The Rush Report
The Q3 2008 Market Rush Review
By
Mark Rush
redgroup2@
October 5th 2008
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Preface
Once again, it is once again time for my quarterly market review, where I examine world events and attempt to understand their implications on the market. This is my time to reflect on current events, portfolio performance, and event scenarios, and their subsequent implication on world equity markets and my investment strategies.
As you read through this review, even if you don’t agree with my thoughts or analysis, please take the time to think about your financial choices and 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 impact 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 fact that I invest money from the United States using US dollars and pay 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. Opinions stated are my own and do not reflect the opinions from any current, past or future employer.
I will/may change my strategy and investment 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
For those who were expecting the Q2 Rush Review last quarter, I apologize. Due to various factors (work, life, etc) I was unable to put out a report this past July. I will at least send a mini-version in the future if such a confluence of events were to occur again.
The past six months contained much more excitement than I ever wanted as the housing situation continued to collapse causing more financial institutional write downs and more credit concerns. Even I was astounded as the world credit system barely escaped total collapse and the investments that I owned at that time were completely decimated. The past six months have not been pretty, but the global credit market has made it through this event, at least for now.
Fannie Mae and Freddie Mac own or guarantee about $5 trillion in home loans, about half the nation's total mortgages. Freddie and Fannie collapsed and had to be bailed out by the US government. We also had the failure of Lehman Brothers, the takeover of Merrill Lynch and the bailout of American International Group, all in the past few weeks. Washington Mutual and Wachovia also needed to be taken over and sold along with rescue plans in Europe for several major banks over there. The Irish government guaranteed all banks in Ireland.
The US Government also had to step in to guarantee money market funds; money market funds contain $2.1 trillion and a run on these instruments would surely have triggered a total collapse of the monetary system, triggering a depression. Three Month Treasuries hit zero percent briefly last quarter during the panic. Just imagine, people were so scared that they were willing to loan money to the government for no return at all.
All this turmoil caused a “run” on credit. It became almost impossible to get short term credit as everyone was afraid of who was going to fail next, so no one loaned money to anyone. Treasurer Secretary Paulson came up with an idea to “rescue” the banking system with a “bailout” package that was signed into law on October 3rd.
Gold, Oil, commodities in general and the value of the dollar gyrated wildly in the past few months also. Commodities prices fell hard on fears of economic slowdown and rose wildly on fears of a collapsing dollar. Bonds and the dollar also gyrated wildly also.
On top of it all, we have an election coming up. I am registered and ready to cast my ballot. Now is the time to think about the potential impact of election results and the possible impact on the portfolio. Soothsaying at its best…
On a personal note, during the height of the credit crisis the company that I work for (Constellation Energy) experienced a severe credit crunch and had to be immediately sold to Warren Buffet for a quarter of the price that was worth just a few months ago. Because of those who lent recklessly and those who borrowed irresponsibly, I have experienced a materially change to my life. I didn’t own a home because I recognized this crisis was on the way but the housing crisis ended up impacting my life anyhow.
-Mark
Chapter 1
The Basics
(Simplistic answers to complex questions)
What the heck is going on in the financial markets and why should I care?
The Treasury effectively nationalized Fannie Mae and Freddie Mac on September 8th. Their combined assets are over $5 trillion ($5,000,000,000,000) or about 10% of the total net worth of the United States. These two firms help guarantee over half of all the mortgages in the US. On the following Monday, Lehman Brothers made the largest bankruptcy filing in U.S. history. Lehman had over $600 billion in assets and 25,000 employees. (The largest previous filing was WorldCom, whose assets just prior to bankruptcy were just over $100 billion.)
The following Tuesday, the Federal Reserve made an $85 Billion bridge loan to A.I.G., the largest insurance company in the world, with assets of over $1 trillion and over 100,000 employees worldwide. The Federal Reserve bought 80 percent of A.I.G., fired A.I.G.’s management, and is nearly wiping out A.I.G.’s current shareholders. The Federal Reserve has never asserted its authority to intervene on this scale, in this form, or in a firm so far removed from its own supervisory authority.
In short, the wheels were coming off the global credit market and if the Federal Reserve had not taken bold and drastic action, it may have caused a major collapse of the world banking system and most likely would have triggered a worldwide depression.
Fannie and Freddie
Fannie and Freddie had been set up to support the housing market. They helped guarantee mortgages (provided they met certain standards) and were able to fund these guarantees by issuing their own debt, which was implicitly backed by the government. The government guarantees allowed Fannie and Freddie to take on far more debt than a normal company and in turn, they were supposed to use the government guarantee to reduce the mortgage cost to the homeowners. Many investors and foreign governments considered the debt of Fannie and Freddie as a substitute for U.S. Treasury securities and snapped it up eagerly.
Fannie and Freddie were poorly supervised and strayed from the core mission. They began using their subsidized financing to buy mortgage-backed securities, which were backed by pools of mortgages that did not meet their usual standards. Over the last year, it became clear that their thin capital margin was not sufficient to cover the losses on these subprime mortgages. The massive amount of widely held debt would have caused collapses everywhere they defaulted; so, the Treasury took over Fannie and Freddie in order to prevent a disintegration of the credit system and the utter collapse of the dollar.
Lehman
Lehman’s demise came when it could not even keep borrowing. Lehman was rolling over at least $100 billion a month to finance its investments in real estate, bonds, stocks, and financial assets. For months, investors became convinced that Lehman’s real estate losses were bigger than it had acknowledged. As more bad news about the real estate market emerged, including the losses at Freddie Mac and Fannie Mae, this view spread. Once people became convinced that if they loaned money to Lehman they would never see it again, people stopped loaning them money. Subsequently, they simply ran out of money and had to file for bankruptcy protection when they could not get new loans.
A.I.G.
