20 minutes to spare and time to update our blog.
On February 3rd when the Dow was down 300 points we sold our short positions in the Emerging Markets (EDZ) and Russell 2000 (TZA) as well as closing out our position in the 20+ leveraged Treasury Bond ETF (TMF) for some nice short term gains. Those gains covered losses in what remaining equities we had and actually resulted in a net positive day for us.
And to defy a client who in jest wondered if I was practicing “voodoo” in their accounts by having their net worth rise on a big down day (Being Irish automatically excludes any Voodoo ability) I went back to the TZA hoping for continued downside in US Markets, it didn’t happen and we incurred a 7% loss, so there.
What have we done lately? We continue to hold on to our municipal and taxable bond funds which account for approximately 40% of our assets. I still believe, lurking out there in the future is a market sell off in the 10% to 20% range. Eventually the S&P 500 has to touch the 200 day moving average which it hasn’t done since 2012. 2013 is the exception to the rule when it comes to revisiting the 200 day moving average.
However, new Fed chair Janet Yellen provided positive testimony to Congress about the state of the US economy and that stopped the selling last week.
We will be entering a short but strong seasonal period that should last into April. Hence we took some cash off the sideline and added to our minimal stock positions. But at most we’re only 50% invested in equities and 40% in bond funds, the remaining 10% is in cash.
Emerging markets have stabilized and that is providing strength to US large/multinational stocks which do quite a bit of business overseas. This large stock strength is coming at some expense to the type of small stocks we prefer causing a bit of lag in our accounts versus the indices. This is likely a short term phenomena.
While a market sell off can occur at most any time, seasonality still points to a peak in US stock prices in March/April 2014 where we can expect an approximate 6 months of net weakness. So caution is still advised.
There will a very good fat pitch coming to us in the September/October time frame and that’s the pitch we want to be ready for.
Brad
No positions
“Who is left to buy” is a rhetorical question of course. But for those not understanding the implications of rampant bullish sentiment, its a quick and easy explanation.
Investor Sentiment is an inverse indicator. The greater the positive sentiment the higher the risk and odds of a market pullback. Peaks in sentiment don’t have to mean the rally will come to an end but it usually implies there will be at least a pause. And, more frequently a sell-off great enough to instill fear back into the market place. As the saying goes: “If this was easy, everyone could do it.”
Adding to the list of extreme sentiment indicators is the National Association of Active Investment Managers. According to Sentimentrader.com the average manager is now 94.6% exposed to stocks along with a very low standard deviation which means there’s a whole lotta group think goin on.
There there is the Investors Intelligence (add joke here) Bearish Percentage: 15% That is a level only achieved three times since since 2008 and in each case there was a moderate pullback.
Brad Pappas
No positions
The bullish data released within the past few days solidifies the probability that the Fed will not have to go another round of quantitative easing (others may call it quantitative wheezing) but the data confirms that the economy may be bottoming here in the third quarter with a slight acceleration into the new year.
This is great news for stocks as our holdings are finding a great deal of traction since the data release but what about bonds?
Bob Farrell was the long time head of technical analysis for Merrill Lynch many years ago and he had a list of rules, of which the first three must be kept in mind regarding bonds, especially Treasury Bonds:
1. Markets tend to return to the mean over time.
2. Excesses in one direction will lead to an opposite excess in the other direction.
3. There are no new eras – excesses are never permanent.
This is a chart of the 20-30 year Treasury ETF “TLT”. Its been in a primary bullish mode since the early 1980’s when Voelker broke the inflation spiral. But in recent years the gains have accelerated and now the current yield is under 3% which means its primarily a capital gains trading vehicle now. But just consider if the TLT were to eventually trade merely to the lows of last year? That would mean a loss of at least 25%! Can it happen? Absolutely. But your guess is as good as mine in terms of the timing but my guess is that it will be fast when the selling starts as investors will desperately want to lock onto their gains.
The selling of Treasuries will likely lead to the purchase of stocks and what I’ve referred to as the “Great Reallocation”. Just keep in mind that its likely that good economic news will be the catalyst.
Long TLT
Brad
Investing in Solar and other alternative energies has been a hazardous experience for investors for several reasons:
- Too much competition which results in price cutting and profit margin pressure which results in volatile earnings and significant stock volatility.
- Reliance on government subsidies in an era of budget restraints.
But these issues are the primary problems associated with investing in solar cell manufacturers.
What about investing in Solar Farms that have their infrastructure in place and long term selling agreements with credible utilities? This is an entirely different enterprise than just selling solar panels since this is really an issue of cash flow.
