Solas- Republishing The Introduction

Solas! Republishing Introduction.

Solas!

Hello and Welcome! Every few months I will republish the introduction and disclaimer to this blog so new readers can find it.

As stated way back when, this is an experiment and Solas! so far seems to me to be the best opportunity to focus on what I want to write in a time efficient and hopefully interesting manner. However, please keep in mind that so far this is a hit or miss experiment. I don't yet know if this is going to work, how it's going to look or even if I am going to be satisfied with the end product. As a work in progress, especially at its inception, this may be a hit or miss endeavor. I don't know how and may never have time to do many of the things that make this look pretty or more professional. Nor am I going to take time away from my business to become an expert blogger. I do over time hope to make this better. I welcome your comments and suggestions.

What this is:

A learning experience. A way for me on occasion to make a point.

A way for me on occasion to discuss markets and investing.

A place for me on occasion to discuss the vagaries of life and perhaps editorialize.

A place to discuss the investment process.

What this is not:

A forum to tout any form of individual investments. (Particularly individual stocks).

A place for me to give individual investment advice. (Call me or others for this).

A theatre for me to tell you how wonderful I am.

An environment for me to make stock valuation claims i.e. "XYZ is worth 50 dollars!" If & when we do discuss valuations (as in our previous GE article it will be in terms of giving a range that a stock might trade within. That will be an opinion and nothing there should be construed as a guarantee of return or a guarantee that a stock will ever trade to an actual price.

And anything else that I might think of going forward.

One other thing. Where I discuss any individual security I will disclose whether I or clients currently own that stock or ETF. That disclosure is only valid for the day of the post as investments can change at any time. Any person who reads this blog and is not a client of Lumen Capital Management, LLC should either do their own research, give us a call or talk to their own investment advisor before making any investment based on anything written within the confines of this blog.

an tSionna: Mid Decade Patterns

There has been a theory making the rounds that 2010 will look something similar to 2004 as far as stock market performance goes. That theory, which is most heavily associated with Oppenheimer's chief technician Carter Worth, goes along the lines that the market spent most of 2004 digesting the gains posted in 2003. The last decade's first bear market ended with the the beginning of the second Gulf War.

While I don't know if I completely buy into his analysis (chiefly because I think the economy is different now), I do think we may be back into the seasonal patterns we saw during those mid-decade years, 2004-2007. That is there was a strong tendency for stocks to experience a run-up of share prices into year's end, then go through some sort of topping pattern early in the new year. This was then followed by a decline that generally lasted into mid-year. Ultimately each of these years saw some some sort of bottoming process of varying length which ended with a rally phase into year's end. Those rallies were often in excess of 10%!

Why did it work that way? Here's my thesis. Each of those years was marked by OK but not stellar growth. Each also had some external outside event that gave markets an excuse to sell off. 2004 was a presidential election year for example. 2005 saw the world worrying when North Korea announced that it possessed a nuclear bomb. Eventually those issues moved off the front burner, the economy puttered along and most importantly Wall Street wanted to get paid! Yes that's right for most people in my business the only number that matters is what the markets print on December 31st of each year! The higher that number goes the more many of us usually get paid or at least not fired from our jobs! Everybody in my business has an incentive to see stocks higher into the end of the year. That's what happened in each of those years we've highlighted in the chart above. Probably not a coincidence!

ETFs-Create Your Own Hedge Fund.

There is an interesting report currently out written by SEI and Greenwich Associates. The document, called “The Era of the Investor” discusses the current state of the Hedge Fund industry and where it is going. contains results from the firms’ second annual survey of institutional investors (conducted in November 2009) and is sure to generate a lot of press in the next few days.

This report was analyzed over at Seeking Alpha by Christopher Holt. Here are a few of the pertinent headlines.

-95% of the 96 institutional investors surveyed this year said they would either increase or maintain their hedge fund allocations over the next year.

-“Diversification” remains the #1 reason to invest in hedge funds – followed closely by “absolute returns”.

-During 2009, transparency rose in importance with over 70% of respondents said they now request “more detailed information from managers than they did a year ago.”

-Since last year, “poor performance” has been overtaken by transparency and liquidity as the main sources of “concerns” about investing in hedge funds.

-The report says that “fee pressures have intensified”

As to the why for hedge funds here is the Holt's primary observation.

"While “diversification” remains the #1 reason to invest in hedge funds,....this year, “absolute returns” ranked only a couple of percentage points behind."

Of course it is our main thesis that many hedge fund strategies can be replicated for individuals by strategies using ETFs. In fact we employ just such these strategies in many of the ways that we position portfolios especially in some of our more aggressive programs. After all, ETFs give investors many of the main objectives that institutional investors said they prized in the survey. They certainly provide diversification and they generally have low fees. Their investments to the extent one understands their underlying index are transparent and because they trade on exchanges they are in general pretty liquid.

In fact an investor that would have owned from December 31, 2008 to December 31, 2009 just the Nasdaq 100 ETF {QQQQ} and the S&P 500 Spyder {SPY} last year would have returned 40.36% which far exceed the S&P 500's 26.5% return and the 19.6% estimated average return for US pension funds.* There are many other strategies that can be adopted with ETFs that also give hedge fund like returns. If you are interested in hearing what we try to do in this area let us know.+

**Long ETFs related to the S&P 500 in client accounts. Long ETFS related to the NASDAQ 100 in client and personal accounts.

