Patience, Grasshopper

The stock markets around the world have returned to their lows of November, and my optimism at the first of the year that a market recovery was beginning now seems misplaced. These kinds of markets have misled brighter minds than mine, but that is little solace as I again have shifted from growth mode to defensive investing.

The longer-term view shows that the stock market is right back to the November lows, which is the same level as the 2002 bear market lows, so the market is at a very critical point. Many people who have held stocks or stock funds all the way through the declines from 2002 or 2008 peaks have felt this pain (a 50% loss) before. What is unknown is how much more pain they are willing to endure if prices slide further. If prices fall significantly below current levels, the disappointment among investors could lead to another selling stampede, perhaps even another crash like we saw in October.

This is not your garden variety risk, so here is what I have done to reduce our market risk.

As the decline in January gathered steam our growth accounts* were initially in sync with the decline. As it became clear that the rally of late December and early January was failing I shifted gears and began to play defense. My style of investment management is not perfect, but when I realize I am on the wrong side of the market I don’t just wring my hands and hope for things to turn around (hope is a four letter word, you know), I do something. I make changes in portfolios that adapt to the changes in the markets.

As the downward trend became more evident I began paring back our exposure to the stock market. In the past few weeks, even as the stock market has continued its decline, our Careful Growth model* losses have been kept to half of the general stock market, yet we are still poised to be invested when the inevitable recovery occurs.

I have added gold mining and energy stocks to our growth portfolios*, both should benefit if inflation picks up as the government begins to print money to pay for its stimulus packages. Neither of these segments follow the S&P 500 Index** very closely, which is good at times like this.

I also have a portion of our growth model* invested in the interest rate markets with some high yield bonds and a fund that goes up as interest rates go up. If you think about it, interest rates are so low they really can’t go down much more, but they can go up a lot. I believe it is just a matter of time before rates will rise, and we are ready for that possibility.

The sharp contraction in the global economy, the instability of the global financial system and the ongoing credit problems are unlikely to be resolved in the first half of 2009. However, the massive US stimulus package is expected to cushion the decline.

Certainly there is a lot of waste in this hastily drawn up plan, but some of the stimulus money will have great effect. Just as the Army lays down a field of fire in battle, spraying an area with bullets, they don’t need every bullet to hit a target to get the job done. Just a few will do. The stimulus package is the same way. If just a part of the spending is effective, much good may come of it.

It is important for us to keep an investment posture that will profit as that stimulus package begins getting traction because the dollar amounts involved indicate that its effect should be huge. The markets will begin to recover when the economic outlook still remains bleak. Human nature dictates that many investors want to sell due to all of the fear and negative news in the media, but now is the time investors should be patient.

As the Shaolin Master would say to Kwai Chang Caine in the old Kung Fu TV series of the 1970s, “Patience, Grasshopper”.

Is Gold Making a Move?

Like everything else last year, gold lost a bunch of its value, dropping 25% from its high of over $1,000 per ounce in March 2008. There are a lot of textbook reasons why gold should not be going up right now, but in fact it has reestablished an uptrend over the past month or two. One of the most expensive mistakes investors make is to argue with facts. Gold is going up, so we have to accept it and not fight the facts. I’ll leave it to history to eventually tell me why it is all happing.

But investing in gold is not as easy as stocks and bonds. There are 3 main ways to invest in gold and each brings a different set of problems.

Purists say own the real thing: the hard, shiny, yellow metal. The problems with that approach are, (1) Where do you buy it? (2) How do you take delivery of it? (3) Where do you keep it so that it is safe? Safe deposit boxes work as long as banks stay open. Secret hiding places work as long as they stay secret, and you don’t die taking the secret with you. Physical gold is a problem. If you buy “the hard stuff” I recommend US gold “Eagle” coins. Skip bullion as it is very difficult to determine exactly what you have without an assay test.

Gold mining stocks benefit from the leverage created by profits that can soar as gold prices rise above mining costs that don’t change much as gold prices climb. But this way of investing involves owning stocks which adds another layer of risk beyond the price of gold.

In 2004 for the first time, investors could buy exchange traded funds that invested directly in the hard stuff. For each dollar you invest, there will be $1 of gold with your name on it in a vault somewhere making it a very easy way to own physical gold. Except you don’t own the gold, you really have an IOU for the gold. So this gets back to the issue of who do you trust with your gold. Exactly whose vault is your gold in, anyway? As this recent article in Seeking Alpha magazine points out, that could possibly be another cause of concern. http://seekingalpha.com/article/121456-is-the-gld-etf-rea

So even for something that seems as simple as gold, the investment answers are not easy. As I mention in my Yavapai College classes, you need to know what is most important to you and have that be your guide.

IRA Planning

Roth IRAs have a significant advantage over Traditional IRAs in that money coming out of a Roth is tax free, not taxable at the highest rates like a Traditional IRA. If you think your tax bracket may be higher in future years, Roths can make a lot of sense.

Traditional IRA owners can convert their IRA to a Roth IRA, but only if their income is $100,000 or less (I am somewhat over simplifying here, and there are other tax ramifications, so talk to your tax adviser for details). This income limitation is a major obstacle for high income investors – those who could use the Roth’s tax free status the most.

However, in 2010, for one year, this limitation disappears from the tax law. New legislation will be needed to extend this benefit beyond 2010, so this means we will have a one year window for high-income Traditional IRA owners to act.

This will be an excellent time to consolidate all those multiple IRA and other retirement accounts that can clutter up your desk. I can do that for you. You can make life simple and explore some great tax benefits at the same time. The time to begin planning this strategy is now so you will be in a position to convert to a Roth next year if you decide to. Call me at 778-4000 for details if you are interested in a Roth conversion or just a consolidation of retirement plan account.

The Great Lesson of 2008

Whenever a client thanks me for steering their investments through the problems of the past 18 months I respond with “Thank you. Please tell your friends”.

Right now, many investors are suffering, and don’t quite know what do since most all of the traditional approaches to diversification and investment management have failed miserably. Now is when those folks need to hear about my work.

The great lesson of 2008 is that ordinary methods of diversification – just owning different kinds of stocks and bonds, etc. – are ineffective in the markets of 21st Century. Diversifying among strategies takes the concept of diversification one level deeper, and this is what most investors, and sadly many advisers, have overlooked in their planning.

Strategies designed to protect principal values in times of crisis are not perfect. Some loss must happen before I know it is time to act, so we do have losses. They are small ones, and sometimes several in a row. But if diversification brings safety to a portfolio, an added level of diversification – among strategies – brings even more safety.

This is what I provide for my clients. An added level of diversification, through the different strategies I employ.

If you have friends who are suffering painful investment losses, please suggest that they call me for a free consultation to see whether diversification into some different strategies might help them. The number is 778-4000.

At a minimum, suggest they sign up for this newsletter to get an idea of what I am describing. After all, they are your friends.

* 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.