June 19, 2012
Greecing the Skids
The Investment View from Prescott, Arizona
By Will Hepburn
The central themes of the financial markets are still job creation, a weakening economy, the presidential election, and Europe.
This newsletter is being written on June 17th, just before the elections in Greece which are garnering more scrutiny than any foreign election I can remember. The elections are expected to have a major influence on financial markets, but the question is: how?
The most popular scenario has Greek voters thumbing their noses at those who have been providing financial bailouts, but this is pretty obvious and when something is obvious, it often does not work out in the stock market quite as expected.
With everyone expecting this outcome in Greece, it is possible that the elections could be construed as “not as bad as they could have been” and produce a yawner in the financial markets.
If things get really ugly, I would expect the Central Banks, probably Europe’s, to step in and provide money to prop up whatever is at risk of collapsing.
Trying to guess what will happen and how to position one’s investments is fraught with error. It is just best to hold a conservative portfolio and just watch.
Spain recently pumped money into their banking system, which may be good in that it will keep the wheels from falling off of their economy for a while longer. But the way Spain did it bothers me.
In return for the money they gave the banks, Spain received bank stock. Stocks are the most risky form of investment because if the company fails, and banks are companies, stock holders get wiped out first and bond holders get what is left. This method of financing puts the Spanish taxpayer at “first risk”, meaning that if there is a loss, they get hit first.
As John Hussman, manager of the Hussman Funds puts it, this financing method means governments are protecting speculators and socializing losses. I believe earlier investors should be forced to bear the cost of their poor decisions and take some losses. How else will they ever learn to be better investors? That is the mechanism that makes capitalism efficient.
I find it fascinating that the media labels groups that protest Wall Street’s actions as socialist, when all around us governments are socializing one loss after another, protecting the large bondholders and in the process, benefiting Wall Street firms at taxpayer’s expense.
The US government used this same tactic in some of their bailouts a few years ago. So, is Wall Street capitalistic or socialistic? It is getting hard to tell, and that is what is so fascinating about watching this all unfold.
Kneed For a Day Off
By the time you read this I will be arriving home from having my balky old knee “scoped” to clean up some cartilage that has locked it up for a couple of months now. After surgery at age 19, the knee held up pretty well for the “high mileage” that comes with being an aging athlete.
I’m told these things are pretty routine, but I’m finding that it is easier to say when it is someone else’s knee. Anyway, I’ll be back in the office on Wednesday.
Scottsdale Office Date
We have several dates that we will be in the Scottsdale office over the next few weeks. Please call if you would like an appointment. (800) 778-4610.
Please Call Us If Things Change
I realize that this newsletter does a good job of keeping you appraised of what I am seeing in the market, how your accounts are behaving, and what I am doing on your behalf as I manage your investments.
The newsletter is purposely designed this way as many of you are not comfortable making investment decisions and have thanked me for making this aspect of our relationship so effortless for you.
Financial practitioners who sell mutual funds and annuity companies require a lot of face to face meetings, some as often as quarterly, because those are opportunities for them to sell you some new investment and make themselves a commission. I don’t work that way, and accept no commissions at all, so I do not require you to come in for meetings.
However, we do need to communicate, especially if your situation changes somehow. Perhaps income needs are rising, lump sum withdrawals need to be planned, or new money may be coming in for you that will need to be invested. These are all reasons to meet. And, a change in your comfort or lack of comfort with the risk in the markets should be addressed as soon as it presents itself to keep my work within your comfort zone.
My style is not to bug you, but to continue to do my work on your behalf, while still being available for you whenever a meeting becomes appropriate.
Please call us if things change in your life. It is important.
Q: What famous North American landmark is constantly moving backward?
A: Niagra Falls
The rim is worn down about two and a half feet each year because of the millions of gallons of water that rush over it every minute.
A Peek Into the Future
The interest on the national debt cost us about ½ half trillion dollars last year. And that is with much of the interest being at only a fraction of a percent. Total federal spending was $3.8 trillion in 2011.
What do you think will happen to the federal budget (and your taxes) if interest rates move back to their historic average of 6%, or perhaps to the 15% we saw in 1982 and the governments interest costs rise too?
Go ahead and do the math. I’ll wait. The answer is below.
Answer: If interest rates go back to the average 6%, the amount of interest we will have to pay may surpass the total amount of federal spending. This means that either:
All government spending will have to cease to pay interest, or taxes must double to pay interest and have government services, or we will all end up working for the people “we” borrowed money from.
It is imperative that we dramatically cut government spending so that we can begin to whittle down the debt before interest rates take off again or we may all get a new perspective on the term being in bondage.
How’s the Market Doing?
So far the old adage of “Sell in May and go away” seems to be working with the stock market having topped out in April and dropping about 10% before trying to recover this past week.
The stock market appears to be trying to put in a bottom so we can get on with the summer rally, but with the Greek elections and problems in Europe casting a long shadow over the market, that may be tough to do.
Interest rates on government bonds are at an all time low, which normally is a good thing, but in this case, not so much.
One thing driving interest rates down is that business is so bad that big businesses don’t want to borrow to expand, hire new workforces, finance inventory buildup, etc. Since interest is the price of money, if the demand for money falls, the price will fall until demand starts to pick back up. Weak demand is not a good economic trait, so in this respect, declining interest rates is not good.
The other thing driving interest rates down is the number of foreign governments that are lining up to put their money in our Treasury bonds. Last week’s auction of Treasury bonds had more than twice the number of buyers than bonds that were being sold, many of them being foreign governments parking their “reserved” or savings in our Treasury.
The bond market works similar to having bond prices on one end of a teeter totter and interest rates at the other. And excess of buyers causes prices to rise as buyers compete to get the bonds they want. Since bond prices are getting bid up, interest rates are going down.
Now, what would make foreign governments want to flee their own currencies and park their money in US dollar denominated Treasury Bonds? I can’t tell you in detail, but the general idea begins with a T as in Trouble. And with the huge amounts of foreign buying, I think that is a capital T.
Normally in this space I spend most of my time talking about the stock market, but in this case, I think the bond market is carrying the real message.
What’s Going On In Your Portfolio?
We haven’t changed much in the growth portfolios lately. We are positioned for a down market and are fully hedged. This means that we have been making a little money on the days the stock market has been down. On up days we tend to go sideways.
If good news comes in the form of Greek election surprises or central bank intervention in the financial markets, we can make adjustments and shift to a rising market portfolio, but right now, I think it is best to stay cautious. This is a fragile market and large, swift declines like we saw in 2010 and last year could be in our future. If they are, we want to be ready for them.
Flexible Income* portfolios are trending sideways, not going up much but not going down much either as the bond market struggles with the question of “how low can rates go?”
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* 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.
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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.