For JULY (7/16/10)

Good news! (Well, that may be a bit presumptuous depending on how you take the following…) I’ve decided to keep the Hog Blog alive and well in our new iteration of content distribution. Previously, I had you believe that we’d replace the HB with a video alternative. We’re going to do both—periodic video commentary (2-5 minutes in length) and posting to the Blog on a monthly basis, with longer commentary.

On to business...

As you can see from the entries since April, I’ve been getting increasingly cautious about risk markets (stocks, real estate, commodities, etc.). For most of the last Quarter, I held the Beta of our Growth portfolio to about +0.15. It helped tremendously as risk assets cascaded into the Quarter-end.

A couple of weeks ago, I took to the Beta to -0.2.

What does that mean/how does that work? Well, with a Beta of 1.0, your portfolio should rise and fall inline with the markets, at the same time and to roughly the same degree. With my prior Beta, I’d expect our portfolio to rise 0.15% for every 1% that the markets do, and vice versa. So now, with a negative Beta, we move inversely with the markets—but only slightly. A 1% decline in the markets should give the portfolio a 0.2% gain. We're not short--we're market neutral and many of our alternative assets (Gold, the Dollar, the Volatility index) tend to move inversely with risk assets.  Obviously, this is a very tempered approach and most suitable to periods where risks of declines are high.

My number one priority right now remains protecting my client accounts against a major decline (or “crash”).

While these kinds of events are almost impossible to predict in advance, it’s less difficult to identify the kind of environment than can incubate a major decline. This is one of those times.

Confessional: I’ve been in this business 23 years, and have had my own firm for more than half of that time. My biggest regrets come from not taking bolder stances when I felt a conviction about a major directional change in a market.  Let's look back at the biggest three:

WHEN: February 2000 (end of Tech bubble)
VIEW: I sensed we were near an end to the Bull, and wrote about it.
PLAY: I drastically underweighted tech stocks, and diversified into international stocks.
RESULT: I was right, but everything fell, so while we did less-worse than the Nasdaq it was small consolation.

WHEN: March 2007 (end of real estate bubble)
VIEW: I saw that real estate was a huge bubble.
PLAY: Tried to become a renter by selling my house. Did little with the securities accounts to directly hedge this.
RESULT: It played out even worse than I could have conceived, but we never did sell the house. There were ETFs that would have done very well had I used them to hedge the bursting of the bubble.

WHEN: June 2008 (start of last Bear)
VIEW: I flat out called it a Bear market well before the Crisis could was conceived, and before the market crashed.
PLAY: Cut my stock weight in half (to about 25%) and bought a whole bunch of other diversifying assets (commodities, currencies, REITs, etc.).
RESULT: Once again, it was a well-timed call. But this time, the correlation of everything went to 1.0, except US Treasuries (which the Growth portfolio didn’t hold).  Again, down less than most...but more than we should have been.

The point is not to remind you how brilliantly prescient I am.  (Ha!) While all of these calls were accurate (and documented), I’ve also made several gaffes. I called for a bottom in 2001 that was way too early, went market-neutral in July of 2009 only to have the markets leave me in the dust, and got contangoed by a Nat Gas futures curve earlier this year.

The point, my dear reader, is not about accuracy—it’s about conviction and follow through. Part of why I haven't gotten  a better reward for being right was that I overestimated the size of the benefit of my "plays." Part of it, if I’m honest, was that I didn’t trust myself enough.  In each of those correct calls above, I was in lonely company, and most of the Great Market Seers were on the other side of my view at the time.

Going forward, I am taking bolder positions to support my views (balanced with my hyper-sensitivity to risk so as to not put too much on the line). Which takes me back to a where I was before the “confessional”...

My number one priority right now remains protecting my client accounts against a major decline (or “crash”). While these kinds of events are almost impossible to predict in advance, it’s less difficult to identify the kind of environment than can incubate a major decline. This is one of those times.

Since I’ve spent the last few months laying out the fundamental case for why a large setback might be looming (see prior Blog comments) let me talk about the technical case, addressing solely US stocks. While I’m not a big fan of technical analysis (using charts and price history to direct your trading), there are a combination of technical factors that have given a "signal" that preceded every Bear market, well in advance. And these factors exist right now.  Problem is: they are a “false-positive” more often than not.