A.I.G. needed to raise money because it had written $57 billion in insurance contracts (Credit Default Swaps or CDSs), whose payouts against losses incurred on subprime real estate-related investments were hemorrhaging. Furthermore, the possibility of greater losses loomed if the housing market continued to deteriorate. The credit rating agencies, looking at the potential losses, downgraded A.I.G.’s debt. With lower credit ratings, A.I.G.’s insurance contracts required that A.I.G. demonstrate it had the collateral to service the contracts. Estimates suggested that it needed roughly $15 billion in immediate collateral.
A second problem facing A.I.G. was that if it failed to post the collateral it would be considered in default on the CDS’s. If A.I.G. defaulted, other A.I.G. contracts (tied to losses on other financial securities) contained clauses stating that its other contractual partners could insist on prepayment of their claims. These cross-default clauses are present so that resources from one part of the business do not get diverted to plug a hole in another part. A.I.G. had another $380 billion of these other insurance contracts outstanding. No private investors were willing to step into this situation and loan A.I.G. the money it needed to post the collateral.
In the scramble to make good on the CDS’s, A.I.G.’s ability to service its own obligations came into question. A.I.G. had $160 billion in bonds held worldwide. A failure of this firm would have tied up these assets for years in court.
In addition, other large financial firms — including Pacific Investment Management Company (Pimco), the largest bond-investment fund in the world — had guaranteed A.I.G.’s bonds by writing CDS contracts. Given the size of the contracts and the number of parties intertwined, the Federal Reserve decided that a default by A.I.G. would wreak havoc on the financial system and cause a cascade of failures. There was an immediate need to get A.I.G. the collateral to honor its contracts, so the Federal Reserve loaned A.I.G. $85 billion in return for 80% of the company.
Why should I care?
The fear of being the next Lehman should convince many of the large institutions that, no matter how much they have already raised, more is needed. It may be expensive to attract more equity financing, but the choices may be bankruptcy or sale. The decision by the Federal Reserve to not cut interest rates suggests the Fed recognizes that the short-term interest rate not the way to address this problem.
As their own funding dries up, the remaining financial firms will be much more cautious in extending credit to other firms and individuals. So, even for people whose own circumstances have not much changed, the cost of the credit is going to rise if they are able to get credit. For an individual or business that falls behind on payments or needs an increase in short-term credit because of the slowing economy, credit will be much harder to obtain than in recent years. Many small and large firms are not going to be able to get the credit to expand operations or, in some cases, to even continue operations.
Ultimately, this will slow growth. We have not seen this much stress on the financial system since the Great Depression, so we do not have any recent history to rely upon to quantify the magnitude of the slowdown. An educated guess by Goldman Sachs suggests that growth will be about 2 percentage points lower in 2009 due to this fiasco. If the banking system collapses, the loss in GDP would be drastically higher and materially more painful.
What are the consequences?
I think we are in uncharted waters at this point and the outcome of this crisis still remains to be seen. We could be primed for return to moderate growth or on the verge of a global depression. Most likely we will fall somewhere in between those two extremes. What is certain is that the US government has taken on much of the risk that was in the system, for better or worse. I believe the government has risked the entire US monetary system to save the credit market and if housing prices were to go into a total freefall, it has virtually guaranteed the complete collapse of the US dollar.
More than likely confidence in the system has been stabilized and we should start working our way out of this crisis. What we can expect are significantly higher standards to get a loan for a house, a reduction in access to easy credit, and that the home equity loan ATM machine is closed for now. This will hurt consumer spending for some time.
Leverage in the system is being reduced. Therefore, we can expect to have less credit available and the laws of supply and demand dictate that if less credit is available the price of that credit will be higher. Lower availability of credit will result in slower economic growth here and abroad.
Also, I believe that we have scared many foreign investors and they will expect a risk premium to continue to invest in the US. This will require the US to pay higher interest rates for its debt in the future and will make the dollar worth less in the long term. Also, I would expect that some foreign investors might be less willing to invest in US Treasuries. I think people are beginning to see that the dollar is not risk free investment. The bottom line is that none of this is good for growth, US Treasuries, or the US Dollar long term.
Who is to blame and who profited from this fiasco?
Let’s start with Freddie and Fannie, this a good place to start putting most of the blame. They had a clear mandate and abused their mission. Let’s not forget to include Congress for letting Freddie and Fannie to go largely unregulated and allowing these entities to get so large then “encouraging” them to lower standards so as to expand home ownership. We must also include the Federal Reserve who let interest rates stay low for too long that fueled the ARM craze.
Also we can’t forget to include the mortgage originators who knowingly wrote questionable loans. Then Wall Street packed these crappy loans and sold them worldwide. The Executives who encouraged their firms engage in this business. Investors are also to blame who profited from various segments in the economy.
What about the home builders who tried to cash in on the housing run up? What about the real estate agents who encouraged people to buy the biggest house they could “afford”? What about the flippers? What about the TV shows that showed flipper how to make money? Let us not forget the people who bought houses that were too big and then chose complex variable rate mortgages that they didn’t take the time to understand? What about people who borrowed against their rising value of their existing house to supplement their lifestyle?
Many more people could be included and the list could go on almost endlessly. The blame resides all across the nation and within all walks of life. Almost everyone had at least a small part to play in this drama, either directly or indirectly almost everyone got something out of the rise in housing prices and the associated economic boom that it created.
Collectively the citizens of United States of America are to blame…
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% for 2009
Probability of Occurrence 50%
Impact 7
The housing market and consumer debt have taken its toll on the economy and I believe that the trend will not improve next year. The rest of the economy also seems weaker than this time last year. On the positive side, energy and commodity prices have retreated somewhat from their peak, but as the world economy recovers I expect commodities prices to rise again. I expect US and European recessions in 2009 as we work though the restructuring of the economy. I believe that the US will come of recession before Europe.
The housing wealth effect has been more or less eliminated and will dampen future consumption for many Americans for the foreseeable future. The process of wealth transfer from current home owners and mortgage lenders to the new owners and lenders is in full swing and until that process is completed the economy will be weak.
