New Quarter—Same Old Problems

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The bullish crowd got a scare Tuesday morning as this quarter started out with the Dow sinking by as much as 167 points with the other major averages in close pursuit. GM proved to be the savior of the day with better-than-expected sales reports for June, and the markets ended up closing in plus territory.

As much as the bulls are hoping this to be rally with legs, most likely it was just simply short-covering off a much oversold market. The problems of the year (low dollar, high oil prices and weak financial stocks) have not gone away and will most likely haunt the averages for some time to come.

Yesterday’s rebound had only a slight effect on our Trend Tracking Indexes (TTIs), which are now positioned as follows:

Domestic TTI: -1.47%
International TTI: -10.63%

As you know, we hedged our mutual fund positions (rather than selling them) on June 12 and as of yesterday that hedge has gained +1.21%. As time goes on, I’ll be reporting more from our continued hedging efforts using mutual funds and ETFs.

A New Beginning

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By now you must have heard that the just ended month of June will go on record as the worst June since 1930. The major indexes declined sharply with the broad S&P; 500 surrendering some 8.6%.

Half way trough the month, our domestic sell signal kicked in and pulled us to the sidelines before the markets fell off a cliff during the last couple of weeks. Our newly established hedged positions worked out well by gaining while the major averages were losing.

As of yesterday, and closing out the month, our Trend Tracking Indexes (TTIs) have remained below their long-term trend lines as follows:

Domestic TTI: -1.54%
International TTI: -10.15%

With a questionable earnings season upon us, along with constant disaster for financial stocks and ever climbing oil prices, what’s next? For a different viewpoint, Bill Fleckenstein wrote an interesting article called “The End of the Super Bubble.” Here are some highlights:

There is a budding realization that the housing bubble’s collapse will be more difficult than the masses and Wall Street had believed. You could see this last week as the market moved back toward the lowest levels since the collapse began last fall.

It’s now obvious that this is a problem not only for the consumer but for the financial system itself, which is in dire straits as it tries to deleverage, thereby compounding the problem.

For quite a while, many believed that because sovereign wealth funds were deemed to be flush with money, the banks and brokers could just grab some capital from overseas investors and cash-rich nations and go back to doing what they had done before. That has clearly turned out not to be the case.

However, leverage is quite capable of creating the illusion of liquidity. Thus what many had seen as excess liquidity was simply massive leverage, which is now being unwound. (The surfeit of savings, which is what “liquidity” alludes to, never existed.)

All of these problems trace their roots to Alan Greenspan’s years at the head of the Federal Reserve.

What began as small bailouts along the way ended with the blowoff of the stock bubble in March 2000. In an attempt to ease the effects of the bubble’s collapse, interest rates were taken to the absurdly low level of 1% and held there far too long. That engendered a housing bubble, which was nourished by the abdication of lending standards in the banking system — as securitization, spearheaded and championed by Greenspan himself, and deregulation of the banking system were thought to be the solutions to any imbalances.

Meanwhile, the aftermath of this housing/credit bubble is far different from that of the stock bubble. Now the lending institutions are swimming in bad debts. Homeowners have mortgages they can’t pay, just as the assets (houses) behind those debts are dropping in price.

As if that weren’t enough, consumers’ paychecks are eroding, thanks to galloping inflation created by the money printing that fomented the housing bubble (and by the credit that Greenspan’s replacement, Ben Bernanke, has subsequently thrown in to ameliorate the aftermath).

The truly sad part is that this outcome was foreseeable.It was possible to anticipate a catastrophe of such dimensions even when the housing boom was still in full swing. Unfortunately, the very institution that had the regulatory authority to supervise the banking system was the one leading the cheering — namely the Fed, in the form of Greenspan. (That was sort of like putting a bartender in charge of adjudicating disputes over breathalyzer readings.)

The collapse of the housing bubble is taking the economy with it and pressuring the stock market as well. Thus we will have all three markets feeding on each other as each deteriorates.

Unfortunately, the Fed is going to be faced with a Hobson’s choice: trying to respond to that triple threat while its hands are tied, to some degree, by inflation. When push comes to shove, the Fed will choose lowering interest rates over fighting inflation, but it won’t matter.

In his latest book, “The New Paradigm for Financial Markets: The Credit Crash of 2008 and What It Means,” George Soros makes the case that we are witnessing the end of a 25-year superbubble.

