I
am back earlier than I thought (comments this week will still be abbreviated) because
much has changed with the S&P (1402) over the past week.It has (1) broken the newly re-set short term
uptrend, (2) broken below its 50 day moving average again [wiggly red line] and
(3) appears to have rejected the break above the former upper boundary of a
short term trading range [1424].
A
word about the latter---our technical discipline’s guidelines for the
confirmation of a break of a short term trend is three days.Clearly that is our guideline and it does not
always work out that way.The current
situation has all the appearances of such a case, i.e. it takes the Market
longer to reject a breakout than normal; however, I am going to give it another
day or so but making that call.
If
in fact, the break to the upside has been rejected, then the former short term
trading range is now operative (1343-1424) with interim support at 1395.The lower boundary of S&P’s intermediate
term uptrend now intersects at 1378.
Fundamental
As
I am sure that you are aware, the reason for the current sell off is the
inability of our elected representatives to come up with a compromise on the
fiscal cliff.This is not a
surprise.I have argued several times
that the major imperative for a compromise would likely turn out to be a
dramatic decline in stock prices.That
said, Friday’s close put the S&P right at its Year End Fair Value---which
hardly qualifies the current sell off as ‘a dramatic decline in stock
prices’.Hence, if this thesis proves
correct, we are in for more downside.
The
good news is our Portfolios have plenty of cash.
The
bad news is that in the midst of a contentious debate on how much to raise our
taxes and not on the real fiscal issue (too much spending), Obama has just approved
a pay raise for all government employees.Take a good look at our future, ladies---a power elite that votes itself
pay increases which it insists must be paid for by raising our taxes instead of
imposing the slightest discipline on itself to manage this country’s budget
responsibly.
Thoughts on Investing—from Adam
Butler and Mike Philbrick
Investment marketing is like
watching a talented magician ply his trade. While the marketing geniuses keep
everyone focused on the hottest new funds and stocks in an effort to chase
strong returns, people forget about the single most important thing that
matters to your retirement portfolio: volatility.
So let's be crystal clear:
retirement sustainability is extremely sensitive to portfolio volatility.
Further, volatility is the only portfolio outcome that we can actively control.
Therefore, volatility is the critical variable in the retirement equation, not
returns.
To repeat: Volatility is the
critical variable in the retirement equation, not returns.
Forget Returns; It's About SWR
and RSQ
If you're within 5 years of
retirement, or are already in retirement, it's time to learn some new
vocabulary:
Safe Withdrawal Rate (SWR): the
percent of your retirement portfolio that you can safely withdraw each year for
income, assuming the income is adjusted upward each year to account for
inflation.
Retirement Sustainability
Quotient (RSQ): the probability that your retirement portfolio will sustain you
through death given certain assumptions about lifespan, inflation, returns,
volatility and income withdrawal rate. You should target an RSQ of 85%, which
means you are 85% confident that your plan will sustain you through retirement.
Forget about investment returns!
From now on, the only question a retirement focused investor should ask their
Investment Advisor when discussing their options is: How does this affect my
RSQ and SWR?
Portfolio Volatility Determines
RSQ and SWR
The chart below shows how higher
portfolio volatility results in lower SWRs, holding everything else constant:
1.
All portfolios deliver 7% average returns.
2. Future inflation will be 2.5%.
3. Median remaining lifespan is 20 years
(about right for a 65 year old woman).
4. We want to target an 85% Retirement
Sustainability Quotient (RSQ).
Note how SWR declines as
portfolio volatility rises.
The green bar marks the
volatility of a 50/50 stock/U.S. Treasury balanced portfolio over the
long-term, while the red bar marks the long-term volatility of a diversified
stock index. Note the SWR of the stock/bond portfolio is 6% versus 3.4% for the
stock portfolio, highlighting the steep tax volatility levies on retirement
income.
Steady Eddy and Risky Ricky
This is actually quite intuitive
when you think about it. Imagine a scenario where two retired persons, Steady
Eddy and Risky Ricky by name, draw the same average annual income of $100,000
from their respective retirement portfolios. Both draw an income that is a
percentage of the assets in their retirement portfolio at the end of the prior
year.
Steady Eddy's portfolio is
invested in a balanced strategy with a volatility of 9.5%, while Risky Ricky is
entirely in stocks with a volatility of 16.5%. Both portfolios earn the same
return (as they have done for the past 15, 20 and 25 years, though we will
address this in greater detail below).
