Archive for August, 2011

Follow-Up to Yesterday’s Post

Thursday, August 25th, 2011

I just had someone email the following pdf from the San Franciso Federal Reserve that talks about the impact of the Baby Boomers retirement on the stock market. That was a large part of my blog yesterday relative to what might happen in 2012.

I’d like to say great minds think alike, but even I am not that egotistical – just close :)

If you want to read their report, you can find it here:

Boomer Retirement: Headwinds for U.S. Equity Markets?

Mark

Unbelievable Market Action

Wednesday, August 24th, 2011

S&P 500

Last week I wrote to you that we had likely put in the bottom for this correction but that the path higher would also likely be a rough one.

So, with several swings up and down on the broad market average, I thought that a visual look at the market might be a helpful thing for us.

In the chart above, I’ve annotated the graph of the S&P 500 so you can see what is happening. The blue horizontal lines show you the Fibonacci retracement levels for the market from the May high to the August low.

I haven’t shown you graphs with Fibonacci retracement levels for awhile, so to refresh your memory, (and quoted from Investopedia) they are based upon the work of “mathematician Leonardo Fibonacci in the thirteenth century. The Fibonacci sequence of numbers is as follows: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc. Each term in this sequence is simply the sum of the two preceding terms and sequence continues infinitely. One of the remarkable characteristics of this numerical sequence is that each number is approximately 1.618 times greater than the preceding number. This common relationship between every number in the series is the foundation of the common ratios used in retracement studies.

“The key Fibonacci ratio of 61.8% – also referred to as “the golden ratio” or “the golden mean” – is found by dividing one number in the series by the number that follows it. For example: 8/13 = 0.6153, and 55/89 = 0.6179.

“The 38.2% ratio is found by dividing one number in the series by the number that is found two places to the right. For example: 55/144 = 0.3819.

“The 23.6% ratio is found by dividing one number in the series by the number that is three places to the right. For example: 8/34 = 0.2352.

“For reasons that are unclear, these ratios seem to play an important role in the stock market, just as they do in nature, and can be used to determine critical points that cause an asset’s price to reverse. The direction of the prior trend is likely to continue once the price of the asset has retraced to one of the ratios listed above.”

If you look at the chart, as if pre-ordained, the recovery off the August low retraced to the 61.8% level where it ran into resistance before falling back down. The good news is that we are developing an upward sloping trend line (see the green line denoting the uptrend that is in formation).

I’ve also annotated a few other things on the chart that I am watching – if you look at the big red circle on left side, I’ve shown the trading volume for different levels of prices. You can see that within the circle, there is little to no volume that would provide overhead resistance to prices moving higher. In other words, there are very few people who bought during those down days so you don’t have to worry about them wanting to sell their shares to break even once the price hits those levels. It’s really not much of a coincidence that above the 61.8% retracement level you have almost no resistance, but below it, you have people that were buyers but that turn into sellers in an effort to get out of those shares with no loss. Once we are able to break above the 61.8% level, with little overhead resistance, prices should have a much easier time moving higher.

How high? My target is for the market to move somewhere into the green box on the right side of the chart. This green box covers about a 60 point span in the S&P 500 (1225 to 1285) that encompasses the beginning of some more serious overhead resistance, the 38.2% retracement level, and the 200-day moving average.

As the market bottomed out, equities appeared to be undervalued and fixed income appeared to overvalued. This presented us with an opportunity to do a few things: (1) invest cash we had on hand, moving accounts to maximum equity exposure, (2) rebalance accounts so that fixed income and cash were taken to target levels with any excess invested into equities, and (3) rebalance equity and mutual fund holdings so that any that had been hit harder than the rest during the downturn would be added to and any that performed better would be rebalanced back to target levels – this should provide excess returns when the holdings that were beaten down more rebound more as we move toward the green box.

When the market put in a top on the chart above, I think that was likely the high for the year. The direction from here should be to move higher as we approach year-end, but the 61.8% level will probably be tough to break through – however, when all of the people who bough at that level who want to sell have done so, then we should break through that resistance and have little resistance as we move up to the green box.

