WEEK OF August 25, 2008

Are we in a Bear Market or aren't we?  To follow CNBC, you'd think it changed on a daily basis.  Every time the S&P dips below 1260 (a 20% decline from its peak), the TV people broadcast "Stock Market in Bear Territory!"  Silly.  A Bear Market began in October of 2007...and it will have ended on July 15th if the Market doesn't breech those lows.  We're not in a "Bear Market" every time the Market is 20% below its peak.  The Bear will be measured to its trough.  We'll be "in" a Bear as long as we're setting new lows from last year's peak.  If we don't hit new lows, the Bear ended 7/15/08--but I think we've got more downside to come.

The future's being foretold overseas.  While our Market bottomed on July 15th, and has bounced up a bit since then, the rest of the world's equity markets have continued to slide.  Below is a chart of the US market (S&P 500), European markets (FEZ) and Asian markets (VPL).  Asia's off 25% since last November, Europe's off 27%.    Both foreign regions are hitting new lows...

Ours is a global marketplace...for the trading of goods and services, but also for equity investments.  I just don't see how our Market can have bottomed while the majority of the world heads lower.

Let's switch gears...

If you still can't see how, as I've postulated, "Inflation concerns are overblown," turn to the wisest seer of all...the markets.  The markets are smarter than their smartest participant.  It's been demonstrated repeatedly.  And what are the markets expectations for inflation?  That inflation will be 2% per year for the next 5 years.  Did he say 20%?  Surely he said 20%?!?!  Nope...2%.

The yield on the 5-year TIPs is 1.09% and the 5-year Treasury yield is 3.09%--a 2% implied inflation per year.  Will it prove to be correct?  Not necessarily.  But it says that for now, the inflation rate looks to be a lot more normal than the headlines imply.

August 19, 2008

I recently summarized our views of the world, and how it affects our investing, in an email to a client.  Thought it might be of interest...

Here's a synopsis of our major themes:

- We entered a Recession in the US in December of 2007. A global recession is likely underway as well, if slightly lagged to the US'.

- The US stock market began a cyclical Bear phase in October of 2007. It's probably got at least one more series of new lows before it can reach a bottom (below the prior low of 1215 for the S&P 500).

- The commodity plunge of late is described by speculator profit taking, but is part of a longer term, upwardly trending move for commodities.

- The dollar may have, I emphasize MAY have, turned a corner. This is explained by the shift in global central bank policy toward easing and away from tightening because...

- For all the headlines it gets, the world's problem right now is not inflation, it's economic weakness. There are a dozen factors that back this up.

- While we may have one more spectacular shoe to drop in the credit crisis (Large bank failure? GSE recapitalization from the gov't? Unforeseen calamity?), we're near the bottom on the financial sector drubbing.

SO, you can see the following anticipations in our strategy:

- Reduction to minimum equity weighting in early June. Defensive within equities.

- Diversification across multiple "alternative assets": commodities, currencies, foreign debt, REITs, derivatives.

- We're UltraShort the Emerging Markets as a protection against a global economic standstill.

- Our currency play is hedged: we're long the dollar vs. the dollar index, but short the dollar vs. the Australian Dollar and the Peso.

- We own domestic and international inflation-protected bonds.

THE RICH LIFE:  Fat boy slim?  Not quite yet.  You may know I challenged my colleague Kirby to a weight loss contest.  I went from 189 to a recent low of 175 (post-workout, fully-dehydrated, buck-naked on the gym scale [sorry for the visual]).  But I've hit a wall...175 is my long standing equilibrium weight.  But I'll stay at the weight loss...at a more measured pace.  We'll see what I can do.  However...let's just say that absent a tapeworm entering the picture, there's no way Kirby's going to hit his target either.

August 8, 2008

Hey, two postings in a week!  Wow, I might actually be getting some of my life back.  Not complaining...just busier than I want to be, in a rich-life context.

Jobless claims took the oomph out the Market today, didn't they?  For good reason...the Market's in a Bear Market Rally and focusing on good news, not bad.  So news that joblessness is increasing at a faster pace than expected served to throw a wet blanket on stock price ascension.  But I suspect the rally will continue with possibilities of the Market bumping up against its 200-day moving average level (~1370--it's at 1260 now).  But that's not a rule.  Rather, it's what I see as the upper most threshold to which it could approach.  Somewhere between here and there, I suspect we'll make a test of the 1215 level (the lows of the last three years, set just a few weeks ago).

Ford Equity has a proprietary model of valuation for stocks that bolsters my view that we have a bit further to fall before the Market exits the Bear phase.  Note that like every model I've ever seen...it gives rare false-positives...but it's an interesting consideration.

THE RICH LIFE:  Had a dream come true the other night.  Took my oldest three to the fly tying Master, Damien Nurre.  They tied their first flies: one olive wooly bugger, and a steely-bugger.  Awesome!  Was the next best thing to actually being on the water.

August 4, 2008

If I had to guess, I'd say the National Bureau of Economic Research (NBER) will posit that the Recession began in December of 2007.  That would be consistent with the Market figuring it out in October, just a couple of months prior.

