April 24, 2012
Presidential Politics and the Stock Market
The Investment View from Prescott, Arizona
By Will Hepburn
My friend and newsletter writer, Tom McClellan, who I will be meeting with next week in Atlanta, while warning of a soft stock market for the next few months has several other studies that show strength in the market later this year and into next, which is nice to hear.
Part of Tom’s work is interpreting the presidential election cycle and its affect on the stock markets. Year 3 of the presidential cycle (last year) is normally the best of the 4 years for the stock market. Year 4 (this year) is usually good, with normal weakness in the second quarter. Year one and two of the election cycle are the worst of the years as the administration tries to get the bad news out of the way before they have to run for election again.
The Presidential election cycle is always the topic of much investment speculation, so this begs the question “Will this year be a normal election year for the stock market?”
In my experience, the stock market does not seem to care whether there is a Democrat or Republican in office. What the market likes is stability, and what drives it down is uncertainty.
When the market went in the tank in September and October of 2008, it was clear to me that the market was signaling a change in administration from Republican to Democrat, and the uncertainty of what that change meant was part of what was upsetting the markets.
If we get a strong stock market this summer and fall as McClellan’s work indicates, I wonder if it will be because the status quo is likely to continue with another four years of President Obama, or a relief rally because the market sees the big-government initiatives ending with a Republican victory. It’s hard to say for sure, but makes for interesting conversation.
As with so many indicators, just because the market acts one way “on average” may not be a reason to invest all by itself. Remember that 2008 was a 4th year, normally strong, but it was a huge loser for investors. Consider also that 2009 was the first year of the presidential cycle, typically one of the two worst of the 4 years, yet 2009 saw the beginning of a powerful bull market. Last year, 2011, the third and usually strongest year of the cycle saw losses in virtually all markets around the world except one, the Dow Jones Industrial Average** which only had two of its stocks showing price gains in the second half of the year.
This reminds me of the adage about being able to drown in the middle of a lake that averages only 3 feet in depth. Averages are deceptive.
So sure, Presidential politics makes for lively discussion, but don’t go betting on it in the stock market.
As Nassim Talib said in his book, The Black Swan, “One of the worst mistakes an investor can make is to mistake probability for certainty”.
Vidalia Onions, Anyone?
I don’t know if you are a fan of Vidalia onions, the sweetest onions around, but I sure am. The local Shrine Club sells onions as a fund raiser to help pay for the transportation of kids to the 22 Shriner’s hospitals around the country, and I am happy to say that this is onion season!!
You can pick up a 10-pound bag of Vidalia onions at our Prescott office for only $10 – while they last.
And remember, if you know of a child in need of care for burns, orthopedic issues or cleft palate, just let me know and I can help start the admission process to the Shiners Hospitals. There is no cost whatsoever to the parents.
A Slice of Life
Yavapai on Broadway!
I have a bad habit of announcing my wife, Cathleen’s, singing performances after they have happened, much to the chagrin of you music fans. This time I am pleased to give some advanced notice.
As you may remember, Cathleen teaches Voice at Yavapai College and last year she sang in a memorial service in Lincoln Center in New York on the 10th anniversary of 9-11, and also on the deck of the USS Missouri in Pearl Harbor on the 4th of July. The girl gets around.
Next Sunday, April 29th at 3:00pm at the Yavapai College Performance Hall, she will be performing, along with many others, in a show called Yavapai on Broadway. The music performed is from Rent, Showboat, Smokey Joes Café, Hairspray, Oklahoma and other Broadway hits. It ought to be a terrific show, and a chance for you to hear some real talent, all for only $5; children 14 and under are free.
“I Cannot Tell a Lie” said the Number
By Bryan Jarman
When you rely on numbers as much as we do it is wise to question the validity of the sources.
One would suppose that a number is a number is a number. “Numbers don’t lie” is what we have all heard. The numbers themselves do not lie, but there is an art of making the numbers say what you want them to say. A simple example: a 10% chance of rain is also a 90% chance of it not raining.
Calculations for Gross Domestic Product (GDP), Consumer Price Index (CPI) and unemployment figures are done using sample data - only a portion of the entire data population. This practice of using sample data is normal, acceptable and cost effective. Statistical models verify the level of confidence that can be given to the output of such figures. The numbers at this point don’t lie.