From a fundamental standpoint, there are several things that support the market moving higher:

(1) at the low when we started to move to a fully invested position, the broader market was trading for a P/E of around 11 compared to a normal range of 22 during economic boom times and 10 during recessionary depths – the P/E of 11 was almost completely discounting a recession 6 to 9 months from now;

(2) current economic reports do not, in my opinion, show that we are heading into a recession – the Chicago Fed National Activity Index showed improvement in its last report, and was consistent with a slow growth economy; rail car loadings were also recently reported and show that we are in an expansionary economy, but a slow growth one; Fed Ex shipments for the recently ended fiscal year continued to grow and have surpassed 2008 for the first time since then; major exporters like Caterpillar and Deere are reporting increased exports and are increasing hiring; car sales are on the rise with GM and Ford both reporting that the industry is recovering.

(3) corporate earnings season gets underway next month and if the trend continues, earnings will be strong – strong earnings growth leads to increasing stock prices.

Our current plan – but obviously subject to change as fundamentals and technicals in the market change (remember my advice: invest what you see, not what you believe you should see) – is to begin to raise cash as we approach the green box. That could be sometime during earnings season, but in any event will not go past 12/31.

We are viewing 2012 as an even more challenging year than the current one – if we are going to see a recession, then it will become apparent in 2012. Why 2012?

(1) I’ve written in the past about the baby boomers retiring and how that will have an impact on their spending. I think we will see a cutback in spending during 2012 as this huge demographic group starts to retire in earnest. That will also put pressure on the top end of the housing market as many will want to downsize – the upper end of the market will have overhead resistance on prices most likely, but the middle part of the market, condos, and rentals – maybe even in very hard hit areas like Florida – will see some demand.

(2) Those retirees will also put pressure on the Social Security and Medicare funds pushing them closer to insolvency – which will push the folks in Washington to do something about it – watch for benefit reductions and tax increases, both of which will have an initial negative impact on the economy – in the long run, it is required but taking one’s medicine is never an enjoyable experience.

(3) We continue to issue significant levels of debt and there is no realistic end in sight, in spite of the discussions on deficit reductions of $4 trillion. At some point, our lenders will require higher interest rates to fund our spending problems. Those higher rates will negatively impact our economy – yes, yes, I know some of you out there will say that we had higher rates under Reagan, Bush 1, Clinton and Bush 2, and that we got along just fine. That is absolutely true – however it is the magnitude of the change that matters to the economy, not the fact that we are returning to a previous level where we were in an economic expansion. Going from a short-term interest rate of 0.25% to 2% is a 700% rate of change, and that is what will have an impact.

(4) 2012 is a Presidential Election year, so anything can happen.

From both the technical and fundamental standpoints, moving higher seems the most likely course for the market. Again, it won’t be a straight move higher as we are in for some volatility and madness. Watch for the upward sloping trendline to converge toward the green box. If events in Europe relative to their banking system hiccup again, we could see another violent downswing, but likely not lower than the August lows, and I’d hope that the forming trend line would provide the market support, if not the 61.8% level once we break above it.

Brace yourselves – the market will continue to be unbelievable for the foreseeable future.


Click Here to Watch today\'s video on You Tube

Mark

PS – search your memory and see if you can name the 80’s/early-90’s comedian who starts off the song in this video

The High And Low Of It

Wednesday, August 10th, 2011

S&P 500 Index with Technicals

Since I stuck my neck out yesterday and said my assessment of the market was that we had seen the low for the year based upon the various reasons given, I wanted to follow up since today is one of those inevitable down days that we will see as we fight our way higher from the lows.

In the chart above, I wanted you to look at the volume in the market so far today compared to the past few days. If you look at the second section of the graph, you will see the volume bars with a black line overlaying it. If you look all the way to the right side you will see a small red bar compared to the big green bar and preceding days’ big red bars.

Today’s selloff – at least so far – is happening on significantly less volume than the previous several days. This to me says that the selling pressure has subsided and that there are fewer market participants pushing prices down. This is significant if my thought from yesterday’s blog post is true – that we saw a capitulation in selling the other day which helped to support the hypothesis that we put in the low for the year and the end of the current correction (don’t get the idea that it will be an easy road higher, it will be a fight and a scary one at that, but I truly believe we will be higher as we move into year-end based upon the many reasons noted yesterday).