*Source for this total return information came from the S&P Spyders website and the Invesco Powershares website. Source for estimated pension returns; Pensions & Investments; January 25, 2010, p.3. Please note that this example refers to a very simple example where an investor would have employed a simple buy and hold strategy with just two securities. This example also assumes that an investor held no cash or other securities in this hypothetical portfolio. Cash holdings in this portfolio would have likely resulted in a portfolio that did not return the above stated amount. It should also be noted that a portfolio that employed this strategy would have suffered a substantial draw down in last years first quarter before beginning a recovery in early March. Nothing here should be understood as a guarantee that such results could occur in the future or that any individual portfolio could have returned this exact amount last year as commissions, size of the portfolio and exact purchase price could have impacted the final return. Please do not emulate such a strategy until you have discussed this with your own financial advisor or initiated some investment research of your own.

+Lumen Capital Management maintains a portfolio strategy for more aggressive investors that mimics certain hedge fund strategies generally with ETFs. This portfolio is not suited for all individual investors. While we have every confidence in our ability to add long term value to this portfolio, nothing here should be construed that these strategies will be able to remain effective on an ongoing basis.

The Era of the Investor

Egg On Face?

So far it looks like most of what I wrote this morning is turning out to be wrong as investors have more time to digest what's occurred since yesterday. A couple of brief thoughts:

1. Plainly markets are still under distribution (liquidity is still being withdrawn). That being said we are now becoming more oversold and the odds of some sort of short term rally increase. While I thought the odds of stocks being higher today were pretty good prior to the open, I also stated that "you have the recipe for some sort of bounce in stock prices over the next several days. While that may not be today I still think some sort of rally is possible during that period.   One of the Boston Boys tells me that most of today's decline has to do with concern on the solvency of Greece and is not so much a response to President Obama's speech last night. 

2. Notwithstanding that statement I am seeing some more technical damage to some of my investment positions that may necessitate us to become a bit more defensive in our investment posture than we currently stand. I said we'd listen to the market for clues on what to do. The clues so far seem to indicate that the character of this market is changing.

3. On a relative basis financial stocks & ETFs seem to be holding up much better than the rest of the market. I find that an interesting development. {Note: I am long certain financial ETFS and certain bank stock preferred stocks in appropriate client accounts.}

an tSionna-Illustration

Here's a follow up to our post of this morning.  Probably should have included this when I wrote that piece.  This should clearly show the resistance levels I've been referring to recently.

*Long ETFs related to the S&P 500 for client accounts.

A Premarket Thought

Yesterday gave us an investment trifecta: Apple announced its Ipad, the Federal Reserve announced its policy going forward on interest rates and the President delivered his State of the Union Address. At least in the short run I think all three are slightly market positive.

-President Obama seemed have read the electorial winds and moved slightly towards the political center. That at least seems to be what the opinion shapers are saying this morning. For the moment (pre-market as futures are higher this morning) markets are interpreting this as a positive.

-The Fed's statement yesterday afternoon showed almost no change from its past announcements. Markets seem to be interpreting this today that the very low interest rates we've seen most of the past year will remain in place at least through the summer.

-Ipad introduced by Apple yesterday I think will provide enough of a "wow" factor to help tech stocks at least in the short term.

Add to this a market that on a very short term basis has become somewhat oversold and you have the recipe for some sort of bounce in stock prices over the next several days. Again, remember if we are experiencing a change of trend then it will likely show itself in the nature of any rally we see in the next week to 10 days. A weak rally that either falters after a couple of days or fails decisively at the overhead resistance we've highlighted this month would be indicative in the least of a range bound market and on a more negative basis a market that wants to move lower.

On the other side a market that moves higher through resistance would be indicative of a market that has simply paused in its rally similar to what we've seen several times since the market bottomed out last March. We of course have no way of knowing what way we'll go. We've become more defensive in our tactical orientation this past month. In some accounts based on their own risk/reward criteria that thinking has caused us to raise a slight amount of cash. That however should not be interpreted as us becoming bearish overall on the markets for this year.

As I've stated before I think stocks have the potential to trade between 1,250-1,350 on the S&P 500 by year end. But one of our overriding disciplines is the study of money flows and those have turned slightly negative since mid-month. We have to follow their lead as part of the game plan. That same money flow analysis will be our guide as we go forward into this year. In other words we're going to listen to the market and let it give us our clues on what to do whether we go higher or lower from here.

*Long Apple Computer in several client accounts as legacy positions. Long ETFs related to the S&P 500 in certain client accounts.

What's Wrong With The Economy?

Published January 20, 2010 in the Wall Street Journal. {Excerpt with link at the end. Highlights are mine.}

Unlike previous recessions, the current downturn was not caused by Federal Reserve tightening and therefore couldn't be reversed by lowering interest rates. President Obama was correct to conclude that boosting economic activity required a fiscal stimulus.  Unfortunately,....most of the President's economic policies have done little to help the problem. And indeed, many of these policies have created even more problems than they solved.

For starters, the president allowed congressional Democrats to design the $787 billion stimulus package. The result was an unnecessarily large increase in the national debt for a very modest rise in gross domestic product, with too much emphasis on redistributing income and preserving public-sector jobs and not enough on raising economic activity. Only about one-fourth of the nearly $800 billion will be used for government spending that adds directly to GDP. In contrast, the funds given to households will be largely saved or used to pay down existing debts. And the dollars that went to state governments relieved pressure to use their "rainy day" funds or levy temporary tax increases......

.....The flaw in the stimulus package wasn't, as some say, that it was too small. It was that it was poorly targeted. Instead, Congress and the president could have gotten more stimulus from accelerating the repairing and replacing of equipment in the civilian and defense sectors. Long-term reductions in marginal tax rates of the type used by Presidents Kennedy and Reagan would also have been better than temporary tax cuts that have no positive incentive effects.

