Something To Think About.

Mutual Fund inflow data out of AMG* this week reported that investors added money into funds at a very high rate in the first part of this year. I thought that I would go back and look at some other instances when individual investors were either adding money to the market or taking it out. The illustration above is a monthly chart of the S&P 500 Depository Index {SPY}* going back through the year 2000. The letters on the chart correspond to each entry below. {Note: You can click on the chart to make it bigger.}

A. March 2000: 44 Billion dollars is invested in equity mutual funds. 100 Billion is invested in the 1st Quarter of 2000. Result. (Stock Market begins its historic decline with the S&P 500 losing almost 50% of its value.)

B. February-March 2003: 15 Billion dollars is removed from the equity markets in the buildup to the 2nd Gulf War. 10 Billion of this is removed in the 1st three weeks of March. (Stock Market rallys over 30% between March and the end of 2003.)

C. November-December 2003: 25 Billion dollars is invested in equity mutual funds. (Stock Market returns are flat until after the 2004 Presidential Election. Market experiences almost a 7% correction between January and August. August of 2004 sees equity outflows of almost 2 Billion. From August the stock market advances over 11%. )

D. November-December 2004: Over 20 Billion dollars is placed in equity mutual funds. (Stock Market declines almost 7% in the first 5 months of the year.)

E. Mid October 2005: Dollars invested in equity mutual funds are basically offset by dollars being taken out of funds. (Stock Market rallies almost 11% in the next four months.)

F. January-February 2006: Almost 30 Billion dollars is invested in equity mutual funds in the 1st two months of the year. (Result ?????)

*Certain clients of Lumen Capital Management, LLC were long SPY at the time of this post. Although positions can change at any time. Mutual fund data can be found @ http://www.amgdata.com/

President's Day Posting

Light posting this weekend due to the President's Day holiday. As a reminder the Market is closed on Monday as will be Lumen Capital Management.

1) Mid-term election years tend to trade sideways for the first nine months of the year.
2) I am less worried about the consequences of the slow down in housing than others. Still I do think that there are housing markets that are overbuilt and where some people are going to get burned. Parts of the New York area may fit this bill. (See a glut in new homes)
3) Will commodities become more popular than hedge funds among institutional investors?
4) An interesting article on stock market tops and bottoms. A bit on the technical side however. You can find part 1 here. http://www.thestreet.com/_tscrmb/markets/marketfeatures/10269345.html. Here is part 2. http://www.thestreet.com/p/markets/marketfeatures/10269355.html
5) If you want to see a couple of articles about the Dutch response to disasterous flooding in 1953 go here.http://en.wikipedia.org/wiki/Delta_Works and here http://en.wikipedia.org/wiki/Oosterscheldekering. Unfortunately something long term like this probably needs to be done in New Orleans.

How To Count Performance?

Warren Buffett announced today that he was stepping down as a director of the Board of Coca-Cola. http://biz.yahoo.com/rb/060214/food_cocacola.html?.v=3. Buffett who controls his shares through an insurance holding company, Berkshire Hathaway, is Coke's largest stockholder. He owns 8.3% of the company or over 200 million shares. Buffett stated that he has no plans to sell his stock at this time. Buffett purchased shares in both 1989 and 1994. Based on an average "guesstimate" his total cost basis is probably someplace between $13 & $17 per share. For the purposes of this post let's pretend $15.00. In that case we could argue the following.

1. Buffett is a genius and shows the promise & benefits of long term investing. This a great American company. An icon of American business. His gain on these shares (assuming I'm close on the cost basis & using last nights Coca Cola closing price of $40.74) is almost 172%! It is even more if you include the dividend! Warren should hang on to what he has or perhaps buy more if the stock trades down. Over the long term it will be fine.

2. Buffett stayed too long at the party. The stock is a dog and is going nowhere. Besides he left almost 20 points on the table from where it was in 2000. He's down over 50% from its high in 1998! Coke has way underperfomed the market since then as well! He should have dumped this loser when he had a chance!