I recently did some work using moving averages (if you’re not familiar with what a moving average is, spend a minute online looking it up), based on some research I got my hands on, and running historical trials with downloaded price data going back 60 years (love that Internet).

What I discovered was that an accurate Bear market warning signal occurred when:

- The 200-day moving average (MA) began declining (at least three days in a row)
- The 50-day MA was crossing down through the 200-day
- The stock market’s level was below the 200-day MA level

Here’s when these events converged a few weeks ago.
 

The dark blue line is the S&P 500, the green line is the 200-day MA, and the red line is the 50-day MA. The light green arrow shows you the aforementioned event taking place, and the light blue line is where the market was at the time.

These are certainly long standing and widely followed measures, and while I’m not aware of anyone using these three quite like I do, there’s nothing magical in them. Yet, those three conditions, when they come together, can be a very strong early warning signal.

There have been 20 such times in the last 60 years. If you sold out of the stock market (or went market-neutral) on this basis alone you would have avoided a 51% decline in the last Bear market (from the trigger-point to the market trough), a 45% drop in the Tech bubble burst, and the bulk of every Bear market of the last 60 years.

On the other hand, more often than not, it was a bad signal (there weren't 20 Bear markets). The market never went 10% lower than the trigger point in 12 of the 20 circumstances (60% of the occurrences).  So if after getting the trigger, you sold/went market-neutral, and held out for a 10%-or-greater decline, you never got it, and would have probably left money on the table, depending on where and how quickly you reversed course.

From a logic standpoint, think of it like this: All Bear markets are preceded by these 3 measures; but, these 3 measures don’t always precede a Bear market.

Which is why you wouldn’t ever bet the farm in the other direction, when the signals occur. Even though you’d make a fortune when you’re right, you’d be wrong too often. Instead, I think you get maximally defensive when the confluence of events occur, and pre-determine buy-back points to either lock in your performance gain, or terminate the opportunity cost.

But once you've taken your stance, you have to let go of the outcome—it’s not about being right, it’s about protecting against major loss. It's about taking a stand and being convicted...something I wish I would have done more of in the past.
 

Week Ending: June 11, 2010

Where do you go?

That’s the refrain from the CFA conference that I attended today and yesterday in Seattle. The conference’s title was “Asset Allocation for Private Clients” but it could have easily been titled, “Where do you go?”

By “Where do you go?” investment managers attendees meant, “Where do you invest these days?” The three traditional investment classes are unattractive on a historically significant basis--and if our group of 100 or so investment analysts was a representative cross section of the rest of the industry, professional investors everywhere are scratching their heads about what to do with their investment funds.

These days, stocks are fraught with the risks associated with the increasingly evident global fiscal and economic problems, real estate is still on its arse, and bonds don’t yield anything. Where do you go?

Part of the answer, in my mind, is alternative assets, but that has yet to occur to the crowd. Alternatives are often regarded as an anathema or an enigma to most investors, particularly non-professionals. Often, when someone hears the term alternative investments, they don’t know what is meant by it, or they read it to mean “hedge fund.” (Hedge funds aren’t an “investment” at all, but rather a structure with which to invest. And yes, often the investing done within hedge funds can be thought of as “alternative.”) By my definition, anything outside of the three traditional areas (stocks, bonds, and real estate) falls under the heading of “alternative” including, but not limited to: commodities, foreign currencies, foreign bonds, private equity/debt, collectibles, farm-/timber-land, long/short, derivatives…you get the point.

The world will come to appreciate alternatives as their benefits become clearer as the traditional assets falter. Multi-asset class diversification remains an imperative component of wise investment strategy for the next several years.

Hedging is another key component, and we’ll talk more about that in coming weeks.

Another theme I’ve observed a lot lately is the growing angst arising from the awakened view to how truly fragile our global financial system is, especially from people with justifiable reason to be apprehensive—those concerned about retirement. Just a few years ago, nary an American could have conceived of a world where their real estate assets would fall in value by half; almost none alive today can remember when the stock market fell by more than 50%; and who would have thought that we would have questioned the solvency of money market funds and the FDIC? Which is to say nothing of the mind-boggling level of debt this country has assumed...

These last few years have been the equivalent of a 9/11-like event, for how it’s shaped people’s conception of the true range of what’s possible.