Other programs by the administration have had similar failings. "Cash for clunkers," for instance, was successful in raising auto buying and gave a temporary boost to GDP, since two-thirds of the third-quarter GDP rise was motor-vehicle production. The credit for first-time home buyers also gave a temporary boost to the housing market. But both programs just borrowed demand from the future.

In health care, President Obama has focused his efforts on adding some 30 million lower-income individuals to the Medicaid rolls or giving them means-tested insurance subsidies.....Because the new health law would require insurance companies to ignore pre-existing medical conditions, millions of middle-income individuals would have a strong incentive to drop their current coverage, pay a small fine for being uninsured and buy insurance only when they need expensive care. If that occurred, then Congress would want to completely revise the health-care legislation, pushing the country closer to publicly financed insurance for all. Perhaps that was not unintended.....

...Local banks around the country have cut back business lending because they fear future losses on existing real-estate loans. The administration's plan to prevent mortgage defaults by helping millions of homeowners reduce their monthly mortgage payments fizzled down to helping just a few hundred thousand. Moreover, nothing was done to reduce the incentive to default among the 15 million homeowners whose mortgages now exceed the value of their homes. And nothing has been done to deal with the $1.5 trillion of distressed commercial real-estate loans that will have to be rolled over during the next five years.  The administration's plan to induce local banks to sell impaired loans to nonbank investors....failed, despite generous proposed subsidies, because banks don't want to reduce their accounting capital.

Although solving the banking and real-estate problem is key to recovery, the President's focus on his health legislation and the public's concern about future deficits appears to have stopped him from dealing with these problems....

The enormous increase in budget deficits and in the national debt is one of the most worrying aspects of the Obama administration's first year. The Medicaid expansion and health-insurance subsidies would add nearly $1 trillion to the national debt over the next decade......

...The International Monetary Fund estimates that annual U.S. budget deficits will be about 7% of GDP from 2012 through the end of the decade. Such deficits would absorb virtually all of the nation's household and business saving, thus reducing the funds available for business investment and housing construction that are needed to raise productivity and our standard of living. It will also keep the U.S. dependent on inflows of funds from the rest of the world.

—Dr. Feldstein, chairman of the Council of Economic Advisers under President Ronald Reagan, is a professor of economics at Harvard University.

Link:   Feldstein-Missing The Target

Harvest Season: Making The Most Of Your Losses.

Last summer we did an entire series on Capital Gains and Losses. If you want to review what we said then and what was our logic for taking these losses go to these posts: Tax Loss Synopsis, Losses in Taxable Accounts and Losses in Tax Deferred Accounts.

Turns out others agree with me, especially when it comes to ETFs. Below is an article in ETFR Magazine that makes most of my same arguments. Below are excerpts. Highlights are mine.

"For the majority of investors, 2009 has been a year of recovery and some chunky capital gains; in other words the complete opposite of the previous one. For those who are invested in ETFs, such a volatile back-to-back performance has created the perfect environment in which to harvest capital losses in order to maximize returns.

Tax loss harvesting works like this: If an investor is showing losses on a particular security, he or she can sell that security and book the capital loss for tax reasons. The investor then has one of two choices: either keep their money in the new securities, or switch back into the original investment, after no less than 30 days. In either case, the result is that the loss incurred on the original investment can be rolled over into profits elsewhere, reducing the amount of capital gains tax the investor ends up paying.

There is nowhere this strategy makes more sense than in the world of ETFs. With a rapidly expanding number of funds, along with record sums in assets under management this year, its getting easier and easier to find ETFs that are almost exactly correlated to one another......

Tax loss harvesting is about the closest thing to a free lunch in investing. You sell one position and buy another that will give a similar performance, hold it for 30 days, and switch back.....

The IRS does have some rules around exactly what can and cannot be swapped and qualify for a tax loss. Specifically the IRS requires that two products cannot be 'substantially similar'; it doesn't want you making the swap exclusively for tax reasons, selling one security and immediately buying it back. It requires the two securities to be different.

Unfortunately, they've never said exactly what that means and {one} can find advisers who are cautious or aggressive in interpreting this mandate.....Most people agree that two funds tracking different indexes meet the IRS' guidelines, but in practice, there will never be a major month-to-month variance in performance between {different funds that basically track the same index but are comprised of certain different components}.....

An investor should always consider transaction costs and trading risk when executing tax loss harvesting strategies, but generally speaking, it's a straightforward way to boost overall returns."

Comment: There is a bit more to this subject than what this article briefly sketches out. I'd refer you again to my series on this topic if you would like a bit more detail. Here is however someone else making my same arguments regarding losses. The article also sites certain examples of how this could be done using specific ETFS which I don't believe are germaine to this post. I have a copy of this article and I would be willing to discuss the examples Harrison uses should any of my readers be interested. Also a brief reminder that we at Lumen Capital Management, LLC are not in the business of giving out tax advice regarding portfolios. Individuals should consult with their own tax advisers and also talk to their own investment advisers before implementing these kind of strategies.

Source: "Harvest Season: Making the Most of Your Losses", Daniel Harrison, ETFR Magazine, November 2009, Pages 6 & 12.

Today's close.

A very disappointing close today. Market just gave up the ghost in the last hour. We've said we'll look for clues by how the market reacts as it tries to rally.  Today's action was different from what we saw most of last year, especially in the last six months.  Then stocks would rally into the last hour.  Recently they have been sold in the last 60 minutes.  Liquidity is being withdrawn right now.

