The Investor’s Dilemma: Bet With The Government Or Rely On Fundamentals?

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Third Quarter 2010

Although stock market volume has declined markedly from its level earlier in the year, price volatility has increased.  Stocks plummeted in the second quarter by 11.4% then soared in the third by 11.3%.  A similar pattern unfolded within the third quarter as well, as a very strong September followed an extremely weak August.  Those violent fluctuations left the S&P 500 up for the year by 3.9% through the end of the September quarter.

For reasons we have been voicing consistently over the past dozen years, severe economic dangers provide the background for these sharp securities market moves.  In such an environment we have strongly counseled against the traditional buy-and-hold investment approach.  Our preferred value-based strategic allocation approach worked against us over this past year, as both stocks and bonds have rewarded risk-taking.  Quite a different picture emerges, however, over most longer periods of time.  Even including the recent underperformance, Mission’s portfolios have outperformed stocks over two, three, four, five, six, nine and ten years.  We underperformed the average equity return by just 2/100 of one percent over seven years and by 2.9% over the eight-year span.  For the century-to-date, our portfolios have outperformed common stocks by more than 5% per year.  Very few portfolio managers in the country can point to such a record of strength and consistency.

Stocks started their current rally at the beginning of September.  One particularly strong Friday performance was attributed largely to pre-opening comments made on CNBC by successful hedge fund manager David Tepper, who spelled out his bullish case as follows:  Equities are a good bet because either 1) the economy gets better and stocks rise or 2) the economy stays weak, the Fed intervenes again with QE2 and stocks rise. Hardly a fundamentally strong case for investment, his argument is instead a justification for speculation that hungry hedge funds and return-starved investors have seized upon.  It is a bet that government stimulus, past and proposed, will succeed–at least for the market.

On a fundamental basis, corporate earnings continue to grow from the extremely depressed levels of the 2008-09 recession, although they are still not back to pre-recession highs.  While we continue in a jobless recovery, businesses have aggressively cut fat and increased productivity, so profits have grown.

The fuel for continued corporate earnings growth, however, is running low.  Economic progress has stalled despite the largest stimulus efforts in history.  We remain in the worst unemployment situation since the Great Depression.  And housing makes new negative headlines weekly, with prices dipping again coupled with a huge backlog of probable foreclosures.  As we have frequently pointed out, our economy is highly unlikely to experience a sustained recovery until consumers regain confidence and increase spending.  Such a recovery remains unlikely with housing and employment in distress.

Federal Reserve Chairman Ben Bernanke sees the bleak picture clearly and has, therefore, pledged another massive infusion of new money.  At the very least, QE2 is an admission that the “shock and awe” of the greatest rescue effort in history was insufficient to push the economy into a sustainable upward trajectory.  This is likely testimony to the vast extent of our economic problems.

Not all agree with the wisdom of additional quantitative easing.  Ex-Fed official Robert Heller contends that the nation is in a liquidity trap, in which injecting additional funds will have no appreciable effect.  Former Federal Reserve consultant and Shadow Open Market Committee member Allan Meltzer maintains that the Fed is ignoring the deleterious long-term consequences of their expansionary actions.  The negative effect on savers and the retired is already apparent.  Fed monetary policy and bond purchases in the open market have pushed interest rates to negligible levels on fixed income securities, so important to risk-averse retirees.  Furthermore, the monumental build-up of debt has done potentially huge damage to the financial condition of future generations.

Beyond potential danger from additional quantitative easing, there is a serious question regarding its likely effectiveness.  A recent poll of Wall Street professionals revealed an expectation that QE2 would have very little positive effect on either the economy or the stock market.

QE1 put a floor under a plunging stock market and an economy that many commentators argue was headed for the next Great Depression.  The massive stimulus program is winding down, however, and with the economy still so unstable, the Fed has deemed QE2 necessary.

Many countries around the world are not eager to participate in a second round of stimulus.  Many European nations in fact are leaning toward austerity and fiscal integrity.

In evaluating the potential for Fed success with this new effort, it’s important to remember that many on the current Fed, including Chairman Bernanke, were the experts that promulgated the monetary policy which led to the real estate bubble and the later stock market collapse from 2007 to 2009.  Do we have reason to believe that they are any wiser today?  Or are they simply desperate in their search for any solution that might work today, regardless of longer term consequences?

Of course, quantitative easing is merely a euphemism for printing money.  Will other nations around the world simply sit back and let us try to print our way out of the current crisis by debasing our currency?  Or will they fight back, leading to a currency war?  Brazilian Finance Minister Guido Mantega has declared that war already under way.

I wrote at greater length about the potential for a currency war in my October 22 blog post at

The effect on the world economy of a currency war is highly problematic.  History argues that protectionism and trade wars would be likely results, with potentially serious consequences for world equity markets.  The sheer size and volume of trading on the currency markets creates an unstable condition when countries with disparate interests contest.  The potential for huge financial accidents is significant.