And while that awakening of the public is actually good, for retirees--or those with their heart set on it in the next decade (in other words, most of the Baby Boomer generation)--this new paradigm is far more deeply upsetting than I hear hardly anyone talking about.

These folks, who are leaving their income-producing positions in society (or who have already left) too ask, “Where do you go?” How do they protect their assets in the new-normal for the world? I fear for many within this group because the knee jerk responses to uncertainty and fear is usually ill-timed investment movements that are likely to make many a bad personal financial situation worse.

Truly, this is not a commercial for the financial advisory industry or a plea for acknowledgment of what we’re doing. Rather, it’s an observation--and a warning that the real enemy of the retirement account is mostly not the professional swindler, or the inept investment adviser, but rather the erstwhile fellow, trying his best, and making all the wrong moves at all the wrong times, swept up in the chaos.

As professionals, we’ve got our work cut out for us, managing the risk within portfolios and managing the understandable apprehension of our clients. While you’ll never hear me complain about my lot in life, I will say it’s a hell of a lot easier to manage money in a period like the 80’s and 90’s than it has been since then.

 

CHART OF THE WEEK

This is a chart of a new index of Consumer purchase behavior, thought to be more dynamic that reported Retail Sales figures from the Commerce Department. It appears to be a leading indicator of overall US economic growth (GDP). If so, it suggests a contraction in the Second Quarter of this year, which would be a shock to the consensus view of little, but positive, growth. I guess we’ll see.

THE RICH LIFE: We’re phasing out “The Rich Life” section, as part of the coming switch to an all-video alternative to “The Hog Blog” concurrent with the introduction of the new website (slated for July). We think you’ll appreciate the new way with which we’ll communicate with you, and appreciate your bearing with the evolution of our content distribution.

Week Ending: June 4, 2010

I hate cheering against the stock market. I really do. But I'm doing it every morning.

I’ve been market-neutral (beta of about 0.0) since May 5th.  The more stocks fall, the better it is for my decision. I believe we entered a new Bear Market in late April, but can’t begin to tell you how it will manifest itself in terms of duration or magnitude.

Overall, in my estimation, I remain more concerned about financial and economical events than what I deem to be the “consensus view,” and thus, the proper stance is to be bearish on risk assets. If I’m right, prices will adjust downward, and consensus will come around to my point of view.  Eventually, it will probably get too bearish, at which time the proper call will be to up your beta and increase your exposure to risk assets.

Allow me to summarize my beliefs (concerns) of late (in case you've fallen behind a few Blog postings):

- I believe that Europe’s problems are our problems. They’re in an undisputed bear market and a full blown debt crisis, and those that suggest that it won’t affect us seem to be misguided. As I write, the Euro just fell below $1.20 (it peaked around $1.60, and hasn’t been at $1.19 in over 4 years); and LIBOR and EURIBOR spreads over the OIS keep rising (a measure of growing counterparty risk, reminiscent of our TED Spread during our crisis—although the European spreads are not as of yet as severe).

- I believe we will begin to see our own intractable debt crises at the municipal finance level, from State government on down. The upshot for education is that the union leadership will finally be pitted against the stakeholders of public education (taxpayers, students, and parents)--only good can come from this, in the long-run. (Our Chart of the Week below shows the current deficit condition of most states.)

- I believe that the country has blown the opportunity to instill and encourage financial prudence in its citizens.  In part this comes from "blaming the dealer" (banks) and victimizing "the addict" (borrower).  It also comes from bailing out banks, which says, "Consequences are less important than the least painful decision."  And now, we're further stripping away the consequences of personal financial irresponsibility for those that are opting away from their loan commitments. “60 Minutes” recently did a piece on an apparent growing movement (it even has a name: "Strategic Defaults") of people walking away from their mortgage—even though they can afford to pay it! Apparently the stigma that used to prevent voluntary default is gone (and I'd suggest that the 60 Minutes piece contributes to it).  Don't get me wrong--unavoidable foreclosure is an unfortunate, and a necessary out for those who need to restore their financial standing.  But "strategic default" on a mortgage doesn't square with me.

- I believe that the country is finally coming to grips with how poorly run our government is, at all levels, with at least respect to dealing with economic and fiscal issues. Here’s an example of that point that also ties in the former point about the lack of accountability. Watch what Barney Franks says about homeownership now versus back in 2005. This is our Chairman of the House Financial Services Committee!  If people want to understand why public policy just keeps making the financial crisis worse, they need look no further than the character and lack of expertise of the people we elect.