Perhaps tomorrow's news out of Apple will help or at least blunt what many "Wall Streeters" are expecting to be a very populist State of the Union speech from President Obama. On a short term basis by our work the market is becoming over sold so that may help here in the next several days. I may have more on this tomorrow depending on how we open and how we trade during the day.

*Long ETFs related to the S&P 500 in client accounts. Long Apple Computer as legacy positions in several client accounts.

10 Things That I'm Pondering.

Things that I scratch around in my notebooks. {Some we'll perhaps cover in more detail in subsequent posts}:

1. Whether that 10% rally we saw in stocks November to early January was the real thing or end of the year portfolio goosing by mutual fund managers.

2. Whether the Obama Administration after setbacks in elections and on health care will take to the center or lash out and become more populist. Populism is likely a multiple contracting event for stocks.

3. Whether tomorrow's expected tablet announcement from Apple Computer will have a positive effect on technology stocks or if it's already baked in.

4. What did yesterday's less than stellar stock market rally mean?

5. What are the long term implications from the tragedy in Haiti?

6. What is the market telling us that the response to this year's earnings season so far has been to sell the mostly good news coming from America's corporations.

7. Where is a good place right now to put new investor's money? Have we adopted enough of a defensive posture in client portfolios commiserate with their profiles?

8. What are the possible unlooked for events that could have a significant impact on the economy and on stocks?

9. On a timeline basis how far along are we into the "Great Reset"?

10. When will we see warm weather in Chicago? When will the Cubs win the World Series? Will Indianapolis win the Super Bowl by 10 or 14 points?

*Long Apple Computer in several client accounts as legacy positions.

an tSionna 1.25.10

Well now we know that our concerns flagged through the past couple of weeks about the markets were warranted. We took on a much more defensive posture in our thinking last week-making some sales in risk appropriate accounts depending on their known investment criteria and depending on various other factors such as current cash positions and what they owned. We could become more defensive depending on what we see early next week and the nature of the inevitable rally that should occur after this kind of sell off.

Stocks first showed cracks by behaving poorly off of both IBM & Intel's earnings this month. What I think most surprised the market was the attacks on the banking sector by the Obama Administration on Thursday. Credit tightening in China and speculation on the Re-appointment of Federal Reserve Chairman Bernanke added to the negative mix. Given this sort of news mix we should not wonder that liquidity dried up and the buyers disappeared. People are so often amazed at how quickly stocks can decline often giving back days and weeks of movement in very short periods of time. That is unfortunately the nature of modern markets where traders can move thousands of shares with the single flick of a computer mouse and low commissions make it easy to re-enter positions at any given moment.

Stocks have experienced weeks if not months without a serious correction of 10% or more. That's why a drop of close to 5% in three trading days is concerning. A drop that happens this quickly should be followed by a counter trend rally of some sort. We will get our first clues about the nature of trading going forward by what follows. A market that stabilizes and recovers and ultimately takes out the early January highs would likely be considered a bullish development. It would also be in keeping with how stocks have traded since last March.

However a market that fails at those early January highs and or makes a series of lower highs and lower lows could mean that the character of trading is changing and would force us to become much more defensive in our investment posture. As usual we will let our analysis of the money flows be our guide.

There are a lot of longer term positives. I still think the economy is rebounding and think stocks have an attractive valuation longer term based on what we know right now. Company earnings and forecasts so far have trended positive and may ultimately save stocks. But I do think we need to be aware that the market is giving us a heads up that things could be changing.  Stocks are likely to behave differently going forward into 2010 and the trading environment looks like it will be more challenging than what we have seen since last spring.

*Long ETFs related to the S&P 500 in client accounts.

Obama, The Market & The Banks.

President Obama went after the banking sector on Thursday. The market obviously didn't like what it heard. This was not the only reason stocks sold off-tightening of money in China and a so far lack-luster start to earnings season-contributed also to the decline. We've shown you here: Two in One Week and here: A different look. our concerns for the market's behavior. President Obama certainly didn't help matters much.

*Long ETFs related to the S&P 500 in client accounts. Long certain banking stocks {although none of them are mentioned in this article} in certain client and personal accounts. Long ETFs related to the banking sector in client and personal accounts.

Roth IRA's

I've spent a fair bit of time since the beginning of the year researching whether or not it makes sense to suggest to clients to convert traditional IRA's over to Roth IRAs.  It's a complicated subject, not given to one blanket recommendation. Most of the accountants I've spoken too think that high income wage earners should take advantage of the provisions, especially if the IRA holds assets not easily marked to market.  However, at least one that I've spoken to thinks doing the conversion isn't worth the time and effort especially because it generates a tax bill in a year when money for a lot of folks is still tight.  Below I've excerpted a Barrons article on the subject from last week.  I'm still trying to work out what I think of conversion for clients.  Here's what Barrons said.  (Highlights mine).

You Can't Take It With You, but You Can Convert

By J.R. BRANDSTRADER

WANT TO LOCK IN A TAX-FREE LEGACY for your heirs this year? Well, if you're wealthy enough to have built up assets that normally would be subject to the estate tax, this is an excellent time to meet your maker -- because that onerous levy has at least temporarily been eliminated. But a less drastic course would be to convert your traditional individual retirement account into a Roth IRA.

On assets held in a traditional IRA, taxes are deferred until distribution. This is because for people in certain income groups, contributions to a traditional IRA are tax-deductible. So Uncle Sam demands part of any gains when withdrawals are made.