Due to the lower volatility of
Steady Eddy's portfolio, his income is less volatile: 95% of the time his
income is between $82,000 and $117,000. In contrast, Risky Ricky's portfolio
swings wildly from year to year, and therefore so does his income: 95% of the
time his income is between $67,000 and $133,000. Of course, both of their
incomes average out to the same $100,000 per year over time.
All other things equal, which
person would you expect to be more conservative in the amount of income they
spend each year? Obviously, if your income were subject to a large amount of
variability each year then you would tend to be more conservative in your
spending; perhaps you would squirrel away some income each year in case next
year's income comes in on the low end of the range.
This relates directly to the
impact of volatility on SWRs in the chart above. Volatility introduces
uncertainty which is amplified by the fact that money is being extracted from
the portfolio each and every year regardless of portfolio growth or losses.
How Much Gain Will Neutralize the
Pain?
Of course, this effect can be
moderated by increasing average portfolio returns, which would then increase
average available income. The question becomes, how much extra return is
required to justify higher levels of portfolio volatility?
The chart below defines this
relationship quantitatively by illustrating the average return that a portfolio
must deliver to neutralize an increase in portfolio volatility. In this case we
hold the following assumptions constant:
1. Withdrawal rate is 5% of portfolio
value, adjusted each year for inflation.
2. Inflation is 2.5%.
3. Retirement Sustainability Quotient
target is 85%.
Again, the green bar represents
the balanced stock/Treasury bond portfolio discussed above, and the red bar
represents an all-stock portfolio. From the chart, you can see that the
balanced portfolio needs to deliver 6.8% returns to achieve an 85% RSQ with a
5% withdrawal rate. The higher volatility stock portfolio, on the other hand,
requires a 9.2% returns to achieve the same outcomes.
In theory, higher returns in your
retirement portfolio should equate to higher sustainable retirement income. In
reality, higher returns at the expense of higher volatility actually reduces
your retirement sustainability.
Focus on What You Can Control
There are many ways of improving
the ratio of returns to volatility in a portfolio, mainly through thoughtful
diversification across asset classes (our particular specialty). However, many
investors are (perhaps rationally) concerned about diversifying into bonds now
that the long-term yield is 3% or less, so let's see what can be done with a
pure stock portfolio to take advantage of the growth potential of stocks while
keeping volatility at an appropriate level to maximize RSQ and SWR. What if, instead
of letting the volatility of the stock portfolio run wild, we set a target
volatility for our portfolio and adjust our exposure to stocks up and down to
keep the portfolio volatility within our comfort zone.
For example, let's set a target
of 10% annualized volatility, so if stock volatility is 20%, our allocation to
stocks = target vol/observed vol = 10% / 20% = 50%, with the balance in cash.
If stock volatility drops to 15%, our allocation would be 10% / 15% = 66.6%
invested, with the balance in cash.
For the purposes of this example,
we will assume that cash earns no interest, because it currently doesn't, and
we want to focus on the effect of managing volatility alone.
More specifically, let's assume
we measure the trailing 20-day volatility of the SPY
ETF (which tracks the performance of the U.S. S&P500 stock market index) at
the end of each month, and adjust our portfolio at the end of any month where
observed volatility is 10% above or below the volatility we measured at the end
of the prior month.
For example, if we measured
volatility last month at 15% annualized, and the volatility this month was
greater than 16.5% or less than 13.5% (10% either way from the prior month),
then we adjust our exposure to the SPY ETF
according to the most recently observed volatility using the technique
described in the last paragraph. If this month's volatility does not exceed the
threshold to rebalance, then we do not trade this month.
By using this simple technique to
control volatility since the SPY ETF started
trading in 1993, we achieve 6.65% annualized returns with a realized average
portfolio volatility of 10.73%. This compares with returns on the buy and hold SPY
ETF of 7.99% with a volatility of 20%. Note that our average exposure to the
market over that period was just 69%, with the balance earning no returns. All
returns include dividends.
The chart below shows the
Sustainable Withdrawal Rate for the two portfolios: the volatility target SPY
and the buy and hold SPY.
Source: Butler|Philbrick|Gordillo
& Associates, 2012. Algorithms by QWeMA Group.
You can see that by specifically
targeting portfolio volatility our sustainable withdrawal rate rises to 4.7%
per year, adjusted for inflation (at 2.5%) versus the Buy and Hold portfolio
which will support a withdrawal rate of 3.65% per year. This despite the fact
that the Buy and Hold portfolio outperforms the volatility-targeted portfolio
by 1.35% per year.