Well there is no right answer of course because different people have different investment horizons and goals. But how you view both sides of this coin says a lot about how you invest your money & how you look at the stock market.

No individual positions in either Coca-Cola or Berkshire Hathaway.

The Long Island Express {NBBT Part. III}

"Long Island and New England had been lashed by rain for four straight days. The air was unnaturally warm & muggy. Ears felt queer because atmospheric pressure was decreasing. In Vermont people noticed the smell of the seashore in the air"......The storm happened quickly. People on the southshore of Long Island saw what one of them described as a 'thick and high bank of fog rolling in fast from the ocean...When it came closer we saw that it wasn't fog. It was water. '....The storm surge stuck Long Island around 2:30 PM (near high tide) on September 21st 1938. So mighty was the power of that first storm wave that its impact registered on a seismograph in Sitka, Alaska, while the spray carried northward at well over a hundred miles an hour whitened windows in Montpelier, Vermont. *

With Hurricane Katrina back in the news this week as Washington holds still more hearings on what went wrong I felt the need to revisit N.B.B.T. again. The reason? Katrina didn't happen out of the blue. Everybody knew what would happen if a major hurricane hit New Orleans. All of the governmetal studies and Army Corp of Engineer reports basically detailed exactly what happened with the critical exception "THAT THE MAIN FURY OF THE STORM, i.e.the eye, MISSED THE CITY. That is all of Katrina's damage resulted from a near miss. So it could have been much worse. Yet in spite of all these studies New Orleans was not prepared. Forget about whose fault it was-government at all levels failed the citizens of New Orleans and the Gulf Coast. In the 1960's, New Orleans was lashed by Hurricane Betsy which also flooded its lower 9th ward and Camille just missed giving it but a glancing blow. In spite of this history it is beyond comprehension to understand how she wasn't ready for an event that was sure to come once again. But New Orleans isn't the only area to be ravaged by intense storms. New England is an unlikely place for most of us to consider devastating hurricanes but they do occur. Below is a brief history of the 1938 Hurricane that lashed New England. Katrina was likely a piker compared to this storm. To grasp the energy of these storms remember that a category 1 hurricane-one with winds blowing in excess of 75 m.p.h. is as powerful as 500 Nagasaki-type atomic bombs and contains more electricity than the entire United States uses in six months.

The 1938 Hurricane is the strongest tropical cyclone to strike the Atlantic coast between Virginia and Massachusetts since at least 1869. Every record for wind speed, tidal surge, and barometric pressure in New York, Connecticut, and Rhode Island - can be traced to this single event. In terms of fatalities and property damage - the 1938 hurricane stands as one of the worst disasters in American history. In a matter of hours, 600 people were killed, 3500 were injured, and more than 75,000 buildings were damaged. The states of New York, Connecticut, and Rhode Island, suffered their worst natural disaster in recorded history.

At the time of landfall on central Long Island, sustained winds in the 1938 hurricane have been estimated at 115 to 120-mph. However, the extreme forward speed of the storm (estimated at up to 50-mph) increased the winds on the right side of the storm to much stronger values. Some conservative estimates place the peak winds to the east of the center at 150-mph along the immediate coastline. Many who experienced the 38 storm along the immediate coastline, reported the sound of the wind reached an incredible high pitch - almost a scream.

The 1938 hurricane produced the some of the most extreme coastal flooding ever known on the United States Atlantic coast. The 38 storm created a very fast moving storm surge more characteristic of a strong category 4 hurricane (winds 131 - 155 mph). This occurred because of the combination of a strong hurricane, moving at an extreme forward speed (50-mph), and striking the coast at almost the exact time of the autumnal high tide. Tidal surges up to 16-feet above mean sea level on Long Island and Rhode Island, and up to 12-feet in eastern Connecticut, have been estimated. Newspapers reported damage to buildings more than 20-feet above sea level. The 38 hurricane also sent a tidal surge of epic proportions funneling up Narragansett Bay. The city of Providence was flooded with 14 feet of water, submerging hundreds of cars, trolleys, and buildings. Along the open ocean facing coastal roads in Rhode Island and Long Island - the damage was horrific.