Distributions from Roths, in contrast, are tax-free, because contributions are made with after-tax income. So, even if you don't give a hoot about Junior, converting to a Roth may still make sense -- given that there's a strong possibility that taxes will rise. Says Vern Saper, an employee-benefits attorney with the law firm of Warner Norcross & Judd in Grand Rapids, Mich.: "After 2010, tax brackets will revert to their pre-2001 levels. That means the highest four brackets will be 39.6%, 36%, 31%, and 28%, instead of the current 35%, 33%, 28% and 25%." And given the enormous national debt, there's little reason to believe that taxes will subside in the near future.  For retirees, Roth IRA distributions usually -- there are exceptions -- don't count as taxable income, whereas distributions from a traditional IRA do.

THE PROBLEM WITH CONVERTING a traditional individual retirement account to a Roth is that the amount being converted is immediately taxable.  However, with many retirees' nest eggs having been reduced substantially by the stock market's 2008-early '09 swoon, the taxes that would be owed after a conversion have been reduced, too. Better still, Uncle Sam is allowing the payments to be delayed. They can even be spread out over 2011 and 2012. What happens if the market takes another sickening nosedive? You can "recharacterize" -- meaning undo -- the conversion.

Says New York-based John Carl, president and founder of the Retirement Learning Center in Brainerd, Minn.: "Let's say you convert $100,000, and the market tanks. You can recharacterize, and it would be like it never happened.".........Despite all the potential benefits of converting to a Roth IRA, David Fusco, a certified public accountant and financial planner in Staten Island, N.Y, wonders how popular converting will be......adding that people are still reeling from the recent Wall Street meltdown and don't want to think about their finances......Fidelity finds that only 7% of investors surveyed say they will convert to a Roth IRA now, and that 88% are unaware of the opportunity.....Government mistrust is another factor. A TD Ameritrade survey found that 36% of ideal candidates for conversion suspect that Washington will somehow change the rules later to help reduce the national debt, partially at Roth IRA holders' expense.....

.....So should you convert?....{T}he younger you are, the greater the advantage because of the time value of money allows your investment to compound tax-free, rather than tax deferred.... Roths have another advantage over traditional IRAs: There are no mandatory withdrawals after the age of 70½. (Mandatory withdrawals were suspended for 2009 because so many portfolios were hurt by the financial crisis -- but just temporarily.)

The Bottom Line:

Converting to a Roth IRA can help reduce taxes on retirement assets. But most investors will need expert advice to navigate the thicket of tax laws -- and the risk that these might change.  In general, the move makes sense if you don't need the money, you want to prepay taxes for your heirs, you will be in a higher tax bracket when you retire...or you have battered investments and want to reposition them.

You may want to pass if you have to use IRA assets to pay the taxes or any penalty on the conversion. "You shouldn't make the conversion unless you have the resources set aside to pay the taxes. Don't do it if you have to sell stock or other securities to pay the bill," says Elizabeth Ruch, a San Diego-based financial advisor at Waddell & Reed.  Above all, don't do this on your own. The rules are many and complex, and without expert advice, you could end up owing more than you figured.

Link:  Barrons on Roth IRA conversions

Massachusetts

As I'm writing this the market is selling off, giving back most of Tuesday's gains. I've had a few folks question me on why that should be the case given Scott Brown's Massachusetts's upset Tuesday night. Here's my two cents.

First I think we're seeing a sell the news mentality. Markets discount the future. It always is more interested in tomorrow than today. Coakley's plight and the possibility of a Republican pulling off the political upset of the century began to seep into investor's mindset over the past two weeks. By yesterday most polls showed her running behind and the Democrats began to lower expectations about her survival over the weekend. It's likely Tuesday's rally in the face of the election came in anticipation of Brown's victory.

Second I think it is somewhat unclear where this means we're headed. Now in the short term it means that the Democrat's Washington agenda has been compromised. Initiatives such as a carbon tax for example are likely dead in the water this year. This election along with Democratic gubernatorial losses likely mean a democratic tack to the center over the course of 2010. I think that this is a net positive for stocks in 2010.

I am not as prone to thinking that health care reform is completely dead in the water as perhaps some others. I still think we're going to have some kind of health care package this year-the President and the Democrats have staked too much political capital for them to just go away on the issue. Whether they will try to pass the bill through now as it currently reads or tear it up and start from scratch is probably a better investment issue to analyse. As this becomes more clear in the days and weeks ahead then I wouldn't be surprised if health care stocks and maybe the market in general jostle around. Health care companies are still statistically cheap. I'm long certain health care ETFs in appropriate client accounts and I think the sector could do well in 2010. But it wouldn't surprise me if they went to sleep and even drifted lower in the coming weeks and months.

Finally I keep coming back to the troublesome fact that the market is up close to 10% since November first. That kind of advance at some point needs to be worked off. We've touched upon this a couple of times with charts in the past week. Stocks have now experienced three pretty good sell offs in the past six trading days {that's 50% for those of us arithmetically challenged.}. The action of the tape continues to be choppy. This is often the action that makes for short term tops. Not saying that this will happen but like we discussed last week it is the sort of action that makes us want to be more vigilant on stocks. Time to dust off and review the defensive pages of the playbook in case we need them in the coming weeks and months.

Bogle Editorial {Repeat}

We ran this editorial article last year and I think it also bears repeating about once a year.  I have a lot of new readers since we last ran this.  {Highlights are mine!}

John Bogle of the Vanguard Group of Mutual Funds has an editorial in today's Opinion Section of the Wall Street Journal. I've decided to excerpt this as this seems to be the week of lists around here.