We can't control the returns that
markets will deliver in the future, but we can easily control portfolio
volatility by observing and adapting. Withdrawal rates from retirement
portfolios are highly sensitive to this volatility, and we have demonstrated
that by controlling volatility we can increase our safe withdrawal rates, and
therefore boost retirement income, by almost 30% before tax.
Just imagine what's possible with
a diversified portfolio of asset classes when you volatility-size them. But...
that's for another article.
The Christmas holiday is here and I am once again going to take a
break. I will be back on 1/2/13 but the notes that week will be
abbreviated. Oklahoma plays Texas A&M in the Cotton Bowl the evening of 1/4/13 which will involve incoming friends from
out of town as well as pre and post game festivities. I will be back full time of 1/7/13. In
the meantime, I, as usual, will be keeping abreast of the Market; and if action
is needed in our Portfolios, I will be in touch via Subscriber Alerts. Have a very happy holiday season.
Statistical Summary
Current Economic Forecast
2012
Real
Growth in Gross Domestic Product:
+1.0-
+2.0%
Inflation
(revised): 2.5-3.5 %
Growth
in Corporate Profits: 5-10%
2013
Real
Growth in Gross Domestic Product +1.0-+2.0
Inflation
(revised) 2.5-3.5
Corporate
Profits 0-7%
Current Market Forecast
Dow
Jones Industrial Average
Current
Trend (revised):
Short
Term Trading Range 12460-13302
Intermediate Up Trend
13009-18009
Long Term Trading Range 7148-14180
Very LT Up Trend 4546-15148
2012 Year End Fair Value
11290-11310
2013 Year End Fair Value
11590-11610
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 1426-1476
Intermediate
Term Up Trend 1373-1968
Long
Term Trading Range
766-1575
Very
LT Up Trend 651-2007
2012 Year End Fair Value 1390-1410
2013 Year End Fair Value
1430-1450
Percentage Cash in Our Portfolios
Dividend Growth
Portfolio 33%
High
Yield Portfolio 34%
Aggressive
Growth Portfolio 35%
Economics/Politics
The
economy is a modest positive for Your Money. This week’s economic data was basically mixed:
positives---existing home sales, personal income, durable goods orders, and the
Philly Fed manufacturing and Chicago National Activity indices; negatives---mortgage
and purchase applications, housing starts, jobless claims, consumer sentiment
and the New York Fed manufacturing index; neutral---weekly retail sales, personal
spending, third quarter GDP and the November
leading economic indicators.
These stats are
nicely supportive of our forecast:
‘a below average secular rate of recovery
resulting from too much government spending, too much government debt to
service, too much government regulation, a financial system with an impaired
balance sheet.and a business
community unwilling to hire and invest because the aforementioned along with
the likelihood a rising and potentially corrosive rate of inflation due to
excessive money creation and the historic inability of the Fed to properly time
the reversal of that monetary policy.’
(1) our improving energy picture.
The US is awash in cheap, clean burning natural
gas.... In addition to making home heating more affordable, low cost, abundant
energy serves to draw those manufacturers back to the US who are facing rising foreign
labor costs and relying on energy resources that carry negative political
risks.
(2) an improving Chinese economy.
As you know, I added this factor last week but with the caveat that
there is disagreement among the experts about the extent of the progress. All
things considered, I think that there is sufficient evidence to support the
notion, even though we got no statistical collaboration this week.
(1) a vulnerable banking system.
The Libor price fixing scandal continues to widen with UBS
getting tagged with a $1.5 billion fine.
Once again this didn’t involve a US institution; but it is still illustrative
of several points that I have been making: [a] the continuing lack of financial
controls at major global institutions and [b] the negative consequences of an
easy money, zero interest rate policy spawning the chase for performance by investors
in particular those who are gambling with someone else’s money.
‘My concern here is that: [a] investors ultimately
lose confidence in our financial institutions and refuse to invest in America and
[b] the recent scandals are simply signs that our banks are not as sound and
well managed as we have been led to believe and, hence, are highly vulnerable
to future shocks, particularly a collapse of the EU financial system.’
(2) the ‘fiscal cliff’. This week, the republicans abandoned the talks
on a compromise, tried to pass Boehner’s Plan B, failed and went home for
Christmas. This most likely means no compromise before 1/1/13.
