October 29, 2013
The Low Down on the Shut Down
The Investment View from Prescott, Arizona
Being an advocate of “less is better than more” when it comes to government, I smiled inwardly as the nation largely ignored the federal government shutdown that dominated the news the first half of
October.
The fact that the feds keep over 1 million “non-essential” employees on the payroll is an indication of just how much fat there is in the federal budget.
But the government shutdown may provide even more tangible benefits for investors, primarily because the federal government is such a large portion of the economy. The shutdown has economists madly crunching numbers to determine just how much productivity was lost when the feds stopped spending for a few weeks.
Word on the street is that economic numbers for the 4th quarter will be barely positive due to lost productivity. This means that the Federal Reserve withdrawing cash that was earlier used to stimulate the economy, as was suggested, will likely be postponed to avoid sending a weak economy into an outright recession, a good thing for investors.
That a poor economy translates to good times for investors sure seems backwards, but that is what makes this business so interesting. Many times things appear backwards from the way they affect investments.
The stock market saw this coming and yawned off the shutdown, proceeding higher as soon as a deal was announced. The chart I posted in my October 8th newsletter showing that the stock market usually does well in the wake of government shutdowns is looking to be accurate again this time.
Bond buyers, scared off from the bond market during most of the summer, came back into the market bidding bond prices up and interest rates down as the threat of the Federal Reserve slowing down its Quantitative Easing program by cutting back bond purchases faded.
I noted that my friend Eric Leake, Chief Investment Officer of Anchor Capital, thinks interest rates could drift back down to near the levels last seen in May as rates were beginning to spike higher.
Declining interest rates paint a rosy picture for bond buyers. However, I have not seen any market watchers identify a reason that interest rates may go below the May levels, and that means that the long term trend of rising interest rates I have mentioned in several newsletters this year is likely to remain intact.
Interest rate markets zig and zag like any other market as they move in the direction of their primary trend. Picture a set of stair steps going down. The fact is that the ultimate low in interest rates was in the summer of 2012, and until the low rates of May 2013 are exceeded by even lower rates, the zigs and zags are rising – the basic definition of an uptrend.
Rising interest rates affect our lives much more directly than stock prices, and not in a good way. Interest paid by businesses cuts into profits and gets passed along to consumers in the form of higher prices.
So although interest rates have drifted down, and may even drift a little lower over the next weeks or months, I would not suggest you become a long term buyer of bonds, because over the long term bonds will continue to face a pretty serious headwind as resale values drop faster than interest can offset the loss.
How’s The Market Doing?
The concerns that were signaling caution in the stock market over the past few months have quietly been overcome.
Both the stock market and the bond markets are performing well right now, and there are some encouraging signs that the long term trend in the stock market is also turning favorable.
My friend Tom McClellan, publisher of the McClellan Oscillator market indicator, does fascinating work tracking “ripples in the liquidity pool,” meaning linking changes in money supplies to subsequent changes in various markets. Usually these downstream changes take months or even years to manifest themselves, but anything that gives us a peek into the future is incredibly valuable in this business.
One of Tom’s more intriguing finds is a relationship between crude oil prices and the Down Jones Industrial Average, where the Dow closely mirrors the major trends of oil prices, but 10 years later. No one knows why this delay occurs, not even Tom, but the pattern goes back over 110 years, so the body of evidence is rather convincing.
There was a huge run up in oil prices that ended with oil being $145 a barrel in the summer of 2008. It started in the $30 range in 2003, so the price rise to $145 was significant.
What this suggests today is that stock prices will be significantly higher in 2018 than they are today if they again follow the pattern set by oil, 10 years earlier. Can I tell you how high? No.
Tom’s comparison does not generate a price target, but the suggestion is that we well have generally rising stock prices over the next 4-5 years. Good news for investors, for sure.
However, before you get too bullish on stocks, it appears that inflation may be getting ready to take off over the next two years. The federal government just rejiggered the CPI calculation to reduce the housing component from 41% to 31%, probably because housing prices have begun to rise and the feds don’t want them to affect the official inflation numbers. But a 31% housing allocation is still a big part of the CPI total, so there will be a significant effect.