Here is the full article: http://online.wsj.com/article/SB123137479520962869.html

Six Lessons for Investors

Be diversified and don't assume past performance will continue.

There is almost no limit to the ability of investors to ignore the lessons of the past. This cost them dearly last year. Here are six of the most important of these lessons:

1) Beware of market forecasts, even by experts. As 2008 began, strategists from Wall Street's 12 major firms forecast the end-of-the-year closing level and earnings of the Standard and Poor's 500 Stock Index. On average, the forecast was for a year-end price of 1,640 and earnings of $97. There was remarkably little disparity of opinion among these sages.

Reality: the S&P closed the year at 903, with reported earnings estimated at $50.  Strategists aren't always wrong. But they have been consistent, betting year after year that the market will rise, usually by about 10%. Thus, they got it about right in 2004, 2006 and 2007, but also totally missed the market declines in 2000, 2001 and 2002, and vastly underestimated the resurgence in 2003. Ignore the forecasts of inevitably bullish strategists. Bearish strategists on Wall Street's payroll don't survive for long.

2) Never underrate the importance of asset allocation. Investing is not about owning only common stocks. Nor are historical stock returns a sound guide to future returns. Virtually all investors should keep some "dry powder" in their portfolios.....With all the focus on historical returns that greatly favor stocks, don't ignore bonds. Consider not only the probabilities of future returns on stocks, but the consequences if you are wrong.

3) Mutual funds with superior performance records often falter. Last year was an extreme example. With the S&P 500 off 37% for the year, Legg Mason Value Trust fell by 55%. Fidelity Magellan Fund, after a good 2007, was off 49%. Funds managed by proven long-term pros felt the pain -- Dodge and Cox Stock down 43%; Third Avenue Value down 46%; CGM Focus down 48%; Clipper down 50%; Longleaf Partners down 51%. (Full disclosure: Four of Vanguard's actively-managed equity funds also lagged the market by wide margins.) Only time will tell whether the disappointing shortfalls experienced by these and other funds will be recovered in the future, whether the skills of their managers have atrophied, or whether their luck has run out. Whatever the case, chasing past performance is all too often a loser's game. Managers of funds seeking market-beating returns should make it clear to investors that they must be prepared to trail the market -- perhaps substantially -- in at least one year of every three.

4) Owning the market remains the strategy of choice. Such a strategy guarantees a return that lags the market return by a minuscule amount, and exceeds the return captured by active equity-fund managers as a group by a substantial amount. Why? Because the heavy costs incurred by investors in actively managed equity funds can easily amount to 2% to 3% annually.....As a group, investors are by definition indexers. (That is, they own the entire market.) So indexing wins, not because markets are efficient (sometimes they are, sometimes they are not), but because its all-in annual costs amount to as little as 0.1% to 0.2%. Indexing won in 2008 by an especially wide margin. Low-cost, low-turnover, no-load S&P 500 index funds outpaced nearly 70% of all equity funds, and (admittedly a fairer comparison) more than 60% of all funds focused on large-cap U.S. stocks.

5) Look before you leap into alternative asset classes. During 2006-07, equity mutual funds focused on developed international markets and emerging markets provided strong relative returns to U.S. stocks. During that period, U.S. investors made net purchases of $285 billion in mutual funds investing in non-U.S. stocks, and liquidated on balance some $35 billion from funds focused on U.S. stocks. This extreme example of "performance chasing" at its worst is hardly defensible. But, disingenuously, it was touted by fund marketers as adding "non-correlated assets," or "reducing volatility risk." In 2008 -- with non-U.S. developed market funds falling by 45% and emerging market funds tumbling by 55%, we learned once again that, just when we need it the most, international diversification lets us down. Commodities were no different. As the global recession developed, commodity funds sank, the largest such fund tumbled 50%. Always keep in mind: When the investment grass looks greener on the other side of the fence, look twice before you leap.

6) Beware of financial innovation. Why? Because most of it is designed to enrich the innovators, not investors.....Our financial system is driven by a giant marketing machine in which the interests of sellers directly conflict with the interests of buyers. The sellers, having (as ever) the information advantage, nearly always win. ....While the events of 2008 reinforced that message, perhaps these stern and oft-repeated lessons of experience will help investors avoid similar mistakes in 2009 and beyond.

Note: I'm not sure I completely agree with Bogle on point six. After all it was financial innovation that gave us index funds of which his Vanguard group is a huge investor. I think I'd rather say beware of financial innovation that has not been around long enough to withstand the test of bull, bear and sideways markets.

*Long as of 1.19.2010 ETFs related to the S&P 500 in client accounts.

10 Things Investment Pros Do That Amateurs Don't! {Repeat}

Ran this last year.  I think it bears repeating at least annually. 

1. Pros always have cash


2. Pros tend to worry less about the day to day with stocks and try to focus longer term.

3. Pros try not to invest in things they don't know.

4. Pros recognise that not everything is analyzable.

5. Pros are as concerned with the downside as the upside.

6. Pros always look; they never avert their eyes from a downturn.

7. Pros accept that not everything works or is going to work at once.

8. Amateurs are worried that they aren't making enough but pros are worried that they are making to much money.

9. Pros do their homework.

10. Pros know things go wrong. They are more likely to cut losses and let profits run.

Barron's Round Table.