On the other
hand, we already know what Obama wants and He clearly holds all the cards right
now. The Tea Party republicans now appear
to have two choices: (1) play hard ball, refuse to compromise, push the economy
over the cliff and suffer the consequences, i.e. lose control of the House in
2014 or (2) take Ann Coulter’s advice, vote present on the Obama plan and make
sure the electorate knows that He owns this plan.
#2 above is roughly
the alternative built into our Model [some tax increases, few spending cuts, and
nothing to alter the longer term sub par growth rate of the economy]. However, the odds of #1 above occurring have
gone up; and were it to happen, the economic outlook for 2013 would turn
decidedly negative.
A problem related to the ‘fiscal cliff’ is the
potential rise in interest rates and its impact on the fiscal budget. As I have noted previously, the US government’s debt has grown to such a size
that its interest cost is now a major budget line item---and that is with rates
at/near historic lows. Moreover, government
debt continues to increase and the lion’s share of this new debt is being
bought by the Fed.
So the risk here is two fold: [a] to the
Fed---its balance sheet is levered to the point that Lehman Bros. looks like it
was a AAA credit. So if interest rates
go up {and prices go down}, the very thin equity piece of the balance sheet
would disappear. The Fed would then be
technically bankrupt. and [b] to the Treasury---it must pay the interest
charges. Hence, if rates go up, the
interest costs to the government go up; and if they go up a lot, then this
budget line item will explode and make all the more difficult any vow to reduce
government spending as a percent of GDP and/or
manage the fiscal cliff.
(3)rising inflation:
[a] the potential negative impact of central bank money printing. In last week’s Closing Bell, I posed the
question of how soon would the rest of global central bankers follow the Fed’s
attempt to break the intergalactic speed record for money printing. This week, Japan
was the first to join.
‘The risk of a massive global liquidity
infusion is, of course, inflation. The
bulls argue that thus far, all this money has gone into bank reserves [meaning
it has not been spent or lent], that as long as banks are too scared to lend
and businesses to borrow, it will remain unspent and unlent and therefore will
have no inflationary impact. And they
are absolutely correct. But the whole
point of the Fed’s exercise, i.e. QEIII {QEIV}, is to encourage banks to lend and businesses to invest. So on the off chance that the plan works,
inflationary pressures will grow unless the Fed withdraws the aforementioned
reserves before inflation kicks in.
And therein lies the rub. [a] Bernanke has already said {four times}
that when it comes to balancing the twin
mandates of inflation versus employment, he would err on the side of
unemployment {that is, he won’t stop pumping until he is sure unemployment is
headed down}. That can only mean that
the fires of inflation will already be well stoked before the Fed starts
tightening and [b] history clearly shows that the Fed has proven inept at
slowing money growth to dampen inflationary impulses---on every occasion that
it tried.
[b] a blow up in the Middle East. There was not much news out of the Middle
East this week, save that Russia was sending two naval squadrons to the area. However, I don’t think that this lack of news
mitigates the risk that a larger scale conflict {US invades Syria, Israel bombs
Iran} brings impairment to either the production and/or the transportation of
crude oil out of the Middle East long enough to begin hindering US {and global}
economic growth and ultimately pushes the economy into recession and/or adds
fuel to inflationary impulses
(4) finally, the sovereign and bank debt crisis in Europe
remains the biggest risk to our forecast.
This week was generally quiet though there was some improvement in the
economic data suggesting that conditions may have stopped getting worse (‘may’
being the operative word). On the other
hand, the political situation in Italy
is deteriorating with former PM Berlusconi threatening that Italy
may leave the EU if his party regains power in the upcoming elections.
All in all,
this news does little to alter my opinion or assuage my concerns; although the
longer investors are willing to believe that the EU can ‘muddle through’, the
better chance there is that the eurozone economy can improve and allow the
eurocrats to sustain their pipe dream. It
may happen; but if it doesn’t (and I still think that the odds are that it
won’t), I can’t quantify the downside and that’s a problem.
Bottom line: amazing as it is, the US
economy continues to growth though admittedly at a historically below average
rate. Unfortunately, our political class
is doing nothing to correct that problem; and this week’s events only confirm
that the obstacles created by irresponsible fiscal, monetary and regulatory
policies will be with us indefinitely.
Indeed, the odds of running off the fiscal cliff appear to have
risen. In other words, not only are our
politicians not trying to improve the economic environment, they seem
unconcerned that they are getting close to making it worse.
