2010Jan10 Week In Review
January 10, 2010
WEEK IN REVIEW:
It all depends upon who you ask. Major Wall Street analysts are becoming more optimistic about 2010’s economy and corporate profits. While the money from recent “stimulus” legislation has not been completely spent, it is expected to finally have some positive impact on the national economy. Elections are looming and the rest of the “stimulus” money will be spent. Direct beneficiaries of the disbursements will most likely reside in Democrat Congressional districts with low polling numbers.
The other influencing factor is the persistence of the Federal Reserve’s accommodative monetary policy. So far, it has primarily resulted in the banking system shoring up its reserves. If there is growth in the economy, banks are expected to increase lending to businesses. Business loans will become more attractive if the Fed becomes less accommodative. However, business owners have to be sufficiently optimistic to want to borrow money. We aren’t so sure about that.
Business expansion will take more than a banker’s new eagerness to lend. It will require a real increase in sales that appears sustainable. Where will that come from? It is not coming from job creation. Unemployment numbers improve primarily from discouraged workers running out of unemployment benefits and no longer counted as part of the unemployed. That is government accounting in action.
Thirty six states are now facing significant budget shortfalls. Only eighteen states have actually cut budgets to handle their situation. More tax proposals will be forthcoming as the year progresses placing an increasing drag on any recovery that may be under way. We are already in the final year of the Bush tax cuts. Next year, 2011, ushers in a large income and capital gains tax increase. The Senate version of “health insurance reform” has 14 new taxes for us. Basic economics acknowledges that taxes reduce economic activity. Government borrowing reduces credit otherwise available to business for expansion. To be determined is whether current policy will merely be a drag or become an anchor as it has in Japan.
Yes, Japan’s economic woes are back in the headlines as they continue a twenty year decline economically and demographically. The US, at least, has turned the corner with an upsurge in births which will lead to an increase in consumption and related economic benefits as we move into the 2020s. Japan is facing another round of deflation with the stock market down 73% from its 1989 high and urban real estate down by two thirds. In 2009, Bloomberg.com reported “During the 1990s, Japan spent 135 trillion yen on 10 economic stimulus plans and lowered interest rates to zero, none of which succeeded in promoting sustainable growth.”
Our government has the opinion that Japan just needed more and bigger stimulus packages. Takashi Kamiya, chief economist at T&D Asset Management Co. in Tokyo, told Bloomberg.com “There’s no way to expect the emergence of a domestic growth driver that can propel us out of this funk.”
For Japan with a declining and aging population, there is no way to reverse these trends. An older population and a population that is decreasing in size cannot create sufficient wealth to sustain the government’s current spending much less future health care commitments.
For the US, this decade will experience even further declines in consumer spending as Boomers shift money paying for children’s education to saving for retirement and accelerating debt repayment. Our government has no viable plan to repay its enormous borrowings of recent years. Congressional assumptions are for economic growth to return to patterns of the past quarter century. Demographics are the determining factor in risk taking, business and wealth creation and the shift to wealth preservation and risk avoidance. It is a Congressional pipe dream. Portfolios must be managed defensively today while watching for increasingly limited opportunities in our markets.
Strong growth abroad is expected to be positive for US exports. This is positive for investors who have flexible portfolios. Concentrated portfolios emphasizing sector rotation will benefit. However, standard portfolios with minimum allocations to US equities generally have little ability to accept significant holdings in sectors or foreign markets.
If the Fed, as anticipated, becomes less accommodative in the last half of this year, then we may well see an uptick in interest rates. Currently, the 10-year Treasury is at 3.83% with a forecast of 5.5% by mid-year. That is not good for bonds that have recently been the investment of choice as evidenced by mutual fund money flows. Bonds are most likely the next market bubble to burst.
Recent headlines have named the first ten years of this century “The Lost Decade” for investors. As with many issues, it depends on what you look at. While buying and holding the indexes was not profitable, avenues were available for portfolios with investment policies that allow for both flexibility and concentration. A recent Wall Street Journal article reported:
“Meet the decade's best-performing U.S. diversified stock mutual fund: Ken Heebner's $3.7 billion CGM Focus Fund, which rose more than 18% annually and outpaced its closest rival by more than three percentage points.
Too bad investors weren't around to enjoy much of those gains. The typical CGM Focus shareholder lost 11% annually in the 10 years ending Nov. 30, according to investment research firm Morningstar Inc.” (Emphasis added)
While the numbers were slightly different, the experience was the same for investors during the 80s with Peter Lynch and Fidelity Fund’s flagship, the Magellan Fund. Mr. Lynch’s investment style was in vogue and was very profitable overall. Investors responding emotionally to market changes turned profits into losses.
Portfolio managers in the last protracted bear market (1966 to 1981) were not confined to style boxes and arbitrary limits on market sectors. Many managers provided returns in excess of the Dow or the S&P.
Any extended bear market requires a systematic monitoring of the flow of investor money into or out of market sectors as well as countries. Data revealing buyer and seller activity is available daily. Point and Figure is a century old process where data quickly reveals sustainable or changing trends.
As we begin this year, we have a list of forty Exchange Traded Funds pre-screened for the portfolios we manage. The S&P500 (SPY) is 27th on the list. Yes, we have twenty six other asset classes, countries or sectors providing better returns than the major index. No, we do not currently hold the S&P500 in any of our managed accounts.
If you have examined any of the 20 company retirement plan reviewed on our website, you will find a common theme from us to all plan participants:
Modern Portfolio Theory uses Bell Curve price assumptions in the structure of standard retirement plan and portfolio strategies.
“In fact, the bell curve fits reality very poorly. From 1916 to 2003, the daily index movements of the Dow Jones Industrial Average do not spread out on graph paper like a simple bell curve. The far edges flare too high: too many big changes. Theory suggests that over that time, there should be fifty-eight days when the Dow moved more than 3.4 percent; in fact, there were 1,001. Theory predicts six days of index swings beyond 4.5percent; in fact there were 366. And index swings of more than 7 percent should come once every 300,000 years; in fact, the twentieth century saw forty-eight such days. Truly a calamitous era…perhaps, our assumptions are wrong.” (Mandelbrot: The Misbehavior of Markets; pg 13)
As illustrated last week with the example of Starbuck, portfolios and wealth are not created nor preserved on fundamentals but on prices. Since the markets are daily auction markets whether foreign or domestic, equity or fixed income, keeping track of the action between buyers and sellers can reveal changing trends and risk.
For more information on adopting Point and Figure risk adjusting strategies, call us at 800-317-9119 or contact us at info@InvestorResourcesInc.com.
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