May 29, 2008
The Latest Investment Scam
While in Phoenix a few months back I noticed a one-hour seminar on becoming a stock trader, and since my business there was finished, I sat in to see what they were selling. It turned out to be snake oil.
After mentioning my experience to some colleagues, I have found that this same scam is operating in many areas in the country. And it is set up to evade normal regulatory safeguards for investors.
This outfit brags about the millionaires they have made and how some of them will come back to teach you all their secrets at a two day seminar. The seminar costs several thousand dollars – offering a money back guarantee, of course.
The skeptic in me wondered why millionaires would be coming back to train more competition for themselves.
They promise to show their system of identifying good stocks for trading, how to spot “set-ups” or conditions that suggest greater potential for success, and when to “pull the trigger” – actually starting a trade. We would get to see some real live trades unfold right before our eyes and be entered on the stage.
The company was so interested in our having a good experience that they were even going to have extra computers set up in the back of the room so that we could enter the same trades as their pros did, and get to make a little money on their coat tails. We were told that students often made enough with these trades to pay for the course. Uh-huh.
Then the light bulb came on in my head. What this firm is doing is a stock manipulation scheme called “front-running”, an illegal practice in my business.
Front-running involves using privileged information to buy a stock before other investors, therefore benefiting from the run-up in price created by all the other investors piling in and buying later on. It can also be done in reverse by selling in front of a wave of other selling.
Money managers using individual stocks have this ability to abuse their position, so this kind of activity is closely scrutinized by regulators. Mutual funds are not susceptible to this type of manipulation, just individual stocks.
However, the firms conducting these seminars are not regulated. They are “educators”, not Registered Investment Advisers like Hepburn Capital.
So the millionaire instructors can buy a stock during class, knowing that many of the students will enter their own buys running the price up. Normally the targeted stocks will be small companies for which a small amount of buying can really drive the price up a lot. Of course the rising price just makes the instructor look that much smarter to the students, so the next trade gets even more students buying.
Now you know how all these traders get to be millionaires.
And in a few days after all the students will have bought, who do you think will be among the first sellers? Yep, the instructors. Now you know how they stay millionaires.
A Rare Tax Break
The tax rate for long term capital gains (holding periods of more than one year) for the years 2008-2010 for investors in the lower tax brackets (15% and below) has been set to zero. For married taxpayers filing jointly this includes taxable incomes up to $65,100. For single taxpayers the 15% bracket goes up to $35,500.
Yep. I said 0% tax. Frankly, not everyone will qualify, but this is still one of the best tax deals I have ever seen. And the income levels mentioned above are taxable incomes, which is normally less than gross income.
What to expect from the Market
This past week was a tough week in the stock market with the S&P 5002 losing 3.47%, its worst week in several months. The media reported that inflation is the culprit. There may be some truth to that, but more likely traders are taking profits after several strong months in the markets.
The S&P 500 index2 has been in an uptrend since March 17th, and is due for a breather. Considering that the market is still in a long term decline this could be the end of the rally, or strength could continue into the summer after a short “correction” in the trend. Markets never go in a straight line for very long. Corrections are the zigs and zags that make up the larger trend.
I will keep a close eye on this mini-decline. There can be many profitable intermediate up-trends in a lousy market, and this has certainly been one of them. But all trends end sometime. It is just too early to tell if that is the case with the recent up-trend.
An item suggesting that the strength in the markets will continue is the relationship of long and short term interest rates, called the yield-curve. It is one of the more accurate predictors of coming economic conditions.
The Pig in the Python
More adjustable rate mortgages, or ARMs, are scheduled to adjust their rates during May of 2008 than at any time in history
Right now the Federal Reserve is scrambling to make cheap money available to the banking system so that mortgage rates will be adjusted at low levels and remain affordable for as many homeowners as possible.
Although recent foreclosure rates have been paced by the high number of rate adjustments, there is a lag time of several months. Because of this, I expect foreclosures to continue to rise for at least another year keeping pressure on the real estate market.
What will happen then to interest rates after the rate adjustment “pig” has moved its way through the system? My best thinking is distilled into my investment models, and you can read it in Account Updates in this newsletter.
If inflation is on the rise it would be expected to pull longer term interest rates up with it, benefiting our inflation resistant holdings in this model. However, the Federal Reserve is doing everything it can to hold down mortgage rates right now so this part of the market has not moved much. However, the Fed action is like a rubber band being stretched.
When the Fed decides that fighting inflation should become a greater priority that avoiding foreclosures, the risk of a snap upward of interest rates becomes significant, so I expect our inflation resistant investments to perform very well at some time in the future. Right now we are just marking time with them and being patient with small gains.
Municipal Bond accounts continue to make money slowly. Since the credit upheavals between July and January, these dependable investments are back to being . . . well, dependable.
During the last week, our growth models* gave up some of the strong gains from the first part of the month, but are still positive for the month of May. The decline pulled us back below break-even for the year by a percent or two depending upon the strategy, but all strategies are still well ahead of the S&P 500 Index** which is still down 6.35% for the year.
If the stock market weakness continues, I may do some hedging to reduce the risk of being caught in a larger decline. I’ll talk more about that in the next newsletter.
Our Socially Screened model is also doing better than the stock market as a whole, but still down for the year. If I begin to hedge the growth models, I will hedge the socially screened accounts at the same time.
What to expect: Last week’s weakness did not invalidate the uptrend that began in March, so it is time to just be patient until the market gives us a clearer signal of its direction.
It is prudent to do a periodic review of your accounts at least annually. If you would like to schedule a review, anyone at the office can schedule my personal consultations, just ask . It is important that we talk if you have experienced any changes in your financial situation, investment objectives, tolerance for risk or if you simply wish to change strategies. Please call the office at 778-4000 for an appointment to meet or speak on the phone.
From time to time we update our federal disclosure document, SEC Form ADV, Part II to reflect changes in our business. You received a copy of this document when you opened your account. If you would like a current version, please call the office and we will be happy to mail one to you.
Please note: Comments are as of this writing, May 23, 2008.
1. *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.
2. **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.
Information in this newsletter is 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 constitutes a solicitation for the purchase or sale of any security. Adviser will not transact business unless properly registered and licensed in the potential.