Where the opportunity for disparity enters is in the formula for the calculations. Over time the formulas have been changed to include different data or to give greater importance to certain data. One would hope that such changes to a formula would give more reliable and accurate output. However, the effect of these changes seems to be less for integrity purposes and more for political purposes.
GDP numbers are revised for months after their initial release as additional data becomes available. One would expect revisions to be balanced between upward and downward adjustments, but there is an oddly consistent downward bias of GDP revisions after the initial release. This suggests a motive to give higher GDP numbers when they are first released and get a lot of press.
The inflation and the unemployment figures have similar quirks in their calculations that seem to give sway to adjustments. In fact, Shadow Government Statistics at ShadowStats.com tracks changes to CPI calculations and shows over 10% inflation when using the 1980 formula versus 2.7% using the current government formula. More than just a little difference, huh?
We are at a critical juncture with the direction of our nation. Very important decisions are made relying on numbers that should not lie.
Right now, the respective reporting agencies are providing a black and white number for GDP, CPI and unemployment; however, if they were required to report a color-coded figure that was either red or blue to indicate the political sway of the underlying formula, just think how much easier it would be to determine what those numbers really mean.
Tip O' The Day
Remove crayon masterpieces from your TV or computer screen with WD40.
How’s the Market Doing
The market is looking shaky as of the close on Friday, April 20th, but after updating my 150 indicator list, it appears that the correction is well along, without any serious price damage to the stock market. That is a good sign.
Our proprietary Safety Net Indicator which is a complex calculation based upon a volatility related index has been flirting with a sell signal for the past 2 weeks, but has refused to kiss it on the lips. I guess I’d call this an avoid signal, rather than a sell signal.
The bond market seems to be under control once again. I use that term, because the Federal Reserve has been trying to manipulate the interest rate markets, and lost control in mid-March, causing a brief spike in interest rates. Rates are once again drifting down, but they are not yet back to levels seen in January. Does this mean that the January low was the ultimate bottom for interest rates and we have officially entered the era of rising rates that could last 30 years, if history repeats itself? Could be. Stay tuned because it will be a big deal for investors when this trend shifts.
Municipal bonds seem to be the strongest segment of the bond markets, contrary to what all the experts were predicting. Many municipalities have proved to be more financially resilient than the analysts expected, plus, bond holders are pretty high on the pecking order for getting repaid. Despite a few headlines made by municipal bankruptcies in Harrisburg, PA and Birmingham, AL, the rate of overall muni defaults remains low.
Gold continues to slide. I have expected it to find a bottom and resume its uptrend by now, but bottoms are usually marked by a sharp selloff and the gold decline remains orderly. Is this a sign of underlying strength in the gold market, or is there another shoe to drop? I don’t know for sure, so I will wait until the pattern of lower highs and lower lows is broken before even considering buying gold, and that is nowhere in sight at the moment.
Despite what you hear in radio ads, gold has been declining for most of the past 8 months. I’ll be speaking next week with Newsletter writer Ian McAvity, one of the foremost gold experts in the entire world, and I will report more on the outlook for gold in my next newsletter.
What's Going On In Your Portfolio?
Both our Flexible Income* and Shock Absorber Growth* portfolios have been affected slightly by the recent corrections in both the stock and bond markets over the past month or so.
We have adjusted the Shock Absorber* hedge up and back down over the past few weeks, and it is now at a “moderate” 27% of the portfolio. The rest of the growth side is in funds holding stocks of consumer products, retail, real estate and health care companies.
Flexible Income* now holds about 1/3 in municipal funds, along with high yield and floating rate bond funds. Our high yield funds slumped between 1-2% briefly touching stop loss levels, but have rebounded a bit, so we are being patient with them.
Our Spotlight Strategy
The market strength earlier this year has pushed the Growth side of our Adaptive Balance portfolios* to 50% of the portfolio, with the other 50% allocated to Flexible Income*. At the beginning of the year it was down to about 20% growth and 80% income, so the current allocation recognizes the strength of the market in the first quarter of the year.
*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.
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.