Running Out Of Steam

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In an almost identical performance from the prior trading day, the early rally attempt on Wednesday was rebuffed, and the major indexes ended up essentially unchanged.

For the time being, it seems that selling sets in when the S&P; 500 moves to its resistance level in the 1,125 area. Even decent economic news could not prevent the slide.

Maybe it’s the calm before the storm on Friday when the Labor Department issues its nonfarm payroll report. Economists predict a loss of 75,000 jobs in February in part due to the winter storms.

If this number comes in much better, we might see another attempt to break through the S&P;’s resistance level. If it comes in much worse, we could see more acceleration to the downside. Again, there is no reason to make quick, irrational decisions; let the market come to you and execute your sell stops if/when necessary.

Will Gold Be The Next Bubble?

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If you believe the heavy hitters of the investment world, gold could be the next bubble as “Soros Signals Gold Bubble:”

George Soros is helping drive up gold prices by doubling his bet in a market even he considers a “bubble” as Goldman Sachs Group Inc., Barclays Capital and HSBC Holdings Plc predict more gains before it bursts.

Soros Fund Management LLC, which manages about $25 billion, increased its investment in SPDR Gold Trust, the world’s largest exchange-traded fund for the metal, by 152 percent in the fourth quarter, a Feb. 16 Securities and Exchange Commission filing shows. While prices have fallen 9.2 percent since reaching a record on Dec. 3, 15 of 22 analysts in a Bloomberg survey say gold will reach a new high, with the median forecast predicting a 17 percent advance to as much as $1,300 an ounce this year.

“When interest rates are low we have conditions for asset bubbles to develop, and they are developing at the moment,” Soros said at the World Economic Forum’s annual meeting in Davos, Switzerland, in January. “The ultimate asset bubble is gold,” he said.

In a Jan. 28 Bloomberg Television interview, the 79-year- old billionaire recalled that former Federal Reserve Chairman Alan Greenspan warned of “irrational exuberance” in financial markets three years before the technology bubble burst in 2000. The Standard & Poor’s 500 Index rose 89 percent in the period. Buying at the start of a bubble is “rational,” Soros said.

What is rational to George Soros with his deep pockets may or may not be rational to you. While a bubble may indeed form in the future, the path to bubble level will not be a smooth one and very likely be interrupted by violent price swings in both directions.

So don’t be lured by his assumptions, which may very well come true but could bankrupt you if you plowed a large portion of your assets into gold. Treat gold like any other investment by using a trailing sell stop to limit downside risk.

Getting stopped out does not mean you can’t reenter again, just be aware that gold can be extremely volatile and caution is advised despite its long term potential.

Disclosure: We currently have limited positions in GLD.

10 Rules For Buying ETFs

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I came across this article titled “The 10 Rules You Need to Know Before Investing in ETFs.”

While most are well known, I was surprised to see rule # 8 “Have an Exit Strategy;”

What would cause you to change your mind and re-evaluate your position? Is the reason you purchased the ETF still valid? Have the fundamentals changed? Have the technicals changed? “Consider the use of a stop loss, even a mental one that causes you to re-evaluate your holding,” says Jergovic.

I applaud this writer for including one of the most elemental safety nets of investing in this article.

Here’s rule # 10, which I want to hone in on a little bit:

Separate Your Serious Money From Your “Ice Cream Money.” Know the type of money you are investing in ETFs. Never speculate with serious money you cannot afford to lose, says Jergovic. “When investors speculate with serious money and invest long-term with ice cream money, meeting objectives becomes problematic.”

This is a very important topic, which I have discussed many times, but not written about. There are some investors with the urge to do big things, like the equivalent of hitting a home run in the investment arena.

Actually, I have clients like that. They have divided their money into two pots; a small one, which is called their play money and a larger one, which I manage, which I refer to as their serious money.

With that small pot, they do the wildest things in the market you could ever imagine, hoping for a big hit, while at the same time satisfying their gambling instinct.
There is nothing wrong with that if you are so inclined. Their serious money is invested conservatively with clearly defined risk as per the trend tracking principles.

Some investors I know prefer doing their own thing and are managing both pots. Therein lies the danger in that the goals for each can become blurred and overlapping with the result that a clear separation can’t be maintained.

If do your own investing, and you are facing this situation, be absolutely clear as to which account you are dealing with so that you never become tempted to do crazy things with your serious money.

Saving A “Good” Mutual Fund From A Bad Ride

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Stupid Investment of the Week,” mentioned some good mutual funds with a bad ride in 2008. Here are some highlights:

In a few weeks the worst of the stock market’s meltdown will fall off the short-term performance charts. In its place will be all of the rally, and one-year performance numbers that in some cases look downright showy.

Yet investors will not soon forget the misery of 2008, and while they will be happier with the rebound numbers, they should look at the longer-term picture to see whether the ride they have been on is the one they signed up for. In many cases, it won’t be.

One mutual fund where that is clearly the case is Masters Select Equity Fund (MSEFX), an offering with a good reputation but a bad ride that should have investors wondering if they’ve gotten what they paid for or if they own the Stupid Investment of the Week.

It’s not that MSEFX qualifies for the Stupid Investment of the Week; what qualifies for that distinction is holding any equity fund through a bear market.

