The Rush Report
The Q1 2008 Market Rush Review
By
Mark Rush
redgroup2@
April 1st 2008
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Preface
It is once again time for my quarterly market review where I try to examine various world events that occurred and understand their implications on the market. This is my time to reflect on my stock strategies, current events, portfolio performance, event scenarios, and the implications on the world equity markets.
As you read through this review, even if you don’t agree with any of my thoughts, please take the time to think about your financial choices and think about ways to improve your returns. It is my goal in life to have my money working for me instead of me working for my money.
Please email me with your thoughts, questions, and insights on the opinions that I present. The purpose of my effort is to stimulate a dialogue around current events and their impacts on the markets.
This document may be distributed to anyone free of charge as long as it is provided in an unaltered form. I reserve all Intellectual Property Rights of this document.
Regards,
Mark Rush
redgroup2@
Please read this important notice
Disclaimers
As you read this document keep in mind that I do not have any special insights into the markets nor do I have any type of training or experience in any kind of investments. I am not a financial advisor nor do I have a degree in economics or finance. Remember these facts as you read and ponder my unprofessional opinions.
This document should not be construed as investment advice; you and your financial advisor are responsible for making your investment decisions. The purpose if this document is for me to “think out loud” and stimulate thoughts regarding my investment ideas for my portfolio. I am asking you for your feedback about my thoughts, strategies and conclusions.
Nothing in this document should be construed as tax advice or estate planning. Tax laws are complicated and change often. I do not have the time to follow changes in tax codes; therefore, any thoughts I may have on the subject are very likely to be obsolete or at the very least dated. Before you attempt to implement any tax strategies you should consult a tax professional or financial advisor.
All thoughts and strategies are based on the on the fact that I invest money from the United States using US dollars and pays US taxes. All comments and views are from my American investment perspective. Many of my strategies consider US tax implications and currency exchange rates that may not be valid when viewed from outside the US.
The views and opinions in this report are strictly my own based on publicly available information. I do not have any special perspective into the markets, just my own opinions which are often very wrong. Opinions stated are my own and do not reflect the opinions from any current, past or future employer.
I will/may change my strategies and investments ideas radically and suddenly between reports without notice to any receivers of this report. My own investment strategies can be extremely aggressive and my portfolio should not be replicated by anyone, including me.
I am an amateur investor and this document is a hobby for me. Any thoughts and concepts should be treated as such. Please consult a professional financial advisor before you make any investment decisions regarding your investment ideas, goals, and strategies. Continue reading this document at your own risk…
Introduction
The market looked incredibly weak during the first few weeks of January. When the unemployment numbers in January rose above 5% I started selling my portfolio, but I didn’t sell it fast enough. As each news item came in things looked worse, and then per my plan from the last report, the Volatility Index ($VIX) went over 25%, causing me to sell even more of my portfolio. For the first time ever in my life, I was net short the stock market. Even being net short the market didn’t stop my loss of money since the foreign stocks that I held were falling much faster than my S&P 500 short sales.
Then in late January we had a market crisis in Europe and the Federal Reserve dropped interest rates a full ¾% in an emergency meeting. In my opinion, this reaction was overdone and the large European market sell off was most likely due to Society General unwinding a very large position from a rogue trader. After the dust settled, the markets knew that the Fed was their bitch and in turn began to stabilize.
Needless to say, I was shocked when the news of Bear Stearns in March hit the street (JPMorgan Chase offered to buy the company for $2/share then later for $10/share for a company that was over $170/share not much more than a year ago). I thought the market may have a hard sell off after the collapse of Bear, but to my amazement it didn’t and actually staged a rally. What were people thinking? Needless to say, times look rough at this point, but investors thought this was the end of the crisis. Some believe that the market is near a bottom now, I believe (with no basis what so ever) that the market will bottom sometime this summer or fall--so you can call me a skeptic.
I still think it is time to hunker down (and I could be very wrong about this) and keep building up those emergency reserve funds. I am not an eager investor at this point and having a pile of cash sitting around might not be a bad thing right now. Since I think we are going to have a recession and during that event cash can be used for one of two things, buying stocks at once-in-a-lifetime prices or having money if you were to find yourself unemployed. Times could get tough and having a plan B and C should be contemplated.
A very well deserved thank you goes out to Blaire who out of the kindness of her big heart decided to “reduce” my typos/sloppiness and volunteered to proofread my “masterpiece”. I thank you and more importantly my readers applaud you.
-Mark
Chapter 1
The Basics
(Vastly over simplistic answers to very complex questions)
Momentum Investing and Technical Analysis
I could attempt to give you a detailed write up on theories on technical analysis and how people use it. Certainly the subject is deep and some seriously intelligent people spend their entire lifetime devoted to the subject and many fine books have been written on the subject. It has always been my philosophy that you don’t have to know how to build a tool to use it. After all, everyone reading this document received it on a computer via the Internet and no one reading this document (for that mater no human) is likely to understand all the vagaries that made this magic transfer of my thoughts to the various readers around the planet.
Hopefully one of the benefits of this document is that I do some of the heavy lifting and research, with the intent of passing my findings on to my reader in an easy to understand way. So in essence, technical analysis is the art/pseudo science of trying to determine where the market is going based on previous price actions. The theory is that the market is comprised of humans buying and selling and they buy and sell in certain patterns. If you can recognize these patterns, you can profit from understanding the pattern, therefore predicting the next market move. Personally, I do use some basic technical analysis to help me make decisions. I like to buy stocks that are rising and also try to sell stocks that go below certain resistance points.
