Happy New Year

Whatever leads us to year end, most of us look to each new year with a sense of hope, even if not a sense of positive expectation.  2009 witnessed a transformation from the worst economic disaster in the lives of most of us to a rescue that the majority could not have envisioned just a year ago.  With the U.S. consumer flat on his/her back, our government decided that it would pledge the assets of future generations toward rescuing our banking system, our automobile industry, major parts of our insurance industry, state budgets and a variety of other special interests.  As a country we have always argued that capitalism is our economic foundation.  Interestingly and ironically, some of the loudest voices promoting government bailout of the financial system were some of the staunchest advocates of laissez-faire capitalism.  Once the major banks and insurance companies were off the endangered list, however, those same voices resumed their strident opposition to government interference.

To date Wall Street has largely been saved, yet most of Main Street remains in peril.  Much more government largesse has been promised, but it is far from certain whether the most dramatic intergenerational transfer of wealth will ultimately result in a stable and thriving economy.  We do know, however, that repaying the resulting debt will serve as a millstone around the economy’s neck for generations to come unless we choose to default or inflate it away.  We will address the longer-term picture in subsequent blog posts and in our year-end commentary.  We close 2009 today with a look at factors having the strongest influence on our short-term outlook.

The most obvious force affecting the stock market over the past many months has been positive momentum.  There is a lot to be said for the law of physics that a body in motion tends to stay in motion.  Even investors with a cautious or pessimistic fundamental outlook have become momentum players, since stocks have risen so persistently without any significant corrections.  As a result there are many less than bullish investment managers with portfolios full of stock.  They will benefit if the positive momentum continues.  They could be hurt badly if a major geopolitical event suddenly shakes world confidence.

Economic statistics, both national and international, continue to improve for the most part.  As mentioned in prior blog posts, the percentage gains in most of these economic indicators have been impressive, simply because gains are coming off severely depressed bases.  Despite positive progress from the lows, most of these economic readings remain low on an absolute basis, many still at levels observed years ago.  Unless some surprisingly dire economic data present themselves, investors will likely continue to interpret improving economic statistics as bullish, despite their weakness on an absolute level.

As we examine market technical data over multiple time frames, we currently observe very diverse messages in those various periods.  Over the very longest time frame, comprised of secular cycles that average about a decade and a half in either their bullish or bearish mode, we remain in the bearish cycle that began in 2000.  We expect that this cycle will endure for several more years.  We will discuss this further in a subsequent blog post.

If we examine the cycles lasting from several quarters to several years, we find it probable that the positive cycle that began in March 2009 will eventually move to higher levels before its conclusion in 2010 or beyond.

When we come down to the intermediate term, in which market moves unfold over many weeks to a few quarters, we are well overdue for the first meaningful correction to the move that began in March.  While momentum has remained positive, its pace of growth has weakened markedly, often a precursor to a reversal of direction.  Although market averages are at or near rally highs, a decreasing number of individual stocks are supporting the move.  Such a decline in breadth, while not immediately fatal, is often a warning that the move is nearing its end.  Further concern arises because the market’s volume has steadily decreased since April as prices have continued to rise.  There is an old investor’s axiom that volume confirms price action.  When volume is absent, price moves become increasingly suspect.  Another factor that could soon start working against stock prices is the sharp rise in longer-term interest rates evident throughout the month of December.

Over the very shortest term, covering periods ranging from a few days to a few weeks, the picture is particularly cloudy.  The upward move in prices through December has raised most short-term market measures into overbought territory, leaving stocks vulnerable to an imminent correction.  On the other hand, with most managers heavily laden with stocks, large interests are motivated to do what they can to give stocks a positive start to the new year. Many market analysts view the market’s early behavior as a good forecaster of the entire year.  Of considerable concern in the short term is the almost unanimous belief that there is no immediate danger to stock prices.  This week, for example, the Investors Intelligence Advisors’ Survey shows the smallest percentage of bears in almost 23 years.  Such surveys often prove to be excellent contra-indicators of market direction when they display extreme readings of optimism or pessimism.

With so many cross currents, we strongly urge investors to remain flexible and prepared to adjust portfolios rapidly if conditions warrant.  The economy and the markets were in danger of collapse just nine months ago.  Government and central bank actions around the world have pulled us back from the brink of the abyss.  It remains an open question as to whether the cure is lasting or whether the financial system and the equity markets are merely in the eye of the hurricane.