MSEFX performed just like any other equity fund when the bear market of 2008 struck–it got clobbered. Let’s take a look comparing this fund to the S&P; 500:




The red arrow shows our domestic sell signal of 6/23/08. If you followed this sell recommendation, it would not have mattered that this fund performed worse than its peers or the S&P; 500; you would have been safely on the sidelines.

To me, the “Stupid Investment of the Week and the Decade” is holding any equity fund when the trend turns bearish and not whether a certain mutual fund “only” lost 40% while another one dropped 50%. This type of sick “outperformance” thinking permeates buy and hold where a “lesser” loser is considered a winner.

Disclosure: We have no holdings in the funds mentioned in the article.

Sunday Musings: Higher Interest Rates Ahead?

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Reader Jim pointed to an article titled “Bracing for Higher Interest Rates.” Here are some highlights:

That was the unmistakable message from the Federal Reserve last week when it increased the discount rate, the rate it charges banks for borrowing reserves. Although the move came sooner than many expected, it was a healthy step toward more normal conditions and a sign the banking system is healing. The Fed stressed that the move doesn’t mean any imminent rise in the more important federal-funds rate. Despite the soothing words, it’s a clear warning that near-zero interest rates won’t last forever, and that the Fed is prepared to act when necessary to raise rates.

In the abstract, this can’t be a surprise. With short-term rates near zero, and even longer-term rates the lowest they’ve been in my lifetime, interest rates really couldn’t go much lower. But the question has always been one of timing. It’s not clear exactly what the Fed means when it says it won’t raise the federal-funds rate for an “extended time.” Is that three months? Six? The Fed itself may not know for sure. But we now know it won’t be an indefinite period. The tightening cycle has begun.

This has significant implications for investors, since markets anticipate events. Assuming we are in the very early stages of a credit-tightening cycle, investors need a whole new strategy for a world of rising interest rates.

Reader Jim came to the following conclusion:

1. The dollar should increase in value
2. Gold should lose value
3. Junk bonds should lose value

So the trend is up for UUP, down for GLD and JNK. What you think?

While I agree that eventually higher interest rates will be in the cards, the timing part is the big unknown. Currently, we are stuck in a severe deflationary scenario along with a weak economy, both of which do not support higher interest rates.

Of course, the potential always exists that we end up in a “stagflation” environment, where economic growth stagnates and inflation rises along with interest rates. Articles like the above one make a good case, but that does not mean you need to adjust your investment strategy.

The key is to go with the trends as they are right now and make corrections if and when they change and not before. Why? Because you’re basing your decision on guesswork of what might be happening and not on facts as they are right now.

In Jim’s example, the major trend for UUP, JNK and GLD is up, and if you have positions wait until the trend turns before liquidating or, better yet, let your trailing sell stop be your guide as to when to get out. Wild guesses as to what may or may not be happening will inevitably lead to investment losses.

Disclosure: We currently have holdings in the funds discussed above.

Bond ETF Bubble Protection

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ETF Trends featured “How to Protect Yourself from a Bond ETF Bubble.” Here are some excerpts:

It’s going to happen sooner or later: interest rates can’t remain at record lows indefinitely. The Federal Reserve at some point is going to have to step in and raise them. If you’re holding bond exchange traded funds (ETFs), you need to understand the risks and how to cope.

Bond sales are booming. Nearly $400 billion has gone into bond funds since the start of last year. Those sales have pushed prices higher; corporate bonds and Treasuries have gotten increasingly pricey.

Where do you come in? The primary risk lies in inflation, Arends explains. As consumer prices increase, the interest you’re getting from your bonds becomes worth increasingly less. When bond yields are high, this isn’t much of an issue, but right now bond yields are low. Inflation could sock investors once it kicks in. But that’s not all: when inflation kicks in, the government tends to raise short-term rates.

Some people argue that bonds and related ETFs are a reasonable value, and inflation will stay subdued.

No one is certain about what’s going to happen or when it will happen. The best you can do is to be on your guard and ready to act.

Don’t buy mid- and long-term bonds at their current levels. Long-term bonds will be hit hardest when yields rise.

Consider corporate bond funds, which are offering attractive yields right now: SPDR Barclays Capital High Yield (JNK), iShares iBoxx $ High Yield Corporate Bonds (HYG) and iShares iBoxx $ Investment Grade Corporate Bond (LQD).

Check out TIPs bond funds. Treasury Inflation-Protected Securities are bonds with built-in inflation protection. Right now, the 20-year TIPS bond promises to pay about 2% a year on top of inflation. iShares Barclays TIPS Bond (TIP) or iShares Barclays 1-3 Year Treasury Bond (SHY)

Vanguard Utilities ETF (VPU) yields about 4%.

I have compared the various ETFs mentioned in the article in the above chart. The red arrow shows that all bond ETFs took a dive during the 2008 massacre, some more so than others.

What it comes down is that it really does not matter which ones you own from the above list, you still need to watch the long-term trend. Yes, that means that there are times when bond funds can be held and there are times when they need to be sold, which translates into the use of a sell stop.

As discussed in a previous post, depending on the volatility of the bond ETF, you can apply the same sell stop as with equities (7%), while for slower moving funds, you could reduce that to 5%.

Look at your risk tolerance and establish an exit plan “now” and not when the market heat is on and interest rates are heading higher.

While I don’t see this happen in the immediate future, you should, nevertheless, be prepared to act.

Disclosure: We have holdings in some of the ETFs discussed above.