So what is the point of all this? The point is that if you do some research and understand some of the basics of technical analysis it can help you invest (or at least feel better about doing it). The subject is too broad and deep for me to cover it all in this report, and frankly, I am not qualified to discuss it in detail. What I want you to take away from this is a great website that you may not know of that I use often call “barchart”. This is great graphing website that will show you almost any traded index, stock, ETFs, commodity around the world. If it trades on an exchange they most likely can graph it and perform some basic technical analysis for you.
The real sweet spot of this web site is that it will not only do a lot of technical analysis for you, it also displays it in an easy to understand format, free of charge.
Below is the Barchart link for the S&P 500
$INX
You can enter just about any symbol in the upper left hand page and press opinion and get a mathematically derived technical “opinion” of just about any investment. It breaks it down into long-term, short-term and medium-term opinions. In this document I will be using the composite (all) opinion. So in this case (on the day this report was written) the overall indicator was -40%, which in this case is an overall sell recommendation.
Now just a word of warning, I don’t use this as my sole indicator to buy or sell a stock. It is; however, a nice thing to refer to (in fact, the very last thing I look at) before I buy or sell. In my experience, it is slow to pick up changes in the market and is only good at picking up “big” directional movements. Most of what it tells you any reasonably intelligent person could see by looking at the chart. In my case when the market was selling off and I was “in love” with my foreign stocks, this program showed me that some of those stocks were falling and likely to continue to fall.
Remember this is a backward looking calculation so it is very good at telling you what you should have done, but it’s not so accurate telling what you should do…
For a quick introduction to technical analysis try this link
If you want more reading try Amazon and search for “Technical Analysis;” several good books are available. If you are still stumped, email me with what you are trying to get from a book and how much of a math background you have had and I will attempt to select some books for you to read.
Bottom line: To get quick, unbiased (unemotional) backward looking mathematical “opinion” for your investments use the following links:
Major US stock Indexes
S&P 500 $INX
Dow (DJIA) $DOWI
Nasdaq $NASX
Russell 2000 $IUX
Mark’s Model Portfolio Components
SPY
QQQQ
VTV
IWM
EFA
EEM
TLT
IEF
AGG
LQD
SHY
Chapter 2
Market Dynamics
Economic Projections
It is time to review world events applying my “opinion” to the probability of the event occurring (0-100%) with my “opinion” of the market impact on a scale from 1 to 10. A “1” represents little to no impact on the markets; whereas, a “10” indicates that if the event occurs, I expect a widespread fundamental market directional change to occur. This is totally unscientific, based on my irrelevant opinions with absolutely no other basis other than my limited understanding of how the world works.
The purpose of this section is to highlight current risks in the market. I will attempt to quickly try to explain my thought process behind each rating.
US Economic Indicators (my view)
US Gross National Product (GDP) grows > 1.0% in 2008 (down from 1.5%)
Probability of Occurrence 50%
Impact 7
It is obvious that the housing market and now consumer debt are beginning to hamper the economy and I believe that this trend will continue and accelerate for the rest 2008. I believe that we may already be in a mild recession now.
Economists’ consensus for the GDP growth in 2008 was 2.0%. I think that is optimistic and this recession will not be very deep but will drag on longer than most think it will. Clearly Americans were tapping into the value of their houses to fund current consumption and I believe that strategy will be muted in the foreseeable future for obvious reasons.
Thanks to the growth of the third world, the macro world economy is still growing and this will prevent a “severe” recession (a severe recession is the one that affects you directly). Globalization will continue to soak up excess production around the world. By the time the wealth transfer from current home owners and mortgage lenders to the new owners and lenders, the US economy will likely start to expand again.
To some extent, the impact of the housing market on credit markets are now known; my new big worry is what if China goes into a tailspin? The Chinese economy has me a bit concerned and it would have massive implications for world GDP if it had a hiccup at this point. This is where I have my eye now…
Slowing growth in economy is a negative for the market
Low unemployment of < 5%
Probability of Occurrence 50%
Impact 7
The housing market slowdown hasn’t seem to hit the unemployment numbers too bad as of yet (current rate in February was 4.8%). I don’t really foresee a massive unemployment explosion (> 6%), but that could change. If employment stays near its current levels (less than 5% unemployment), I believe this will get us though the current economic weakness without too much pain. Something worth noting is that some believe that the downturn in the housing market is masking the real weakness in the job market. The thesis is that the construction workers are vastly overrepresented by illegal aliens and they don’t go to the unemployment bureau when they are let go; therefore, true unemployment is actually higher. This seems like a plausible scenario.
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Note the uptick in the unemployment rate… One must pay attention to this!
Low unemployment is a positive, conditions appear to be deteriorating slightly
Federal Reserve raises interest rates 2008
Probability of Occurrence 20%
Impact 7
I personally think that the Fed needs to resist lowering too much more and find other way to inject liquidity without causing inflation. Recently they have found some creative ways to open up credit to the broader market, which if temporary, I give my blessing. My issue with the Fed is that each time we lower the rates the dollar falls and we seem attempt to prop up the housing market by making money worth less (transferring wealth from debtors to creditors). Since capital is always in search of higher returns, capital will divest itself of US based assets making the dollar worth even less; therefore, the stuff that we like to buy (oil, BMW’s and Chinese goods) gets more expensive (inflation).