Warren Buffett’s MidAmerican Energy Holdings Co. agreed to buy the Topaz Solar Farm in California from First Solar Inc. on Dec. 7. The project’s development budget is estimated at $2.4 billion and it may generate a 16.3 percent return on investment by selling power to PG&E Corp. at about $150 a megawatt-hour, through a 25-year contract, according to New Energy Finance calculations.
“After tax, you’re looking at returns in the 10 percent to 15 percent range” for solar projects, said Dan Reicher, executive director of Stanford University’s center for energy policy and finance in California. “The beauty of solar is once you make the capital investment, you’ve got free fuel and very low operating costs.”
With Treasury yields in the 2% to 3% range solar farms offer a viable alternative to bonds. In my opinion its only a matter of time before solar farms are offered in either a REIT or MLP structure to the public, where the cash flow generated is passed on to shareholders with special tax considerations. Best of all, the cash flow comes without the risks and headaches of solar panel manufacturing and sales.
Now we’re finally getting somewhere.
Brad
No positions
Despite a terrific first quarter, 2011 morphed into a miserable year as the combination of US political bickering and misplaced worry over the prospects of a European debt contagion caused both professional and individual investors to flee to ultra safe alternatives. What made 2011 especially maddening was that investors who did stick with equities chose to hold their assets in the Dow 30 stocks which became almost bond surrogates at the expense of small and mid cap equities. This bifurcated situation created one of the largest spreads ever in performance between the Dow Jones Industrial Index of 30 stocks (+1%) and the Russell 3000 (-7%).
Consistently ignored in second half of 2011 was improving domestic economic data: Improvements in Housing, Consumer Confidence, Auto Sales and Jobs was ignored by the deafening, attention grabbing headlines from Europe. Corporate earnings which are the primary driver of stock prices continued to grow at an approximate 10% pace and look to repeat this performance in 2012.
Despite the improving data, the consensus of opinion amongst investors is gloomy and that is where I believe the opportunity for 2012 is. Professional and individual investors have abandoned equities with a ferocity unseen since 2008 and are settling for yields in Treasuries in the 2% range. Simply put, at a yield of 2% it will take 36 years for the principal to double in value.
Investors having sold heavily in the second half of 2011 have likely discounted the bad news from Europe and the unfounded fears of a US recession. I seriously doubt renewed fears of European recession or budget issue can muster a second similar selloff. Domestic and European issues are well known and have a likely probability of diminishing in consequence.
It’s a frequently commented upon topic that the consensus view of economics and investing will usually be the strategy that bites you the hardest since it’s rare that the consensus view actually comes to fruition. Investing would be quite easy if that was the case, since you could simply find what the prevailing opinion was and invest accordingly.
For 2012 I offer what I believe will be five minority/contrarian views that have a better than average chance of being accurate in 2012.
1. The stock market has a very good year and our models and client portfolios have a very good year. The long term top of 1500 on the S&P 500 is a very good possibility by 2013 as
investors realize the fear driven mistakes of 2011 and move assets from bonds back to equities. A Romney victory would likely be a significant market positive (I am a Democrat) and could propel stocks to 1500 sooner than expected. Newt, on the other hand would likely be a major market headwind while the re-election of President Obama (the likeliest possibility) would be a moderate positive for stocks.
Investors who shunned small and mid-cap sized equities in favor of Index mutual funds and bonds had either minute gains or losses while the vast majority of Value portfolios had a terrible 10 months. The biggest groups of investors: Institutional, Hedge Funds and especially Individual investors are very poorly positioned with very high allocations to cash, gold and bonds.
It’s my belief that 2012 will be a year of mean reversion, where the investments that performed poorly in 2011 will produce outsized gains while bonds post negative returns and Indexes lag managed portfolios by a wide degree.
The 50 year average yield on the 10-year Treasury note is 6.6% and now its 2% while the 50 year average multiple on stocks is 15 times earnings, now it is at 12.
As mentioned in my blog previously: The US market risk premium (earnings yield minus the risk free rate of return) is at a 37 year high. This is another statistical metric highlighting the unusual value and upside potential in equities at present.
2. Treasury bonds will post negative returns in 2012.
I expect 10 year Treasury bond yields to rise in excess of 3.25% resulting from an expanding economy and less worldwide fear. The decline in bond values should provide the impetus for an asset allocation shift away from bonds and into stocks.