Investors are faced with an intense dilemma: whether to jump on assets that have been moving up – stocks, bonds and gold – in response to government stimulus and Fed rescue efforts, or to protect assets which could decline severely if those rescue efforts fail.  The proposed degree of government stimulus and monetary creation is a massive undertaking, which could push asset prices higher if the government wins its bet.  Investors are left to speculate on whether or not the monetary authorities can print us into prosperity.

Notwithstanding unprecedented money creation and more to come, if consumers remain cautious and continue to unwind debt levels, stocks could fail again as they did from 2000 to 2003 and from 2007 to 2009.  Contrary to Wall Street propaganda, stocks are expensive by traditional measures of valuation.  And the debt problems underlying the economy have been papered over, not solved.

Bond yields are near historic lows.  The Federal Reserve has been a huge direct buyer of bonds and may buy more.  A major question is how long China and Japan, our largest creditors, will allow us to debase the dollar, yet still hold and buy our bonds.  A reversal of that pattern for either financial or political reasons could push interest rates much higher, doing severe damage to bond portfolios, as happened for four consecutive decades from 1941 to 1981 in the last rising interest rate cycle.

Anyone can choose to speculate on a favorable outcome, but could be hurt badly if the Fed loses its gamble.  It is critically important to recognize, however, that a buy and hold approach to either stocks or bonds in this environment is not investment, but pure speculation.  This is an especially critical recognition for individual or institutional investors who could not easily replace lost assets if the Fed loses its bet.

We prefer to stay in sync with securities fundamentals rather than speculating on the success of the Fed’s efforts.  We will continue to maximize return on secure, short-term investments while looking for strategic opportunities in stocks, bonds, gold or foreign currencies on sufficient price retreats, as we have done successfully throughout the first difficult decade of the twenty-first century.

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 or call (520) 529-2900 to speak with one of the Portfolio Coordinators.


Have Currency Wars Begun?

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Over the last several months U.S. and Chinese government officials have volleyed back and forth criticisms of the other country’s monetary policies.  Just weeks ago the Bank of Japan formally intervened on the currency markets to weaken the yen.  Other central banks, including Brazil, Colombia, Peru, Romania, Russia, Serbia, South Korea, Switzerland and Thailand, have similarly acted to prevent their currencies from rising, not all successfully.  Australia, England and Israel are plotting strategies to push their currencies to levels that will keep their exports competitive.  Brazil’s Finance Minister Guido Mantega declared that currency wars have begun.

This is more than an arcane footnote in pages of the financial press.  History has not been kind to the equity markets of countries caught in the maelstrom of currency crises.  When countries with conflicting objectives undertake beggar-thy-neighbor monetary policies, protectionism and trade wars frequently result.  Most notably in our own country, the competitive devaluations of the 1930s, plus actions like the Smoot-Hawley Tariff Act, provoked retaliatory actions with our trading partners that contributed to a halving of U.S. trade volumes.  The subsequent consequences for the stock market during the Great Depression are legendary.

The progress of competitive currency devaluations is extremely hard to predict, even among normally friendly trading partners.  We can see among our European allies how contentious is the issue of a common rescue of overindebted nations within the European Union.  And this is among countries trying to protect a common currency.  Contentiousness can grow exponentially when far more disparate national objectives are introduced into the equation.

We have all learned to our great dismay over the past decade the extent to which excess leverage can multiply adverse effects in the equity markets.  The currency markets are far larger and are monumentally leveraged.  In a September 30 blog post, Graham Summers pointed out that the currency markets trade over $4 trillion per day on average.  At that rate, a mere nine days of currency trading would equal the market capitalizations of all the world’s stock markets combined.  At leverage rates that can magnify positions by 50 to one or 100 to one, mistakes or mere miscalculations by warring central banks could have disastrous consequences.

We cannot know how this growing currency war will conclude, but its size and leveraged nature offer myriad opportunities for untoward results.  As countries grow increasingly protective in a world of deficient consumer demand, a favorable outcome becomes increasingly unlikely.  It poses yet another big danger for the equity investor.

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 or call (520) 529-2900 to speak with one of the Portfolio Coordinators.


Beware Of Unanimous Opinion

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At Wednesday night’s fall seminar, we examined the question of how investors should balance risk and reward.  Among the many topics covered, we noted how polarized bullish and bearish attitudes have become on a variety of assets.

In the period since Federal Reserve Chairman Ben Bernanke indicated the likelihood of additional quantitative easing, investor sentiment has soared for stocks and for precious metals.  Most investors find great comfort being in agreement with the majority of other investors.  Ironically, markets typically provide their poorest returns when investors share extreme bullishness.  Conversely, the strongest rallies usually begin at points of maximum pessimism.  As a result, at least at extremes, sentiment tends to be an excellent contrary indicator of coming market direction.

Since the Fed’s expressed intention of raising the rate of inflation while simultaneously depressing interest rates with direct bond purchases, the dollar has fallen precipitously.  The outlook for the dollar has become so gloomy that a mere 3% of investors expressed bullish expectations in this week’s Daily Sentiment Index (DSI).  To put that in context, as the dollar approached and reached its June peak following a six month 18% rally, 95% to 97% of investors registered bullish expectations.  As the dollar plummeted by 10% over the next two months, bullish readings fell to just 7%.  That was enough to provoke a 4% relief rally prior to the present decline that began in August.

