November 3, 2009

The market is in the midst of its harshest decline in 7 months.  I have said all year that the amount of money being pumped into the economy by our government is unprecedented, and its effect has changed us from expecting bear market (negative) outcomes to expecting more positive outcomes as we see in bull markets.  

We are also entering the strongest period in the markets, historically.  Colder months generally bring stronger average returns for the markets.But just like the fellow who drowns in a lake that averages 3 feet deep, counting on averages when investing can be a dangerous thing.

Although the stock market ought to be going up now, it is not.  And I deal with the reality of what is actually happening, not what is expected to happen.  As John Maynard Keynes once said, “the markets can remain irrational longer than you can stay solvent.”

And this market needs to be treated with great respect.  Our economic foundations are still very weak despite trillions of dollars of government stimulus money at work.  

Steve Hochberg, who writes the Elliott Wave Financial Forecast, said in last Friday’s newsletter, “The decline that started October 19th should capture all awards in the bear market record book.”  Gulp.  That is a strong statement.  Did you notice the absense of weasel words so prevalent in these kinds of prognostications?  I did.

Some of my work points to a major market low a year from now.  Does that mean that we could be entering a year long slide that does not end until a year from now? I really don’t know.

By some measures, the past 2 weeks have seen more selling pressure in the stock market than at any of the market lows of this past year –  despite the S&P 500 Index** only being down 5.62% from its October 19th highs.

I expect us to get a bounce after all this selling has run its course.  The nature of the bounce and subsequent zigs and zags will tell me whether this has just been a temporary “correction” in a continuing up-trend or the beginning of a more serious decline.  Right now, I just do not have enough data to know for sure.

I try to ignore the corrections and focus on the major trends, but every major trend change begins with what appears at first to be just a correction within the previous trend.  Please know that I am watching this unfolding situation very carefully.

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Spam browned over an open fire on a stick like a marshmallow has the fat melted right out of it and tastes more like bacon than the fried spam of our youth.  It’s a veritable delicacy!

I discovered this treat when I lived in Alaska in the 1970’s and 1980’s and we would take whitewater rafting trips for 4-5 days at a time.  Spam doesn’t need refrigeration so it was our plan-B when the fish weren’t biting.

We have begun to turn spam into an off-beat happening with our 4th annual Spamarama, a spam cookout in our back yard at 7:51 a.m. on a crisp autumn morning. Of course, to keep our arteries in balance, we also have yogurt, fruit, pastries and eggs,  along with coffee and Bailey’s, but spam is the main attraction.

This year someone brought the Spamalot song from Monty Python, and I think it may become the theme song of Spamarama in future years.

One nice thing about Spamarama is that it is over by 10:00 a.m. so I can get to other fun things like writing this newsletter.

By the time you get this newsletter I will be in Chicago for a couple of days of meetings with other money managers at a National Association of Active Investment Managers conference.  For several years I have been speaking at these conferences or presiding over them as President of NAAIM.  This is the first year that I have not had to work at this conference and it will be nice to sit back and just learn.

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We have set a Hepburn Capital record for the number of referrals received in a year.  Referrals are the highest compliment you could pay me.  Thank you.  I am grateful for the confidence you show in me by mentioning my work to your friends.

The easiest way to start a referral is to forward this newsletter or send someone to our website.  Both vehicles are designed to let someone get to know me and Hepburn Capital and how we do business without the pressure of a face to face meeting.

Thanks again for your referrals.  Please keep them coming.

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“Technical trading (like we do at Hepburn Capital) is not glamorous. It will rarely tell you that you bought at the lows or sold at the highs.  But trading should be a business and a systematic program is a plan to profit over time rather than from a single trade, in a single week, single month or single year.  High expectations are essential to success, but unrealistic ones just waste time.  Computers do not tell users how to make profits in the market, they can only verify our own ideas.” Cognitrend GmbH, Frankfort

Some people like to call high yield bonds “junk” bonds, but despite the name they can be great investments. 2009 may end up being a record high earnings year for junk, and we have participated with junk holdings in both our Flexible Income* and Careful Growth* models.

Regardless of our success with junk bonds this year, they are not a slam-dunk investment.  In fact, I would never recommend buying them outside of a managed account.  Even though we are having great success with junk this year some of these funds lost 50% of their value last year. An investor without a plan to deal with the ups and downs of junk bonds can have a painful experience.

When it comes to high yield bond investing, “Kids, don’t try this at home”.

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Q:  No sooner spoken than broken. What is it?

A:  A silence.      And if you said “a secret”, you are also right.

The IRS has issued IRS Notice 2009-82 which states that customers who have taken a required minimum distribution (RMD) in 2009, but who would like to take advantage of the suspension of RMD rules in 2009, may roll back those distributions into their retirement account until the later of these two deadlines:

• -By November 30, 2009 or ”
• -The end of the customers’ normal 60-day rollover period for taking distributions and depositing the assets into another retirement account.

Note:
-The rule that allows for only one IRA rollover per calendar year still applies.
-RMDs taken by non-spouse beneficiaries are not rollover eligible.

IRS Notice 2009-82 is posted to the IRS Web site.

If you have taken an RMD in 2009 and wish to roll it back into your IRA, please contact the office immediately at (928) 778-4000 as there is a November 30th deadline.

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The selling in the stock market, mentioned earlier in this newsletter, has reached the point where it may have significance. Therefore, in the past few days our Careful Growth* portfolios have gone from fully invested to being hedged to the equivalent of having only 30% exposure to the stock market.  

The hedges we use are risk control measures using inverse index mutual funds or exchange traded funds that are designed to go up as the market goes down.  Beside the hedges, we still hold investments in Latin America, international mid size value, gold mining stocks and high yield bonds.  The hedges allow us to control the risk of continuing to hold our strongest performers while the market sorts itself out.

Our Flexible Income* model ended the month with a gain that seemed puny compared to some of the previous months, but it was a gain.  And, any gain is a good gain.

The past two newsletters have featured the new reporting format for our Flexible Income* and Careful Growth* strategies.  This week you can see how our Balanced* strategy looks.  Balanced* is a 50/50 mix of Flexible Income* and Careful Growth*.  Some firms call this blend of strategies a “growth and income” style, but whatever you choose to call it, Balanced* is the strategy that more HCM clients use than any other.

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*    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