Archive for April, 2010

Line of Safety – This Chart Says It All

Thursday, April 29th, 2010


The chart above comes from Colin Twiggs and in my opinion best illustrates my affinity for Canada, Australia, Switzerland and South Korea as sources of investment ideas.

The chart compares projected 2010 deficits to net public debt, both expressed as a percentage of GDP. Nations below the diagonal line risk falling into financial distress and present more risk for their equity and fixed income investments than those above the line.

The diagonal represents two risk factors as a single measure: (1) the larger your public debt, the more precarious your position, and (2) the greater your current deficit (below zero) the faster your financial position will deteriorate.

The US, for example, with net debt below 60 percent is in the same risk category as Italy, because it is running larger deficits. Greece and Japan are obviously in the worst position, but the UK and Ireland*, with deficits greater than 10 percent, risk joining them within the next five years.

I have had a few questions from readers of the blog asking why I have been writing about Canada in particular but other countries with sound monetary policies so frequently – and why Bank of Montreal was my first purchase after raising cash. The answer to the viewer of this chart should be clear: a sound economy should produce better investment results than a profligate economy (like the United States).

Bank of Montreal is just the first of the Canadian holdings we will be adding if/when the markets correct. We will be concentrating on high cashflow stocks from Canada like Toronto Dominion Bank and BCE (fka Bell Canada) and we are in the process of researching similar companies in the countries above the Line of Safety.

The Line of Safety: remember it as you are investing your own money; we are taking it very seriously.

Click Here to watch Joe Cocker

Tomorrow is the 35th anniversary of the Fall of Saigon, one of the principal historic events in my life.

Today’s trivia: this week marked the anniversary of the creation of the universe according to a famous mathematician and astronomer. Can you name him?

Most of you that read this blog lived through some part of the Vietnam War. Whether you were a supporter of President Johnson or a supporter of the protesters, this was a transformative time in our history. Whether we learned anything or not is another question, but that isn’t a debate I want to hold on this blog. Remembering the lessons of history is important for investing as well as for running a country. Tomorrow, do your best to celebrate the lives of those in our country impacted by that war.

Tomorrow, I have a very special video picked out. I hope you will enjoy it.


Dead Cat Bounce?

Wednesday, April 28th, 2010


We had a bit of a bounce back today in the market, but we were unable to recapture the 13 day moving average. The technicals still show that the market is likely to be under pressure – and if we get some additional selling we will be buying into it.

We bought a bit of Bank of Montreal today – with the Canadian central bank making noises about raising interest rates, that should keep the Canadian Dollar growing in strength against the US dollar, and should make Canadian stocks relatively more attractive. Plus, Canada seems to have the best economy and banking system in the western world, so that is where we want our equity exposure to be concentrated.

Click Here to watch Edwin Starr sing War

Your Vietnam Era trivia tonight is centered around the above video. The song was originally recorded by another famous soul group, but their record label didn’t want them to release it so as not to alienate the music buying public. Can you name the band?

Have a nice night.

The PIIGS Impact the Markets

Tuesday, April 27th, 2010


First, let me say that the several days post April 15 are always crazy as we try to catch up on all the things that get put aside during tax season. Consequently, the blog has been ignored while we’ve been hard at work playing catch up and managing portfolios.

That said, not much happened until today that I hadn’t written about earlier – the market got ahead of itself and we were raising cash into the run higher.

Today, however, news that Portugal’s debt was downgraded and Greece’s bailout was still not certain led investors to raise some cash. You can see from the chart above that we had a pretty significant selloff that was contained by the 34 day moving average. You can see the little tail on the candlestick that touched the moving average line but closed slightly higher.

The run up since February has been happening on below average volume until the past week or so. Then, a euphoria seemed to hit the market as people who have been sitting on the sidelines decided to move cash into the market. The herd is usually wrong, which is why we’ve been taking the opposite tactic.


On the chart above, I’ve drawn two of the oscillators that I follow: the McClellan Oscillator and the Summation Index. I like this chart because if gives me a feel for the short-term and intermediate-term psychology of the market.

The red area graph dipping below the zero line shows that the market has turned negative – and it did so even as the near-panic buying was going on over the past week, but is not yet oversold. Short-term, this tells me we are likely to have a bit more downside before its time to put some of the cash we have accumulated back into the market.

The green line hovering around 40 is still nicely positive, but not yet overbought. This tells me that on an intermediate term basis, we are likely still in a general up-move and that once the red area graph (or maybe some other indicator we follow like the relative strength index) gets oversold, we will want to increase our equity exposure…maybe not to fully invested position (there is a lot of news risk out there plus lots of other fundamental headwinds) but earnings are strong and indicative of higher equity prices down the road absent something crazy.