Uncle Ben isn’t
helping matters either. In my opinion sooner
or later, QEIV will almost certainly lead to higher inflation. That said, the fall in the price of gold this
week at the very least raises doubts as to the timing of any surge in price
levels. For the moment, I am sticking
with my forecast that the longer the Fed pumps money into the system and the
more bloated its balance sheet becomes, the harder it will be to get the timing
and magnitude of monetary tightening correct.
However, as I noted in Friday’s Morning Call that assumption is now
under review.
The biggest risk
to our Models is multiple European sovereign/bank insolvencies, though, as I said
above, recent data suggest Europe may be through the
worst of its current slowdown. Coupled
with investors’ current overly faithful confidence that the eurocrats will
somehow hold the EU together, it would seem that our ‘muddle through’ scenario
has a bit of a better chance of succeeding than I have been reckoning of
late. That doesn’t mean that the EU will
‘muddle through’; and if it doesn’t, I still have no clue how to assess the
consequences of a crisis though I believe them to be significant.
This week’s
data:
(1)housing: weekly mortgage and purchase applications fell
sharply; November housing starts declined more than anticipated while existing
home sales came in above forecasts,
(2)consumer: weekly retail sales were mixed; weekly
jobless rose more than expected; November personal income was above estimates
while personal spending was in line; December consumer sentiment came in lower
than anticipated,
(3)industry: November
durable goods orders were strong; the December NY Fed manufacturing index was
very disappointing while both the Philly Fed manufacturing and the Chicago
National Activity indices were above expectations,
(4)macroeconomic: third quarter GDP
was revised upward; however most of the change was due to inventory build; the
November leading economic indicators fell but in line forecasts.
The Market-Disciplined Investing
Technical
Friday, the indices
(DJIA 13190, S&P 1430) had a rough day.
While the Dow closed back below the upper boundary of its short term
trading range (12460-13392), the S&P did not return to a comparable level
(1424) and remained within its newly re-set short term uptrend
(1426-1476). Both continue to trade
within their intermediate term uptrends (13009-18009, 1372-1968).
Thursday’s DJIA break
above the upper boundary of its short term trading range has once again been rejected. So any move back above that boundary will
simply re-start the clock on the time element of our discipline.
The Dow is also now
back out of sync with the S&P which has broken out of its short term
trading range and re-set to an uptrend. This
pin action suggests that stocks are in a battleground zone between the bulls
and bears---which means that our job is to stay patient until the Market works
itself out directionally.
Volume on Friday
soared (but it was option expiration); breadth was down. The VIX was up a little; however, it couldn’t
close above the upper boundary of its short term downtrend which I think a
positive for equities.
GLD was up
fractionally, but remains in a newly re-set short term downtrend. However, it continues to trade above the
lower boundary of its intermediate term trading range.
Bottom
line:
(1)the DJIA is in a short term trading ranges [12460-13302],
while the S&P has re-set to a short term uptrend [1426-1476]. Both remain within their intermediate term
uptrends {12948-17948, 1368-1963},
(1)long term, the Averages are in a very long term [78
years] up trend defined by the 4546-15148, 651-2007 and a shorter but still
long term [13 years] trading range defined by 7148-14198, 766-1575.
Fundamental-A Dividend Growth Investment Strategy
The DJIA (13190)
finished this week about 16.7% above Fair Value (11300) while the S&P (1430)
closed 2.1% overvalued (1400). Incorporated
in that ‘Fair Value’ judgment is some sort of compromise on the fiscal cliff, a
‘muddle through’ scenario in Europe and a lowering of
the long term secular growth rate of the economy.
‘As you
know, our assumption on the fiscal cliff is that (1) there is no ‘grand
bargain’, (2) a compromise will be reached; and if not by year end then by
early 2013 and provisions will be retroactive and (3) the agreement itself will
do nothing to help the economy. That is,
taxes will be raised and spending will be barely cut, if at all. This is exactly the scenario built into our
Models; so nothing will change in terms of equity valuation unless we get a
grand bargain or our political class allows the cliff to happen.’
This week our
political elite took two steps backward on the fiscal cliff---Boehner tried
Plan B and failed. There was nothing
left to do but go home for the Holidays.
As you know, I still think that we will get some half assed excuse for a
compromise. It may come later than many
wished; but probably not so late that more damage is inflicted on the economy.