Also, global cooling over the past few years will begin to push food prices up as harvests are smaller, and that will add to inflation, also.
This also does not mean that we shouldn’t worry about market corrections along the way, and in fact the market has come a long way in the past couple of weeks and we may be due for a short term dip to keep investor’s feet on the ground. But it is a well-founded suggestion that stocks will do well over the next few years.
The gold market has risen for the last week or so after its last drubbing that began in August. One pundit suggested a new run is happening for gold, but I don’t see it yet. Gold has significant overhead resistance in the form of a declining trend line connecting the February and August peaks that it must break through before a genuine uptrend can get underway, and as of this writing on October 25th it has not yet done that. This is a time for gold buyers to be patient.
Model Portfolios
When I use the term “model portfolio” or “strategy” it describes a hypothetical $250,000 account, currently our minimum size for new accounts. We often accept smaller accounts as an accommodation for existing clients, referrals and friends, but larger accounts are most efficient for us to manage.
Despite trading at the same time in investments with similar objectives, smaller accounts occasionally end up with different results than larger accounts.
The reason for this is that some trades involve fixed transaction charges, such as the $15.50 the custodian charges to execute a stock or ETF transaction. Large accounts have larger trade sizes and can absorb these fixed costs without greatly affecting performance. The profitability of a smaller trade can be more greatly impacted by transaction costs, so as a policy matter we try to have fewer of them in smaller accounts, focusing instead on no-transaction fee mutual funds.
This may lead to different holdings in different sized accounts, and can create different performance results, too. For example, there were six times in 2011 that we had different holdings in Flexible Income accounts of various sizes. Usually, the performance difference is minimal, but not always.
One exception occurred in early 2011 when we bought gold and silver bullion ETFs in the Flexible Income model. To minimize transaction charges in smaller accounts we only bought gold in them while we bought both gold and silver in larger accounts.
As it turned out, silver was by far, our best trade for the year, adding almost 5% onto the return of larger accounts. Unfortunately, there was no way to know that ahead of time, so smaller accounts did not participate in this particular gain.
So when I mention model returns, it is possible that your returns will be different, sometimes significantly so. I’d be happy to sit down with you in person and show you how this works anytime you have questions.
What’s Going On In Your Portfolio?
Both our Flexible Income and Growth models are having strong months in October.
Growth has been fully invested most of the month in strong growth stocks and has performed in line with the stock market despite taking less risk. We currently have holdings in energy, health care, international, retail, banking and leisure stocks and even a 3D printing company along with a diversified growth fund.
The Flexible Income model has not seen any changes for more than a month when we bought some high yield funds. In addition to high yields we hold floating rate bond funds and two diversified bond funds.
Our Municipal Income model is also fully invested in high yield municipal funds.
I’m pleased to say that all of our holdings are doing well as of this writing on October 27th.
A Housekeeping Item
Ira Fee Notices in the Mail
This is that time of year when IRA custodians charge account fees for the extra accounting associated with IRA accounts, including Roths, SEPs and Simples.
There can be confusion because the fee notifications often look like bills, which they are. For accounts managed by HCM we have already arranged for the IRA fees to be billed directly to your accounts, so there is nothing for you to do. You do not need to send in a check unless you essentially want to add another $50 to your IRA.
Scottsdale Office
Please call the office (928 778-4000) to schedule an appointment with Will in our Scottsdale office.
Our Spotlight Strategy
With our Flexible Income strategy, we strive to provide high total return consistent with Capital Preservation.
Your money will be invested in bond or currency funds, including precious metals that may be used as currencies and equity-income investments whose price trend is up. If the price cycles down, holdings are replaced with new investments that are going up. Repeat as needed. Growth stocks are not used.
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Don’t Stand in the Post Office Line
Hepburn Capital has a commercial account with UPS, so if you want to avoid standing in Post Office lines to mail Christmas packages, we can help.
Bring your shipping-wrapped packages to the office and we can weigh them, calculate your shipping cost, print the UPS label and have UPS pick up your packages at the office.
Thursdays are the best day for us to help you with your shipping, as we normally have extra staff in the office on Thursdays.
Think of this service as your Christmas present from Hepburn Capital.