When we start adding to positions, I’ll let you know.

Click Here to watch Buffalo Springfield video on YouTube

As we fast approach the 35th Anniversary of the Fall of Saigon on Friday, I wanted to give you one of my favorite 60’s songs. Obviously it’s the Buffalo Springfield singing in this video, but the name of the song never appears in the lyrics. Your trivia for today is to tell me where the name of the song got its origin – and I’ll be honest, I only know the story that I’ve heard a few times in the past – so if you know for sure, please share!


Watch for Pullback in Near Future for Buying Opportunity

Monday, April 12th, 2010


I saw a version of this posted by Tyler Durden today on his blog and thought it was another visual representation of how the market is near a pullback in the 6% range, before it moves to the next leg of this rally.

This chart shows the S&P 500 Index compared to the VIX Volatility Index and Volume. You can see that I have added Bollinger Bands (the blue lines) to both the S&P 500 and the VIX, which represent price action within two standard deviations around the 20-day moving average (yeah, that was pretty geeky, but it provides some very enlightening data points to analyze).

Look at the juxtaposition of the two charts – whenever the black VIX chart hits and moves outside the bands, the red S&P 500 chart reverses in price. It appears to have a near perfect record, and you can see that today we moved outside the lower blue band on the VIX, meaning that we very well could see the S&P 500 reverse to the downside.

The VIX is important because it is a measure of fear and complacency in the market. Right now, investors are extremely complacent which is a contrary indicator to market valuation.

We made the call to raise cash and the market has trickled higher. You can see from the volume bars at the bottom, the blue trendline is angled down over time and that the green positive volume bars are in general below the line and the lines that move above trend are mostly on down days.

This is a market that technically should move lower – however, the fundamentals are strong at the moment. Earnings should continue to grow stronger in the interim – but significant headwinds are out there and we will continue to monitor them.

Our near-term plan is to continue to let our stop losses run, collect cash if any hit, and invest it in short-term bond funds until the market pulls back and we can reinvest in equities. Given the hard won gains post-crash, protecting them with our current strategy is important to me. I’ll keep you up-to-date as things progress, but given what the technicals are saying, being conservative is prudent.

Jefferson Airplane – White Rabbit (click to play video at YouTube)

Its been a couple of posts since I included any Vietnam War era videos, so I thought I’d include one that I had some requests for.

Your trivia tonight is related to the Jefferson Airplane. In Vietnam War era, there were three very famous rock festivals, and they were the only band to play all three. Can you name them?

Enjoy this video from the Smothers Brothers TV show and I’ll be back soon.


VAT Tax Proposed

Tuesday, April 6th, 2010

I didn’t think we’d hear about it this year, but in the 2010 Forecast I told you that eventually a European style VAT tax would be implemented to cashflow our national debt and budget deficit.

Today, Paul Volker laid the ground work today in the story below from Reuters. Keep an eye on this as it is growing more likely.

Volcker: Taxes likely to rise eventually to tame deficit
Tue Apr 6, 2010 7:57pm EDT

NEW YORK (Reuters) – The United States should consider raising taxes to help bring deficits under control and may need to consider a European-style value-added tax, White House adviser Paul Volcker said on Tuesday.

Volcker, answering a question from the audience at a New York Historical Society event, said the value-added tax “was not as toxic an idea” as it has been in the past and also said a carbon or other energy-related tax may become necessary.

Though he acknowledged that both were still unpopular ideas, he said getting entitlement costs and the U.S. budget deficit under control may require such moves. “If at the end of the day we need to raise taxes, we should raise taxes,” he said.

Investment Commentary

Friday, April 2nd, 2010

Printed below is the Investment Commentary that is being sent to clients next week as a part of their quarter-end statements. I thought you might want to read what our clients receive from us that explains the impact of our investment activities on their portfolios.

Over-bought, Over-extended, Over-hyped

A bit over a year ago, the stock market made an important bottom in its post-crash movements. Readers of this Investment Commentary know that we moved from a heavily cash position to an over-weight equity position at that time based upon the valuation and technical indicators that we follow. It proved to be the right move since the market has recovered over half of its crash-induced losses.

Now, we have the opposite situation: those same valuation and technical indicators show that the big move off that bottom has gotten ahead of itself as the market is over-bought, over-extended and over-hyped. Don’t get me wrong, I still believe we are in a bullish cyclical move up and that equity exposure is the right thing for the intermediate term. However, near-term the market needs to pull back to a technical level that supports earnings and economic expectations so that the next leg higher can occur.

