Money Matters Newsletter:
October 6, 2015
In Support of the Turtle
The Investment View from Prescott, Arizona
The investment world is all about returns. Is the S&P 500 up or down for the day? What is the top-performing stock or mutual fund this month, this quarter, or this year? How have the top managers performed?
While the obsession with short-term returns and market moves is natural, it has a tendency to overshadow the reality that smaller but steady, consistent returns can produce better long-term results than short-term gains mixed with declines.
In my Yavapai College class, I use a chart that shows pokey old bonds performing as well as stocks over long periods because they avoid the gut wrenching 50% drops that we have seen twice in recent memory.
A journalist can calmly point out that avoiding volatility is more important to long term investment performance than posting big numbers in strong stock market years, but for an individual investor, 50%+ declines become emotional, even personal. They can be life changing, and not in a good way. They can literally wipe you out if you catch one at a bad time.
Is there a better way? There certainly is.
While techniques, investment types and indicators have changed since I got into this business over 30 years ago, the challenge of active management continues to be to reduce volatility, particularly negative volatility, and put upward volatility to work. At times, this may produce results that look like a turtle’s pace. But turtles can be winners in the longer race.
An active management approach doesn’t have to outperform a rising market to produce better returns than a buy-and-hold approach. It just has to outperform in declining markets. Avoiding the majority of the loss allows me to actually build value from a higher plateau, instead of making up lost ground during each cycle. I may not get it right every time, no one does, but this is exactly what I try to do here with my strategies that Adapt to Changing Markets®.
Add to this the ability to access investment strategies across the investment horizon—from tactical tools to leveraged strategies to alternative investments—and active management may get that turtle moving faster than one might expect.
Slice of Life
How Are The Markets Doing?
Don’t Get Mauled by this Bear Market
The Federal Reserve stopped printing money by the bucketful ($85 billion per month at the peak) over a year ago, relying on increasing fiscal stimulus from central banks in Europe and Japan to pick up the slack. They refer to this as a tapering off of stimulus. It is intended to keep the world economy from having to go cold turkey on the cut off of cash.
Within months after the end of Fed stimulus, the US stock market lost its momentum and has dropped sharply in the past 7 weeks as we continue to go through easy money withdrawals.
But the real spoiler now appears to be China. The Chinese government has created tremendous growth over there, primarily to employ and feed the hundreds of millions of peasants who have migrated from rural areas to the cities. If they don’t keep them employed the Chinese risk an uprising so large that it might not be able to be controlled.
In the process, China has built entire cities that no one lives in. Chinese banks were pressured to make flaky loans for these projects, endangering their financial system. A deep and prolonged recession in Europe means fewer Chinese doo-dads being sold there, putting added pressure on the Chinese economy.
Now it appears that China is exporting their economic problem to the rest of the world to get cash needed to keep the peasants eating. Several news sources reported that in August China sold between $85 billion and $115 billion of US dollar reserves, including a lot of our Treasury Bonds.
How big is $115 billion? That is more than the Fed injected into the economy at the peak of the financial stimulus programs they called Quantitative Easing.
The effect on the economy is just like you selling an old car. You put the car into the hands of someone else in the economy and you take the cash. China sells their bonds into the world financial market in return for an equal amount of cash.
Since buyers need to have cash to buy stocks, those who bought bonds from the Chinese are no longer potential buyers of stocks. Is it any surprise that our stock markets went down the tubes as the Chinese were sucking cash out of the economy? There was $115 billion less cash circulating in the financial markets at the end of August than earlier. Ross Perot’s “giant sucking sound” may just be the life going out of world financial markets as the Chinese sell investments like our Treasury Bonds.
Falling Chinese demand for oil as fracking floods the energy markets is depressing oil prices and causing projections of lower profits in almost half of the S&P 500 industries. Almost all of the fundamental indicators I look at, including corporate earnings, sales and return on assets, are looking weak.
This Chinese problem does not appear to be one that will go away soon. I believe the stock market tops we saw earlier this year may not be seen again for several years.
One of the oldest investment strategies was developed by Charles Dow, of Dow Jones fame. Called Dow Theory, it is now confirming a shift into a long-term bear market.
Technical indicators (all those charts and graphs that look like a foreign language to the uninitiated) have turned down as well. I maintain a list of 159 indicators that forces me to look at things that I don’t see every day, such as money flows, inter-market relationships and various momentum gages. Right now my Indicator list is near all-time lows where it spent a lot of time in late 2007 and 2008.
European and Japanese markets have both broken downward since my last newsletter. I don’t know what Brazil’s Olympics will look like, but their economy is in shambles and their stock prices in the tank, so I’m not sure how they will afford the billions in projects for sports venues that are planned.
On top of all that, it is now October, the month that brought crashes in 1987, 2001 and 2008. Oh yeah. There was also a little crash in October of 1929. If the market drops below the August 25 lows, a realization among investors that the market is not bouncing but failing, combined with a lack of liquidity caused by Chinese sucking up cash, could cause a sharp decline to occur.
Risk may subside in a month or two if this does not happen, but right now, market risk is very high.
Eventually stocks will begin to build a bottom that they can move up out of. As they do, there are important market developments that will take place, none of which I am seeing now. As usual I will be watching for those signs and when they appear, I will move client accounts to take advantage of them.