The Presidential election will also play a role, I believe no matter how the election turns out, a majority of the people will have gotten their way so they will feel good and hence start spending/investing again. Another factor in play is uncertainty, after the election that uncertainly of who will be in power will be gone and is likely to be a positive psychological effect on the economy.
The overall world economy should continue to grow and this will encourage economic expansion in the US. Globalization will eventually soak up excess production here and around the world. I believe the US economy will become stagnate but a massive worldwide recession will most likely be adverted.
The economy is weak and likely get weaker worldwide
Unemployment of < 6% by the end of 2009
Probability of Occurrence 50%
Impact 7
Unemployment hit 6.1% in the past quarter and I find that number very troubling but I do not think unemployment has peaked… It certainly got much higher than what I was expecting six months ago, unless something else unexpected occurs, I don’t really foresee much lower unemployment for the next 9 months. If employment stays here or improves (back under 6% unemployment), I believe this will be the sign that the economic weakness is not as bad as I expected. I expect unemployment will peak next spring or summer.
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I believe that unemployment has not peaked and we will continue to rise in the future
Unemployment is high and trending higher
Federal Reserve raises interest rates > 2% by the end of 2009
Probability of Occurrence 85% for ‘09
Impact 6
I believe that the Fed will leave rates low until unemployment has started to change directions. Current low short term rates are very inflationary although low rates are good for the stock market longer term it causes inflation. Low rates are bad for the value of the US dollar so the Fed should start being concerned about inflation next year therefore the Fed will raise rates in the second half of 2009.
I believe that by the end of 2009 we will begin the march toward 5.5% interest rates, but very slow. If history is any guide it will take almost two year to get there.
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Low interest rates are good for the market…
Inflation exceeds 5% by the end of 2009
Probability of Occurrence 50%
Impact 7
There has been a dramatic fall in prices around the world in most types of raw materials, from oil to food. This is the best hope that inflations may be waning. Prices are still high and inflation is still a threat but the thought of $200 oil is not burning in the back of my mind any longer. Prices are still relativity high on a historical basis and when the economy recovers the upward pressure on commodity prices should reappear. Once the economy starts to recover, inflation will return faster than most will expect.
Moderate inflation in the US is a negative for the market
Return of spending by US consumer in 2009
Probability of Occurrence 40%
Impact 7
More than 6.4% of all residential mortgages are now in delinquency. Clearly the housing ATM machine is broken and many people lost their house so they could fill it with more junk. The sad part is that rates are still “low” and some people with Adjustable Rate Mortgages (ARM) are going to make it through this round but short term interest rates will head above 5% vs. 2% now. Therefore ARMs will get reset higher over the next two year (this is unavoidable). Foreclosures will be higher than historical for the next 2-5 years; consumer spending will take years to recover since much of the spending was financed via fictitious housing values.
My next fear is a credit bubble in credit cards and in student loans. The bubble in student loans is already evident. Lending standards are going to rise and money is going to get more expensive therefore not as much spending by the average citizen.
I believe this indicator has stabilized but will remain weak.
Corporate profits exceed YoY growth of flat in 2009
Probability of Occurrence 50%
Impact 6
It is general consensus on Wall St. that corporate profits will stabilize or recover some in 2009 which seems reasonable to me. I believe that corporations are not a drag on the economy but they won’t add as much as it has in the past few years. Profits are not falling; they just aren’t growing as fast as they were two years ago. Profits from corporation with significant overseas exposure should still do well while the ones in banking and housing, not so much… Corporations are relatively strong in this down turn (except financial institutions).
I expect earnings growth to be stable
Real Estate prices drop greater than 10% in 2009
Probability of Occurrence 50%
Impact 3
Housing dropped another 16.3% since last July. I think that we will get another 5%-10% drop in 2009 real estate prices. The banks are getting possession of houses and they are not afraid to move product. I believe this was the year that the banks dominated the housing market. I believe that 2009 will bring stable prices, but not rising prices. I believe 2009 we will be “near” but not at the bottom…
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 6.6%, this is a reflection of the credit crisis. 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 by the end of 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.
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Lack of horrible news here is not negative news...
$1,000,000,000,000.00 (Trillion Dollars) Trade deficit by 2010
Probability of Occurrence 25%
Impact 3(short term)
The 2007 deficit fell to $738.6 Billion from $811.5 Billion in 2006. We have a reprieve on this for now with falling oil and slowed economy. 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 weaker 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 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
I have actually lost count of how much money that government has backed but I think it is about 7-8 Trillion dollars since my last report. That’s roughly $25,000 per person (including children) in the United States. Do you think that will worry anyone who loans money to the US?
Long-term, I don’t believe the US 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 $1.41 and I don’t foresee this trend changing anytime soon. The credit crisis had an odd effect on the dollar, after the crisis started a lot of people around the world moved money into the dollar and you can see the results of that capital flow on the chart below.
Chart: How many dollars does is cost to buy 1 Euro?
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Long Term bad for US investing; Good for Foreign investments.
Improved Liquidity in 2009
Probability of Occurrence 90%
Impact 9
I started to talk about liquidity over a year ago and I have been pointing out the importance of this indicator. Liquidity became almost nonexistent for a few days during the height of the crisis and the lack of liquidity could have caused a worldwide credit meltdown… I still believe that liquidity is and it will remain materially weaker for some time, although it should begin to improve. If it doesn’t improve then the meltdown will have started and a severe global recession. This issue will be with us for a least another year.
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The above chart shows what is called the TED (Treasury Euro-Dollar) spread. This shows the premium that banks must pay over Treasuries to get money. This is kind of like a fear index for the credit market. Notice how that spread spiked after 9/11, again at the start of the Iraq war and look at it today. In simple terms lenders are 3-4 times more afraid to lend money than they were after 9/11 or during the start of the Iraq War.
Here is a link for you to keep track of the latest TED spread…
When the great depression occurred it was caused by a run on the banks. What we have now is run on credit. If not stopped soon, it may have a similar outcome.