Whatever transpires in the year ahead, we wish all of our readers a year of peace, good health and the enjoyment of life with family and friends.


Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.

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Merry Christmas

In a shortened Christmas week, I wish each of you and your families a relaxing and enjoyable Christmas season.  In a period of extensive financial distress, I encourage each of you to reach out, and to the extent of your ability, to make life brighter for someone less fortunate than you.

This week’s blog post is an article I wrote for the December 21 edition of Inside Tucson Business.

Acknowledging Uncertainty Could Preserve Your Portfolio

December 21, 2009

The investment industry is characterized by bold pronouncements and confident forecasts.  Investment managers that develop a broad national and international following typically come across in the media displaying great conviction.  Investors gravitate towards such confidence, especially if it conveys a bullish message.

Such behavior became firmly ingrained through the decades of the 1980’s and 1990’s when stocks and bonds both provided outstanding returns without lengthy negative interruptions.  Nearly all investment managers produced excellent returns.  Doubts have arisen intermittently, however, through this first decade of the new century as stocks suffered two of their worst declines since the Great Depression, and bonds offered sharply lower returns than in the prior two decades.  Despite having endured seriously flawed forecasts in recent years, investors stubbornly continue to heed the predominantly bullish forecasts of investment industry “experts”. 

The common wisdom of such investment gurus is essentially to stay the course, invest for the long run, select an appropriate asset allocation strategy and rebalance to your chosen allocation periodically.  In a period of great financial uncertainty that advice could cost investors dearly.

Throughout my 40 years in the investment industry, I have never before seen economic or market conditions present such a broad spectrum of possible outcomes.  If all goes well from here, governments and central banks around the world will succeed in reviving economies still reeling from the worst recession since the 1930’s.  Residential real estate will stabilize and commercial real estate will be saved from declining into a multi-year funk.  Most importantly, consumers will regain confidence and will begin to spend again without fear of a darker tomorrow.  On the other hand, if unemployment persists, consumers could remain unwilling to spend for anything but necessities and may depress economic conditions for years to come.

From past experience we have been conditioned to expect that a recession continues for a few to several quarters, followed inevitably by a resurgence of business conditions which leads us to even brighter economic tomorrows.  We are dealing, however, with unprecedented economic conditions, so we have no clear guidelines as to how consumers and the body politic will respond to the unfolding drama.  I strongly believe that the critical variable will be the psychological response of global consumers.

Bulls on the economy and the investment markets expect that consumer response to the current recession’s end will resemble that which we have seen over the past few decades.  Bears fear that the unprecedented levels of debt built up over the past quarter of a century have set the stage for consumers to emerge from this recession more circumspect with respect to spending versus saving.  As leveraged as our U.S. economy remains, any significant consumer slowdown will greatly diminish business profitability and consequently the outlook for our equity markets.

We cannot know how consumers and investors will emerge from this recession.  We do know, however, that the vast majority of investors, especially institutional investors, have structured their portfolios based on confidence that market outcomes will resemble those of the most recent several decades.  Should the record levels of government stimulus fail to sufficiently offset potentially growing amounts of collapsing debt, we could experience serious economic and market declines that far surpass those anticipated by most investors.

Equities could soar if the world’s central banks continue to flood the financial system with newly minted money and prices of assets were to float upward.  Equities could plummet if unprecedented levels of debt collapse as government initiatives fail to reignite consumer confidence.  Government and other top quality bonds could be the performance stars if serious recessionary conditions should push interest rates below recent historic lows.  Virtually all types of bonds, however, would be decimated if the flood of new money ultimately results in runaway inflation.

Should the government’s unprecedented financial measures ultimately prove successful, we could see a return to the glorious days of the 1980’s and 90’s where traditional asset allocations proved consistently successful, and all asset classes rose.  On the other hand, if the flood of new money leads to an interest rate surge, both bonds and stocks could suffer badly for years, defeating even the most prudent of traditional asset allocations.

No one knows how the economic and securities markets will unfold over the next several years.  Investment analysts offering convincing guidance are making best guesses.  Most have offered less than helpful advice through the perilous last decade.  Investors will benefit by abandoning traditional fixed asset allocations and remaining flexible to avoid potential worst case scenarios and to take advantage of new and possibly non-traditional investment opportunities.


Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.

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Stock Market Pros and Cons What Are the Critical Variables?