Whole beach communities were swept away - some without a trace. Some sections of the Rhode Island coast never recovered from the storm. To this day - several inlets created during the 38 hurricane still persist - along with the slabs and foundations of several buildings. The day after the 1938 hurricane slammed into the United States the attention of the world was on major political events unfolding (Hitler invaded Czechoslovakia). It was more than a week before news of the appalling death and destruction along the U.S. Atlantic coast reached the rest of the World. {This history is paraphrased from geocities. You can find the whole article here. {http://www.geocities.com/hurricanene/hurr1938.htm}.

The 1938 hurricane has been estimated to have traveled from the Washington DC area to Long Island in about 12 hours. It put most of Long Island under water. Back then Long Island was largely pasture and summer homes. Today 7.4 million people call it home. It is 118 miles wide and 20 miles long at its widest. Its highest point is 122 feet above sea level. The 1938 storm submerged almost all of it. There are two major expressway arteries leading to New York City. Home to another 8 million people. It is estimated that 13 million people lived in the path of the 38 storm (it has no meteorological name-papers at the time dubbed it the "Long Island Express"). Today that same area has close to 45 million people. A sizeable percentage of which would be trying to evacuate the areas of prejected landfall.

The City of Providence erected a Hurricane Barrier after being flooded in 1938 and in 1954 by Carol (a category 2 storm that again submerged substantial portions of its downtown). To my knowledge no other major east coast city has any extensive hurricane systems or protections in place, nor are there any realistic plans for evacuating areas such as Long Island WHEN the next major storm arrives. As in New Orleans, government at all levels hopes to continue to kick this can down the road.

Except a category 3 hurricane of this sort lashes New England about once every 80-100 years. We're 78 years into this cycle so every year that passes just raises the statistical probability that such a storm will occur sooner rather than later. Allstate, the giant insurer of homes & automobiles, announced this week that it won't be renewing some homeowners policies in the New York area citing fears of massive losses in the event of a Katrina type hurricane. It has already said it wouldn't take on new home insurance in Westchester County, Long Island and the five boroughs of New York City. http://www.foxnews.com/story/0,2933,183980,00.html. Governments may take no action but don't be surprised to see private companies start to prepare.

*Paraphrased from The Glory & the Dream, William Manchester, Bantam Books, 1973. pp 183-186.

Some statistical data taken from various entries at www.wikipedia.com. There is a great book about this storm which is a quick and easy read. "Sudden Sea" by R.A. Scotti. Here is an Amazon.com link. Note. I don't endorse things nor am I compensated by plugging this book. I just thought it was a good read. http://www.amazon.com/gp/product/0316739111/102-4038786-1788913?v=glance&n=283155

End Of Year Letter

Stocks spent most of 2005 going nowhere! The Dow Jones Industrial Average was down -0.61%, the S&P 500 was up a bit over 3% and the NASDAQ Composite closed with about a 1.4% gain. 2005 will be remembered by investors as a year of skyrocketing energy costs with inflation as an uncertain part of the economic equation. The economy had to handle the aftermath of Katrina and the ongoing Iraq war continued to fester. Worse for investors who owned securities with fixed income, the Federal Reserve {hereafter the Fed} kept ratcheting up yields which made the market value of these investments decline. These economic headwinds kept stocks volatile but ultimately little changed. Stocks have now carved out a narrow albeit slightly rising base for the past two years.

Investors have voted with their feet. The U.S. stock market has not experienced the same influx of capital as other investments such as real estate, or even foreign equities. Investors can point to the history of this decade to justify their lack of confidence since all of the major averages still show losses from their 1999 highs. In fact one has to go back to the early 90’s to find a time when the major averages spent so much time doing so little. Yet I have been arguing since July for a more positive market going forward. I wrote then that stocks had the potential to rally, that a sea change in equity performance might occur going forward and that I was becoming less defensive in my outlook. (You can find a reprint of this @ http://lumencapital.blogspot.com/2005_07_01_lumencapital_archive.html) Let’s add to that letter’s conclusions today.