This indicator is exceptionally weak
Technical Indicators
Current values N/A
Impact N/A
Model Portfolio technical indicators from +100% (buy) to -100% (sell)
US Stock 9/30 3/31
SPY -96% -40%
QQQQ -96% +8%
IWM -80% -24%
Foreign Stocks
EFA -96% 0%
EEM -96% -32%
Bonds
TLT +40% +72%
SHY +88% +56%
Volatility
VIX +100% +8%
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We have talked about the stock market Volatility index (VIX) before as the stock market fear index and once again you should notice that it spiked after 9/11 and during the start of the Iraq war. Fear is very high and liquidity is extremely low.
These indicators are weak for US stocks and strong for US Government Bonds, and foreign markets are weak
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?
Recent news of foreclosure rates even stunned me, the perpetual housing doom and gloom guy. What troubles me the most is that 6.41 % of All US residential mortgages are delinquent and 2.75% of all mortgages are in foreclosure… 10,000 houses per day are being foreclosed upon and this will have an impact on the economy.
I previously stated we were in ACT II of this play but now believe we are now moving into that elusive ACT III of this drama. This means there is light at the end of this tunnel… Keep in mind, act three has only just barely begun; this play is far from being over!! I have extended this crisis out through 2010, I am now thinking about buying a house in 2010 and or late 2009, I think home prices will fall more… Unfortunately!
The three “acts” of the housing bear market are:
Act I: Build and they will come! 2003-2007
Act II: I have to repay this loan? 2007-2008
Act III: Banks liquidate and crush housing prices… 2008-2010
So since we may be closer to the end, shouldn’t I be relieved and start investing like a mad man? The liquidity crisis caused by the housing crisis seems to have received some effective triage. Still there will be other bankruptcies, write downs, and more bad news. It will be a bumpy ride but I believe the risk/reward is relatively low but not anywhere near zero. We still will have firms going out of business and many more foreclosures. It always looks darkest before the dawn… and my goodness it looks appallingly dark…
The capital markets need to work through the entire liquidity, mortgage, foreclosure, recession and inflations issues before the econmomy can fully recover. We still clearly have at least another year of pain if you are a home owner but for those of us with capital to put to work I believe that this “might” be a good time to invest since conditions should be improving, or at least not getting any worst…
I now expect Act Three to take at least another 18 months or more before I declare this play over. Bottom line is that I expect the housing slump to go on for at least one more year. As I have stated before “When Act Two is over, then it may be the time to invest”.
I still want to make it clear that I don’t think housing “real” prices will go up until 2010-2012 at the earliest and then only modestly after that. I do want to buy a house but it’s not because I think houses are going up but because I can borrow subsidized money cheaply… I believe mortgage rates are going to go up to 7-9% over the next two years and I want to get a subsidized loan (tax write off) before those rates go up. Also I believe that longer term we are going to experience inflation and owning a house is a good hedge when combined with a large fixed price loan.
Credit Markets
Wow, what can I say…? The credit markets are in trouble and they are going to take months to fix. I believe that government made a HUGE mistake when they let Lehman fail. I believe that if the economy collapses history will judge this as the triggering event. For a mere 30 billion or so in guaranties they could have arranged for a buyout. They let Lehman fail on principle and it has completely seized up the credit market in the process.
Recession
The credit system is clearly broken and will take months if not many months to become functional again. This will hinder capital flows and makes our economy very inefficient. Add that fact that the housing ATM machine is closed for the foreseeable future I expect weaker consumer spending.
I think that “bailout” plan that was put before Congress was necessary but the ancillary effect was it brought a lot of attention to the current financial crisis to main street and that will end up having disastrous effect on consumer confidence. I believe now that a recession is almost unavoidable.
The “rescue/bailout” plan won’t energize the economy much; its main function is to prevent the complete collapse of the banking system. Even though I am a libertarian and capitalist, I supported the plan because I feel the alternatives were just too risky.
Inflation
Low rates coupled with high commodities prices were a formula for disastrous inflation outcomes. The current economic slowdown has caused a fall in world commodities prices but I believe that once this world economy kicks back into gear that commodities will be in the drivers’ seat again. So long term, I expect demand driven inflation caused by high raw material and energy prices.
Energy inflation: if you look at the chart below you can see that GDP growth has out stripped world oil production. A portion of that is caused by the Chinese using a lot of coal to “fire” their economy but once the average Chinese person is able to afford a car the oil component will have significant pressure to the upside… the problem is that the world lacks the will and/or the ability to make more oil. In developed countries like the US we lack the political will to drill (AK, CA, FL have lots of untapped oil) the other places around the world that have oil are just plain screwed up… The Middle East, Russia, Venezuela, Mexico…
The world is expected to use 1.4 million bbl/day more in 2009, where will it come from…?
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So long term this graph is telling me that as the world GDP continues to grow oil demand has lagged but it continues to put upward pressure on oil prices… recent pullback in oil prices, in my opinion, are a buying opportunity in the energy and commodity arena. I think it was way overdone to the upside but now, I believe, equally overdone to the downside. I plan to invest in energy and raw material for the long run at this time.
The Dollar and US Bonds
The US government has effectively backed the US financial system to the tune of trillions of dollars. If the housing market were to go into complete freefall the dollar would collapse as would bonds. All these loan guarantees are fine as long as housing prices ‘stabilize’. If housing values were to plummet, say 50%, my guess would be that the US would have to suddenly borrow several trillion dollars. Wait… Isn’t this how all the banks got into trouble?
None of this is good for the US dollar long term; the only reason that the dollar is where it is now is because of a flight to some sort of “perceived” quality. Longer term, more rational minds are going to see that US Dollar is at risk and the resources of the US Government are not unlimited. Currently the US is at a higher risk for default than it ever has been since WWII.
I will not buy nor shall I ever hold US Treasuries Bonds (except for TIPS). If anything I am considering shorting them. Yields are far too low for the risk being taken, the flight to “quality” has artificially driven rates low (bond prices high) and they will fall. The Federal Reserve will need to raise rates and this will also cause bonds to fall. We can expect that tax revenues will fall materially this year. Add to this the looming Social Security issue and likely inflation; how could any serious investor expect to only want 4% on their money for the next 10-30 years?