As we head into the final two weeks of both the year and the new century’s first decade , eyes are peeled for evidence of a Santa Claus rally. For the better part of the past century, market performance research demonstrates a year-end positive seasonal bias. Its occasional absence, followed often by a weak market, gave birth to the couplet: “If Santa Claus should fail to call, bears may come to Broad and Wall.”  To determine the likelihood of seeing Santa this year, I’ll list the many pros and cons that analysts and commentators cite for a continuation of the 2009 rally or for its possible demise.  There is a tremendous diversity of opinion.

The rally off the March lows has seen all major U.S. stock markets advance by more than 60%.  The absence of even a single correction of 10% or more testifies to the power of the rally, although momentum has waned noticeably since October.  Measures of buying power have declined significantly over that period, but selling power has declined even more, permitting the market averages to continue their upward drift.  Volume has also declined markedly as the rally has lengthened, which calls recent advances into question in the minds of seasoned traders who want to see volume verify price moves.

Bulls are encouraged by the inability of prices to break down out of the trading range that has characterized the past five weeks.  On the other hand, bears note that there has been no follow-through on several small breaks to new price highs.  Neither side has shown enough fire power to sustain a meaningful move.

Most analysts see the 60% plus move as the first leg of a new bull market.  A smaller group of mostly older analysts judge the rally to be nothing more than a partial recovery of the massive decline from October 2007.  They point out that even after one of Wall Street’s greatest rapid rallies, stock prices are merely back to the levels of 1998–more than a decade ago.

Investor confidence, almost non-existent near the March market lows, has surged as prices continue to rise and fend off all attempts at meaningful corrections.  That process is  positive to a point, but investor sentiment has now reached levels of excessive optimism that is typical at market peaks.  Risk was an abhorrent four-letter word just eight months ago; many investors are welcoming risk to their portfolios with open arms today.  It is noteworthy that the best returns this year have come from the riskiest, most volatile areas.  Junk bonds have done spectacularly well, and the very best returns have come from the junkiest of the junk, those companies just a heartbeat away from default.

Interest rates remain near historic lows.  That is clearly good for business, and low bond yields provide little competition for stocks.  Direct government purchases of fixed income securities ranging from U.S. Treasuries to toxic mortgage-backed paper obviously played a major role in pushing rates down across the board.  It’s anyone’s guess as to what will happen to interest rates when government steps back and lets free market forces determine interest rates.  Will massive money creation lead inexorably to inflation–even hyper-inflation–or will unprecedented levels of debt push the economy into a deflationary debt collapse?  Could foreign debt holders like China defeat U.S. monetary authorities’ intended policies?

The grandest government rescue program in history is still unfolding.  The most obvious immediate beneficiaries have been our largest financial institutions.  To a lesser extent consumers have benefitted from various stimulus efforts designed to avoid foreclosures and to accelerate purchases for such major items as automobiles.  Corporate earnings are growing, albeit largely from cost cutting rather than revenue gains.  Corporate inventories–dramatically depleted when companies worried about business coming to a standstill a year ago–are being rebuilt, and industrial production is growing to meet that need to rebuild inventories.  Rebuilding inventories is a one-time phenomenon, however, and corporate output growth and earnings growth will be sustained only if consumers resume spending.

Consumer sentiment is improving, but off a very low base.  Sentiment numbers are still at levels typical during recessions.  Retail sales are likewise growing, but also compared to the horribly depressed base of late 2008, when markets and the economy were collapsing.

Bullish economists are encouraged by the relatively steady decline of job losses and are forecasting a return to job growth in early 2010.  While companies are evidently laying off fewer workers than in recent quarters, the total number of unemployed continues to grow, and most economists expect the unemployment rate to trend yet higher before peaking.  With job uncertainty still prevalent and impending retirement ever closer–especially for the Boomer generation–it is unlikely that consumers will soon revert to recent past spending patterns characterized by little regard for saving or debt levels.  On the contrary, households are clearly cutting back on their levels of debt and are adding to savings.  While that behavior is certainly prudent at the micro level, it is dangerous at the macro level, which needs heavy doses of consumer spending.

Even with government amelioration programs, foreclosures are still numerous and are expected to continue.  That inevitably has a crushing financial and psychological effect on a measurable segment of our society.  Most households–even short of foreclosure–are still reeling from the huge loss of net worth over the past two years due to the collapses in both equity and real estate prices.  Even the well-to-do have become more circumspect in their spending.