Keep in mind a lot of money is loaned to us from overseas; as the value of the dollar falls foreign investors will see poor returns here compared to other global opportunities. In turn, they will sell their US stocks and bonds and receive dollars. To repatriate their capital, they will sell those dollars and buy foreign currencies, thereby causing the dollar to fall more, and then we go back to the beginning of the cycle… To stop that cycle, the US will have to compete for world capital by offering rates that are higher than the expected foreign exchange deprecation rate. This bodes well for higher long term interest rates.
Lower rates are inflationary, and although good for the stock market (if nothing else changes, stocks should theoretically match inflation) longer term, it causes a flight of capital, which is very bad for the US as it is a debtor nation.
Lower rates are good for the market short term…
Inflation exceeds 3%
Probability of Occurrence 60%
Impact 6
Three forces are at work on this question: world production is producing more goods and services at cheaper prices, strains on world raw materials and maintaining ample supply of raw materials, and falling value of the US dollar; therefore, the vast amount of products imported will cost more… Since we are a net importer it will take more dollars to purchase things that we buy from foreign markets resulting in the prices of these items increasing in terms of the dollar causing inflation.
Low inflation in the US is a positive for the market
Continued strong spending by US consumer
Probability of Occurrence 30%
Impact 7
Clearly the consumer is still far more resilient than what I thought they would have been, but they seem to be weakening (never underestimate the creativity of the American public to find new ways to support their addiction to buying more stuff). What I fear (and more importantly the data supports) is that as the sub prime mortgage fiasco is working its way through the lending system and all types of sub prime lending are being affected, especially credit cards. A great number of American consumers are not prime borrowers. This indicator is to be watched with vigilance!!
This is the a very important indicator and I believe this indicator is weakening
Corporate profits exceed YoY growth of 5%
Probability of Occurrence 50%
Impact 6
It is general consensus on Wall St. that corporate profits will slow down in 2008, which seems reasonable to me given a good chance of a recession. I believe that corporations will not drag on the economy but won’t add as much as they have in the past few years. Profits are not falling; they just aren’t growing as fast. Profits from corporations with significant overseas exposure are still doing well while the ones in banking and housing, not so much…
I expect earnings growth to be down; this is a negative indicator
Real Estate prices drop greater than 7.5% in 2008
Probability of Occurrence 50%
Impact 6
Last year I predicted 10% drop in home prices for 2007 and the January numbers show a drop of 10.7% in the top 20 US metro areas. I think that we will get another 5%-10% drop this year (I am hedging that by using 7.5%) in real estate prices. The banks are getting possession of houses and they are not afraid to move product. I believe this is the year that the banks will dominate the housing market. I believe that 2009 will bring stable prices, but not rising prices.
In the middle of this selling, be on the look out for a “dead cat bounce” or market fake out in the housing market. One month very soon housing prices will go higher but this will be a fools rally and all it will do is bring the frustrated sellers back into the market and push it even lower. Housing is unlikely to recover anytime soon. Look at Japan and see their 15+ year old real estate bear market.
Currently the 30 year mortgage rate is up to 6.033%, which in the scheme of things makes rates still attractive and down 0.5% from just a few weeks ago. Currently, I don’t own a house and plan to rent for at least one more year because I expect housing prices to come down more. I expect houses to stabilize in 2009, not because of intrinsic value, but due to the new tax and spending scheme in place, higher inflation, and voter bias to have the tax base subsidize home ownership. I believe that real estate, at that time, will be a reasonable safe haven for capital, only if you can borrow the money at a low tax subsidized fixed rate.
In my last report I reported what was going on in the jumbo mortgage market. Jumbo loans are larger loans that exceed $417,000 and those loans could not be bought by Freddie or Fannie. The going rate for large loans for people with excellent credit and at least a 10% down payment was almost a full 1% higher than conforming loans that were below that limit. Previously I thought the upper end of the market was going to be immune to this meltdown (after all the rich are getting richer), but without government backing no one wanted to make these kind of large loans without significant (market) compensation.
Thanks to shrewd thinking by lawmakers (sarcasm), our government has come to the rescue of those poor destitute soles that were trying to borrow more than $417,000 (Jumbo loans). After all, who would want to live a house worth less than $500k? Congress quickly passed legislation that Freddie and Fannie can now buy those types of loans up to $729,750. It is hard to find a good quote on the internet for a jumbo loan, but I have determined they are falling very fast. Thank goodness for all of us that need to buy a million dollar house, we can now get financing at a good rate (more sarcasm). Your tax dollars hard at work for you!! Why did this section of the real estate market get bailed out so fast? 1) It was easy to do 2) Most congressmen fall into this price range for a house.
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Obviously this is a big negative for the investing since it is destroying equity.
$1,000,000,000,000.00 (Trillion Dollars) Trade deficit by 2010
Probability of Occurrence 35%
Impact 3(short term)
That is not a typo, T as in Trillion not B as in Billion. The 2007 deficit fell to $738.6 Billion from $811.5 Billion in 2006. A recession will likely reduce it more since we won’t be able to afford to import as much stuff. Latest monthly number was -$58.2B ($698.4 annual rate). Now it would seem that this is a good thing on the surface, but what I fear is that it’s because we can no longer afford to buy as much stuff and the weak dollar is helping our exports. As much as I hate a large trade deficit in the long run, currently, I believe that this is reflecting the weakness in the dollar and the US economy.