Each year Barron's magazine publishes a three part round table series where they interview some of the "wise old men and women" of the investment business. It is usually early in January and published serially later in the month. Along with their prognostications and picks for the coming year, Barron's also  gives the performance of the stocks recommended by the participants from last year. We published a review of how they did last year.  Here is a link to that post:  Barrons 2009 Round Table Review  Here is how they did this year.

Collectively as a group last year they made 83 specific recommendations.  On a collective basis these returned 43.78% which handily beat the S&P 500's 26.5% return.  However, it is not clear to me whether some of the investments sited in this article could have been purchased by the average investor.  For example Felix Zulauf last year recommended the purchase of crude oil.  That investment would have returned 71.3%.  However it's pretty hard for the average investor to buy crude and the ETF which tracks oil (USO) has a pretty poor record of tracking the commodity.  Mark Faber had the most picks (29) and the best performance-up 77.46%.  He also used the most ETFs A third of his picks were specific asian companies that would have been hard for the average investor to duplicate.  Bill Gross outperformed by suggesting only bonds or bond ETFs-which are his firm's speciality.

What did stand out for me was the diversity of investments away from classic portfolio stock selection.  Close to half of the managers interviewed last year used ETFs.

Four of the ten managers underperformed the market.  (Scott Black, Abby Joseph Cohen, Archie MacAllaster & Oscar Schafer)   MacAllaster also significantly underperformed the market in 2008.  Gabelli returned over 29% but on a risk adjusted basis may have done no better than the market given the nature of some of his holdings. 

While I haven't seen the final numbers yet for 2009, a simple review of the charts shows that an investor at the beginning of 2010 who would have put 100% of his money equally into two ETFs-the S&P Spyder {SPY} & the Nasdaq 100 composite {QQQQ}-would have returned just under 40% last year.  Only three of the 10 managers reviewed by Barrons beat that number.  Again both Zulauf and Faber did so by investing in ways that may not be able to be replicated by most investors.  Faber however would have still outperformed. 

Again like last year I would point out that collectively these managers employ at least hundreds of people many of whom do nothing each day but analyse securities.  Most can probably call companies up on the phone and speak to somebody pretty high in the chain of command about business. They still for the most part did no better than a simple ETF strategy.

*Long ETFs related to the Nasdaq 100, Nasdaq Composite and S&P 500 in client and certain personal accounts.

 

Two In One Week

We've now had two days out of the last five where the market has experienced a pretty decent sell-off.  Friday's action was classic sell the news off of Intel's earnings.  Intel's earnings were good but they were also the numbers that the market was expecting.  This sell the news action set in a bout of profit taking from which stocks-in the face of a long weekend-could not recover.

Since last summer the market has reboounded pretty well from days like this.  Two poor days in the course of a week though is starting to give me some room to pause, especially in light of how far stocks have traveled since November.  Nobody of course knows the answer of where the market will go.  We can at best make guesstimates based on history and probability.  From such experience the Playbook is formed and last weeks market action means in the Playbook we need to be ready to become more defensive if we see more of this weakness in the coming week which also begins the meat of the earnings season.  Stocks are still overbought which is another reason for us to be a bit more vigilent at this juncture.

an tSionna 1.15.10

Again a different view of the market.  This is a monthly chart of the S&P 500.  It shows in pretty basic detail our 'Lost Decade" of investing.  I suppose we ought to call it our lost 12 years as stocks for the most part are trading at the same level they were back in 1998!  Currently our rally looks an awful lot like the rally we had back in 2003 off of the Gulf War lows.  This has led many pundits to speculate that stocks could stagnate this year, virtually unchanged by the time we travel to December.  That may happen.  However, there is another side to that story which I will start going over in the next couple of weeks.  One of the things that I note (and will cover in more detail in the coming weeks)  is that our money flow analysis says we Could trade as high as 1300-1350 sometime in 2010.  Like I said, I'll explain why I think that could happen going forward.  I also will note that I'm not saying it will happen so nobody should take this as some sort of guarantee or prediction and casual readers of this blog should do their own work or talk to their own advisors before reacting to what I've just said.

I've been a bit light on the posts since mid-December.  End of the year business errands and a vacation kept me away from doing some of the analysis we try to put forward.  Also we're working on our end of the year letter to clients which will take much of our 2010 analysis into account so expect to see more than pictures and charts as we trudge deeper into January.

*Long ETFs related to the S&P 500 in certain client accounts.

an tSionna 1.14.10 A Different Look

A different look at the S&P 500.  This is a 2 month chart of the index.  It shows something that is beginning to nag at me a bit.  Specifically the S&P is up about 10% since the first of November.  Now what this chart doesn't show is that the Market flopped around for most of September and October before finally moving up.  But even so, this is still a pretty good move in a short period of time.  Most of our other trend indicators show that the current rally from November is still intact although we are somewhat overbought.  We'll let our indicators be our guide but this big move is something that I'll just tuck away and keep monitoring.  I think we'll begin to look at what defensive measures we might need to consider going forward and marry those to our client profiles.  Remember that stocks can correct by time as well as price so it could be when we finally stall out we do so by going nowhere for a certain period of time.

*Long ETFs related to the S&P 500 in certain client accounts.

Weak Job Growth in Pictures.

Continuing on the jobs theme, Chart Of The Day took a look last week at jobs gains by decades.  Here's their analysis:

{Friday}, the Labor Department reported that nonfarm payrolls (jobs) decreased by 85,000 in December while the data for November was revised upward and now shows a gain of 4,000 jobs. For some perspective, today's chart illustrates the percent increase in the number of jobs for every decade since the 1940s (the data goes back to 1939). As today's chart illustrates, the number of jobs at the end of a decade has been anywhere from 20% to 38% greater than 10 years prior. That 20% plus growth has been the case until the decade just passed during which the number of jobs basically ended the year where it began. This subpar job growth is particularly noteworthy due to the fact that the US population has increased by 10% in addition to a significant increase in global wealth during the same time frame.