While federal efforts have rescued major financial institutions and, at least for the time being, stabilized the financial system, great fragility remains.  Medium and small-sized banks continue to fail weekly, and the FDIC’s “insurance fund” is dangerously low.  Giant banks are repaying the money loaned to them under the TARP program, but hundreds of billions of additional rescue dollars will yet be needed to keep afloat such entities as Fannie Mae, Freddie Mac, AIG and GMAC.

The financial system remains in precarious condition.  Much of the toxic paper that nearly brought the world economy to a halt remains unsaleable and rests on the books of commercial banks and the Federal Reserve.  Dubai, Greece, Ireland, Spain and inevitably others demonstrate that even sovereign debt may not escape this financial crisis unscathed.

Just months ago the Fed distributed massive amounts of U.S. taxpayer money to our commercial banking system, and there it remains. Strong admonitions from the President notwithstanding, banks are not lending that money.  Banks have raised their lending standards, and borrowers who could qualify are reducing their debt levels.  Small businesses, which would employ more people if they could grow, are finding it very difficult to borrow.  Big banks are retaining money in the form of free reserves, bolstering their capital ratios and making almost risk-free returns off the very steep yield curve spread.

The greatest growth is occurring in emerging nations.  Many analysts believe that such countries will be the prime engines of growth to pull the world out of this recession and into a multi-year advance.  Of course those emerging governments and their central banks, as in the United States, have provided record levels of stimulus. Historically these have  largely been exporting countries.  It is pure speculation to suppose that they will easily convert to importers.  There is also much concern that unparalleled levels of stimulus in China, for example, may result in bubbles, bank failures and runaway inflation.

Markets are always in danger of out-of-the-blue surprises.  There are, however, a few areas of identifiable concern.  Increased taxes and increased government regulation are almost certainly coming, with the timing a little hazy.  We’ve heard at least the beginning of geopolitical saber-rattling with the looming prospect of Iranian nuclear power.  Economic problems are surfacing in Europe.  Commercial real estate default problems are coming; we don’t know how severe they will prove to be.  Huge amounts of private equity debt are coming due over the next few years.  The asset values of most companies purchased with that debt are badly depressed.  Will these debts be rolled over or defaulted away?  As industries in countries throughout the world are financially stressed, there is a growing tendency for protectionism.  Though politically effective at home, protectionism works to contract world trade volumes.

By way of broad summary, we are experiencing significant growth in most economic measures, but off a severely depressed base.  The rates of growth are impressive, but the actual levels of production and sentiment are still depressed.  It remains to be seen whether the impressive growth rates prove predictive of economic progress in the quarters ahead or whether they are merely a “sugar high” born of the greatest stimulus infusion in history.  A major part of the investor’s bet is whether the government will ultimately get it right.  Will a collection of academics, Wall Streeters and politicians, who as a group didn’t see the problems arising–in fact, facilitated them–, find the right path on which to steer the world economy?

Ultimately the near-term determinant of the stock market’s path will be the investing public’s expectations of eventual outcomes.  In the short run investor psychology is more key than fundamental conditions.  That makes market direction highly unpredictable.

Overall we can see that the most negative conditions already exist.  The most positive conditions are those that we anticipate and hope for based on projections of favorable trends.  One overriding consideration in looking into such an uncertain future is that to buy stocks at current levels is to pay far above historically normal amounts for a dollar of sales, earnings, dividends and book value. At these levels the most favorable expectations must be realized or prices could fall significantly.


Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.

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Dubai, Greece, Spain: Who’s Next, Illinois?

dominoes

In our December 4 post, we wrote:  “At this point, we can’t know whether or not Dubai is a stand-alone situation.  As a firm believer in the cockroach theory, however, we suspect that having seen one Dubai, we can be reasonably confident that there are many more lurking in the darkness.”  We had no idea how quickly some of those cockroaches
would surface.

Technically the effective default of Dubai World was not a sovereign default.  A great many investors in the development of Dubai, however, did rely on an implied government guarantee.  It is now an open question how the tens of billions of dollars in claims will be settled in an environment with few precedents for such defaulted debt resolution.

This week PIGS have been prominent in the financial news.  This inelegant acronym refers to Portugal, Italy, Greece and Spain, all countries whose debt is seen as increasingly endangered.  Some argue that the name should include another “I” to position Ireland in its rightful place at the trough.