Because of this analysis, we have used trailing stop losses and price target sales to generate cash and reinvest it in a collection of short-intermediate term bond funds. Given the Federal Reserve’s policy to keep short-term interest rates low, keeping the sales proceeds in a money market fund earning a fraction of a percent makes no sense – it’s easier on us to do that, but not in your best interest. That is why we are utilizing the bond fund strategy so that you can get a return on your invested assets.

So, what specifically are the valuation issues?

Rising Interest Rates: the bond market has reacted negatively to signs of a strengthening economy and lack of demand from buyers of treasury bonds. That has driven yields up in the past week to levels that, if surpassed, can make 10-year treasury bonds a viable alternative to equity securities in a portfolio – that level has historically been in the 4% to 4.5% range, and we have moved up to 3.9% as I write this. Higher yields historically have reduced P/E values on stocks.

A Growing Deficit: growth in government spending at a time of falling tax revenues has called into question the creditworthiness and AAA rating of the United States, which could raise interest rates across the board for government borrowings. A lack of faith in the US Government leads to higher rates on its debt, and higher yields reduce P/E values.

An Increasing National Debt: as the deficit grows, the government needs to borrow at increasing amounts in order to fund the deficit and to rollover their current debt. Supply and demand fundamentals show us that as the supply of treasuries increases the demand for higher yields increases. Higher yields, lower P/E’s.

Forecasts of Higher Inflation: the current concensus is that inflation is not present. However, if you look at some of the underlying components of the Producer Price Index, for example, you can see that the crude goods component is showing signs of rising prices in the basic materials used to produce durable goods. The crude goods component of the calculation has a good track record of predicting increases in inflation because producers ultimately raise the prices of their finished goods as the components of their production increase in cost. Higher inflation historically translated into lower P/E’s.

Unemployment Will Remain High: we are still in the 9.7% range, and most economist forecast that we will be well above 8% for the foreseeable future. Our own forecast is for 9% to be the new 5% – the level we enjoyed from the mid-80’s, 90’s, and 00’s that was brought about by pro-economic growth policies of those various presidencies. Unfortunately, those pro-growth policies (low taxes, reduced government size, spending caps) were high jacked first by one political party then the next to geometrically increase spending beyond reasonable increases in revenue. Now, it will be exceedingly difficult to reasonably increase tax revenues to fund increasing levels of spending given the sustained high unemployment levels. Rising taxes reduce money available for consumer spending → consumer spending is 70% of our economy → economic growth is reduced due to reduced consumer spending → reduced economic growth sustains high unemployment and limits corporate earnings growth → limited corporate earnings growth means equities have less comparative value for investors.

There are other issues that concern me, but this list gives you a feel for many of the important ones. I mentioned P/E values several times above and I wanted to make sure that you understood what I am writing about: the P/E is a ratio of the stock Prices to Earnings. It is just a way to tell us how much investors are valuing the earnings of a company. At times when the economy is good or stocks are in a bull market, investors value a company’s earnings higher, and stock prices move up accordingly. At times when the economy is bad or stocks are in a bear market, investors value a company’s earnings lower, and stock prices move down accordingly. In the various issues above, all of them historically have caused investors to value a company’s earnings lower and stock prices have moved lower.

So what specifically are the technical issues?

The technical indicators we follow are really just a proxy for investor sentiment. We can fairly easily determine the fundamentals of a company or of the broader market by looking at earnings, earnings growth, sales, market share, debt, and all the other components of their financial reporting. This is called the fundamental aspects of investing. There is, however, an equally important component that represents the sentiment aspects of investing. You can’t find investor sentiment in financial statements, so we need another way to gauge how excited, fearful, or complacent the investing public is relative to the market. For that we use various technical indicators – some related to the overall market and some related to specific companies. Here, we are discussing those related to the overall market. I’ll apologize in advance if the following is confusing or boring – I know I have some readers that enjoy these sorts of discussions, so if you are not one, feel free to skip past it.


McClellan Oscillator: a momentum indicator that is applied to the advance/decline line. It indicates to us short-term investor sentiment relative to the number of stocks advancing or declining in the current market move. Statistically, there are certain levels on the graph that have proven to be good indicators of investor sentiment (that investors have gotten too complacent or too fearful) and a change in market direction is likely once those levels are reached. You can see that this indicator has already moved below the zero line indicating that there is a significant loss of investor momentum and the likelihood of a pullback is near. We began to reduce exposure to equities when the indicator peaked in March.


Summation Index: a momentum indicator that is applied to the McClellan Oscillator. It indicates to us intermediate-term investor sentiment and gives us a broader view of the current market movement. There can be short-term changes in the market’s direction that are contained within longer-term moves in either an upward or downward move in the market. The concerning thing here is that the index has reached a top and has curled down. It is still in bullish territory on an intermediate basis, but could be indicating a more than short-term move lower the closer it moves toward zero. If it were to move below zero, that would provide an intermediate bear market signal.


