August 30, 2011

Still Fighting the Last War

The Investment View from Prescott, Arizona

Other than printing a few trillion new dollars, the government has not really done much to fix the economic problems that got us into this pickle, and this is the main reason our economy is still in the doldrums.

There is a concept in economics called the velocity of money – how quickly a dollar spent in one place gets re-spent and ripples through to other places in the economy.  I used to hear that a dollar that went into real estate was spent again seven times within a year as Realtors, construction workers, bankers, travel agents, etc. all spent the pay checks they earned.

Right now we have a very low velocity of money. It just is not circulating and that is what is holding our economy back.  Real estate got us into this mess, and I believe real estate will lead us out of it, too.

Currently 25% of homes have been or are currently in foreclosure and the government controlled loan process now precludes those folks from borrowing again for 2-5 years. 

There are another 25% of homeowners who owe more than their house is worth and are stuck.  They can’t move, can’t sell their house, can’t borrow to run businesses, and all their cash is getting sucked into the black hole of debt repayment.

Both of these groups comprise a huge number of people who are locked out of the circulation of money element of our economy.

We have a government lending agency, Fannie Mae, whose leaders looked the other way a few years ago while it was being fleeced (and profited handsomely while doing so, too).  They, along with other government mortgage arms, Freddie Mac, VA and FHA still appear to be clueless about how to handle this crisis.

They are giving us a double whammy by first trying but failing to prop up the real estate market by withholding the huge un-sold housing inventory from the market, and second, restricting new loans by demanding onerous loan provisions.

Years after the problem began, prices are still trending down as the market seeks its natural level.  The prospect of further declines keeps even more people out of the market – real estate investors, mortgage money investors and prospective home buyers.

The government needs to understand that most of the risk is behind us, and back away from the mortgage market and let private enterprise take the lead.  Banks are awash in money but often can’t lend it because of governmental regulations.  Let banks lend without ridiculous restrictions and the bureaucratic processes borrowers now face.  Lenders are paid to take the risk of the loan, let them do it!  Trying to eliminate all risk doesn’t really work and just bogs the system down.

If the government would have moved in this direction in 2009, we would now have lower, but rising home prices, the velocity of money would be increasing and lots of new jobs would have been created.  We would be getting back to normal.

Instead, they are like the proverbial generals who take great losses thinking that every war should be fought like the last war.

We need to get the huge numbers of foreclosed homeowners back in the market and let the millions of underwater homeowners get on with their lives so that we can get the money circulating back into the economy instead of being hoarded by the bailed-out banks.

The government thinks that by pulling the band-aid off slowly, the pain will be less.  We need to get the pain over quickly and let the markets begin to work again.

Clean Out Your Closet!

Sheri Congdon, the wonderful voice of Hepburn Capital, has a developmentally disabled son who has lived for many years in a group environment at Salem Christian Homes in California.  Salem, like most social services outlets, is experiencing large budget cuts due to government cutbacks in spending and many of you have helped in the past with donations to Salem.  Thank you again for that.

Salem is partners with two other agencies in a thrift shop in Chino, CA, and they realize that they could be selling a lot more in the shop if they only had the inventory. 

So this is your opportunity to clean out your garage and closets and drop off gently used items here at the office on Wednesday and Thursday, August 31st and September 1st  so Sheri and her sister Susan can load them up and take them to California on Friday.

We will be staying open until 5:00 each day, so please take the time to help this week by donating items for the “3-Way Thrift Store”, and pick up a receipt for your tax deductible donation.  Thank You!

What We Were Saying Back Then.

In a special notice to my clients and friends on August 5, 2011, the evening of the announcement about the downgrade of the US credit rating by Standard & Poor’s, I cited occasions where the markets did not act as one would expect after downgrades like ours.

Since the downgrade affected US bonds and the institutions that hold them, you would have expected bonds to be sold off, driving the bond market down and interest rates up. 

Since the dollars changing hands every day in bonds is nine times greater than in stocks, changes in the bond markets affect us all much more than stock market moves.

But the bond market rallied on the downgrade news as investors sold stocks and fled to the perceived safety of – you guessed it – those lowly rated US Treasury bonds.   I guess now we know what investors, who voted with their dollars, think of Standard & Poor’s opinion.

This is such a crazy business.

Mental Floss

Count every ‘F ‘ in the following text:

FINISHED FILES ARE THE RE
SULT OF YEARS OF SCIENTI
FIC STUDY COMBINED WITH
THE EXPERIENCE OF YEARS…

How Many?