Within just the last few days the major rating agencies have downgraded the debt of both Greece and Spain.  Japanese and Irish Finance ministers, Fujii and Lenihan respectively, warned of future dangers if their countries’ budgets were not soon repaired.  Ratings officials have even threatened the formerly sacrosanct AAA ratings of the U.S. and the UK, whose balance sheets have grown perilously and whose assets have deteriorated markedly with the acquisition of otherwise unsaleable collateralized debt obligations.

Of course, there may be a vast gulf between ratings downgrades and actual defaults, but these ratings agency actions highlight a growing nervousness about the ability of an increasing number of countries to pay their debts.  This week’s headlines are all the more remarkable in light of the huge stock and bond market gains since their respective lows many months ago.  They clearly indicate that considerable instability lurks beneath the improving veneer of the worldwide financial condition.

Also this week Illinois joined the ranks of California and Michigan in the ignominious group of states whose debt ratings have been reduced.  We expect membership in that club to continue to grow.

Most investors would be surprised to learn that sovereign debt defaults are not an uncommon phenomenon.  Carmen M. Reinhart and Kenneth S. Rogoff, co-authors of This Time Is Different, elaborate in detail on what they categorize as “eight centuries of financial folly.” Their comprehensive history chronicles the surprising frequency of government defaults.  In keeping with the principle of “forewarned is forearmed,” investors would be well advised to know what has repeatedly led to past episodes of debt default.

We have warned for several quarters that a great many corporate and municipal bonds are likely to default before we bring down the curtain on this financial crisis.  (See our post on September 28, 2009 “Why Not Buy Bonds?”)  Concern about such defaults is certain to grow as the imperiled financial condition of governments and major institutions becomes increasingly manifest in the months ahead.


Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.

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Debts Are Coming Due

dubai

For the past dozen years we have been warning of the extremely dangerous imbalance brought on by the monumental amounts of debt outstanding in the United States relative to the Gross Domestic Product of our country.  Many others looked at the data and were similarly alarmed, but most did not let that danger deter them from continuing the investment patterns they had practiced successfully for many years.  A few argued that we were unnecessarily concerned, because the debts were not excessive in light of the growth in value of stock and real estate assets.

A great many of those debts are now starting to come due both domestically and internationally.  Loans with balloon payments and reset features have already caused havoc in our domestic markets.  The Dubai crisis is demonstrating on a grand scale the flawed belief that asset prices go in only one direction.  Those of us with decades of seasoning have lived through the cyclicality of both stock and real estate prices.  Perhaps each generation has to learn from its own bitter experience.

Until now we have seen a broad willingness of governments and central banks to shore up a large portion of debt that would otherwise fall into default.  This week’s sobering news out of the Middle East that there may be no government guarantee behind the debts of Dubai World could, however, signal the onset of an extended period in which debts may have to be evaluated on the creditworthiness of the borrower alone.  The danger exists that some of the world’s largest bond portfolios are bearing far more risk than they had earlier believed.

For the past year we have suggested that a great many corporations and municipalities would default on their bonds before this credit crisis is completely unwound.  The government’s largesse has rekindled enough investor enthusiasm to permit many deeply indebted entities to roll over debt or recapitalize in the equity market.  The Dubai crisis might, however, reduce investor willingness to buy new debt and equity issues.

At this point we can’t know whether or not Dubai is a stand-alone situation.  As firm believers in the cockroach theory, however, we suspect that having seen one Dubai, we can be reasonably confident that there are many more lurking in the darkness.


Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.

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Dubai Could Be A Turning Point

Because Thanksgiving week is typically one of the slowest, least eventful of the year, we normally schedule our vacation at that time.  I did not expect any market fireworks this week.  As anticipated, the week opened quietly, and there was little reason to expect the abbreviated Friday session to provide any excitement.  As we in the United States, however, paused Thursday over turkey and all the fixings to give thanks for so many blessings, the rest of the world had to wrestle with the shocking news that Dubai is seeking a rescheduling of tens of billions of dollars in debt.  Stocks plunged on scores of exchanges, as uncertainty about longer term implications prevailed.

U. S. markets, with most senior traders on holiday, opened dramatically lower this morning and spent most of the shortened session recouping part of that initial loss.  In all likelihood, we will get a far clearer picture of the market’s reaction next week when the regulars return to the floor.

As I have indicated previously on this site, this is a market rally primarily controlled by technicians and momentum players.  It will continue only so long as investor confidence remains high.

Valuations remain extreme by all long-term measures.  Those who claim that valuations are moderate can be comparing them only to the unprecedented levels of the past decade, which we know in retrospect was characterized by a series of unprecedented bubbles.