Additionally, I reviewed the New York Stock Exchange statistics (see below) for all trading days in August for new Highs and new Lows in the market:

8/1: New Highs 35 Vs. New Lows 93
8/2: New Highs 20 Vs. New Lows 169
8/3: New Highs 14 Vs. New Lows 275
8/4: New Highs 10 Vs. New Lows 445
8/5: New Highs 6 Vs. New Lows 828
8/8: New Highs 3 Vs. New Lows 1292
8/9: New Highs 3 Vs. New Lows 717
8/10: New Highs 3 Vs. New Lows 162

As you can see from the data above, the number of companies making new 52 week lows in stock prices grew significantly moving into what I’ll call (hopefully not just temporarily) the capitulation day. And they lessened significantly yesterday during the big rally. Today, so far, they are way less than they have been: Fewer new lows indicates that the sellers exhausted themselves on the capitulation day.

As I write this the market is down 2.5% from yesterday’s close. Honestly, that is a healthy consolidation of yesterday’s big gains – and given the low volume it doesn’t sway my opinion.

We have been buyers today for clients with significant cash levels on the books. In coming days, we will be reallocation from significantly overvalued bond allocations to undervalued equity allocations in other accounts. We will also be swapping among companies from those that we don’t believe have as much upside going into year-end to those that we see having more upside. That will likely include adding some dividend yield to portfolios – we are getting confirmation today that dividend yield will be important going forward.

If you look below, you can see a screen cap of our Cash Flow Equity portfolio. We have a number of clients that need additional income during their retirement years to supplement other sources of income from retirement accounts. These are mainly Master Limited Partnerships and REITS that pay a 6% to 8% dividend yield.

cash-flow-equities

Investors have read between the lines in the Federal Reserve statement from yesterday and seen that since the Fed plans to keep yields low for at least two years, companies with solid income streams that pay out most of their dividends to their shareholders are going to be favored investments for people who need income from their portfolios to sustain their lifestyles.

This is probably what normal will look like in the future.

Mark

Today’s Summary: What A Long Strange Trip

Tuesday, August 9th, 2011

Today's Trading Action

We had a very wild ride today. The market was up > 3% early in anticipation of the Federal Reserve meeting, it was down 2% as Fed Chairman Bernanke talked, but when he got to the part about the Fed doing everything in its power to fix things, we immediately went vertical on the chart and ended up > 4% on the S&P 500 Index.

The machines are definitely in charge – humans can’t move the market that quickly and turn on a dime.

As I scan our holdings performance today, I see some amazing things: Northern Oil and Gas was up +39.77%, Avalon Rare Metals was up +17.69%, ESB Financial was up +21.16%, Alstom was up +10.25%, Chicago Bridge & Iron was up +14.42%. Of the 300+ companies in our universe, we had eight that were down and all of those were fractionally lower. This is just an amazing thing.

What we are looking for is follow through. Will we reverse these gains tomorrow or are we on our way to recovering what we’ve lost this month? My best guess is that some of the biggest gainers give back some of the outsized gains. However, once the reactions and over-reactions settle down, where are we going?

One of my favorite indicators to give me an idea of the direction of the market is the Equity Put/Call Ratio:

equity-put-call-ratio

You may want to click on the chart to see a larger version of it as the blog tends to distort wider images.

If you look at the chart, you will see where I’ve circle the time where it said we were oversold and shown you the direction of the market when those reading hit. Invariably, even if not instantaneously, over the past seven years (that is the extent of the available data) when we get above the oversold threshold, the market moves higher from there.

Below is the chart of the S&P 500 year-to-date. I’ve included my favorite indicators, and even though I don’t have time to annotate it for you, they are all saying that we are severely oversold. Additionally, the volume bars sure look like we had a capitulation day yesterday where all of the sellers just puked up every bit of selling energy they had in them.

sp-500-ytd

I still feel pretty good about my statement on the blog yesterday that we will rally into year-end. I will go ahead and also say that from my viewing of the chart for the market year-to-date, when combined with the statement from Chairman Bernanke and the oversold nature of the market — and absent any major policy blunders out of Washington (that is truly a big caveat given the turmoil in DC) — that we possibly could have seen the lows in the market for the year. There are a lot of moving parts and since the computers are in charge of the bulk of the trading in the market these days, we can have things that just don’t make sense come about.

But I am going to operate under the assumption that the indicators I follow and trust are pointing me the right way, and we will continue to add to positions in client accounts at the right prices. It won’t be a straight up move, but I think the charts are telling me that we are in a recovery phase and we can make some money here.