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Excessive imports are a bad thing…
International value of the US dollar declining >20% in next 5 years
Probability of Occurrence 75%
Impact 7
We need to watch to see if the dollar falls too much too fast. It may be good for our exports but let’s face it, we import a lot more stuff than we export. A lower dollar is inflationary since you will need to pay more for the things manufactured abroad.
If the dollar falls too much, foreign money will want to leave the US and interest rates will need to go up in order to convince foreign capital to stay.
Although the economy has grown over the past few years, I don’t believe it can continue to support the current public and private debt burden. I believe that in the long term the dollar has no direction to go but down. The combination of poor education, poor fiscal discipline (public and private), and mass retirement only leads me to believe over the next 20 years it would be better to place a significant portion of your investments overseas to obtain better growth and to take advantage of the eventual currency devaluation and fall in local purchasing power.
As you can see from the chart on the next page, in 2001 it took about 85 cents to buy a Euro, today it takes over $1.57 (a 7.5% drop in the dollar since the last report) and I don’t foresee this trend changing anytime soon. It is going to get worst…
Chart: How many dollars does is cost to buy 1 Euro?
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This chart should have scared you; this is not a good thing…
The weakening Dollar is bad for US investments.
Technical Indicators (New indicator this issue)
Current values N/A
Impact N/A
Last issue I added the Volatility Index to the list of indicators and in this issue I am going to add technical indicator for some of the Major ETFs that are tracked in the Model Portfolio.
US Stock
SPY -40%
QQQQ +8%
IWM -24%
Foreign Stocks
EFA 0%
EEM -32%
Bonds
TLT +72%
SPY +56%
Volatility
VIX +8%
These indicators are weak for US stocks and strong for US Government Bonds, the VIX is neutral on the US Stock Market; the foreign markets are weak to neutral
Liquidity
Probability of Occurrence 35%
Impact 8
Liquidity almost dried up this year and the lack of it could have caused a worldwide credit meltdown… I have previously stated I feel that this was one of the more important indicators. The Fed is getting more creative about injecting liquid and it is having a positive effect. I feel that some of the liquidity issues are kind of behind us, but certainly not over. This still leaves us to worry about foreclosures and a recession.
This is still a big market negative but seems to be stable
Chapter 3
The Plan
Every trader reserves the right to make a more intelligent decision today than he made yesterday.
- Sheldon Natenberg
The Housing Market, where are we and where are we going?
I believe that we will still see more misfortune ahead of us and I still believe that we are still only in ACT Two of this drama.
The three “acts” of the housing bear market are:
Act One: Build and they will come!
Act Two: I have to repay this loan?
Act Three: Banks liquidate and crush housing prices…
In the January report I stated that “we are still just in the beginning of Act Two”. I would now like to advance that clock forward a bit to “Middle of Act Two”. One thing to be watchful for is an intermission, just because the stage goes dark and the house lights come up doesn’t mean that the play is over… We would still have sufficient time for more bankruptcies, more Fed action, more credit crises, more congressional gifts to the public, more dollar collapse, and with a rebel yell she cried “more, more, more!!!”
So since we may be near the midpoint, shouldn’t I be relieved and start investing like a mad man? Theoretically, I guess that the worst could be behind us, but I really don’t think that is the case. The liquidity crisis caused by the housing crisis seems to have received some effective triage, but this is treating the symptom not the disease. What we do see is that the public (market) becoming aware of the problem and we are taking action to fix the problem (many of them well intentioned but most are only making things worse in the long run). There will be other shoes to fall and more bad news. Again it might be at a bottom, but I still think it’s a bit risky. We will have a recession. We will have more US dollar failure. We will have more firms going out of business. The capital markets need to work through the entire liquidity, mortgage, foreclosure, recession and inflations issues before the econmomy can recover.
Act Two will play out for about another few months or so and I now expect Act Three to take another year or after that. Bottom line is that I expect the housing slump to go on for at least one more year. When act two is over, then it may be the time to invest.
We are still riding a cyclical bubble that started in 1998 with a stock market bubble, then to avoid economic calamity, we lowered interest rate, which caused excessive cheap money and resulted in massive housing buying. This is now causing massive liquidity issues in the credit markets that will cause an inflation/commodities bubble. At the end of the day, we will all have to pay the price for this ill conceived 10 year long cycle of fixing bubbles and delaying pain with easy money policies. That day of reckoning shall be an unavoidable, prolonged, stagnant economic growth along with inflation… Stagflation may be in our economic future and if it is, it will be long and painful economic future.
Why I will buy a house in 2009
Now believe it or not, I am convinced that the housing market will bottom sometime in 2009 and I plan to buy a house in a year or so. I plan to buy a house larger than I need and I plan take out the largest loan that I can get.
Why? Do I expect that housing markets will bounce back to the pre 2007 levels and a new great boon in real estate? HELL NO!! I want to buy a house for the sole purpose of borrowing discounted debt and by discounted debt I mean government subsidized debt. I believe that the marginal tax rates are very likely to go up in 2010, so the value of the subsidies will increase as marginal rates increase.
I expect long term interest rates and inflation to increase starting in a few years due to deficit spending and social programs. I also expect these problems to weaken the value of the dollar; thus, causing inflation. I do not ever expect that trend to reverse quickly.
