July 17, 2012
Blind Optimism
The Investment View from Prescott, Arizona
By Bryan Jarman, CFA
Back in 2007 at my former employer, which had very rigid investment policies, I was given a slap on the wrist for questioning whether their buy and hold investment strategy was appropriate around the same time that the stock market was starting down into the crash of 2008-09.
I suggested that they were investing with “blind optimism” – believing the stock markets will just continue to go up forever. After all, “buy low and sell high” didn’t get to be the investing mantra by accident. Smart investors actually do sell to avoid declines!
When economic and financial risks are discussed amongst regulators, legislators and executives, it is usually done behind closed doors, concealing from the public the true level of concern. Projections of severe negative effects can spook the markets.
Some would argue that the lack of confidence is what has been holding back the stock markets. The Federal Reserve has attempted to boost markets by printing cash and buying assets to keep interest rates down and investment prices up – although the desired “wealth effect” hasn’t really happened.
In fact, the Fed recently released their minutes from their June meeting and a few members said it would be “helpful to have a better understanding”. I take that to mean they really don’t know what the effects of their actions will be which is a sobering thought. They are all smart individuals, but they are dealing with a group of problems that no one has ever seen before.
The problems facing us seem overwhelming: anemic job growth, ballooning US debt, slowing European and emerging markets and political gridlock over tax policy – just to name a few. As history has taught us, the problems always get solved somehow.
I don’t believe it takes blind optimism to invest in the markets, but complete pessimism isn’t sustainable in the long-run, either. For all the negatives, we still live in the greatest, most resilient country the world has ever known. Our abundance and daily comfort are unparalleled in history. We need to let the free enterprise system work its magic and pull us out of the rut we are in.
Someone please tell the government.
What’s the Fed Really Doing?
By Will Hepburn
Bryan mentioned the Federal Reserve’s actions in his article about “Blind Optimism”, and Mohamed El-Erian, CEO of mutual fund giant PIMCO, had some insightful comments on last month’s speech to Congress by Fed Chairman Ben Bernanke. I’ve summarized a few of his comments here:
Bernanke stated a need to shift the government from monetary policy (printing of money to solve problems) to fiscal policy (budgetary restraint on the part of Congress and the Administration). He wants Congress to accept financial responsibility for policy decisions instead of putting that burden on the Fed. This is a powerful voice of reason telling Congress “put a lid on the spending, please.” [Personally, I applauded when I read this. – WH]
Mario Draghi, President of the European Central Bank, their equivalent of our Fed, has also been unusually vocal in recent weeks about the need for politicians in Europe to step up to the plate and deliver on their policy responsibilities; and he has been clear that relying just on the ECB has its limits.
This is all consistent with the growing view in both academic and policy circles that central bank intervention in the markets is becoming less effective over all. Bernanke referred to lower effectiveness of additional Fed stimulus plus the risk of unintended consequences to the economy.
With a short-term mentality dominating as a result of central bank interventions in the markets creating an uncertain investment outlook, the likely upshot is continued volatility.
The continuation of the volatile markets means a great environment for investors who can time the markets and ride the waves up while getting off of the waves down, and a rough time for “buy and hold” investors who long for the good old days of the 1990s.
Did You Know?
The term “Green Berets” came from a British commando school.
During World War II, select U.S. Army Rangers and U.S. Office of Strategic Services personnel volunteered for an intense commando course in Scotland. The soldiers were relentlessly trained in field survival, mountaineering, snow warfare, small boat operations and river crossings.
British Commandos wearing distinctive green berets conducted the school, and those American soldiers who successfully made it through the course were awarded the same beret. The U.S. Army didn’t authorize it for wear, but the hardened American commandos didn’t worry too much about that, secretly wearing it while out in the field.
Read the full text here: [Mental Floss]
A Slice of Life
It sure was nice to see the rains come to Arizona this past week. It seems like it has been almost 3 months since we had any measurable precipitation. I can almost hear the plants and animals going “Ahhhhhhhh”.
How’s The Market Doing?
The answer to the question of how the market is doing depends entirely on one’s time frame. Long term, the market has been down for 5 years now having peaked in October 2007 and remaining well below its peak level. With the S&P 500 Index** being up only 1.6% over the past as of this writing on Thursday, July 12th, one could say that the market is pretty flat on an intermediate term basis. However the market is up over the past 5-6 weeks. So, it all depends . . .