I certainly agree with his observation and would note that the time frame of this superbubble roughly approximates the career of Alan Greenspan, who in my opinion was responsible for its creation — and the enormous pain caused by its collapse.

I have to agree with Bill’s assessment, which pretty much throws a cloud on the future especially if you are looking for a place to put your money. I think that we’re still at a point where taking an outright short position could be hazardous to your financial health. Even though we’re below the long-term trend lines, violent blow off rallies ala 2000 could happen at anytime.

This is why I have done a lot of work designing simple hedge positions, which work well with mutual funds and ETFs (IRA and brokerage accounts) along with our Trend Tracking approach. It allows you to make money whether the markets rally or sink to lower levels. This type of a hedge smoothes out portfolio fluctuations and offers you continued market exposure, although much more conservatively.

Unfortunately, most 401k plans do not have the necessary fund choices available for hedging, so being on the sidelines in money market is your safest bet during these times of great uncertainty.

Reader Question: Re-Entering The Market

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With the markets having slipped into bear territory, some readers are looking ahead towards the point when a new Buy signal is being generated. Reader Ron had the following question:

Thank you for your excellent blog and services.

I have read through all the Reader’s FAQs, and I am still a little confused about your buy strategy.

Assuming I have $100,000, and I would like to buy 50% international and 50% domestic. At the next domestic buy signal, you mention you will enter position with only 1/3 of your allocation. I assume you mean you will buy 50,000 * 1/3 = $16,500. So when exactly will you enter position for the other 2/3 allocation of domestic fund?

Or do you actually buy the entire 50% domestic when you see the next buy signal?

While this is not an exact science, here’s how I approach it. The first issue is that we don’t know yet whether the domestic or the international Trend Tracking Index (TTI) will signal a Buy first. So you need to stay flexible and not go by the fixed assumption that you want to invest 50% international and 50% domestic—you need to let the market trends tell you what to do.

Lets’ say the domestic TTI signals a Buy first. Using your above numbers, I would allocate 1/3 of portfolio value ($33k) to that area. If the market continues to rise and your positions gain some 5% in value, I would add another 1/3 to that market and so on until you’re fully invested.

If, however, after you have committed the first 1/3 to the domestic market, the international TTI signals a Buy, then I would allocate 1/3 ($33k) to that arena as well, which will result in our portfolio being invested 66%. You can now sit back and watch which positions gain in value and add to those until you are 100% invested.

Alternatively, if you are more aggressive, you could also divvy up the remaining 1/3 in various sector and country funds, which will get you to a fully invested position much sooner.

Again, it all depends on your risk tolerance and your objectives.

Sunday Musings: Questionable Advice

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With the major indexes having jumped of a cliff this past week and into bear market territory, questionable (or even downright stupid) advice as to how to handle the current environment has made front page news. Two such stories were featured online, with the first one titled “Set It And Forget It.” Here are some highlights:

When the Dow rockets 300 points or the stocks of retailers, say, get decimated, I devour the news. After all, I work at a financial-news company. But here’s my admission: I’m a buy-and-hold investor, and a lazy one at that. My employer prohibits us news folks to trade equities on a short-term basis anyway, but even if it didn’t, I’d still buy and hold.

The bulk of my portfolio is in two retirement accounts, and neither stock-market gyrations nor major financial earthquakes prompt me to tweak my allocations. I simply hold a fairly routine mix of low-cost U.S. and international stock mutual funds, plus a bond fund, and I stick to it.

Given that I work in a business whose lifeblood springs from finding out what the markets are doing and why, I often question my lackadaisical approach to investing. Shouldn’t I be more worried, particularly in these volatile times?

In a word, no. The fact is, a buy-and-hold investor with a decently diversified portfolio should celebrate her ability to remain firm in the face of financial-news tidal waves which prompt many, less staunch, to jump in and out of investments, often at the worst possible time.

Some might say the staunch investor is akin to a passenger on the Titanic, refusing a lifeboat to safety due to misguided loyalty to the idea of “buy and hold.” But as long as three prerequisites are satisfied, that investor is among the most prudent savers around.

Those three requirements? A well-diversified investment plan, invested in low-cost index funds, with a long-term outlook.

It’s obvious that this author has either no clue what a bear market looks like (or the effect it can have) or her assets are so small that the outcome of a bull or bear scenario is inconsequential.

From the thousands of readers I have emailed with since the last bear market, there hasn’t been one who considers Buy and Hold and the subsequent devastation of assets a viable strategy.