My “investment” in housing is a two fold strategy. I will buy a house, which is an asset, but I only expect housing prices to keep pace with inflation and I expect no “real” inflation adjusted gain. Again I do not expect housing prices to increase faster than inflation I only expect prices to keep up with inflation, but I expect inflation to increase and the dollar to fall (this is a very important concept). I will borrow as much money as possible at a fixed rate and pay back the loan in the distant future, presumably with materially less valuable future dollars. I hope to have very little out of pocket money involved in my transaction. My expectation is that the assets (houses) will rise only due to inflation, and the “real” value of my fixed rate loan will fall due to increasing interest rates and inflation.
The beauty of this concept is that houses are the only investment instrument, that I know of, that you can make material capital gains on an asset and NOT pay any taxes on that gain (up to $500,000 for a couple). This is also an important concept as high inflation is actually a tax on wealth. This strategy is the only one that I can think of to legally get around that wealth tax.
The key to this “spread” or inflation arbitrage is getting a long term fixed interest rate loan. When inflation kicks in, assets increase in value and debt decrease in value; therefore, you would want to own assets (houses) and owe debt (take out loans). I have been preaching the fall of the housing market and now I will be preaching (in a year or two) the value of having a house with lots of fixed debt against it. Oh yeah, the tax breaks on the loan and the fact that you don’t pay taxes on the capital gains on a house make it that much more enticing. When everyone else is zigging, we should be thinking about zagging.
The housing subsidies chain:
• Freddie and Fannie back loans using government money, making loans “below market”
• When you borrow this money it is tax deductable
• When you make a gain on the sale of a house, you pay no taxes up to $500,000
Profits from selling houses, the IRS webpage…
Higher taxes are coming and higher inflation is coming. Leveraged real estate investments are a proven hedge against both, primarily due to our convoluted tax laws. The falling value of the dollar transfers wealth from the creditors to the debtors. Having some subsidized debt gets you a little more on the debtor’s side of this equation. As in previous issues, I don’t believe paying off a house early is a good strategy.
The next round of the credit crunch…
Recently Moody's Investors Service hinted that the United States' "triple-A" government bond rating could come under pressure in the long-term if the Medicare and Social Security programs are not reformed. This isn’t likely to happen any time soon, but they could downgrade US debt in the next10 years or so… What would this mean? This event will cause even higher taxes (to pay for interest on the debt) and a massive fall of the US dollar. The poor and middle class will be decimated, and the rich may start to leave the country. This may be a good time to (re)read Atlas Shrugged…
Summary of Mark(et) US Economic Indicators
GDP Growth – Weakening
Unemployment – Low but trending up
Federal Reserve Bias – Lower and rates are trending down
Inflation – Stable but moving higher
Consumer Spending – Weakening but resilient
Corporate profits Growth Rate – Lower
Real Estate Market – Lower
Trade Deficit – High but stable
Volatility Index – High
Technical Indicators – Weak stock, Strong bonds
Liquidity – Problematic, but stabilizing
So… What is the Plan?
This is what I think (time to reread that declaimer on page 3 again). Clearly globalization has not and will not go away for the next 30 years. Clearly the US has demonstrated its dependency on credit. Add in the fact that we have a growing social security time bomb and it still brings me back to the same theme that I have had since the first issue of this report. With my long term view on global macroeconomics and my view of the US macroeconomics of the US debt markets, I have no choice but to invest heavily outside of the US as much as possible, having little to no exposure to US dollar and especially US Government bonds in the long run…
I believe at the end of the day I will (eventually) make a lot of money off this current credit meltdown event. The world economic changes that are occurring are not going to be stopped by this temporary hiccup in capital flows. Longer term, more than a billion people on this planet are in the process of becoming “middle class” and they are going to want things and they will have the means to buy them.
Am I calling a bottom in the market and jumping into the market aggressively now? No!! But I do expect that sometime in the next year or so, I will be aggressively buying global growth story to the extent that I will not be able to sleep at night for fear of the size of my investments (but if I am right it may be easy for me to sleep at night for the rest of my life)… The game for now is to try to have a big pile of cash for when the waters start to clear. When you are able to invest at that point the rewards will be quick, swift and unprecedented.
I see two paths before me, the first path is to be safe and stay on the sidelines while this event unfolds and then have a pile of cash ready to put to work when the coast is clear. The second path is to believe that the upside outcome is so positive and the return so swift that if I were invest NOW I might loose money short term but I will not miss any of the recovery. One could see a payoff that will be so high that 10%-30% loss now is insignificant in the long term… This “market timing” will be my most important investment decision of the next 5 years… I am going with mostly plan A and some of plan B.
Now let’s talk about the case for owning bonds, I still believe that they are likely to do well over the next several months as the flight to quality should still be in vogue. Longer term all this injection of liquidity should cause inflation (the larger supply of money the less its worth). Bonds do very poorly during inflation. I believe that by the end of the year bonds will have become a bad investment.
Gold sold off this quarter after a good run; I believe that long term that this is still an excellent investment vehicle. I sold most of my GLD (the gold ETF) around $95 and would like to see it come down to the $80-85 range before I buy it all back. If gold doesn’t continue to fall and starts to rise past $1000 (GLD = ~$100) then it may be time to get back in…
I also bought some TIPS (Treasurer Inflation-Protected Securities) this quarter, as the name implies these pay a yield based on current inflation rates. I bought Western Asset (WIA) which is a TIP CEF. Right now I am getting about 5.5% on my money (beats short term treasuries) and it should give a higher yield if and when inflation goes up. I would like to buy more TIPS, so if anyone out there has some ideas please let me know. I am currently researching another Western Asset (WIW) and hope to report back next quarter.