My long time friend John Lyons is a money manager from Chicago. John put an interesting perspective on the question “How is the market doing?” in his recent newsletter:
“On this Leap Day, February 29, 2012, the S&P 500** closed at 1366 (rounded). Amazingly, on Leap Day 2000, the S&P 500** also closed at 1366. More amazing still, on Leap Day Eve 2008, the S&P 500** closed at 1367 — so much for Wall Street and academia’s buy-and-hold mantra!”
At Hepburn Capital, we are intermediate term traders. We don’t want to trade daily because short term movements in the stock markets are notoriously hard to predict, and long term investors can be dealt horrible losses before they can take action. We prefer to look at trends that are weeks to months long, because we feel it is there that the best relationship between risk and reward can be found.
We were pleasantly surprised in late June when many of our indicators changed from red to green. Right now our proprietary Safety Net Indicator is flashing an “all clear”, as are several other key indicators we follow.
It is more important for us to recognize what is actually happening than to understand why it is happening. In fact, if we wait until we understand why the markets are moving it is often too late to invest.
So, as nervous as the world economic situation makes us, we have to recognize that what is really happening is a stock rally. We invest based upon what the numbers tell us is actually happening, rather than on the oh-so subjective news casts and opinions that are a dime a dozen.
The market is rallying right now.
Scottsdale Office Meetings
Will and Bryan are happy to meet with clients in the Valley. If our Scottsdale office is more convenient for you than our Prescott office, just call (928) 778-4000 for an appointment to meet Will or Bryan one of the days that they are in Scottsdale.
And if you are in the West Valley and have a place we can meet, we can save you a trip and come there rather than Scottsdale. Just let us know . . .
What’s Going On In Your Portfolio?
Our Shock Absorber Growth* portfolio is currently fully invested for an up market. We hold utility, real estate and Japanese stock funds, with the smallest amount of hedge allowed under our system.
The fact that we only hold 3 “long” investments instead of 4 or 5 as we have held in the past is another reflection on the strength we see in the stock markets.
The chassis upon which Shock Absorber Growth* is built is called sector rotation. We move into investment sectors like industries or geographic regions as they become market leaders. The highest returns can be achieved from choosing a single sector to invest in at a time – the hottest one. However, the volatility and added risk of not being diversified also cause a “single shot” strategy to be a very wild ride.
We like to focus on lowering the risk of ever having large losses for our clients, so having 3, 4 or 5 sectors represented is another way of managing risk through diversification. When we go with 3 sectors it is a reflection on our confidence in the market.
Of course things can change, and if they do we will change too, but this is one of those times to say “If I am not going to be fully invested in this market, when would I ever be?”
Flexible Income* portfolios have been held back by our use of a “bond hedge”, a mutual fund that will go up as interest rates rise. Rising rates normally cause losses for bonds, so this is an “inverse” fund acting opposite of most bond funds.
We first bought the hedge when 10-year treasury rates were hitting record lows back in May. It is logical to assume that from record lows there is a lot of room for rates to rise, and less likelihood that they would fall to new record lows. Everything in investing cycles up and down, including interest rates. Unfortunately for us we have seen new lows for T-bond rates, so our hedge is showing some small losses rather than the gains we are looking for.
The biggest institutions, commonly referred to as “smart money” are heavily invested to protect against rising rates, just as we are. These folks can go for a while without being right, but they usually end up being right in the long run. So, I am trying to be patient with this holding, waiting for the rates to head back toward normal.
Our other holdings in Flexible Income* accounts are all doing well. They include municipal, high yield and floating rate bond funds.
Mental Floss
Q: What happened in 1961 that will not happen again for over 4000 years?
A: The year’s date reads the same when turned upside down. That will not happen again until 6009.
Our Spotlight Strategy
With our Flexible Income strategy we strive to provide high total return consistent with Capital Preservation.
Your money will be invested in bond or currency funds, including precious metals that may be used as currencies and equity-income investments whose price trend is up. If the price cycles down, holdings are replaced with new investments that are going up. Growth stocks are not used.
For more information please click here: [Flexible Income]
* 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.
Traditional Income
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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.
