July 3, 2012
Kudos to the Guys in Washington
The Investment View from Prescott, Arizona
The tug of war in the bond market continues with the Federal Reserve insisting that they have enough ink in the printing presses to generate the dollars needed to continue buying bonds in the attempt to keep the interest rates low.
Actually, Operation Twist, as they call it, is a smart move by the Fed, even if it is for reasons other than what they state.
Many of us who remember the Savings and Loan collapse 20-some years back have had an eerie feeling of deja-vu watching the fed finance the long range federal debt by buying up the Treasury’s short term bills and notes as fast as they are printed – keeping short term rates low in the process.
The risk they run is that if interest rates ever do slip out of their control and short term rates spike up as the short term notes mature, they will need to be replaced by higher and higher paying notes, right then, or there will be a default. That was the mistake of S&L managers 20-some years ago, borrowing short term (CDs) and making long term loans.
With 2-year notes paying only 3/10%, this dynamic has the potential to increase the cost of servicing the government debt by as much as 20 times if rates move quickly to the historic average yield on Treasuries which is close to 6.0% since WWII.
Our current federal budget is around $3.8 trillion, and current interest on the Federal debit is a little over $500 billion. What do you think would happen to this country if that $500 billion of interest became 20 times more – $10 trillion? Now that would be a problem.
By buying longer term bonds instead of shorter term bonds, not only does the Fed hold down longer term interest rates, but they can avoid having many of their IOUs come due within a short time – probably when interest is highest if Murphy’s Law still holds true.
So, as easy as it is to pooh-pooh those guys in Washington, with Operation Twist, which is their name for selling short term notes to buy long term bonds, at least they are locking in those oh-so-low interest rates for the U.S. while the locking is good.
That is a smart move.
A Slice of Life
By Bryan Jarman, CFA
The Passing of “The Greatest Generation”
My grandfather, E. Robert “Bob” Jarman, passed away on June 20, 2012 at the age of 88. I had the great fortune of growing up around this incredible man.
He served in the Army during World War II on the front lines in Germany. He returned home to Phoenix, Arizona and married my grandmother on May 8, 1946, exactly one year after Germany surrendered.
As a business owner he regularly had homeless people stopping by his shop asking for assistance. He never turned them away, but understanding the importance of personal self-esteem he would find odd jobs for them to do around the shop to earn the money instead of just receiving a handout.
He was committed to good causes and kept promises his entire life that he made in a foxhole in Belgium during the war. He was a devoted member of the Boy Scouts of America as he recognized the importance of helping mold boys into men.
The principles of industry, innovation, thrift, humility, honesty, commitment, service, faith and charity were embodied in my grandfather. These characteristics need not be lost with the passing of the greatest generation but should be passing on to the next generations to carry on their legacy. Our future depends on the degree to which these traits are evidenced in our own lives, communities and nation.
Q: A certain five letter word becomes shorter when you add two letters to it. What is the word?
A Real Life Comparison
Tiger Woods is back in the news – this time for winning golf tournaments. His total earnings over his career are approaching the $1 billion level.
Tiger’s earnings in 2008 were $12 million from golf and $110 million from endorsements and commercials, etc., for a $122 million total for that year. That is a lot, but how much is it really?
At that rate Tiger earns $334,246 a day. That’s enough to pay cash for one of the nicer homes in our town…every day.
In the time it takes Tiger to play a round of golf – a day of strenuous idleness, according to William Wordsworth – he earns $62,671.
And while you are watching one of Tiger’s Nike commercials, he earned another $235, even if he is asleep.
So, I think we can agree that Tiger Woods makes a staggering amount of money.
And, if Tiger were to save every dollar he ever earned for 508 years straight, he would then have as much money as Bill Gates.
Power to the nerds!!
Will and Bryan are in the Valley frequently. 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 they are in Scottsdale.
How’s the Market Doing?
As hard as it is to believe, many of our stock market indicators have begun flashing green recently as the market crawls out of its low point on June 2nd.
There really are only two things that matter in investing. How much money there is, and how willing people are to invest it. After the Federal Reserve’s first two stimulus programs expired in 2010 and 2011, the markets were rocked by nasty declines as liquidity dried up and there wasn’t much money to invest.
This time perhaps the Fed got the idea and did not allow a lapse in their pump priming efforts, but extended “Operation Twist” before it expired.
A recent report from my friend Tom McClellan says that there is plenty of liquidity, which solves the first half of the equation. This should put a nice wind at our back for a while anyway. In this condition, any market correction, whether news driven or otherwise, has a low risk of being a bad one. I like that a lot when investing your money.
It is hard to believe that next month will be the one year anniversary of gold’s all time high and the peak of gold fever. Whodathunk that gold would be going down for almost a year! And with no signs of recovery in sight – yet.
Municipal bonds have had a great run since late last year. I know there has been lots of talk of municipalities being in trouble, but despite several high profile municipal bankruptcies, most are finding ways to deal with budget issue without stiffing bondholders.
Last week, Stockton, CA declared bankruptcy after collapsing under the weight of city pension plans, yet the several municipal funds we own in client accounts have not budged a penny since that announcement. Stockton’s BK was a yawner.
But this underscores an important point about owning municipal bonds. It is important to have a professional credit analyst choosing the bonds. You and I are not qualified to do that work, and expecting a broker to analyze municipal budgets is unrealistic. Just staying on top of the changing landscape of municipal finance is a major task.
Municipal bond mutual funds come with experienced credit analysts. This is why I use mutual funds exclusively for this purpose, and I would strongly suggest you avoid ever buying individual municipal bonds.
What’s Going On In Your Portfolio?
I’m really, really glad the second quarter is over.
Between April 2nd and June 1st the S&P 500** lost 9.93% with the technology oriented Nasdaq Index** losing 13.29%, The Russell 200 Index of smaller companies lost 12.28%, Emerging Markets dropped 15.75% with China leading the way down, and the International Index of developed countries, called the EAFE, lost 16.17%.
Out of 5,963 stock funds reported in the FastTrack database that I use, 93% lost money this past quarter. The median loss was 5.24%. It was an ugly period for stock market investors.
We were overly conservative with our Shock Absorber Growth Strategy* this past quarter and because of our defensive posture we outperformed the market in May by 4.8%. That is the good news. The bad news is that April and June losses were big enough to drag us backwards for the quarter.
Fortunately the stock market appears to have turned up a few weeks ago, so we have reduced our hedging activity and loaded up on utility, real estate and Japanese stock funds which have all been leading the recovery in June. Hopefully we will get a good enough uptrend to recoup the recent losses.
The Flexible Income* model posted a 2.27% loss for the second quarter, taking away the profit we had going into it. The investments causing the losses were quickly sold and replaced, so the portfolio is once again doing OK at this point.
Bonds can lose a lot of value during periods of rising interest rates but our Flexible Income* holdings are the type that if interest rates do rise we ought to do pretty well.
We continue to hold a good chunk of municipal funds, which have leveled out, but still look to have legs. Floating rate bond funds and some high yield bonds are included as is an “inverse” bond fund, one that will go up as Treasury bonds go down.
Our Spotlight Strategy
With Adaptive Growth* we strive to provide high total return from a combination of investments from both the equity and income markets with the emphasis on equities.
You can see the details on Adaptive Growth* and how its holdings Adapt to Changing Markets® here: [Adaptive Growth]
* 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.
Shock Absorber Growth
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.