A 60%, essentially uncorrected rally off the March bottom leaves the market at least short-term overbought.  Confidence, an excellent contra-indicator, has reached extreme levels typical of at least interim market tops.

We can’t know yet how serious the Dubai problem may become, nor do we know whether this is an isolated instance or whether this is the tip of a far more inclusive iceberg of debt difficulties.

Market momentum has been waning, and this could be the logical lead into the first meaningful correction of the 2009 rally.  Of course, it could even have larger negative implications, but it is premature to make that judgment at this point.  Confidence may yet result in a continuation of the rally, but the fallout from Dubai could be a game-changer.  We hope to be able to offer some clearer observations after we see the market’s reaction to possible weekend developments.


Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.

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Bubbles? What Bubbles?

Although New Years Eve is not yet upon us, there’s lots of talk about bubbles.  Having suffered from the popping stock market, real estate and credit bubbles in just the last decade, legions of investors are rightfully wary of anything that resembles an inflating bubble.  Clearly people are suffering from loss of value in their homes. The spectacular stock market rally since March notwithstanding, barring a dramatic surge into year end, the 2000-2009 decade will go down in history as the worst decade ever for U.S. stock returns, eclipsing even the Depression-filled 1930’s.  We still face significant potential fallout from the credit collapse.

The stock price surge of the past three quarters has occurred not just in the United States but around the world, with some emerging markets setting a torrid pace.  Apartment prices in Hong Kong are starting to dwarf anything we experienced at the height of the U.S. real estate frenzy.  While gold has surged to all-time highs, almost daily we hear even higher forecasts. These prognostications are eerily reminiscent of the competition among analysts to post the highest price target for dot.com companies in the late 1990’s.  Third quarter Chinese industrial production and retail sales growth have each just been reported at more than 16%.  Chinese stocks have roughly doubled over the past twelve months. There is growing unanimity that China and other emerging nations are now the engines that will lead us out of this recession and into the next sustainable period of growth.

All of this has developed in just eight months since we were told by government officials, economists and bankers that our economic system was on the verge of a collapse that could conceivably doom the world to a repetition of the Great Depression.  As markets plunged almost daily in the first quarter of this year, it became apparent that investors could not stop the bleeding and rescue themselves.  Who could possibly save us from our own financial folly?

Ta da!  Government to the rescue.  Led by U.S. monetary authorities, governments and central banks worldwide opened the financial floodgates and promised to bail out almost every imperiled entity in sight.  The United States, the greatest debtor nation in the history of the world, with no cash reserves, pledged the assets of our grandchildren and our grandchildren’s grandchildren to rescue us from our pecuniary sins.

To date those aforementioned asset price surges have at least raised confidence among the upper strata of the investor class.  Thank God, the bonuses are safe for the imperiled bankers whose survival was assured by taxpayer rescue.

For hedge funds and other large investors who can now borrow at virtually zero cost thanks to Federal Reserve largesse, there is a massive amount of money available that is not going into business growth but rather into investment assets of all sorts.  The apprehensive among us think we see bubbles growing.

Once again the Fed to the rescue.  Just this week, from venues as widespread as Paris and Hong Kong we heard a coordinated chorus of Federal Reserve Governors (Bernanke, Kohn and Yellen) and a Federal Reserve Bank President (Evans) all singing from the same hymnal.  Their song:  No Bubbles In Sight.  Is this possibly a coincidence that they all simultaneously addressed a topic not normally one of the Fed’s talking points?  I expect we are to infer that this provides justification for a continuation of the policy of making future taxpayer money available to wealthy financiers essentially free for an extended period to come.

We have no way of knowing how far asset prices can continue to rise in an environment of free money.  It’s a function of how long investor confidence remains elevated.  We do know, however, that there is always a day of reckoning.  Asset prices must ultimately relate to their underlying fundamentals, even if that day of reckoning is long deferred. Countless mammoth hedge funds are long but not bullish.  Most intend to exit before reversion to mean valuation ensues.  History teaches us that the exit doors are narrow and that most won’t escape unscathed.