As I've said, despite the ubiquity of the idea that a recession is defined as two consecutive quarters of declining GDP, that's not true...at least according to the NBER, the so-called arbiter of economic cycles in the US. (The last recession in this country didn't see back-to-back quarters of contracting GDP.)  While the NBER leans mostly on GDP, it takes a broader look, and the Wall Street Journal gave us a snapshot of four other important indicators under the watchful eye of the NBER.  Sure looks an awful lot like the Recession started in the Fourth Quarter of last year to me.

Three interesting aspects to last Quarter's GDP figure (showing 1.9% annualized growth).  First, it includes some of the effect of the stimulus checks, which is temporary.  Secondly, net of trade flow, the economy would have contracted.  Finally, the price deflator was a remarkably low 1.1%--were it inline with CPI, GDP would have been negative.  Am I saying GDP, as calculated, is misleading?  Nah...I'm just saying that it's not a very strong number last Quarter.

What I don't understand is how Barrack Obama's not beating John McCain by 20 points in the polls.  While Obama's convincingly touring the world as the heir apparent to the throne, McCain's holding town hall meetings covered on the back pages of the nation's newspapers (sometimes I wonder if his campaign is being run by a couple of Poly Sci majors from George Washington U).  Which is to say nothing of the fact that it's a tough year to share political parties with this President.  And yet, McCain's lagging by just a tad, and closing the gap of late.  Interesting.

Source: RealClearPolitics.com

July 30, 2008

The Fed's backed into a corner...with two dragons at bay.  One is Inflation.  Food and energy prices are trickling into core prices and the Fed's weapons of choice are to raise rates and constrict the money supply.  The other dragon is economic weakness.  In this case, the Fed's weapons are to lower rates (or at least leave them where they are) and to grow the money supply.  While the Fed's stated mandate is balance price control with economic growth, this is the first time in a very long time when both policy objectives are problematic and of course the solutions are diametrically opposed.

Clearly, the Fed's choosing to focus more on the economic dragon.  The Fed Funds futures predict that rates won't be even 1% higher any time in the next two years.  And while the Fed waxes hawkish in the public domain, it's clear that they're trying to jawbone inflation expectations downward.  But they're really not on the verge of using any other tool in their arsenal aside from "moral suasion."   Part of the reason is that there's scant evidence that inflation expectations have spilled over into wages.  Below is the Employment Cost Index.

Let's switch gears.  Is it better to own energy commodities or energy stocks?  Lately, the hands down winner has been the commodities.  Below is a chart comparing the energy stocks (XLE) to oil (OIL).

Finally, did you see the article about the family that was given a house on Extreme Makeover, and then leveraged it to the eyeballs only to default?  Come on people...

THE RICH LIFE:  Was hiking with my two oldest the other day.  We were walking up an old logging road that was made rutty by a dry channel that is obviously where the rain flows when it pours.  The kids eyes were drawn to a little toad bouncing around on the road when Lindsay shouts "Ohmigosh!" and unearths a five-inch obsidian spear point in perfect condition (identical to the one in the picture).  41 years I've been hoping to stumble on an Indian artifact.  Lucky little punk...

July 24, 2008

So much to talk about...I'll hit the high points, with some help from some of the charts and tables that are part of our Second Quarter Review...top secret stuff!

Let's start with the Stock Market.  Have we turned the corner on: The Market? Financials? Banks? Housing? Inflation?

My response, in order: "No, no, no, no, and ummm...No!"  We're in the middle of a cyclical Bear Market.  As I said last month, it started in October of last year, and accepting my premise, it would suggest that we have further to go.

The bounce of late is a Bear Market rally, with an obvious catalyst: extreme over-sold-ness!  It will run out of steam soon, and we'll be back in the pattern that's characterized much of the past two months.  Namely, a falling market, led by Financials.    Let's take a look at prior 11 Bear Cycles, using data I pulled for the broad Market, post-WWII:

So from this we see that the average peak-trough decline is 30% (so far, using the low from two weeks ago, the market's lost 23%).  We see that on average, it takes 13 months for the trough to manifest.  That doesn't mean we have to lose 30%, and hit a bottom four months from now...but I suspect we have at least one more downward plunge.  When it happens, if it's drawn out enough, and comes with a climactic purge at the end, it just might be enough to allow the next Bull Market to be born.  Otherwise we'll need another false-start-and-retrenchment (or two) for the bottom to be put in. I suspect the Market's resting place will be somewhere between 30-45% below it's October peak (see below).

Does that mean there's still a "play" to the downside?  For the true gamblers, I suppose, but at this point, we're probably closer to the bottom than the top, so it's a risky endeavor.   There's a risk to getting Bearish too late, and staying Bearish too long. 

I love how are portfolio feels now.  A typical client, with a "Moderate Growth" mandate, has the following exposures to the eight asset classes we use (the "V-8").  This is the kind of diversification that has me sleeping soundly at night.  Most poor folks are still saddled with the 1980's buy-and-hold 70/30 stocks-to-bonds, with a little foreign stock for "diversification."  That can't be feeling good these days...

THE RICH LIFE:  The Valentines had a fantastic cross-country trip.  What a great country we have the privilege to live in.  For those keeping tabs on my weight loss bet with Kirby, I added 5 lbs on vacation, but have been working at it feverishly since, and am down from 189 to 180...on my way to 165.  Kirby...he won't tell me where he is...but he's looking a little soft to me.  Five and a half weeks left. 

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