Monday, December 31, 2012

The Morning Call--This is your future

The Morning Call


The Market

            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.

            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.

      News on Stocks in Our Portfolios

   This Week’s Data




  International War Against Radical Islam

Saturday, December 22, 2012

Thoughts on Investing

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.

Source: Butler|Philbrick|Gordillo & Associates, 2012

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%.
       4. Median remaining lifespan is 20 years.

Source: Butler|Philbrick|Gordillo & Associates, 2012

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 Closing Bell--Happy Holidays

The Closing Bell


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


Real Growth in Gross Domestic Product:                      +1.0- +2.0%
                        Inflation (revised):                                                             2.5-3.5 %
Growth in Corporate Profits:                                 5-10%


                        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%

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.’

And (short):

Update on the big four indicators:

            The pluses:

(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.

       The negatives:

(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.

And (short):

‘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

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.’  

          The latest from David Rosenberg (medium):

            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. 

(3)                                defense is still important.

DJIA                                                    S&P

Current 2012 Year End Fair Value*                11300                                           1400
Fair Value as of 12/31/12                                 11300                                                  1400
Close this week                                                13190                                                  1430

Over Valuation vs. 12/31 Close
              5% overvalued                                 11865                                                    1470
            10% overvalued                                 12430                                                   1540 
            15% overvalued                             12995                                             1610
            20% overvalued                                 13560                                                    1680   
Under Valuation vs.12/31 Close
            5% undervalued                             10735                                                      1330
10%undervalued                                  10170                                                  1260    15%undervalued                             9605                                                    1190

* 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.

Friday, December 21, 2012

As you might expect, Santelli is frustrated

Morning Journal--More dishonest government accounting


   This Week’s Data

            November existing home sales rose 5.9% versus expectations of a 2.9% increase.

            The December Philadelphia Fed manufacturing index came in at +8.1 versus estimates of -2.0 and November’s reading of -10.7.

            November leading economic indicators fell 0.2%, in line with forecasts.

                November durable goods orders were up 0.7% versus forecasts of up 0.5%; ex transportation, they were up 1.6% versus expectations of up 0.2%.

            November personal income came in up 0.6% versus estimates of up 0.3%; personal spending rose 0.4%, in line.
            The November Chicago National Activity Index increased to 0.1 versus October’s reading of -.64.


            More dishonest government (inflation) math (medium):

The Morning Call--Oops

The Morning Call


The Market

            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):

            And (short):

            And (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.

            Bullish sentiment near highs (short):
Most bear markets start near year end (short):

            And this from Chris Kimble (short):


            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.