There are 6 — no joke.
Anyone who counts all 6 ‘F’s’ on the first go is a genius.
Three is normal, four is quite rare.

How’s the Stock Market Doing?

Bear Market or Not?

When the stock market drops 20% or more it is called a bear market.  However, as with so many other things in this business, it is not as simple as it appears because there is more than one “market” for stocks.  There are markets for US stocks and for foreign stocks, for large company stocks and small company stocks.  These are often summarized in various stock indexes that focus on specific markets.

While some indexes were only down 15-17% over the past few months, some were down 24%, and when we look at all the major indexes around the world combined, the average decline was 20.75%. For this reason, I am treating the current market as a world-wide Bear Market and investing accordingly. 

(As a side note:  If you have friends who invest the same in this bear market environment as they do in normal times, do them a favor and suggest they talk to me before the next leg down in this market arrives.)

Bear Markets often do most of their damage in 6-9 months, but the 2007-2009 Bear took 18 months to find its bottom.  We are only four months into this new Bear Market, so investors who do not take action to defend their portfolios in the face of the Bear are taking an extraordinary risk.

How’s The Gold Market Doing?

Gold broke down last week after a torrid run, taking its largest drop of the year in only two days of trading. This abrupt kind of price action often marks some type of turning point for an investment. 

Gold may be in a long term uptrend, but this sudden volatility indicates very high risk for gold investors right now.  From the way the charts look, gold could drop all the way to $1,500 from its current $1,780 (as of the close on August 26th) and still be considered in a long term uptrend. 

Gold is due for a normal cyclical decline, and was also way overdue for a correction in its uptrend.  We need an occasional zag to compliment its zigs – remember nothing goes in only one direction for long.  So it is possible that we could see a surprisingly large dip in gold prices before the upward trend continues.

And, of course gold could just continue on up without any more of a break.  This is such an interesting business.

The bottom line is that we should not depend upon gold to be a safe haven during the remainder of the current bear market decline.  If things in the stock market get tougher this Fall, as some of my work suggests, gold could start being sold to offset other losses.

Both the bear markets of 2001-02 and 2008 saw gold experience large declines.  The strength of gold this past month as the stock markets collapsed was the exception – not normal at all.

What’s Going On In Your Portfolio?

With all the wild rides in the markets during August, both our Careful Growth* and Flexible Income* accounts were showing gains for the month about half the time.  Even when we dipped into negative territory, our losses were generally kept in the 1-2% range.  Compared to double digit losses on most indexes so far for August, I feel pretty good about that.

I finally cut our gold holdings from 25% to 10% last week as gold’s strong uptrend faltered.  I wanted less exposure to a possible gold downturn which may be in the early stages, but I wanted to hold enough to participate in gains if the price rise continues.

In our Careful Growth* accounts you will see a paired trade combining a Japanese Index fund and an inverse US index fund, one that goes up as our stock market goes down.  When it works, this type of pairing cancels out most of the stock market volatility and captures the better performance of the Japanese index, with very low risk.  Considering the high risk market environment we are in, this ought to be a good risk management tool.

All models hold 30-40% in cash as of this writing on August 28, 2011.

Am I Meeting Your Expectations?

My style is to not call my clients and bug them.  That stereotype is born of commissioned salesmen who must speak to you to sell you on the newest, latest, better-than-the-last-one investment so that they can earn another commission.

I just quietly take care of your accounts so you can go about your life and don’t have to worry about where your money is or isn’t.

This newsletter works well as my primary means of communication with you.  You can frequently see what I think about the market and what I am doing in accounts to manage the current conditions.

But this medium does not tell me what you are thinking, feeling and experiencing in your lives. 

If you have changes in your life circumstances or your tolerance for risk, or if something is just bothering you, please let me know so that I can make sure that I am using the appropriate investments for your situation.

Our Spotlight Strategy

The Municipal Bond Strategy moves from high yield to high quality municipal bond mutual funds and ETFs to produce greater income than buy and hold, with lower risk as measured by fluctuation in principal values.   HCM’s Adaptive Market Strategies® direct investments into parts of the municipal markets showing the greatest strength.  If the price weakens, they are replaced with new investments that are going up or hedged until the market stabilizes.

*    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.

Balanced Strategy Description and Performance Information
Careful Growth Strategy Description and Performance Information
Flexible Income Strategy Description and Performance Information

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.