3. There will be no recession in the US and we will have at least one quarter where our GDP growth is in excess of 3%. Earnings growth in 2012 remains at a moderate 10% growth rate and the US Federal Reserve leaves interest rates unchanged which is very friendly to a rising stock market.
4. President Obama is re-elected. In my opinion the President’s electability will have much to do with the comparative un-electability of the Republican opposition. Be it Romney, Gingrich, Paul or Santorum, they all have major comparative flaws and would be hard pressed to gain the important Moderate electorate. If I’m wrong and Romney is elected, there is the possibility of reaching 1500 on the S&P 500 earlier than expected as his election would be viewed as a market positive.
5. The European Union will not crash. Problem solving in Democracies is almost always a messy proposition. Seamless and definitive political decisions are the hallmark of Authoritarian rule. Only until a crisis is upon the decision makers do they generally drop their political biases and come to an agreement. I don’t think that there will even be a defining moment when the Euro crisis has been solved; it will be from a series of decisions and actions rather than an all encompassing point in time.
Deep discounted financing (loans provided by central banks at very low interest rates) worked in 2008 to avert our banking crisis and they will likely work again for Europe. The import issue is that their banks simply get financing, the rate is of secondary importance.
Investment Status: Equity markets at present are in excellent shape with all major US indices breaking out to new rally highs. I believe it’s quite possible that that the rally will continue for several more months at least and that 1500 on the S&P 500 are attainable. As you can see in the chart below the SPX has been making a series of higher lows since September but our portfolios really began to out-perform in early December.
Another positive factor for equities over the next several months is that volatility continues to subside. This is necessary for investors to feel secure to deploy funds into equities and is frequently common in the early stages of new market rallies.
One of the biggest factors that I see driving markets higher in 2012 is that the alternative investments, particularly money market funds, CD’s and US Treasury Bills all pay under 1%. Should markets continue to move higher there will be a tremendous amount of cash coming out of those investments to seeking a higher rate of return. Investors may actually panic at the thought of being left out while their present fixed income returns so little.
All in all I expect that 2012 will result is a good year for our clients. Investor expectations are virtually nil and the masses have parked a huge amount of capital in ultra low yielding money markets and short term bonds. 1% returns are not going to help anyone in their retirement or capital growth plans. If equity markets continue to show strength and reduced volatility I do expect a very large asset allocation swap out of low-risk investments and into equities. Regarding equities, I am especially in favor of equities that had a rough year in 2011 due to their expected better than average risk / reward rather than the much beloved darlings like Apple and Google.
RMHI Model: There was no surprise that our investment model took a beating last year. Since my own retirement accounts are invested in the model as well, I can certainly identify with investor pain.
The chart above is the hypothetical back-test of the RMHI model (without hedging) dating back to 2001 till the first week of 2012. Actual client portfolios have tracked very closely to the chart below and while 2011’s decline was severe the performance began to curl higher in December. The chart is divided into thirds and the blue line is the S&P 500, which appears as a simple flat line over 10 years due to its lack of net progress.
The best way to gauge the model will be to track its progress during our current rally and all appears positive at this present time. As of today (1/23/2012) equity portfolios year to date are up an average of 7.5% net of fees and expenses versus 3% for the S&P 500.
All in all, I expect a good to very good year.
Brad Pappas
This letter does not constitute an offer to provide investment advisory services or attempt to effect securities transactions in any state or jurisdiction where such an offer or the provision of such services would be prohibited. Such an offer can only be made in states where we are registered or where an exemption from registration exists. The purpose of this letter is solely for the dissemination of general information on products or services. Investment advice or the rendering of investment advice for compensation will not be made absent of compliance with the state investment advisor requirements. For information concerning the licensure status or disciplinary history of an investment advisor a consumer should contact their state securities law administration. The information contained on this website should not be construed as financial or investment advice on any subject matter. Rocky Mountain Humane investing expressly disclaims all liability in respect to actions taken based on any or all of the information on this letter. Rocky Mountain Humane Investing, Corp. does not warrant the accuracy of the materials provided herein, either expressly or impliedly, for any particular purpose and expressly disclaims any warranties of merchantability or fitness for a particular purpose. Rocky Mountain Humane Investing, Corp. will not be responsible for any loss or damage that could result from interception by third parties of any information made available to you via this site. Although the information provided to you on this site is obtained or compiled from sources we believe to be reliable, Rocky Mountain Humane Investing, Corp. cannot and does not guarantee the accuracy, validity, timeliness or completeness of any information or data made available to you for any particular purpose.