Muni bonds "Just say no"
I hear a lot of people talking about “value” in Municipal bonds; I personally would have nothing to do with them. The housing market has given many cities, counties, states artificially high revenue streams and yet they felt the need to borrow more money backed by those revenue streams. Well, as the hosing market collapses and property taxes recede, many of these municipalities are or going to be in trouble. The fall in tax revenues will always lag the housing downturn. Specifically avoid municipalities that recently had the largest downturn in the housing market.
I would think twice before jumping into this arena. I am not saying there aren’t opportunities, but a see a lot of risk also. As always, a well diversified portfolio of bonds would be important. I would expect to start seeing defaults on some of these bonds next year. These may be a better buy next year after things shake out more.
I am looking for more feedback in this area; drop me a line if you have something more to contribute.
Russia
The behavior of Russia during this year has made me raise an eyebrow or two. I have invested in the country/region before and would only do so now with great trepidation. I will also need to add the “Bear” to my list of world events to be on the watch for in my year end report. I can only say, stay clear of that region, it is unstable and only more turmoil is to come from that part of the world.
Capitalism has an odd way of punishing this former communist empire, after their bad behavior in Georgia and combined with the fall of oil prices. Capital exited the country and the stock market had to be closed for a few days…
The Election and your money
I started spending a bunch of time and effort thinking about the two candidates and how their vision of the future was going to change the investment climate over the next couple of years. I was attempting to contemplate the impacts of health care, military strategy, farm subsidies, social program on various stocks and bonds but after a while I began to recognize that in the scheme of things, it really isn’t going to matter as much in the short term who wins the elections compared to the incredible long term investment opportunities created during the current global liquidity meltdown.
On a philosophical basis, I am a Capitalist Libertarian… The Congress will be controlled by the Democrats and if Obama wins I fear an explosion of populist/socialist legislation with little to no ability to slow or stop this legislation. There will be few checks and balances and I fear that all the progress made under Reagan will evaporate in a year. I believe that the new Washington will be hostile toward wealth creation and give away resources that we can not afford. Once the redistribution policies are in place and the economy stalls the Democrats will scratch their head as Government revenues drop and unemployment goes higher. They will then wonder how they will fund their wealth redistribution programs, even higher taxes?
I believe between the Federal Reserve and the Treasury we have just created the fourth branch of the government. Executive, Legislative, Judicial and Economic… With all the powers transferred to the Secretary of the Treasury I would give some thought of who will be the pick for Secretary of the Treasury rather than worry about who will be going to funerals (Vice President).
I suspect that the stock market will embrace McCain more so than Obama. Under McCain I don’t expect much change and more continuity to the capital markets. Clearly Oil Company will get hit very hard and drug companies also take it on the chin under an Obama administration. Also taxes will likely rise significantly on those who have excess capital to invest therefore less capital will be flowing into the markets.
I suspect the election will be won by Obama and that I will be writing about wealth preservation in future reports. As a Libertarian the thought of Wall Street effectively under the control of the Socialist via the US Treasurer frightens me… Capitalism is under assault and it is loosing, badly.
Summary of Mark(et) US Economic Indicators
GDP Growth – Falling
Unemployment – High
Federal Reserve Bias – Lower rates in the short term
Inflation – Moderate expectation in the short term, higher long term
Consumer Spending – Stable but weak
Corporate profits Growth Rate – flat
Real Estate Market – Falling
Trade Deficit – Stable
Dollar – Weakening; Long Term bad for US investing; Good for Foreign investments
Technical Indicators – Bad for all stocks good for Treasury bonds
Volatility Index – Extremely High, indicating a great deal fear in the stock market
Liquidity – Extraordinary Poor/verge of collapse
So… What is the Plan?
I see two paths before me (time to reread that declaimer on page 3 again), the first path is to be safe and liquidate 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 to 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%-50% loss now is insignificant in the long term… This “market timing” will be my most important investment decision of my life…
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 outside of the US, minimizing my exposure to US dollar and especially avoiding dollar denominated 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? Well, sort of... I have been aggressively buying the global growth story to the extent that I am not able to sleep at night for fear of the size and risk 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 bet on black 17 and hope for the best, to borrow a phrase from poker “I am all in”. I hope the rewards will be quick, swift and unprecedented, but speaking from experience it is more likely that they will be moderate and painful.
Now let’s talk about the case for not owning government bonds, I still believe that they are likely to do poorly over the next several months as the anticipated Fed rate hikes are factored in. Bonds do very poorly during periods of inflation or rising rates. I believe that by the end of 2009 US dollar denominated bonds will have become a bad investment. Since rates are likely to start going up around the world as the economy recovers and as that recovery puts strains back into energy and commodities, I believe that bonds are a poor investment choice. I am going to take this opportunity to invest in high yield stocks and trusts that are most likely going to keep up with inflation over the long run.
I still own some TIPS (Treasurer Inflation-Protected Securities), as the name implies these pay a yield based on current inflation rates. One name I like is iShares TIPS (TIP) is now getting about 6.4% yield (but falling very fast) and it should give a higher yield if and when inflation goes up. I was buying WIA but I will use TIP in the future because of its higher daily traded volume. This is where I park my inactive cash.
Energy stocks/trusts: Energy has a magnanimous sell off during the second quarter but who are we kidding, we aren’t net producing a lot more of this stuff. A lot of the places that produce the stuff are dysfunctional (Venezuela, Iraq, Iran, Russia, Nigeria) and a lot of places that do have oil won’t produce it (Florida, California, Alaska). A billion or so new middle class people are coming on line and they will want warm houses, cars, and to live the good life. We are going into winter, if world economy is starting to recover, demand will return, and production is maxed out. I have several energy investments…
Financial stocks, I bought these names en mass, the XLF is a good place to start.
