values rose 303% while inflation increased 118%. Farmland appreciation was especially dramatic when viewed in the 30-year period from 1960 through 1989.

And how did traditional investment vehicles like stocks and bonds perform during this ten-year period? In real terms, stocks lost value (up 115% which is less than the aforementioned 118% increase in the consumer price index). Worse, bonds lost almost 70% of their real value (a 10-Year Treasury Bond total return index increased by only 38% in nominal terms). Investors experienced a decade of massive losses.³

Despite this historical precedent, the investment community – to this day – ignores farmland. In fact, few wealth managers will even consider farmland as an investment for their clients. Why? First, the wealth management industry rarely adopts a macroeconomic viewpoint, and certainly not one which deviates from Federal Reserve or other government agency prognostications. Those firms which do hold a macroeconomic opinion embrace Keynesian economic theory which leads them to share the mainstream’s skewed economic expectations. Austrian economists are rare in the wealth management industry, and thus few wealth managers foresee a period of inflationary recessions.

Second, the wealth management industry remains focused on real estate benchmarks that exclude farmland. Therefore wealth managers solely consider traditional real estate asset classes. Absent a change to the real estate benchmarks, no advisor or wealth management firm will act as a “prime mover” and incorporate farmland investments. In the wealth management industry, being the first to deviate from standard investment portfolio benchmarks invites repudiation and entails career risk. So much the better for today’s astute investors, since the price of farmland excludes demand from their clients.

Inflation will come. Not just in the U.S., but in the developed world at large. It may not happen this year. It may be preceded by a brief deflationary period. But it will arrive, regardless of the continued “tapering” of the Federal Reserve’s quantitative easing program. Once a lethal dosage has been administered, reducing the size of additional injections does not cure the patient (for additional information on U.S. inflation, please visit the WindRock article Inflation: Why, When, and How Much? located here). As the U.S. monetary explosion since 2008 dwarfs the increase of the 1970s, the coming inflation may be quite ugly. With the exception of precious metals, few investments can rival the inflationary protection offered by farmland.

Endnotes:

¹ U.S. Department of Agriculture. Production. Supply & Distribution (electronic database). www.fas.usda.gov/psdonline. July 2012.

² U.S. Department of Agriculture. National Agricultural Statistics Service. http://quickstats.nass.usda.gov/

³ InfoPortfolio, LLC. http://dqydj.net/sp-500-return-calculator/ and New York University http://www.stern.nyu.edu.

About the Author

Christopher P. Casey CFA® is Managing Director at Windrock Wealth Management (www.windrockwealth.com)

Combining a degree in economics from the University of Illinois with a specialty in the Austrian School of Economics, Chris designs investment porrtfoliios to maximize rreturns and minimize risk in ttoday’s world oof significant government iintervention. Chris can be reached at 312-650-9602 or at chris.casey@windrockwealth.com.

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