If the Fed’s masters of the monetary universe can’t see bubbles, who are we to claim better eyesight?  On the other hand, perhaps all we need is to evaluate traditional measures of value:  price-to-earnings, dividends, book value, sales or cash flow.  Finding those readings at historically excessive levels in 1987, the end of the 1990’s and 2006-07, we kept our equity holdings at seriously reduced levels.  In each instance our clients’ portfolios performed far better than most.  Again today valuations are historically excessive, and we are finding very few stocks at attractive prices through our historically-based selection process.  While we can’t guarantee that our valuation-oriented process will again prove foresighted, I’d far prefer to rely on it than to hope the government can defy financial logic and spend us into perpetual prosperity with money that doesn’t exist.


Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.

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Stimulus Vs. Debt: Which Will Prevail?

Last week we had the pleasure of interacting with well over 100 clients and friends at Mission Management & Trust’s Tucson fall seminar.  We analyzed the conflicting forces of massive government stimulus and unprecedented levels of debt, characterizing these respectively as the irresistible force versus the immovable object.

We have emphasized in prior blog postings that certainty is impossible in assessing the denouement of such massive economic forces and conditions. In the present case, investing aggressively to benefit from either the inflationary or deflationary environments that would logically result from one of these forces overwhelming the other could be extremely dangerous.  Investments that would likely benefit from widely expected inflation stemming from the huge stimulus package would probably do very poorly should a deflationary debt spiral overwhelm the stimulus efforts.  On the other hand, investing in long-term top-quality bonds to benefit from an anticipated deflationary environment could lead to giant investment losses if inflationary forces dominate.

While investors can speculate on probable outcomes, the magnitude of uncertainty is vast.  It has been obvious from the beginning that even the government doesn’t have a clear idea of how it wants to apply stimulus.  The goals for the first stimulus amount approved by Congress were changed by Treasury Secretary Hank Paulson less than two weeks after the funds were authorized.  There is wide disagreement today about the wisdom of the program and the amounts to be expended.  In the months ahead the political will to continue or discontinue the program or to add to or subtract from its size could change dramatically for reasons that are not yet on our radar screens.

Because of the stimulus, already huge debt burdens have grown monumentally.  As we pointed out at the seminar, the federal budget deficit now exceeds 10% of nominal GDP.  Economic analysts have traditionally viewed a deficit above 6% of GDP as the trigger point for potential financial crisis.

At the seminar we also highlighted that our nation’s combined federal, state and local government debt had just climbed above the $14.1 trillion GDP level.  The 100% of GDP reading is a trigger for the rating agencies to consider downgrading a country’s sovereign debt.  Such an eventuality would be a game changer for the United States, the greatest borrower in world history.  While no single debt auction constitutes a trend, today’s auction of $16 billion in long-term debt attracted less bidding interest than expected.  Should such major holders of U.S. Government debt as Japan and China slow their investments, the cost of servicing our debt could skyrocket.  Our profligate spending over the past quarter century has resulted in the U.S. ceding partial control of its financial markets to interests outside our borders.

We marvel at the irony of the government’s solution. To remedy the problem of excess cumulative debt and excessive credit availability, they would attempt to make credit more readily available and add massive amounts of new debt.  The future will tell us whether this approach was wise or whether we have simply stolen from future generations to fund our generation’s consumption.

David Rosenberg, who does excellent economic research at Canada’s Gluskin Sheff & Associates, finds it remarkable that the U.S. Government:

  • • is trying to promote consumer spending at a time when the consumption /GDP ratio is at a record high of 71% and well above the long-term norm of 64%;

 

  • • is trying to promote credit creation at a time when the household debt/income ratio at 125% is still near an all-time high and twice the historical norm;

 

  • • is trying to promote a higher homeownership rate even though, at 67.4%, it is just about the highest in the world and still well above the historical norm of 64.0%.


Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.

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10.2: The Number Of The Day

More than one in ten U.S. residents interested in working is unemployed, according to the 10.2% unemployment rate released this morning, the worst reading since 1983.  Adding in discouraged workers who are not actively seeking a job and those working fewer hours than they want, the number jumps to 17.5%.  For a huge number of these newly jobless, the lay-offs are not just temporary; their jobs have been eliminated.

Many analysts point with optimism to the fact that the monthly decline in payroll employment is shrinking.  It is hard to find “green shoots”, however, when more than half a million Americans received pink slips last month alone.  About all that can be said by way of encouragement on the employment front is that the situation is deteriorating at a slower rate than earlier in the year.

On the other hand, we are seeing economic growth and corporate earnings pick up around the world.  The rate of growth is remarkably strong coming off the lowest readings for economic production and corporate earnings in years.  The stock market has exploded upward since March, obviously celebrating the attractive rates of growth.  Skeptics emphasize the need to look not just at growth rates but at levels of production and earnings as well. This week no less an authority than former Federal Reserve chief Paul Volcker downplayed the concentration on growth rates by pointing out that fundamentally we are still very near the bottom.