Longer term county ETFs that are heavily linked to commodities. Countries like Canada, Brazil, South Africa, and Australia are a solid long term investment. As with the agricultural plays, don’t expect a swift run up like the last bubble; I look forward to a slow steady growth. Longer term I still like the agricultural names although it did get ahead of itself. I think they are still a good investment but don’t expect it to go “hog wild” this time…
During recent events I began to understand the importance of owning gold (I did not own any) as the price of gold jumped over 10% in a single day. From now on I will not look at gold as an investment but more of an insurance policy. This event showed me that owning scrapes of paper isn’t always beneficial if the wheels came off the world banking system. I am now tempted to buy a small volume of physical gold and put it in a safety deposit box.
After the market runs up a bit I also plan to buy my S&P 500 puts again… I am not sure what happened to that strategy from a couple of years ago but I sold them way too soon. They will be carried into the future indefinitely from now on (once I buy them)…
I am suggesting that some investment values are currently so compelling that I am abandoning all reservation and I have jumped into the market with both feet. This is a very dangerous strategy and will most likely materially affect my retirement age by 5 years, for better or for worst. I have almost no cash parked on the sidelines at this time. I am likely to do very very well over the next few years or go broke…
Chapter 4
Perceived Value
Normally I have a section of domestic and then a section of foreign investment instruments, in this issue I am just going to include a lot of instruments (stocks, ETF) that I think are just plain value. One reason they are so cheap is because they are extremely risky at this time in our economic history, this something to think seriously about.
Energy
British Petroleum
Symbol BP
Sector British Oil Giant
Risk Moderate
Return High
Time Horizon Long Term (36 months – 60 months)
Tax implications Dividend tax rate of 15% applies to this instrument.
Account(s) Taxable and IRA
Ok, this is a tough one… This company is probably one of the more screwed up oil companies going, so why do I own so much of it… Its dirt cheap and it has a high dividend and I expect oil to be higher in 5 years… Current yield 7.0%
British Petroleum Trust
Symbol BPT
Sector Oil Trust
Risk High
Return High+
Time Horizon Long Term (36 months – 60 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 revenue stream from Prudhoe Bay oil fields in Alaska. They sell oil, take out some fixed expenses and give you the remaining money each quarter. Currently, the yield is about 10+%, the yield could go much higher and/or the stock price will increase as oil goes up. Like most trusts, this trust does not pay corporate taxes; therefore, dividends are taxed 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.
This is a very volatile instrument since the dividend is directly based on the price of oil, which we all know is very choppy. If oil prices fall the value of this trust will fall faster.
Precision Drilling Trust
Symbol PDS
Sector Oil and Natural Gas Drilling Trust (Canada)
Risk High
Return Very High
Time Horizon Long Term (36 months – 60 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
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 an 11.3% 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.
Knightsbridge Tanker
Symbol VLCCF
Sector Oil Shipping
Risk High
Return High
Time Horizon Long Term (36 months – 60 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 yields 10+% for now.
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)
Financials
Lloyds TSB Group
Symbol LYG
Sector Foreign Bank (UK)
Risk High
Return High+
Time Horizon Long Term (36 months – 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 a 9.6% 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.
Bank America
Symbol BAC
Sector Banking
Risk High
Return High +
Time Horizon Long Term (36 months – 60 months)
Tax implications Dividends are taxed 15% rate
Account(s) Taxed
Let’s talk about banking but specifically let’s talk about Bank America. Why do I like this one? That is easy; it has a low Price to Earnings (PE) ratio and a great dividend yield (7.4%). It makes about 10% each year on your invested money and kicks 2/3rds of that out to the shareholders as a low tax dividend payable each quarter.
CitiGroup
Symbol C
Sector Financial Services
Risk High
Return High +
Time Horizon Long Term (36 months – 60 months)
Tax implications Dividends are taxed 15% rate
Account(s) Taxed
This is a well diversified financial services institution that also has been hit hard during the current credit fiasco. I believe in a few years once the air has cleared this institution will once again become a prized possession of any portfolio. It like most of the other financial institutions has a very high dividend with advantageous tax treatment that will comfort me while I wait for this stock to return to its former glory. This yields 7.0%
Barclays
Symbol BCS
Sector Investment Banking (UK)
Risk High
Return High+
Time Horizon Long Term (36 months – 60 months)
Tax implications Dividends are taxed 15% rate
Account(s) Taxed
This is another bank with a high divined that seems to be in good financial shape. When Lehman was in trouble they were on the short list to buy them (but passed). It’s good to be in a position to buy things. They have a high relatively high yield 7.2% and down over 50% from their high… so if it takes 5 years to double and I get 7.2% while I wait that’s almost like a simple 27%/year return for the next five year…. I like it…
Goldman Sacks
Symbol GS
Sector Investment Banking
Risk High
Return High+
Time Horizon Long Term (36 months – 60 months)
Tax implications Dividends are taxed 15% rate
Account(s) Taxed and IRA
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. Warren Buffet bought some, so did I.
Financial Select Sector S&P Depository Receipt
Symbol XLF
Sector Financial Sector ETF
Risk Moderate +
Return High
Time Horizon Long Term (36 months – 60 months)
Tax implications Dividends are taxed 15% rate
Account(s) Taxed and IRA
This ETF has a concentrated exposure to the financial sector. Its major holdings are American Express, Bank America, Citigroup, Goldman Sacks, and the likes. This is a simple instrument that allows you to buy all these names simultaneously allowing to you to diversify risk with one easy transaction. This is the quick and easy way for you to buy the entire financial sector. This ETF pays a relativity high yield for an ETF of 4%.
A complete list of the company’s that comprise this index is at this website.
Ultra Financials ProShares
Symbol UYG
Sector Financial Sector Ultra EFT
Risk Extraordinary
Return Extraordinary+
Time Horizon Long Term (36 months – 60 months)
Tax implications Dividends are taxed 15% rate
Account(s) Taxed and IRA
So, you like the safety and security of the Financial Sector (XLF) EFT (sarcasm) but want to kick it up a notch. That brings us the Ultra Financials ETF, this ETF is leveraged such that it returns (or loses) twice as much as the XLF. So if the XLF goes up (down) 5% the UYG goes up (down) 10%. This instrument is great when you are winning, it is very distressful when you are loosing. This instrument should only be used with risk capital and by those who are experienced at taking large swings in value.