Mark

Perspectives

Monday, August 8th, 2011

ted-spread

Given today’s market selloff, I thought we should check out the TED Spread to see if this could turn into a full fledged crash and implosion of the financial system. As you can see, we are bounding along in a normal range and it is not flashing warnings like it did in 2008. We are seeing the margin clerks and machines in charge today, which is making things more volatile than we are used to, but we are not seeing a risk of collapse to the entire financial system that we saw in 2008 with the sub-prime crisis. That said, we added to gold miners a few weeks ago on a relative valuation basis – and as a risk management technique in case something crazy happened. Good thing we did since they are one of the few things up today.

I was interviewed a bit ago by Mary Lynn Foster on Connect FM 93.5/95.3 Radio relative to the S&P downgrade.

Here is a paraphrased transcript of that interview based upon the notes I was taking while we talked – I also added some other points not discussed on the radio that help flesh out the discussion. Mary Lynn’s questions are in italics.

What does an S & P rating really mean?

Standard and Poors is a ratings agency, among other things. This means they are an independent analyst that provides arms-length review of financial information and then provides a risk rating for the entity that is issuing debt. It’s not completely unlike how a bank reviews a person’s financial information prior to granting them a new mortgage.

When you buy a government bond, you are really making a loan to that government. S&P’s purpose, then, is to provide investors with some idea of what type of risk they will incur if they loan money to the entity that is issuing the debt. And those entities can be governments of countries like the United States, local governments like Champaign County, or publicly traded companies like General Electric.

How does that effect the U.S?

There can be many impacts, some of them that we won’t even understand for several months into the future.
Realistically, or at least theoretically, an investor that is taking on more risk requires more return. That could mean that our government might have to pay higher interest rates for the money they borrow when compared to when they had the highest credit quality rating of Triple A.

Getting away from theory, though, if you look at Japan for instance, they were downgraded several years ago and their interest rates are half of what ours were at Triple A. So, much more goes into interest rates than a simple bond rating.

In our case, because we have to issue so much debt to fund our deficits, we could likely see a bigger impact from our lenders – specifically China – demanding higher interest rates in order to continue to buy our bonds.

More than anything though, this is a major tarnish to our image. From a hopeful standpoint, maybe this will be the catalyst for our politicians in Washington to admit their policy errors over the past couple of decades wherein they drove our debt to unsustainable levels through profligate spending beyond our means.

The best thing we can hope for out of this situation is that it leads to comprehensive reform of all spending priorities and our tax system, from defense to entitlements and to a tax system where everybody pays their fair share and loop-holes and special breaks for political contributors and key constituencies are eliminated.

The worst thing that could happen is that we stay on the current trajectory, continue to add to the debt, have the Federal Reserve continue to buy what we can’t sell the rest of the world, and never seriously address the problems that are keeping unemployment high, economic growth low, and that will eventually lead to serious inflationary issues.

How does it effect us?

For you and me, the real impact will be on whether interest rates rise because of the theoretical impact of investors requiring additional return for additional risk. Those interest rate increases can impact interest rates on everything from home mortgages to credit cards to bank deposits. But again, there are significantly more important factors in the level of interest rates than the S&P rating on government debt.

As far as people’s 401k’s are concerned, there will always be ups and downs. The absolute worst strategy anyone could take is to sell everything today based upon the knee jerk reaction of the market to this news. By adding money on a set schedule to an investment portfolio and buying through the ups and downs of the market, over the long-term people are able to accumulate a significant amount despite the swings.

However, everyone should be prudent and periodically look at their investment allocation between stocks, bonds and cash equivalents, and as they begin to approach retirement they need to reallocate their holdings into a more conservative portfolio allocation. That way, when we have news-driven selloffs like we have currently, the overall impact to equity portfolio value is mitigated.

How are the markets reacting today?

The stock and bond markets are down, but gold and gold miners are up.

This is a classic case of risk avoidance, and my best assessment is that the stock market will be down for a day or two because of this, but this is not the beginning of a major 2008-level correction.

To have a 2008-level correction or crash, you need for the economy to be heading into recession and for corporate earnings to be falling (or have the financial system imploding, but the TED Spread is not indicating that this is the case, even with the level of stress caused by the European debt situation).