What’s Going On In Your Portfolio?
Excuse me, My Edge is Showing
As I mentioned elsewhere in this newsletter, investors who make a bunch in up markets and then give it all back in down markets struggle in the long run. The edge I try to provide my clients is avoiding the kind of losses you can feel in your gut when you look at statements.
I try to make a reasonable return in up markets, and not give it back in bear markets. Rarely has the wisdom of this been more evident than in the past few months.
Our Shock Absorber Growth portfolios actually grew in the 1-2% range during September, while most stock markets were down, both here and abroad. We overcame sharp August losses and ended the quarter and year with Shock Absorber Growth accounts down about 1% through September 30th. The S&P 500 was down 6.74% for the same period, so I count my performance as a big win.
The strongest segment of our growth portfolios has been my Future Technologies strategy which was first implemented in client accounts in August 2014. I am proud to say that the independent tracking service at www.ThetaResearch.com has future Tech ranked #1 of all strategies tracked for the year ending August 31, 2015. Future Tech also had a strong month in September, so I expect high ratings to continue when the data is updated.
The allocation to Future Technologies has been bumped up and it now makes up 50% of Shock Absorber Growth portfolios.
Our Flexible Income accounts absolutely rocked in the third quarter, posting gains of over 5% for the period June 30-Sept 30. Much of this gain was due to the government bond strategy we added on July 1. In the past couple of weeks I have increased the allocation to the government bond strategy to 50% of Flexible Income portfolios to take advantage of its strong performance.
With the stock markets weakening, my blended strategies are becoming more conservative, with Adaptive Balance portfolios now 60% Flex Income and only 40% growth. Adaptive Growth portfolios have moved from 80% to 70% growth with the balance in Flex Income. These changes are designed to keep you on the right side of major market trends.
Adaptive Balance and Adaptive growth accounts all showed gains for the quarter while the S&P 500 Index was down 6.94% during the same period.
When markets are down I tend to do best. It’s when they dip and then recover quickly then I tend to lag the market. This market does not look to be the dip and recover type. Plus October is here and it has a nasty reputation for investors. It is time to be conservative and that is what I am doing.
I’m Never Too Busy to Help
Although I am a specialist these days, limiting my practice to portfolio management, and although I spend my time in three different offices (and occasionally the golf course), I am never too busy to sit down with you and review accounts or answer your questions in other areas. It is very important to me to keep a close tab on my clients’ goals.
I spent many years practicing as a Certified Financial Planner; and although I no longer hold myself out to the public as a planner, I still retain many of those skills for the benefit of existing clients. Membership has its privileges, so to speak. So, if you have any kind of financial question, I would be happy to help you with it.
I am also happy to meet with your friends who might have questions. If I can help them, I will. If not, I can probably suggest who may be able to help them.
One of the nicest compliments you can give me is to tell your friends about my work. An easy way to do this is to use the link provided in this newsletter to forward this letter to your friends.
If it is more convenient to meet with Will in Scottsdale, please call the office to schedule your appointment. 928-778-4000
Our Spotlight Strategy
With our Future Technologies strategy we strive to provide a high rate of capital appreciation using primarily equity investments in emerging technologies.
We invest primarily in stocks, ETFs and a money market fund. The proprietary HCM Safety Net suite of indicators is used to warn of potential stock market declines in which case exposure may be quickly reduced or hedged using inverse funds or ETFs.
The independent tracking service at www.ThetaResearch.com has future Tech ranked #1 of all strategies it has tracked for the year ending August 31, 2015. Check it out on our website or at Theta Research’s site.
A police officer called the station on his radio. “I have an interesting case here. An old lady shot her husband for stepping on the floor she just mopped.”
“Have you arrested the woman?”
“Not yet. The floor’s still wet.”
Please do not email trading instructions or leave messages on our answering machine about trades or needing money from your account.
It is important that we confirm your instructions personally to ensure that they are actually coming from you, and also to get your acknowledgement that we understand the instructions correctly. So please call the office and talk to one of our staff when you want to give us instructions on your account. (928) 778-4000.
* The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. Performance and 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.
** Indexes are unmanaged lists of stocks considered representative of a broad stock market segment. Investors cannot invest directly in an Index.
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.
In all investing, past performance cannot assure future results, and as such, our efforts are not guaranteed. Losses can occur. All strategies offered by Hepburn Capital Management, LLC adapt to changes in the markets by changing the investments they hold, therefore, comparisons to broad stock market indexes such as the unmanaged indexes mentioned may not be appropriate. Sometimes client accounts are invested in stocks or markets not included in these indexes. Past performance does not guarantee future results. Investment return and principal value will vary so that when redeemed, an investor’s account values may be worth more or less than when purchased. Mutual fund shares and other investments used in our managed accounts are not insured by the FDIC or any other agency, are not obligations of or guaranteed by any financial institution and involve investment risk, including possible loss of principal. Advisory services offered through Hepburn Capital Management, LLC, an Arizona Registered Investment Advisor. Adviser will not transact business unless properly registered and licensed in the potential client’s state of residence.
Copyright (C) 2014 William T. Hepburn. All rights reserved.