Materials
Arcelor Mittal
Symbol MT
Sector Steel
Risk Medium+
Return High+
Time Horizon Long Term (36 months – 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… If we have a global recession this stock will get slaughtered. This stock has a 2.9% yield based on current payouts.
Countries
Morgan Stanley India Investment Fund (IIF)
India Fund, Inc (IFN)
Sector Emerging Markets Closed End Fund (CEF)
Risk High
Return Extraordinary
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 +
Time Horizon Long Term (36 months – 60 months)
Account(s) Taxed and IRA
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 Medium
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.
iShares MSCI South Korea Index
Symbol EWY
Sector International ETF
Risk Moderate +
Return High
Time Horizon Medium term (12 months – 24 months)
Tax implications Dividends are taxed 15% rate
Account(s) Taxed and IRA
South Korea is another indirect play regarding china. One advantage is that their northern neighbor helps to keep these stocks cheap. Unfortunately they will remain cheap as long as Kim Jong Il stays in power. But given that I think that he just likes being the center of attention I don’t think war will break out.
iShares FTSE/Xinhua China 25 Index
Symbol FXI
Sector International ETF
Risk High+ + +
Return Extraordinary
Time Horizon Very Long term (5 years – 10 years)
Tax implications Consult tax advisor (mostly at 15%)
Account(s) Taxed and IRA
I have been against investing in China for over 2 years, but have capitulated. This ETF returned over 50% last year. It’s where the growth is, it is overpriced, it is volatile, and I don’t think this is the best of investments but it’s a nice speculative play to add SOME to your portfolio. I would consider having small position but keep it below 5% of your net holdings.
Tech
Nokia
Symbol NOK
Sector Electronics
Risk Moderate +
Return High
Time Horizon Long Term (36 months – 60 months)
Tax implications Dividends are taxed 15% rate
Account(s) Taxed and IRA
What can I say about the next pick? Let see 1 billion people in China will need cell phones! Oh lets add another billion in India!! Yes industrialization has come to the third world and long before they all start to buy cars they are going to want to own new cell phones. If you look at the valuations of this stock it much lower now than it has been historically. That is easy to understand, with the economic downturn especially in Europe and the US. How often to you get to buy a tech company that has a 4.4% dividend?
Biotechnology
Amgen
Symbol AMGN
Sector Biotechnology
Risk Moderate
Return High+
Time Horizon Long Term (36 months – 60 months)
Account(s) Taxed and IRA
Amgen is a biotechnology company, engages in the discovery, development, manufacture, and marketing of human therapeutics based on advances in cellular and molecular biology. It offers human therapeutic products in the areas of inflammation, nephrology, and supportive cancer care.
It has fallen a lot last quarter and if you are interested in a biotech stock this may be of interest to you. It has been a victim of a sector rotation, meaning Wall Street decided to sell off this entire sector and all stocks in this sector has gone down. I believe the rotation is over and the stock is cheap and worth looking at again.
iShares NASDAQ Biotechnology ETF
Symbol IBB
Sector Biotechnology (ETF)
Risk Moderate
Return High
Time Horizon Long Term (36 months – 60 months)
Account(s) Taxed and IRA
The investment seeks investment results that correspond generally to the price and yield performance of the NASDAQ Biotechnology Index. The fund uses the process of representative sampling, holding securities that have a similar investment profile to its index.
A lot of new drugs are coming from biotech and this ETF just gives you a wide exposure to the index. It’s just a matter of time before several new blockbuster drugs are discovered by this group.
Real Estate
Hospitality Properties Trust
Symbol HPT
Sector Real Estate Investment Trust (Hotels)
Risk High+
Return Extraordinary
Time Horizon Long Term (36 months – 60 months)
Account(s) IRA Only
Now with all the mayhem in the real estate market you must be thinking “why the hell would he invest in real estate”. The answer is simple, high cash flow. The real estate market is in turmoil but these guys are selling real estate they sign long term agreements for hotels and reserve effectively rent on their properties. Although the hotel is off this year, these guys have long term contracts. The yield is very high and as long as the customers stay solvent (one large client did have to restructure hence the low price/high yield) this instrument, in my opinion, will pay out handsomely over the long run. This trust yields 15.8% because of the current credit crunch. There is a significant risk of a failure of this company.
National Health Investors
Symbol NHI
Sector Real Estate Investment Trust (Health Care)
Risk Moderate
Return High
Time Horizon Long Term (36 months – 60 months)
Account(s) IRA Only
This has a much lower yield than the last instrument but it is far more stable since the properties are medical facilities. This is a reasonable place to put some money. The yield of this name is 6.5%.
Chapter 5
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 |$115.99 |-20.67% |-19.30% |
|NASDAQ 100 Trust Shares |QQQQ |$51.22 |$38.91 |-24.03% |-23.85% |
|DIAMONDS Trust |DIA |$132.55 |$108.36 |-18.25% |-16.86% |
|Vanguard Value VIPERs |VTV |$66.39 |$52.42 |-21.04% |-19.07% |
|iShares Russell 2000 Index |IWM |$75.92 |$68.00 |-10.43% |-10.23% |
|iShares MSCI “EAFA” |EFA |$78.50 |$56.30 |-28.28% |-28.28% |
|iShares MSCI Emerging Markets |EEM |$50.10 |$34.18 |-31.78% |-31.78% |
|iShares Lehman 20+ Year Treasury |TLT |$93.04 |$94.88 |1.98% |3.05% |
|iShares Lehman 7-10 Year Treasury |IEF |$87.01 |$88.96 |2.24% |3.60% |
|iShares Lehman Aggregate Bond |AGG |$101.17 |$98.59 |-2.55% |-1.45% |
|iShares GS $ InvesTop Corp |LQD |$104.84 |$89.79 |-14.36% |-12.67% |
|iShares Lehman 1-3 Year Treasury |SHY |$82.19 |$83.56 |1.67% |2.79% |
As you can see, every stock index got creamed. Corporate bonds got hit also. 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.