Link:  http://www.chartoftheday.com/20100108.htm?T  {Subscription may be required}.

The Shrinking Work Force.

We've looked at the new economy before, especially as it relates to jobs.  24/7 Wall Street had an interesting take on this today which I thought I'd excerpt.  I'm going to have more to say on this at a later date because I believe that we are going to see for many years very high unemployment.  There is no one reason for this.  One of the main reasons however is that the world is changing.  Below is the excerpted article.  Highlights mine.  Link to follow.

"The Great Recession has taken its toll on America. The New-Normal in U.S. economic data and jobs is starting to look like more like Europe every day, except that none of us get five-weeks off or have guarantees of real retirement income or anything resembling assured healthcare even after the new legislation passes this year.   {Last} friday’s jobs data with a 10% unemployment rate and a non-Farm Payrolls figure coming in at -85,000 rather than flat or even a slight gain omits the worst part of the fallacy of real economic recovery down at the worker-on-the-street level.

Sure, things are getting better or at least getting less and less bad, on almost all fronts. The numbers say so and it is impossible to deny that we are now in a much different situation than we were in just ten to fourteen months ago. But there is a real undercurrent that is hard to ignore, and that is that the workforce is shrinking at a rate that you have to scratch your head over how strong the recovery is.

I will be the first one to admit that using year-end jobs data, particularly on a preliminary unrevised basis, always feels more like a guess than an exact science. How many people wouldn’t get out to get the government subsidy or go out to interview for jobs in the last two or three weeks of any given year is anyone’s guess. How many people got snowed in is a guess as well, yet it happens. Companies put off hiring decisions until mid-January at too many places to count. There are also many people who work “off the books” during the holiday season as well. But the headline figures are so far off on the contraction versus reality that grasping the real situation may be different from just the Labor Department’s headline data.

The unofficial unemployment rate is reported by most as being above 17%, meaning the officially unemployed plus those working odd-jobs, short-term contracts, or the under-employed. These workers have very little disposable income. And even fewer of the underemployed have the basics like health insurance, IRA and 401/K contributions, vacation days, pay for sick days, severance rights, and significant unemployment benefits.

......Bloomberg noted, “Had the labor force not decreased by 661,000 last month, the jobless rate would have been 10.4 percent…. About 1.7 million Americans opted out of the workforce from July through December, representing a 1.1 percent drop that marks the biggest six-month decrease since 1961, the Labor Department report showed.”....This feels like Uncle Sam is selling and Joe Public is buying into the notion that these other figures (people) are no more than what technology companies would call ‘pro forma’ or non-GAAP in their financial reporting......There is no way that these people all decided to just become housewives and house-husbands, nor is there a way that most of their household members want them to have that job title.

.......It is arguable about how many new jobs have to be created per month just to get the unemployment back to 7% or 8% by 2012, but almost all agree that it has to be hundreds of thousands. How many “green jobs” can ultimately fill this gap? How many new branch bank locations are being created? How many education and healthcare positions can keep filling the gap? Americans who cannot find work are going to have one of three new job descriptions by 2011… The accidental entrepreneur, the accidental house-spouse, or the independent street technician.......

......Economic models run by economists have stated over and over that unemployment is a very lagging indicator. Arguably it is a sagging indicator. The New Normal is becoming “The Normal of Less and Less.” It was just in November that it seemed as though there was an outside shot that unemployment might register back in the single digits at the end of year data. That may be farther out now, but ultimately that will occur. If they keep counting a smaller and smaller workforce, then the unemployment rate can magically go as low as those creating the figures want them to read.......Every single month we keep hoping that the jobs data will be the last bad month. And we keep having to buy into a jobless recovery as the new normal....

Link:  http://247wallst.com/2010/01/09/out-for-smokes-or-alien-abductions-the-shrinkring-labor-force/#more-57409

an tSionna 01.08.09 Gold

*Long GLD in certain client accounts.

an tSionna 01.07.2010 {Dow}

*Long ETFs related to the Dow Jones Industrial Average in client accounts.

an tSionna 01.06.10 (QQQQ)

*Long ETFs related to the Nasdaq, Nasdaq 100 and S&P 500 in client accounts.

an tSionna: 01.05.10 {SPY}

Been a while since we've looked at charts.  Not much has changed since mid-December.
*Long ETFs related to the S&P 500 in client accounts.

The Dow-Decade of Perspective.

The folks at Chart Of The Day posted this last week.  The 2000s are the second worst decade of the Dow Jones Industrial's performance. 

According to Chart Of The Day "this chart presents the price performance of the Dow for each decade since 1900.....{T}he Dow from the close of 1999 through 2009 was the second worst performance on record. Only the Great Depression decade of the 1930s was worse. The current zeros decade also shares an unfortunate outcome with the 1930s in being a decade during which the Dow actually ended lower than where it started."

I'd note from looking at the chart above that the decades that followed the Great Depression {1940's & 1950's} turned out to be pretty good times to put money in stocks.  

Link:  http://www.chartoftheday.com/  {Link & Registration Required-Subscription required to view their other products.}

*Long ETFs related to the Dow Jones Industrials in certain client accounts.

Happy New Year

Colorado High Country-New Year's Day 2010.