If you look at the leading indicators, we just don’t see that at this time. If you look at the earnings that were reported by General Motors and Ford, you see that there is a major recovery in the auto sector underway which means the consumer is not completely pessimistic about the future.

If we were going into a recession, you’d see Fed Ex deliveries falling, rail car deliveries falling, sea container shipments falling, etc. None of that is happening at this time. Plus the stronger than expected July non-farm payroll number shows that we might see an increase in the economic growth numbers reported in the next few months than people are currently anticipating.

My best assessment is that we will continue on with a slow-growth economy for into 2012, and that the stock market will move higher in coming weeks or months reflecting further growth in corporate earnings. However, if a recession does develop sometime in 2012, look for a major pull back in the stock market – I know we will be raising cash in our clients’ accounts as the market recovers into year-end as one of our standard risk-management practices.

What should we be thinking about for our money now?

The first and best rule is “Don’t Panic.”

As computers do more and more of the trading for mutual funds and hedge funds, the volatility that we have seen in the past few days will continue – to the upside as well as the downside. Market swings that used to take weeks to play out will take (as we’ve seen) days or even hours instead.

Instead, looking at corporate earnings growth is the key. If earnings are growing and the market is fairly valued, then you can feel fairly safe buying stocks. However, you have to have a long-term horizon if you want to own stocks – I always counsel people to keep a rolling seven-year horizon for their stock portfolio. If you need to liquidate your assets within seven years, stocks are not the investment for you.

As far as our current strategy for our clients’ equity portfolios, we have been using the current selloff as an opportunity to add to companies with strong earnings, strong financial statements, and share-holder friendly policies in anticipation of a recovery from the current sell-off. And then, as noted earlier, we will likely be raising cash as we assess the likelihood of a mid-2012 recession based upon some of the leading indicators I previously mentioned.

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As you know from following the blog, I was on vacation for three weeks traveling around Europe, specifically the Balkans. As I read through local English language newspapers, I got a feel for how bad things really are in Europe compared to how they are reported here. I conferred with John and Charlie about various investment matters while I was away, but the key thing impacting us on a going forward basis is debt – both here and abroad.

For those of you that remember my year-end newsletter entitled 2011: A Debt Odyssey, you know that I was concerned that debt would rule the direction of our country and the financial markets in 2011 and beyond. If you’d like to re-read it, or for that matter read it for the first time, you can find it at this link:

2011: A Debt Odyssey

I will be back at the blog in coming days with greater details on our specific activities relative to the current market sell-off.

But I wanted to leave you with one perspective from my trip.

In the early 1990’s, war was rampaging through the Balkans, and the town of Mostar in Bosnia was the front line of the fighting. There was a bridge that was constructed in the 1400’s that connected two sides of a river gorge and advanced a trade route through the Balkans. It survived numerous wars, including WWI and WWII, but was destroyed as the Catholic Croats and Orthodox Serbs tried to divide the Muslim Bosnia and add it to their territories. You will recall that President Clinton had us join in to stop the tragedy, and the Dayton Accords ended the armed conflict, but not before the bridge was destroyed.

Below is an eight minute BBC film on Mostar the bridge that you might want to watch – including the destruction of the bridge. I am a firm believer that if we don’t understand history we are bound to repeat it.

Here is the rebuilt bridge today, a UNESCO World Heritage site:

Mostar Bridge Rebuilt

Managing money in today’s world requires an understanding of its inhabitants. For me, the best way to understand part of the world and how it impacts potential investment opportunities or current portfolio strategy is to be there and learn about it.

The importance of the Balkans is its impact on the wider European investment landscape, whether it’s the assassination of Arch Duke Ferdinand that initiated WWI or the 1990’s war that you can experience on the video above – or even the riots in Greece in which I got a bit of flavor as you can see in the photo below, we cannot invest our clients’ money living in a vacuum. It is critical that we understand how varying parts of the world can impact corporate earnings or investor sentiment and so much of the potential impact comes from the history and culture of a region which is best understood face-to-face discussing it with those who live it.

Athens Riots

Did I find any specific companies to invest in on this trip like I have when traveling in Singapore or Switzerland? No. But I did learn more about the European debt crisis, European’s view of our own issues, and the emerging markets of Eastern Europe – three valuable things that I believe our clients will benefit from in the future.

Mark

PS – thanks to John and Charlie for their posts on the blog in my absence. I hope that you will soon see their input on a more frequent basis.