Breadth Oscillator: an important characteristic of stock market performance is whether a small number of stocks with large capitalizations are dominating the index readings or whether the movement in the index is representative of most of the companies in the market (or in other words, is the movement broad-based or showing good breadth). The important thing to see here is that the blue line is below the red line, that the red line is moving down, and that the blue line is making a series of lower highs and lower lows. This is indicative of a market that has fewer and fewer of its participants moving higher in price.


VIX Volatility Index: fear and complacnecy in the market are generally contrary indicators. Investors adopt a herd mentality, so historically the safest thing to do is do the opposite of the herd. If fear is rampant and the VIX is giving a high reading, that generally means it is a good time to be invested in stocks as the market is likely to make a move higher. If complacency is prevalent, the VIX gives a low reading, and the market is likely due for a correction. With the VIX currently below the important level of 20, there is much complacency in the market and a move lower is possible. Note that we plot the S&P 500 Index on this chart so you can see the generally inverse relationship of the two.

Our tactic of using trailing stop losses and price target sales has been effective. As we have moved toward the top of the current price range for the S&P 500 (you might recall from our 2010 Forecast that we said the S&P 500 would be stuck in a range between the 200-day moving average and 1,250 until more signs of economic recovery have materialized) we have been moving up the price of the trailing stops to protect the hard won gains since the crash. We have also used target price sales to generate cash in companies that have reached or were near the targets we set, also to protect those hard won gains. The proceeds from those sales will stay in the short-term bond funds until our indicators tell us that momentum, breadth, and volatility – as well as earnings growth fundamentals – are supportive of the next move higher in the market. Until then, sitting back and earning some interest while the market finds direction makes sense to me.

For clients in our mutual fund program, stop losses are not available so we have been rebalancing to increase the fixed income allocation in those portfolios in order to accomplish our goal. For clients in our ETF program, we have trailing stop losses set, but due to the index-like nature of ETF’s very few have hit at this point.

For those of you reading this that are in 401k’s and you manage your own portfolios, market movements are a good thing for you relative to your elective deferrals. When markets pull back, you are able to buy more shares of the funds you select. However, it’s not so good for the balances you have already accumulated. If you are overly aggressive in your investment allocation you may be assuming too much risk, and conversely, if you are overly conservative, you may not be assuming enough risk. You should feel free to contact Charlie Osborne at (217) 351-2877 if you have questions about your investment selections.

As always, we want to thank you for being our client during these tumultuous times in the economy and investment markets. We work to provide you with professional investment management services and communicate our strategies and analysis to you through this Investment Commentary with your periodic statements, through our blog on a multiple-times-per-week basis, and though our Investment Strategies newsletter three to five times per year. If you have any questions or would like us to assist you with other investment needs, please do not hesitate to call us.

Oil Closed Above $85

Thursday, April 1st, 2010


Well, oil has broken decisively up from consolidation around either side of the 38.2% retracement level. For long-time readers of the blog, you’ll know that the chart above shows the oil market from its peak in July 2008 to its crash low in December 2008. From there, I’ve drawn in the various statistically significant Fibonacci retracement lines. We had been moving in a range above and below the 38.2% line for about six months but we now have moved about half way up to the 50% retracement line.

Goldman Sachs increased it’s price target on oil to $97 in the six month time frame based upon continued domestic economic progress and increasing demand in the developing world. This happened as the Saudi’s changed their perspective from $70 being a fair price for oil to $80 being a fair price for oil.

So far, this increase isn’t being reflected in the prices at the local gas station, but if it does this will be problematic for our nascent recovery.


This is a shorter term chart that gives you more detail of the current price action in oil. You can see that the last year has provided a strong series of higher highs and higher lows, and a technical price target of $92 based simply upon the technical action in the charts.


The chart above shows you the seasonality in the price of oil. You can see that on a seasonal basis, March is generally the seasonal lows over the past 24 years.

The seasonal factor, combined with Goldman’s fundamental analysis, and the technical aspects of the oil price chart tells me that we are likely in for higher oil prices in coming months.

CCR – Fortunate Son

In keeping up the Vietnam War history of the past few posts, I wanted to give you one of the musical requests I received. Seems that there are some readers out there that recognize the inequities of who was drafted and who wasn’t.

Your trivia for today revolves around the lead singer of CCR. You likely recall his name, but do you recall his mid-80’s career comeback? He recorded an album whose title song is heard at sporting events 25 years later. Can you name the singer, his comeback album and song?