April 20, 2010

Bernie Madoff Had Help

Harry Markopoulos is the guy who had the goods on Bernie Madoff early on, but could not get anyone to believe him.  I recently read some excerpts from his new book “No One Would Listen”, and something he revealed made my jaw drop.

Madoff’s saga is full of jaw dropping items, in terms of the numbers of victims (4,000) and the dollars involved ($65 billion), but my insight was different.

Markopoulos recounts trying to sell a competing investment to14 different old-money investors and institutions in Europe in 2000.  Each of them declined Markopoulos’ offer because they were pleased to say they had their money with Bernie Madoff.

One by one, each of them told Markopoulos the same thing, that Madoff gave them preferential treatment in that they were the only ones allowed to add money to Bernie’s otherwise closed hedge fund. 

As he heard story after story of how each investor believed they were the only one allowed to continue investing with Madoff, Markopoulos was convinced Madoff was a fraud.

Doing the math, Markopoulos calculated that Madoff could not possibly generate the kinds of returns he was reporting – legally, anyway. 

Whenever he mentioned this to one of Madoff’s investors they would acknowledge that they that felt that way, too, but assumed that Madoff was “front-running” all of his other investors in his securities firm to goose returns for themselves.

Front running is a form of insider trading that occurs when someone buys or sells with advance knowledge that someone else will be doing more of the same right afterward therefore moving the price and creating a windfall for the first to trade. 

Needless to say, front-running is illegal. Nevertheless, many big investors, with a wink and a nod, acknowledged that Bernie Madoff was probably doing something illegal, but with such a good thing going they were in denial about it affecting them.

Mr. Whitekeys is a legendary blues man in Anchorage, Alaska. He began creating musical satire at Chilkoot Charlies’ in the 1970’s and opened the Fly By Night Club there in 1980 which has a tongue-in-cheek motto, “We cheat the other guy and pass the savings on to you.”

It is hard to believe that people controlling billions of dollars could actually believe in that line coming true, but according to Markopoulos they did.

So Bernie Madoff was not alone perpetuating his scam.  He had a lot of help.  Many of his clients were victims of their own greed.

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This Week’s Riddle

Q: My life can be measured in hours;
I serve by being devoured.
Thin, I am quick; fat, I am slow.
Wind is my foe.

What am I?

A: A Candle

Social Moods Driving the Markets

The single most important force in the financial markets is the mass psychology of the buyers and sellers.  Admittedly, that is a tough issue for a facts and figures guy like me.

To gain some insights into the psychology behind the markets I have studied Elliott Wave Theory for about 15 years now.  Many people think that EWT is just another way to look at the stock market, but it is much more than that. 

EWT is really rooted in socio-economics: how social moods create what you see reflected in the market place for just about everything.  The waves in stock market activity that I mention so often here are really the result of social moods playing out. 

One tenet of socio-economics is that the icons of success in a bull market, such as we had in the 1980-90s, will all be pulled from their pedestals during the bear market phase which follows.  And, make no mistake, we are right in the middle of a generational-length bear market.

Think about the AOL’s of the world becoming a mere shadow of what they were 10 years ago; Enron and all the dot-com companies that are now toast.

To students of history and social happenings, it should come as no surprise that Bear Stearns and Lehmann Brothers tanked.  Or that Merrill Lynch and Fannie Mae had to be bailed out.  They were all primary actors in the boom years, so their failure was foretold by EWT.

Alan Greenspan, considered the architect of the financial boom, has recently and publicly been accused of being asleep at the switch while the crisis brewed.

Yesterday (Friday, April 16th) the government sued Goldman Sachs for fraud for one piece of their involvement in the financial crisis.  Could this be the beginning of the end for Goldman?  Possibly, however major Goldman shareholders like Warren Buffett won’t stand by idly and watch Goldman go down.

But if his ownership of Goldman Sachs tarnishes Buffett’s image, socio-economics may get a two-fer as both Goldman and Buffet get their reputations dragged through the mud.

When there are no icons of the go-go years left without black eyes we may be nearing the end of this generational bear market. 

The most serious ramification of the Goldman Sachs suit is the newly hostile regulatory environment that all financial firms will have to work within.  This breeds a lot of uncertainty about what can and cannot be done, so nothing ends up getting done and our economy gets held back even more.

A Peek Into The Future

In my April 15, 2008 newsletter in an article entitled “Real Estate Rebound?   I don’t think so.”   I said . . . “further price declines of 19% should be expected”.

History has shown that I was pretty close on that point, so here is another one for you, compliments of my friend and market analyst, Tom McClellan.

I first met Tom in 2003 and have continually been impressed by his ability to see in charts how one part of a market leads or lags another, thus giving us a glimpse of what the future may hold for investors.