Here’s another news story titled “Now’s the time to buy and hold:”

Investors may be seeing the “peak of negativity” in the markets these days, and that’s exactly why buy-and-hold types should be on the lookout for opportunities, T. Rowe Price’s chief investment officer said on Friday.

“Sentiment is so negative right now that you can’t help but make money in some of these companies if you take a three-year, buy-and-hold horizon,” Brian Rogers told attendees of the Morningstar Investment Conference. He expects it will take the next couple of years for the market to recover.

“Buying into stress is usually a good thing to do. And if you look for where there’s the most stress right now, you go to the financial sector,” he said. There are also opportunities to invest in the higher-quality end of fixed-income markets, including mortgages, he added.

Sure, you should not expect a different tune from a mutual fund, whose sole survival depends on you staying fully invested. “Buying into stress” is no different than buying on dips, which may work in bull markets but is an absolute no-no in bear markets.

Who is to say that this is all the stress the financial sector will experience? From my viewpoint, this market slide is only in the beginning stages (my guess), and those trying to be a hero by buying early will have their heads handed to them on a silver platter.

Even if this turns out to be the bottom, I’d rather wait for confirmation to the upside than taking a gamble and becoming another bear market casualty.

Nothing But The Truth

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In the past, I have referred to a variety of Al Thomas’s articles, since he happens to be one of the few who calls it as he sees it, no matter who he may offend in the process. I like this kind of thinking and appreciated his recent piece titled “Cash is a Position,” a topic which I have addressed on many occasions. Let’s listen in:

Cash Is A Position

You will never hear that from any broker. Even the discount brokers won’t utter it. Almost every investor I speak with tells me his account has lost value over the past several months. Most say they have lost about 20%. It is going to get worse.

Brokers tell investors that mutual funds are “safe”.

Safe from what? Certainly not from seeing your money disappear. They never want you to sell. Why? There are many hidden fees even in no-load mutual funds. Between the fund and the brokerage company they are skimming about 2% of your money every year. There are a few that do have less than ½% expenses, but they are few and far between.

In a brokerage company, if a broker had his clients go to cash he would be fired. That piddling 1% skim means a great deal to the office manager. His office is rated on the total amount of funds. If one of his brokers suddenly had his clients transfer several million to a money market account the next day the broker would not have a desk.

Mutual fund managers are paid by the total amount in the fund and NOT by how well or how much they make for shareholders.

When a broker gets his registration he is given two manuals. The first has all the rules and regulations of the Securities and Exchange Commission (SEC). He must not violate any of these or he will lose his license.

The second is a sales manual on how to open new accounts. That is basically every broker’s job – bring in new money and lots of it.

There is no third manual. What third manual?

That is how to make money for customers, but more important how to protect a client’s money from loss. During the 2000 – 2003 crash that saw the NASDAQ evaporate 78%, most brokers were in shock.

They asked their boss what can we do. He either did not know or was not allowed to tell them. Brokerage companies will sacrifice their customers rather than try to help them preserve their capital. Seems pretty horrible. That’s life on Wall Street. The current credit crisis is all about the greed for money. The little guy in a local office that you know just doesn’t know that he doesn’t know. He was never taught. It is not going to change.

It is your money. YOU must protect it. There are two choices. Find a fee based broker or financial planner (and most of them don’t know how to come in or out of the rain) or YOU must have an exit strategy.

Check the portfolio of the broker to see what he did in 2000 to 2003. Make him give references.

You may not like what I said. You will wish you did when it comes to retirement time.

I have been singing a similar song for a long time in preparation for exactly the times we are in right now. Markets go down a lot faster than they go up and, given the bursting of the bubble economy along with the fact that our domestic Trend Tracking Index (TTI) now clearly sits in bear market territory, 100% cash (money market) should be your position. The only exception would be, if you have taken measures to hedge your portfolio such as we did.

No Load Fund/ETF Tracker updated through 6/26/2008

Ulli Uncategorized Contact

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

Being on the sidelines or in hedged positions was the place to be as the bulls got slaughtered this week.

Our Trend Tracking Index (TTI) for domestic funds/ETFs broke decisively below its trend line (red) by -1.66% thereby confirming the current bear market trend.



The international index dropped as well and now remains -9.55% below its own trend line, keeping us on the sidelines.



For more details, and the latest market commentary, as well as the updated No load Fund/ETF StatSheet, please see the above link.