Chapter 4
Mark’s Model ETF Portfolio
Asset reallocation
General profile for a several diversified portfolios
| |Risk |Balanced |Growth |Aggressive |
| |Adverse | | | |
|US Large Cap: |20% |30% |40% |30% |
|US Small Cap: |10% |10% |20% |30% |
|International: |10% |20% |30% |40% |
|Fixed Income: |50% |35% |10% |0% |
|Cash: |10% |5% |0% |0% |
US Large Cap:
SPDR S&P Depository Receipts (SPY) 33%
NASDAQ 100 Trust Shares (QQQQ) 33%
Vanguard Value VIPERs (VTV) 33%
US Small Cap:
iShares Russell 2000 Index (IWM) 100%
International:
iShares MSCI “EAFA” Europe, Australia and Far East Index Fund (EFA) 50%
iShares MSCI Emerging Markets Index (EEM) 50%
Fixed Income (Bonds):
iShares Lehman 20+ Year Treasury Bond (TLT) 25%
iShares Lehman 7-10 Year Treasury Bond (IEF) 25%
iShares Lehman Aggregate Bond (AGG) 25%
iShares GS $ InvesTop Corp Bond (LQD) 25%
Cash:
iShares Lehman 1-3 Year Treasury bond (SHY) 100%
Year to Date Returns
|Name | |12/31/07 Price |Current Price |YTD Gain % |YTD Gain % w/ |
| |Symbol | | |w/o Div |Div |
|SPDR S&P Depository Receipts |SPY |$146.21 |$131.97 |-9.74% |-9.30% |
|NASDAQ 100 Trust Shares |QQQQ |$51.22 |$43.72 |-14.64% |-14.58% |
|DIAMONDS Trust |DIA |$132.55 |$122.40 |-7.66% |-7.15% |
|Vanguard Value VIPERs |VTV |$66.39 |$60.08 |-9.50% |-8.84% |
|iShares Russell 2000 Index |IWM |$75.92 |$68.29 |-10.05% |-10.05% |
|iShares MSCI “EAFA” |EFA |$78.50 |$71.90 |-8.41% |-8.41% |
|iShares MSCI Emerging Markets |EEM |$150.30 |$134.38 |-10.59% |-10.59% |
|iShares Lehman 20+ Year Treasury |TLT |$93.04 |$95.89 |3.06% |3.06% |
|iShares Lehman 7-10 Year Treasury |IEF |$87.01 |$91.96 |5.69% |5.69% |
|iShares Lehman Aggregate Bond |AGG |$101.17 |$102.68 |1.49% |1.49% |
|iShares GS $ InvesTop Corp |LQD |$104.84 |$105.20 |0.34% |0.34% |
|iShares Lehman 1-3 Year Treasury |SHY |$82.19 |$84.24 |2.49% |2.49% |
As you can see, just about everything got creamed and the NASDAQ was toast. Emerging markets and the small cap index, “Russell 2000,” also got hit hard. Everything but the 10 year treasuries got hit or did little. This is the first time since inception of this portfolio that a loss has occurred in all categories (risk adverse – aggressive) and as you can see from the box below the more aggressive you are in the good times the more you make, the more aggressive in bad times the more you loose.
Growth and Aggressive have almost lost their entire gains from last year in a single quarter. This balances out their relative performance to each other the last few years. I am still an aggressive investor because in the long run I believe that I will do better and I believe that the risk adverse portfolio will start to fail next year due to the bond component.
Results for the various “no brainer” portfolios
| |Risk |Balanced |Growth |Aggressive |
| |Adverse | | | |
| | | | | |
| ’08 YTD Return |-2.38% |-4.84% |-8.58% |-9.81% |
|‘07 Return |7.82% |9.40% |10.04% |10.45% |
|’06 Return |9.72% |13.63% |19.09% |21.83% |
|’05 Return |5.49% |7.55% |9.73% |11.77% |
Chapter 5
Domestic Investment Ideas for 2008
I am still avoiding individual stocks and I am emphasizing more focus on ETF and indexes. As stated in the previous chapters, the current ideas are things for me to watch and to buy on dips or to purchase late this summer. Not necessary something I will buy today.
Security Name Goldman Sacks
Symbol GS
Sector Investment Banking
Risk Moderate +
Return Medium
Complexity Simple
Time Horizon Long term (36 months +)
Tax implications Dividends are taxed 15% rate
Account(s) IRA and Taxed
Why do I like Goldman Sacs? That is easy; it has a low Price to Earnings ratio (< 9) and has great growth potential. Of all the investments banks this one had almost no subprime exposure, but its price got hit anyway. Goldman has some of the best financial minds in the world working for it and I think owning some of this company for the long run is a good idea. It doesn’t pay a high dividend because it has better uses for your money. It has been hit with concerns about credit and such but THIS may be the time to buy at least some of this stock. I own some GS.
High Dividend Stocks
The next few picks all have a high yield and should continue to be a decent hedge against inflation. A basket of these types of investment could be a boon for any portfolio in the long run. I believe that many of these stocks will play well in the long run with inflation, but if a hard recession comes these stocks will reflect that price also…
San Juan Trust
Symbol SJT
Sector Natural Gas Trust
Risk Moderate +
Return Moderate
Complexity Simple
Time Horizon Long Term (12 months – 24 months)
Tax implications Dividend tax rate of 15% does not apply to this instrument.
Dividends are taxed at your normal incremental tax rate.