- I believe that we have evolved from low inflation to disinflation and are now in deflation. This will likely lead to a double-dip recession, as this anemic recovery has little foundation from which to advance.  Consider employment. Like many, I was anxiously awaiting this morning’s payroll announcement. I nearly shot coffee out my nose when I read that of the 431,000 new jobs, 411,000 were census workers! (If you listen closely, you can hear a belly laugh emanating from the grave of Ayn Rand).

CHART OF THE WEEK

Week Ending: May 28, 2010

I must confess...I'm thinking more about loading up the RV than what I want to say on the Blog this week.  So...I'll see if there's something that pops up Tuesday...otherwise, we'll have something for you next Friday!  Happy Memorial Day!!  Thank a Veteran!

Week Ending: May 21, 2010

So are we in a Correction or a Bear Market?

I think we’re in a Bear Market and that it makes good sense right now, for all the reasons I cited last week, and the week before, and so on... (Add to it the “Chart of the Week” below.) That doesn’t necessary mean we’re headed straight down. There will be many counter rallies along the way, and it will take months to fully manifest itself.

But that’s just my opinion, and but one more to throw on the pile. And boy are there myriad opinions out there! I got an earful of “advice” from the guests on CNBC this morning, which I picked up on my Sirius radio, during the drive back from dropping Mrs. Valentine off at the airport.

CNBC is the only cable business news show simulcast on Sirius. Long time followers of mine know I haven’t watched CNBC on TV in years (having switched to Bloomberg TV, a smarter cable business news network). And if I wasn’t “in the business,” I wouldn’t watch business news at all during the day. It overwhelms the brain, amplifies emotion, promotes irrational responses to insignificant events, and encourages unnecessary trading.

I wish all individuals, especially my clients, would reject cable business news, for their own good. One of the biggest problems with cable business news is that it’s constantly bombarding the viewer with “what to do” advice. “Be bullish!” “Be bearish!” “Be semi-bullish, but buy energy stocks!” “Don’t be semi-bullish and definitely don’t buy energy stocks!” “Buy Apple!” “Sell Apple!” “Blah, blah, blah!!!!”

Puke. How is the public supposed to make use of that? They’re not. That’s on TV because that’s what the public thinks it needs, not because it’s of any real value.

The thing the public doesn’t discern while watching cable business news is the motivation of the talking heads they parade in front of the screen. Before blindly falling in behind the advice of some smart-sounding fellow, the viewer should ask the following questions about the talking-heads they’re listening to:

- What does this talking-head do for a living and does the advice he’s offering benefit him in any way if I follow it? Personal gain, not objective advice, is the motivation behind much of what you’ll hear on cable business news. Consider Manager X of the XYZ Korean Equity fund. What does he like right now? Korean stocks. Imagine that!?! The Korea recommendation will be supported with a bunch of subjective, but sophisticated-sounding, rationales for being pro-Korea. A lot of these guys are veterans at the smooth pitch, and who knows how many people follow their guidance? I suspect a lot.

- Is this talking-head sticking their head out, or borrowing the consensus view? It takes a very bold analyst or portfolio manager to say something truly unique, if they don’t work for themselves. Why? Career risk. It matters less that you’re right or wrong, than it does if you’re opinion is accepted as convention vs. regarded as outlandish. If you’re outlandish, and wrong, you could be out on your arse, for having elevated your profile and combining it with an embarrassingly wrong bet. It’s OK to be wrong and part of the consensus (“Hey it’s not his fault…nobody could have predicted that…”). And obviously it’s OK to be right—whether your view was part of the consensus or truly original. Ironically, you’d think that being a correct  pariah would be great! Yeah, but the reward for being outlandish and right isn’t of equal consequence to the punishment of being outlandish and wrong. In other words, if you’re wrong, you could lose your job. If you’re right, could you double your income (making the bet even-sided)? No, not usually. For many well paid analysts, the primary motivation is to keep the gravy train coming, not make news. Their goal then is just to sound smart.

So am I trying to say that I’m right (about the Bear Market) because many in the press and on TV disagree with me for suspect motives? No. I could be wrong—done that plenty! Instead, I’m trying to take away a prime driver of viewers to cable business news: good advice. What little, rare, forward-looking and material advice there is is very hard to hear above the noise. Don’t bother.