The immediate Market
question is, will investors retain their Pollyanna attitude toward the cliff
following the demise of Plan B? Friday’s
pin action would appear to at least partially answer that question in the
negative. However, stocks (as defined by
the S&P) are still overvalued (at least as defined by our Valuation
Model). So I don’t think that Friday’s decline
necessarily presages investors giving up hope and panicking. That is not to say that they won’t; just that
they haven’t yet.
I am still of
the opinion that there is a reasonable argument to be made that until investors
do panic and thump the Market, the politicians will continue to dick around and
avoid having to make any firm decisions on taxes and spending.
Gold’s
performance this week has given me reason to question the inflation assumptions
in our Economic Model and the size of the GLD holding in our Portfolios. Indeed, as you know, having Sold all of our
trading position as couple of weeks ago, our Portfolios Sold one half of their
investment position Thursday. That
doesn’t mean that I am changing our outlook.
It does mean that I am reviewing it and in the meantime want to preserve
our profit in this holding.
Europe continues to
‘muddle through’ helped by some slightly better economic data as well as an
investor class that seems to have unbridled faith in their political leaders’
ability to solve the continent’s sovereign/bank debt problem. I don’t believe that the economic risk of
recession or the financial risk of serial derivative defaults by EU banks have
diminished. But as long as the Markets
give the eurocrats a free ride, the danger of some imminent crisis is held at
bay and time is bought for the eurocrats to do something meaningful.
The bad news
is that I still don’t know how to quantify not ‘muddling through’. I do believe that the consequences will be
severe: depressing economic activity (which I can quantify) and creating another
financial crisis (which I can’t; simply because we have no idea how much of the
notional value of current CDS’s held in the banks will become exposed when those
banks start going under).
My investment conclusion: while no economic good will likely come from a
resolution of the fiscal cliff, the Market impact could be significant if these
morons continue to fiddle.
No economic good will likely come from
QEIV. Rather as I have noted, it will
simply continue to distort the math of investment returns, add to future
inflationary pressures, rob savers and line the bankers’ pockets. Sooner or later, I believe this will
negatively affect the rate at which future earnings are discounted.
Europe
remains a problem. A recession will
clearly not help our recovery nor the earnings prospects for US companies; but
(1) as I have said, American business has been spectacular in overcoming the
serial burdens of the last five years and (2) China could more than offset in
EU slowdown.
The more significant issue is the
fragility of both the EU and the US
banking systems caused by the nondisclosure of impaired assets on their balance
sheets, the lack of financial controls and the continued atmosphere encouraging
inappropriate risk taking by proprietary trading operations. When, as and if the Markets ever decide to
challenge banking policies and valuations, global market could be in for a
rough ride. My solution to this dilemma
is to carry an above average cash position as insurance and to insist on lower
stock prices to reflect the risk.’
Last
week, our Portfolios Sold one half of their investment position in GLD.
Bottom line:
(1) our Portfolios
will carry a high cash balance,
(2)we continue to include gold and foreign ETF’s in our
asset mix because we continue to believe that inflation is a major long term
risk [which is now under review]. An
investment in gold is an inflation hedge and holdings in other countries
provide exposure to better growth opportunities.
* Just a reminder that the Year
End Fair Value number is based on the long term secular growth of the earning
power of productive capacity of the US
economy not the near term cyclical
influences. The model is now accounting
for somewhat below average secular growth for the next 3 to 5 years with
somewhat higher inflation.
The Portfolios and Buy Lists are
up to date.
Steve Cook received his education
in investments from Harvard, where he earned an MBA, New York University, where
he did post graduate work in economics and financial analysis and the CFA
Institute, where he earned the Chartered Financial Analysts designation in
1973. His 40 years of investment
experience includes institutional portfolio management at Scudder. Stevens and
Clark and Bear Stearns, managing a risk
arbitrage hedge fund and an investment banking boutique specializing in funding
second stage private companies. Through
his involvement with Strategic Stock Investments, Steve hopes that his
experience can help other investors build their wealth while avoiding tough
lessons that he learned the hard way.
The
indices (DJIA 13311, S&P 1433) resumed their uptrend. The S&P remains in its newly re-set short
term uptrend (1423-1475), while the DJIA traded back above the upper boundary
of its short term trading range. This
will re-start the time element of our time and distance discipline for the
confirmation of break out of its short term trading range. In the meantime (three more trading days),
the Averages will be out of sync. Both
are well within their intermediate term uptrends (12997-17997, 1372-1967).