I want to show you two parallels to our current market atmosphere. Let’s first look to the 1970s. That was also a time when our economy was attacked by inflation, problematic energy supplies, a crisis of confidence in Washington, the residue of a foreign war (Vietnam) and a problematic Middle East. Today one could argue that the world's economic health is much better, and inflation, while still a concern, is lower than what we experienced 30 years ago as are interest rates. The S&P 500 declined at an annual rate of about 2% between 1970-1976. The S&P has lost a similar amount through the end of last year. The rest of the 1970’s were much better for stocks. It also set the stage for the great bull markets of the 80’s & 90’s when stocks in the S&P 500 advanced at an annual rate in excess of 17% PER YEAR.

Markets similarly went nowhere from the beginning of 1993 to the end of 1994. That too was a period where the Fed began an aggressive campaign of raising interest rates, which again were higher in that period then than they are now. Then interest rates were raised 7 times and like now the market was consolidating the run up that occurred in stock prices after the 1st Gulf War. When the Fed completed its work, the S&P 500 rallied 54% in an 18 month period from December of 1994 through May of 1996. That period also set the stage for the explosive markets that occurred later in the decade.

Now let’s look at the two primary missions of the Fed and why it matters so much to the stock market. The Fed’s primary mandate is price stability in order to keep inflation tame. Its second job is to formulate policies that maintain an environment conducive for sustainable growth in the United States. The Fed uses two basic tools to facilitate its policy goals: It can regulate the money supply and it can regulate interest rates. It affects interest rates by increases or decreases on the rate it charges banks to borrow short-term money or to borrow at the front end of the yield curve. Money added to the banking system plus lower interest rates are the tools of an "accommodative" Fed; a Fed trying to spark economic growth. However, if the Fed decreases the nation's money supply and raises interest rates, it is "tightening;" trying to slow the economy and stave off inflation. With today’s interest rate increase the Fed has raised interest rates 14 times in the past two years. Rates are now near a five year high. Investors will look for clues that the Fed is close to finishing its current tightening cycle. Once this is finished stocks could be primed for a much larger rally than many currently believe. History shows that stocks are usually higher 12 months after the Fed finishes raising interest rates.

Why would we revisit a position that we started talking about last summer? For one thing stocks are more attractively valued today than they were several years ago. The forward price earnings ratio on the S&P 500 is about 15 times next year’s earnings. While not as cheap on a going forward basis as some would like, it is an area of valuation from which stocks have rallied in the past. It is also worthwhile to note that this level of valuation is even lower on many larger capitalized companies that have essentially gone nowhere in the past two years. An end to interest increases could also expand the price-to-earnings multiple even more. Business conditions in the United States are generally good when one looks at the overall economy and much of the global economy is currently experiencing at least moderate, if not strong growth.

Now as usual a few caveats. The preliminary 4th Quarter GDP report issued on January 27th showed much slower than anticipated economic growth. The Middle East is again signaling that it will be a foreign policy concern and the growing economies of China & India are competing with the West for natural resources. This last point leads to a fear of a repeat of the inflationary cycle seen in the 1970s. While most analysts agree that any inflation worries could be a bit overdone, others argue that surging commodity prices (especially oil and gold) clearly signal higher prices. The aftermath of Hurricane Katrina could still exacerbate matters although history shows that price surges after natural disasters rarely continue for long. Finally 2006 is an election year. I think there is a larger possibility than most that the Democrats will recapture either the House of Representatives or the Senate and their doing so could insert an element of political uncertainty into the investment equation.

If I could use one word to describe stocks for most of the past two years it would be boring. Let’s face it. With the exception of a few narrow sectors in the market and a few well hyped companies, stocks have not stirred the investment juices for most people. However, I am hoping that we have shown by the above cited examples that boredom can be an investor's good friend as the long slow basing like we have experienced often sets the stage for significant price appreciation in the future.