What Tom pointed out in the March 3, 2010 McClellan Market Report should be good news to anyone looking to buy or sell a home.
Lumber prices, reflected in the futures contracts for lumber, bottomed in January of last year and have almost doubled since then. 

Tom McClellan points out that new home sales trail lumber prices by about a year, so if home prices follow lumber like they have in the past, the moment of the market bottom may have just sneaked quietly by us.  We won’t know for a while – there are never trumpet fanfares at market tops or bottoms – but this is an encouraging sign, nonetheless.

If this analog holds true, a year from now we ought to see home prices rebounding to match the strong rebound in lumber prices underway for the past year.

This is not a recommendation to move all your money into real estate, just to keep your eye on it for signs of change. 

There is no guarantee that comes with this type of observation.  But if history does not exactly repeat itself, it often rhymes.  If we can use this type of insight to improve our probability of investing successfully it will have served us well.

The Voice of HCM Asks for Help

Everyone who deals with Hepburn Capital knows the wonderful voice of Sheri Congdon, who began running our front office in 2001.

What you may not know is that Sheri’s son, Brian Vega, is developmentally disabled and has lived in a group home run by Salem Christian Homes, Inc., (SCH) a non-profit organization that serves individuals with autism, mental retardation, Down syndrome as well as other disabilities in Chino, CA.

SCH has been Brian’s home for more than 30 years, but the stability of Brian’s environment is threatened by the budget cutbacks in California.

A May 1st “5k Run, Walk and Roll” fundraiser will help bridge a $130,000 gap in SCH’s finances.  Sheri plans to participate, and is looking for sponsors willing to donate on Brian’s behalf.

Please consider a tax deductable donation of $25, $50, $100 or more to this very worthwhile cause, and help support Sheri, her family, and the many who need our help now more than ever.

You may get details and register online at http://www.firstgiving.com/shericongdon, drop a check off at the office made out to Salem Christian Homes, Inc., or call the office (928-778-4000) with your credit card information and we can register you on the phone.

Your support is appreciated beyond words.

How to Get Management Fee Discounts

Would you like to save hundreds of dollars annually?  Simply refer family and friends to Hepburn Capital.

We calculate fees on the total amount of money we work with for a family or other groupings of clients, including friends.  The higher the amount of assets being managed for the group, the lower the fee percentage becomes for everyone in that group.

Besides being one of the nicest things you can do for me (and them), mentioning Hepburn Capital to your friends can save you big bucks.

The easiest way to introduce someone to my work is to forward my newsletter to them.

Thank you for your support.

What’s Going On In Your Portfolio?

We have been fully invested for several weeks as the stock market continues to climb its proverbial “wall of worry”.  There are lots of reasons for the market to be going down, but the fact is the market has been in a remarkably steady uptrend for about two months.

Careful Growth* accounts hold a mix of stocks and stock funds totaling about 68% of the portfolio with gold and an inverse Treasury bond fund and some cash making up the rest of the portfolio.  I expect to invest the cash in the next few days in more stocks, assuming that the Goldman Sachs news blows over.

Flexible Income* portfolios are also fully invested as you can see below in the performance summary and continues to make money slowly, which is what that portfolio is noted for.

As usual, our Balanced* accounts have half Careful Growth* and half Flexible Income* holdings.

Municipal Income* accounts remain fully invested providing consistent gains since January.

Socially Screened* portfolios mirror what we are doing in the Careful Growth* model, but only buy within a very limited universe of investments.

Our Spotlight Strategy

The performance objective of the FLEXIBLE INCOME STRATEGY is to outperform (after deduction of HCM’s maximum fees) the Vanguard Total Bond Market Index over any full market cycle (down and up) often 3-5 years or longer, while taking less risk than the Index as measured by peak to trough draw-downs in account value.  (See below)

Referrals are a great compliment.  Thank you for the many referrals we get.  If you like what we are doing, please continue to tell your friends.

*    The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed.   Activity in client accounts may be different from that in the model in amount of each investment, specific timing of trades, and actual security used, which may vary from account to account.  Not all trades are profitable.  It should not be assumed that current or future holdings will be profitable.   A list of all trades in these accounts for the past 12 months will be provided upon written request.

**  The S&P 500 and Nasdaq Indexes are unmanaged lists of stocks considered representative of the broad stock market.  Investors cannot invest directly in the S&P 500 Index.

Balanced Strategy Description and Performance Information

Careful Growth Strategy Description and Performance Information

Flexible Income Strategy Description and Performance Information

This newsletter may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Information in this newsletter may be derived from sources deemed to be reliable, however we cannot guarantee its accuracy.  Please discuss any legal or tax matters with your advisors in those areas.  Neither the information presented nor any opinions expressed herein constitute a solicitation for the purchase or sale of any security.