2010Mar28 Week In Review
2010Mar28 Week In Review
Assumptions about the return of rapidly rising inflation have been dashed again as core inflation, which excludes fuel and food, remains low. The Fed is intent on keeping inflation low and maintaining a priority of fighting “disinflation” avoiding deflation at all costs. That, however, is more easily stated than accomplished.
Investors continue purchasing bonds for a variety of reasons: lingering fear of equities, nearness of retirement, presumption of safety, etc. However, the bond market is showing signs of change that should concern investors. The EU and IMF have created a safety net for Greece and other troubled European governments. The EU has not done this previously; however, the IMF’s track record is abysmal. As with our home mortgage problem, impaired borrowers are not good credit risks even with new financing.
While the UK and the USA have been warned by credit rating agencies that their AAA status is in jeopardy if fiscal changes aren’t implemented, investors have begun to vote.
“The numbers are pretty clear. In February, Bloomberg News reports, Berkshire Hathaway sold two-year bonds with an interest rate lower than that on two-year Treasuries. A company run by a 79-year-old investor is a better credit risk, the markets are telling us, than the U.S. government.
Buffett's firm isn't the only one. Procter & Gamble, Johnson & Johnson and Lowe's have been borrowing money at cheaper rates than Uncle Sam.”
The only choice for bond investors to receive a return that actually supplements retirement income is to be in the longer dated maturities. That is the area of greatest risk if rates begin to rise. The alternative is in the equity market with dividend paying companies. Risk management is necessary in either market.
There has been increasing demand for goods among consumers creating the prospect of renewed pricing power for business. Pricing power should more aptly be attributed to smaller inventories – lower supply – rather than growing demand. Smaller inventories and smaller stores results in fewer employees which equals continuing high unemployment.
There are three major reasons for a family to reduce consumption: financial insecurity, increasing tax burden and the end of child rearing and/or education expenses. The first is prevalent in the high levels of underemployment. The second is inevitable with sun setting of the current income tax rates and amplified by passage of the health care reform bill. The final cause is a demographic change in family needs as retirement accumulation is given high priority by an increasing number of families.
The Administration has failed at dealing with “priority number one.” The Administration is responsible for cause number two. The Administration can do nothing to change number three.
A research update from Fidelity Investments indicates retirees need $250,000 set aside for healthcare alone even with implementation of the new legislation. For the average family, this cannot be accomplished by building a bond portfolio.
Modern Portfolio Theory (MPT) does not provide sufficient downside protection for most investors to reach their goals, and, according to Dr. Markowitz, MPT was never intended to provide that protection. Dr. Markowitz’s financial situation does not represent the average American family when he says “I feel comfortable and have enough money in municipal bonds so that if I die my wife has enough to live off tax-free income. I can afford to be more in equities.” Ignoring the impact of downside risk is not a luxury most can afford.
One solution for investors to manage risk is to use a century old process of tracking prices and calculating relative strength. When prices are grouped by industry, sector and country, adjustments can be made to asset allocation decisions, and to portfolios, reflecting the global consensus of investors.
Just as the cassette tape replaced the 8-track, only to be replaced in turn by the compact disc, itself being undercut by the MP3 player; portfolios must deal with the implications of creative destruction. Economic innovation is a constant process whereby the old leaders are replaced by new ones. Given this reality, how much sense does it make to buy-and-hold? Relative strength is ideally suited to keep a portfolio fresh with the companies that are economically relevant.
Our research in this area has consistently shown that investors had advance warning of increasing market risk when using recent prices and relative strength instead of the “thirty year averages” used in MPT. For information on how we have adapted our processes, and how you can apply this to your portfolio, call us at 800-317-9119 or send us an email.