Ultimately it is highly improbable that we will experience a sustainable recovery until the U.S. consumer resumes significant spending.  What is still far from clear is whether or not the consumer will soon bounce back and resume his/her traditional role as the world’s buyer of last resort.  Count me among the skeptics.  The damage being done to household balance sheets from this recession’s flood of pink slips is unprecedented.  Coming so soon after the massive wealth destruction inflicted by the collapses in stock prices and residential real estate earlier this decade, that income loss has profoundly diminished the consumer’s ability to spend as before.  The psychological damage done by the disappearance of so much of the average household’s financial foundation will likely reduce willingness to spend for many years to come.

Much of the recent increase in consumer spending has been induced by government stimulus.  It is certainly possible that increased automobile and home buying simply reflected an acceleration of planned purchases in order to take advantage of tax credits.  We can only speculate on how the consumer will react when government stimulus stops and, all the more, when it begins to be withdrawn.

Businesses rebuilding depleted inventories and increasing capital expenditures can generate  improved economic statistics in the short term.  Ultimately the rationale for such expenditures must be the reestablishment of consumer demand.  That won’t happen, however, until consumers head back to work.

Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.

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October Ends With a Bang

October’s reputation for danger is well known in the investment community.  Nonetheless, this year for a good part of this historically perilous month, stock prices confounded the multi-decade averages and rose.  Nearly all major equity indexes reached highs for the current rally in the middle of the month.  The back half of the month proved less fruitful, however.  The indexes declined slowly in the initial days of the correction, picking up speed as October came to a close.  Wednesday and Friday (today) saw aggressive declines on rising volume.  Most market indexes declined between 2% and 3% for the month as a whole. 

So far, declines from the intra-month highs are approximately 6%.  The S&P 500 has given back just about 65 of the 435 points it gained from its March low. Still less than 20% of the rally’s gain, that is well within the range of what would be considered a normal correction in an ongoing bull market. Market behavior over the next several weeks will determine whether, in fact, this is simply a correction or whether it has more ominous implications.

We have stated in a number of recent commentaries that market prices have run far beyond levels warranted by business fundamentals.  As a result, deep discount value managers like ourselves have seen very few stocks meet our historically-based selection criteria.  In fact, we have used this powerful rally to our advantage and have rid our portfolios of all unwanted equity positions.  As we indicated in our recently issued quarterly commentary, we would be vulnerable in the short run if the market should disregard fundamentals and continue its rally through the end of the year.

We recognize that markets can ignore fundamentals far longer than most people believe. In light of our own sub-normal equity position, we added a 10% position in the S&P 500 exchange traded fund (SPY) this week when that index declined to the low 1050’s.  This purchase was an acknowledgement that technicians and momentum players have been in control of market behavior over the past few months.  Our entry point was just above the extended trendline connecting the March and July price lows of the current rally–a logical point at which bullish technicians might come in to buy. Our added stock position still left us in an extremely conservative asset allocation posture.

Wednesday’s strong decline saw prices penetrate the trendline and decline further on rising volume.  At the very least, this was an indication that the bulls were getting tired and that the market needed a correction.  While that trendline break increased the probability that prices would ultimately move somewhat lower, many technical factors were short-term oversold.  We anticipated that some rally would likely occur to relieve the oversold conditions.  It happened faster than we expected with a 200 Dow point rally yesterday.  Despite that impressive point gain, market internals, especially volume, were far less impressive.  Since our reason for buying the incremental stock position no longer existed, we chose to use the rally as an opportunity to exit the position with a minimal profit in this morning’s first half hour.  Those exit prices proved to be near the best of the day, as the Dow subsequently dropped by 250 points.

We manage our portfolios almost entirely on a fundamental basis steeped in market history.  Occasionally, as in this instance, we will attempt to take advantage of technical market conditions that appear to offer a low risk supplemental profit opportunity.  This week we were willing to accept a small risk to capital in an attempt to increase this year’s total return.  We were quick to recognize that the market did not follow the pattern we were anticipating and were able to close the position with a small profit

We remain ready to add equities to our portfolios as individual stocks decline to price levels that meet our historically based valuation criteria.  In the meantime we are comfortable not carrying any appreciable equity risk at current levels.


Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.

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