Account(s) IRA only
Basically with this trust you own some of the natural gas in the San Juan basin in the western US. They sell it and give you the money each quarter. Currently the yield is about 6% but longer term natural gas could go much higher (due to high oil prices) and the yield could go much higher and/or the stock price will increase. Be aware that trusts do not pay corporate taxes; therefore, dividends are at your normal marginal rate. Also, keep in mind that this is a declining asset, since the gas produced is falling each year, so this accounts for the higher dividend. It is not a long term hold.
This is a very volatile instrument since the payout is directly based on the price of natural gas in the San Juan Basin. As natural gas prices change, so will this issue.
British Petroleum Trust
Symbol BPT
Sector Oil Trust
Risk Moderate +
Return Moderate
Complexity Simple
Time Horizon Medium Term (12 months – 24 months)
Tax implications Dividend tax rate of 15% does not apply to this instrument.
Dividends are taxed at your normal incremental tax rate.
Account(s) IRA only
Basically, with this trust you own some of the oil in the Prudhoe Bay in Alaska. They sell oil, take out some fixed expenses and give you the remaining money each quarter. Currently, the yield is about 13%, but longer term natural gas could go much higher (due to high oil prices) and the yield could go much higher and/or the stock price will increase. Like SJT, this trust does not pay corporate taxes; therefore, dividends are at your normal marginal rate. Also, keep in mind that this is a declining asset since the oil produced in Alaska is falling each year, so this why the dividend is so high. It is not a long term hold.
This is a very volatile instrument since the dividend is directly based on the price of oil, which we all know is very choppy.
Knightsbridge Tanker
Symbol VLCCF
Sector Oil Shipping
Risk Moderate +
Return Moderate
Complexity Simple
Time Horizon Medium Term (12 months – 24 months)
Tax implications Dividend tax rate of 15% does not apply to this instrument.
Dividends are taxed at your normal incremental tax rate.
Account(s) IRA only
This company allows you to effectively be paid out from its profits from shipping oil around the world. This company owns five doubled hauled VLCCs (Very Large Crude Carrier). It collects the money, pays expenses, and distributes the remaining money to its shareholders. This stock is volatile in the short run since the “value” moves significantly based on the daily shipping rate and the price of crude.
This company is a “foreign” entity that has some particular tricky tax rules associated with it (which isn’t worth dealing with), so I only will buy it in tax deferred account (IRA Rollover)
Precision Drilling Trust
Symbol PDS
Sector Oil and Natural Gas Drilling Trust (Canada)
Risk Moderate +
Return Moderate
Complexity Simple
Time Horizon Medium Term (12 months – 24 months)
Tax implications Dividend tax rate of 15% does not apply to this instrument.
Dividends are taxed at your normal incremental tax rate.
Account(s) IRA only
Ok, I didn’t want to toss this into the foreign stock basket even though most people (and all Canadians) consider Canada a foreign country but it fit so well into this dividend theme. Same type of deal here except that you are dealing with a Canadian Trust. This company owns 240 drilling rigs and deploys them around the US and Canada. They make money, pay expenses and distribute the remaining cash. It’s been paying a 6-7% dividend.
The same applies as the others trusts you are dealing with something very volatile that will go up and down with energy prices and you will have to deal with the complex tax rules if you were to put this into a “normal” taxable account.
Also some the technology stocks that I think are cheap and looking at…
Intel (INTC) as a trading stock when it goes below $20 sell some above $22 but keep some longer term ($28)
Nokia (NOK) down some recently but a great long term play on the cell phone market
Cisco (CSCO) backbone to the internet, that isn’t going away anytime soon….
Other names
Home Depot looks cheap to me… It has a 3.2% yield and I think 90% of all the new is factored in?
Chapter 6
International Ideas for 2008
2008 Economic Growth Forecast by Country
China |9.9% |Poland |5.2% |Brazil |4.5% |United Kingdom |2.0% | |India |7.7% |Venezuela |5.1% |Hong Kong |4.5% |United States |2.0% | |Egypt |7.3% |South Africa |5.1% |Taiwan |4.4% |Germany |2.0% | |Russia |6.6% |Thailand |4.9% |Israel |4.2% |Canada |2.0% | |Indonesia |6.1% |Turkey |4.8% |Australia |3.5% |European Union |1.9% | |Argentina |6.0% |Singapore |4.8% |Sweden |2.9% |France |1.8% | |Pakistan |5.9% |South Korea |4.7% |Mexico |2.8% |Japan |1.7% | |Malaysia |5.7% |Chile |4.6% |Spain |2.5% |Italy |1.3% | |Notice that the United States and Europe lag behind the rest of the world in expected growth this year. China and India once again lead the pack in world growth; Ireland has the lead for developed countries with Australia running a distant second. Now one can’t make an investment in a country just based on GDP expectations, but it is a start…
International Investments that I like
Lloyds TSB Group
Symbol LYG
Sector Foreign Bank (UK)
Risk Medium+
Return High+
Complexity Simple
Time Horizon Long term (60 months +)
Tax implications Dividends are taxed 15% rate
Account(s) Taxed and IRA
Now this pick is a company that has been getting beaten down and in my opinion is a good value, Lloyds. This stock has two things going for it, a very high yield (over 7% and eligible for 15% tax rate) and exposure to the British Pound (not the dollar). When you invest, you are essentially converting your Dollars into Pounds. If you believe the dollar is falling then this is a great stock to own since even if the stock price doesn’t go up in the UK, if the dollar falls the price will go up here in the US.