CHART OF THE WEEK

Let me add one more reason to why I believe we’re in a Bear Market (even though we haven’t hit the 20% loss-from-peak yet). That’s the price of oil. Above is a chart of the OIL ETF going back three years. First note how much less demand there’s been for Oil. And as denoted by the arrow, the price of oil has been cascading lately. What’s it telling us? It’s implying that the world is headed into another contracting economic period…or at the very least, a near-flat overall global growth story. When one the most important base commodities is weak and weakening, it’s telling you the aggregate demand curve is shifting to the left. It also tells you that deflation is becoming a bigger and bigger problem. In both cases, it’s bad for the economy, bad for businesses, and thus bad for the stock market.

THE RICH LIFE: The much awaited new website for Valentine Ventures will contain a small library of to-be-filmed short videos on “rich living”—the balance of money and developing a life rich in things money can’t by, drawn from our experience and endeavor to understand the complexities of the transition to financial independence.

Week Ending: May 14, 2010

Greed kills!

My heart goes out to the investing public, particularly those in retirement that are in a financial calamity to a degree they could have never predicted just a few years ago. The combined effect of the 55% stock market crunch, coupled with the real estate implosion, has left many reeling.

The good news is that with diligent Financial Planning, and an investment approach that recognizes "risk" paramountly to "return," nearly all financial situations can be realigned and protected from further material decay.

The bad news is that instead of taking those approaches, it seems many are gambling on a return to their asset levels of old by hoarding risk assets (most notably stocks) now, largely because they perceive the stock market bounce to be a one-way ride to a return to financial freedom (Greed rules!). The classic pattern for many investors, as I’ve observed, began with too much exposure to risk assets in 2007, that lead to an inappropriate loss in the downturn, followed by a purging at the bottom (Fear rules!). Then, as the stock market’s recovered, the investment public has been desirous of more and more risk assets, the higher stocks go (Greed rules!)  Can you guess what the next part of this repeating cycle is?

The problem is that this approach is bass-ackward. You want to be accumulating risk as assets as they cheapen, and be purging them as they get expensive. Instead, good folks are committing the Gambler’s Sin—betting money they can’t afford to lose, in the hope of getting back money they've already lost. Or, to mix metaphors, it’s like an abuse victim going back to their spouse, thinking somehow this time they won’t abused.

Looking at the stock market’s recent strength another way, to be an aggressive buyer of stocks today is to ignore:

• Europe and China are in Bear Markets…right now. Can we avoid our own? I’ve never known the US to diverge from the rest of the world when it comes to Bear or Bull cycles.

• The fact that the market plunged massively on May 6 for still unexplained reasons. It’s as if it didn’t happen! It did. I believe the institutional investment community has a hair trigger, flash trading is bigger than nearly anyone appreciates, and thus any sell-offs will be sharp and be accompanied by above-average volatility. And as I said last week, many individual investors will blow out of the market early into a decline, for they regret not having done so earlier in the mess two years ago.

• The European Union is a dysfunctional mess, even if they’re putting on a nice face for the public. The latest PR notion they put out is that all member countries will submit their budgets for collective approval by the EU before taking them to their own parliaments. Yeah, right. The intractable conflicts between these countries date back centuries.

CHART OF THE WEEK

This investment (the pro-US dollar ETF, ticker: UUP) gave us a lot of grief at tax time, but it's performance of late goes along way to soothing that soreness.  The UUP is structured as a partnership, and as such, it sends K-1s to our clients--and they sure cut it close to April 15th this year, thus unnerving our clients and their CPAs, who had to consider refiling their taxes in light of the late arriving notices.  Unfortunately, the UUP is really the only pro-US Dollar (vs. Dollar Index) ETF, but thankfully, the Dollar's been a great investment over the last six months. 

THE RICH LIFE:  If you call the office at noon on Mondays, you probably won’t reach who you’re intending. We’ve just initiated the "VVLLC Monday Ride." It’s a lunchtime mountain bike excursion for those of us that work here. Anyone unable to make the jaunt will likely be who you find picking up the phone when you call us. This week, we had our first ride—a muddy, exhausting excursion on but one of Bend’s millions of mountain bike trails. What an exhilarating way to start the work week!

HEDGEHOG ARCHIVE