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 |-8.63% |-13.47% |-19.15% |-21.01% |
|‘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 6
Performance and Holdings
Don’t be foolish enough to try to replicate my portfolio, very few money professionals would even remotely approve of this portfolio. This time it is a ridiculously aggressive portfolio heavily weighted toward banking, energy and technology.
Taxed Account Holdings for Q3 ‘08
|Name | |Price | | |Portfolio % |
| |Symbol | | | | |
|Lloyds |LYG |$16.73 | | |13.33% |
|Goldman Sachs |GS |$128.00 | | |12.23% |
|British Petroleum BP |BP |$50.17 | | |11.99% |
|Barclays |BCS |$24.70 | | |9.84% |
|MS India Investment Fund |IIF |$19.90 | | |9.51% |
|Citigroup |C |$20.51 | | |6.53% |
|The China Fund |CHN |$26.65 | | |5.73% |
|Proshares Ultra Financials ETF |UYG |$17.54 | | |5.59% |
|Apple |AAPL |$113.66 | | |5.43% |
|Indonesia Fund |IF |$6.943 | | |4.42% |
|Chipotle Mexican Grill |CMG |$55.49 | | |4.42% |
|Morgan Stanley |MS |$23.00 | | |3.66% |
|Cisco System |CSCO |$22.56 | | |3.59% |
|Intel |INTC |$18.73 | | |2.98% |
|Nokia |NOK |$18.65 | | |2.97% |
|Home Depot |HD |$25.89 | | |1.24% |
|Arcelor Mittal |MT |$49.38 | | |0.79% |
|AU Optronics |AUO |$11.36 | | |0.03% |
|Continental Dec 17.5 Puts (short) |CALXW |$4.50 | | |-4.30% |
|Cash | |$1.00 | | |0.00% |
| | | | | |100% |
IRA Account Holdings for Q3 ‘08
|Name | |Price | | |Portfolio % |
| |Symbol | | | | |
|MSCI Australia Index |EWA |$20.54 | | |18.1% |
|MS India Investment Fund |IIF |$19.90 | | |17.6% |
|Hospitality Properties Trust |HPT |$20.52 | | |12.1% |
|Precision Drilling Trust |PDS |$16.57 | | |9.8% |
|Knightsbridge Tanker |VLCCF |$26.47 | | |7.8% |
|AU Optronics |AUO |$11.36 | | |6.9% |
|Ireland Bank |IRE |$22.68 | | |6.7% |
|Barclays India Total Return ETN |INP |$45.26 | | |6.7% |
|Western Asset Claymore Inflation |WIA |$10.51 | | |6.2% |
|National Health Investors |NHI |$34.18 | | |5.0% |
|Blackrock Dividend Achievers Trust |BDV |$9.70 | | |2.9% |
|Cash |Cash |$1.00 | | |0.4% |
| | | | | |100.00% |
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 are presenting themselves possibly now
• Short term interest rates still remain relatively low
• Is that a light at the end of the credit crisis tunnel? It might be…
• Improved global liquidity (could it get any worst?)
• Growth is likely to return in 2009
• More stable dollar
• Better corporate profits in 2009 vs. 2008
The Bad
• Continued unwinding of the housing market
• Potential of consumer credit crunch credit cards and student loans
• Falling Tax receipts due to financial turmoil
• Higher energy, metals and grain prices (inflation)
• Run away Budget deficit due to increased spending and falling tax receipts
• Democrats in control of Congress in 2009/2010
• Long term US investment climate in 2010 due to tax cuts expiring
• Trade imbalance
• Relatively high unemployment
• War on Terror/geopolitical instability
The Ugly
• Cascading bank failures could trigger a global depression
• Recent action by the US Government has put the wider economy at risk
• The government has taken charge of a large part of the economy
• Potential for national debt spiral both public and private
• Potential for US bonds may be downgraded in ten years
• 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
Final thoughts:
Turmoil reigned supreme in the markets during the past few months, but it appears the risk of a complete and utter collapse of the financial system has been reduced, but it has not been eliminated. The aggressive action by the government may have contained the damage but it may have only delayed the inevitable. The risk is that the government has may have saved the credit market but it has risked the monetary system of United States of America in doing so. We may have prevented a devastating recession but have raised the very real possibility of a catastrophic global depression.
In the past I have talked about owning gold, put options and short positions. I have owned them several times in the past but have sold them for a profit. In the markets darkest hour, I had none of these defensive instruments. Now I have come to realize that those instruments are not for “making money” and some of these strategies should be kept as an “insurance policy”. I plan to have at least 10% of my money is such instruments in the future and will work on keeping that protection in place.
The severity of what I saw in the past few weeks has also made me realize that in the truest sense that I actually don’t own much of anything “real” in the world. I don’t own a house or many other physical assets. In the strictest sense, I have lots of little pieces of paper that lay claim to parts of businesses around the world. Even those pieces of paper aren’t even real and are only bits of scattered data strewn across the internet. I have come to appreciate the fact that I need to own a few more objects that I can stub my toe on…
During the height of the crisis I felt like I had one of two choices, sell everything or invest aggressively (with the former being the wiser choice). I invested aggressively during the height of the credit crisis; I sold all my conservative investments (at a loss) and made my portfolio even more risky. I either will make significant headway toward my financial security or I have just doomed it. Only time and many of sleepless nights will tell… I honestly think I may have made a bad choice, the risks are too high to rewards are bleak.
The rest of 2008/2009 will be a very tough year for investors. I have invested heavily into the stock market but I will not allocate one more dime into the market until spring.
Buy low, sell high…. I am still working on the first part… for now!
This is the conclusion of my report, I hope to get the next report out January 1st 2009 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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