Also, with the entire banking industry being sold off, this stock got dumped along with everything else. Assuming that the dividend stays in place (I see no reason why it would increase) you can receive 7.5% yield on your investment while you wait for this stock to double in the next 5 years. I like 25% per year returns for the long haul…
This stock risk rating is slightly higher risk since you have exposure to both the UK banking system and British currency. This is my international stock pick of the year…
Security Name Morgan Stanley India Investment Fund (IIF)
Security Name India Fund, Inc (IFN)
Sector Emerging Markets Closed End Fund (CEF)
Risk High
Return Extraordinary
Complexity Simple
Time Horizon Very Long term (5 years – 10 years)
Tax implications Consult tax advisor
Account(s) IRA and Taxed
These funds got hammered, down almost half from the peaks, not only did I hold these CEFs but I bought more. My belief is by the year 2015, these issues will be multiples of where they are now.
Considering the growth potential and long-term outlook, I am still comfortable buying these instruments at these prices. Be forewarned these ETFs are very volatile, and I am no longer shocked when I lose or gain 5-10% in any given day. Last year I received over a 20% dividend check from IIF…
Bottom-line: India has a large population, is organized, has a stable government, hardworking, intelligent, educated workforce, and it has potential strong sustainable economic growth. It has great long term possibilities.
iShares MSCI Brazil Index
Symbol EWZ
Sector International ETF
Risk Moderate
Return Moderate +
Complexity Simple
Time Horizon Long term (2 years – 10 years)
Account(s) IRA and Taxed
Well, Brazil has been making economic progress and then the country suddenly found huge oil reserves to top it all off. With a 4.5% GDP growth expected, this is one way to get some exposure to South America
In the upcoming years, it is possible to see the fruits of untapped capitalism to materially change the economy of Brazil.
Morgan Stanley Capital International Australia Index
Symbol EWA
Sector International ETF
Risk Low +
Return Medium+
Complexity Simple
Time Horizon Long term (36 months – 60 months)
Tax implications Consult tax advisor (mostly at 15%)
Account(s) Taxed and IRA
I bought this to play China and India indirectly; I believe that Australia is a place to invest because of its raw materials and the proximity to India and China. This ETF is traded in the US that matches the Australian stock market, which is a significant supplier of raw materials to Asia. This stock has also taken a beating and I will continue to hold it and have bought more and will continue to do so.
Arcelor Mittal
Symbol MT
Sector Steel
Risk Medium+
Return High+
Complexity Simple
Time Horizon Long term (60 months +)
Tax implications Dividends are taxed 15% rate
Account(s) Taxed and IRA
This is the world’s largest steel company and has 300,000 employees in 27 countries around the world. As developing countries develop they will need steel to build their infrastructure and if you need steel, they make it… a lot of it…
Chapter 7
Final Thoughts
The Good
• Growth in the developing world continues to grow at an unprecedented rate that is contributing to a massive increase in world wealth
• The world is still getting richer, wealth is being created in vast quantities daily
• Spectacular investing opportunities will present themselves in the next two years
• Short term interest rates remain relatively low
• Unemployment is low but is likely to go up
• Is that a light at the end of the credit crisis tunnel?
The Bad
• Reduced global liquidity
• Continued unwinding of the housing market
• Potential of consumer credit crunch due to multiple factors
• Possible recession this year in the US
• Higher energy, metals and grain prices (inflation)
• Dollar has weakened
• Lower corporate profits growth rate this year
• Expanding Budget deficit due to falling tax receipts and increased spending
• Democrats in control of economy in 2009
• Long term US investment climate in 2010 due to tax cuts expiring
• Trade imbalance
• War on Terror/geopolitical instability
The Ugly
• Potential of a international credit meltdown and worldwide economic collapse
• Social Security will cause a US hyperinflation sometime within 20 years
• The US Government borrows too much money and its citizens don’t save enough
• Potential for national debt spiral both public and private
• Free health care for everyone in 2010… Dollar falls (more)
• Potential for US debt to be downgraded over the next ten years
• War! What is it good for? Absolutely nothing.
Final thoughts:
The housing market is a $1 trillion dollar problem in a $13 trillion US economy and $45 trillion world economy. The housing bubble is nothing more than the shifting of wealth, from current owner and lenders to future owner and lender. The housing market problem has actually caused more worldwide loss in stock market value and lost GDP than the underlying problem (i.e. more than a trillion dollars of wealth has already been lost in the various stock markets due to the problem).
China will be the world’s largest economy by the year 2040. On a purchasing power parity basis, China will very likely overtake the US as early as 2015 and simultaneously the Social Security will start drawing on “the trust fund,” which really means the government will need to raise more taxes and borrow more. These two events will mark the ascension of China and the decline of the US as a world superpower.
Globalization helps the economy. Cheaper goods and services appear on our shores everyday and despite the common misconceptions; globalization benefits the US and everyone else on the planet.
I believe that US dollar based bonds will be a poor investment choice by the end to the year. I believe we are headed for higher inflation and a weaker dollar and those both are not so hot for bonds. Learn about TIPS and other inflation resistant instruments.
This is the conclusion of my report, I hope to get the next report out July 1st 2008 and entertain you with my new thoughts and reflections. Please send any questions, comments or topic ideas for future issues to me via email. GOOD LUCK and good investing!!!
Regards,
Mark Rush
redgroup2@
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