Volume
decline; breadth improved. The VIX was
actually up (typically it is down on an up Market day). It is above its 50 day moving average and
within shouting distance of the upper boundary of its short term
downtrend. A break above this trend line
would be a negative for stocks. This
unusual pin action on the VIX suggests that there could be some serious hedging
going on.
GLD
(160) got whacked again. As a result,
the break of the lower boundary of its short term uptrend is confirmed. With much of drop early in day, our
Portfolios sold half of their investment position in GLD---that leaves them
with roughly a 5% holding in GLD.
I
know, I know. If our economic forecast
is correct, then history says GLD is going higher. So why are our Portfolios Selling? The immediate answer is that I could be
wrong; and, as you know, one of my most important investment principles is to
never take a loss because the pin action doesn’t agree with my outlook.
To
be sure, there could be a number of reasons why the GLD price is declining even
though long term the forces are in place to move it higher, e.g. gold is not a
deep liquid market; so if a large fund is in forced liquidation, the volatility
to the downside will be big (it is rumored that John Paulson’s hedge fund---a
big GLD holder---is getting redemption notices and the rest of the hedgies are
front running his sales).
There
could also be more fundamental reasons: (1) it was rumored that China
cancelled a major soybean purchase---suggesting that its economy, and by
extension the global economy, is weaker than currently believed. (2) on
the other hand, it appears that investors around the world are selling most non
stock asset classes and are rushing into stocks.
Clearly, if this
crowd is correct, then I will have been wrong owning too much GLD. I don’t think that this is necessarily the
case but it is certainly a challenge to our current investment strategy and it
tells me that I need to redouble my normal effort to test the assumptions in
our Models. Until that examination is
over, the most practical, least risky steps that I can take is to Sell GLD to
stop the erosion of profits in this holding.
If this latest
collapse in the price of gold turns out to be some sort of trading/liquidity anomaly,
then I may be getting ‘whip sawed’.
However, I am willing to accept
the cost of trading out and then back into a position to insure that our
Portfolios preserve a profit.
Meanwhile,
some reading from those who agree with me about the long term outlook for GLD
(all are short):
Bottom line: the
Holiday party resumed yesterday. While I don’t believe it, our thesis on gold
is being challenged. So I have some work
ahead of me. In the meantime, loss
avoidance is the first order of business; hence our Portfolios sale of one half
of their GLD investment position.
I note that
there are now 18 stocks out of our 157 stock Universe that are on the cusp of
challenging the upper boundary of multi year trading ranges. Whether or not they break through these
barriers should tell me a lot about Market direction.
Lots
of economic data to digest yesterday: weekly jobless claims rose (negative),
third quarter GDP was revised up but that
was a function of inventory building (mixed at best), the leading economic
indicators were down but that was expected (neutral), existing homes sales and
the Philly Fed manufacturing index were both much better than forecasts. Soooo.............a mixed to positive day;
though following a couple days of disappointing stats, I have to rate it a plus
for the simple reason that this pattern fits our Model.
The
rest of the day---well, you know. More
drama on the fiscal cliff. It was
anticipated that the House would vote on Boehner’s Plan B last night. Pelosi, Reid and Obama spent the day
pronouncing it DOA. Then the unthinkable
happened---Boehner couldn’t get enough GOP votes to get passed. Now all bets are off.
Bottom line: I spent
yesterday contemplating whether I am just not getting with the program or are
my fellow stock jocks are drinking too much egg nog. In the midst of that process, Plan B blew up
and I was rescued.
Now the issue
is, has the market-crash-forcing-the-politicians-to-reach-a-compromise scenario
suddenly become operative.
While we await
the answer, our outlook remains: (1) we get a compromise on the fiscal cliff
which will solve nothing, (2) the Fed keeps inching further out of a limb,
printing dollars at hyper speed and (3) the EU’s survival is balanced on the
edge of a knife and if it falls, look out below.
So
far, the primary (Treasury) dealers are not betting on higher rates (short):
Steve Cook
received his education in investments from Harvard, where he earned an
MBA, New York University, where he did post graduate work in economics
and financial analysis and the CFA Institute, where he earned the
Chartered Financial Analysts designation in 1973. His 40 years of
investment experience includes institutional portfolio management at
Scudder, Stevens and Clark and Bear Stearns. Steve's goal at Strategic
Stock Investments is to help other investors build wealth and
benefit from the investing lessons he learned the hard way.