That 7% bullish reading was identical to the DSI level marking the late 2009 low after the dollar had fallen by 16% through most of that year.  Seeing just 7% bullish at the last two meaningful lows and 95% to 97% bullish at the 2010 top should make investors leery of the current miniscule 3% bullish reading.  Investors were extremely optimistic at the top and pessimistic at the recent bottoms.  Today’s level shows even greater pessimism.

DSI readings for the Euro are almost the exact opposite of those seen for the dollar. A better than 20% rally through most of 2009 led to a 93% bullish reading at the top. All of that gain was given back over the next 7 months. The current 17% rally has rekindled an even more optimistic 97% DSI. Can the Euro hold up in the face of such bullishness?

Precious metals have exhibited similar contrary responses to extreme sentiment levels. Silver showed only 12% DSI bulls two years ago at under $8.50. Today at more than $24 everybody loves silver, with a 97% bullish DSI. Gold’s almost 100% rise over that same two years has brought the bulls up to the 98% level.

While stocks haven’t reached the same level of unanimity, they have periodically reached sentiment levels that have signaled danger. Equity mutual funds currently hold just 3.4% in cash, the lowest level in history. Active investment managers surveyed by the National Association of Active Investment Managers have recently raised their equity allocations above the 76% level that has led to negative performance over the past several years. The current Investor Intelligence poll indicates a dangerously wide spread of 22.5 between bulls and bears. Ned Davis Research’s Crowd Sentiment Poll recently reached a bearish extreme optimism level, which has produced negative investment returns for the past decade. Elliott Wave International pointed out this week that 89.4% of the S&P 500’s stocks are trading above their 50 day moving averages. The last six times this percentage has approached 90%, stocks have at least experienced multi-week declines. Approaching 2010’s peak price, however, this reading held in the 90% area for a few weeks before stocks fell 16%. And the widely watched VIX Index now under 20 shows a dangerously high level of complacency.

Extreme optimism does not necessarily sound a death knell for market rallies, but it does accurately identify market tops frequently enough that it should not be ignored. At the very least, these levels of optimism are raising some cautionary red flags. At the other extreme, the excessive pessimism being expressed for the U.S. dollar could well be building a foundation for a meaningful rally. Should the dollar begin to climb, the rallies in stocks, the Euro and precious metals could be shot-circuited, and corrections could soon follow.

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 or call (520) 529-2900 to speak with one of the Portfolio Coordinators.


Interview With GoBankingRates.Com – Part 2

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Last week we posted the first part of an interview I gave to another blog site,  Here is a transcription of the second part of that interview.

4.  With the recent recession and market downturn, many investors have been trying to spot the “bottom” and time the market.  What are your thoughts on this strategy?  Are there advantages or disadvantages you can discuss?

The biggest disadvantage to market timing is that very few people succeed at trying to buy market bottoms.  Quite obviously, the advantage to the few who do succeed is that they buy at the best possible price.

In our investment management work we do very little of what I would characterize as “trading”.  We did, however, successfully buy four short-term bottoms between 2004 and 2008, in each instance with prices severely oversold.  We were otherwise light in equity holdings, and we succeeded in boosting returns for the year in each of those instances.  We anticipated that a similar profitable opportunity existed in March 2009, but we never identified a point at which we saw risk and potential reward properly balanced.  Clearly the potential to add to portfolio return existed, but we missed it. An integral part of our investment philosophy is that we would always rather miss an opportunity than suffer a significant loss.  While there will always be more opportunities, you will be ill-equipped to take advantage of them if you lose significant amounts of capital.

I strongly suggest that investors would spend their time far more profitably learning about the history of market valuations than trying to time market bottoms.  Learning to recognize historically attractive valuations will provide a sound foundation on which to build a successful investment strategy.

5.  Do you have any advice for investors looking to develop their own strategy?

As mentioned in the prior response, the single most valuable tool in an investor’s arsenal is an understanding of what represents good value.  One would certainly benefit from a thorough understanding of the fundamental investment principles espoused by such fathers of value investing as Benjamin Graham and David Dodd.  An essential complement to that understanding is a comprehensive knowledge on a macro level of what has represented attractive valuation levels for the overall equity market for a century or more. Those levels are measured by such ratios as price-to-earnings, dividends, book value, sales and cash flow.

Just as we practice in our own investment approach, we likewise urge all investors to remain flexible.  Invest when and where you find value, but don’t be afraid to retreat to safe cash equivalents when value is absent.

Beware of the herding instinct.  Almost all of us feel more comfortable when we believe what most others believe.  At extremes of both positive and negative sentiment, however, securities prices have a strong tendency to reverse course.  The vast majority of investors are wrong at every major market turn.  Find a data source to identify such extremes.

Benjamin Graham titled his outstanding book The Intelligent Investor.  Becoming an intelligent investor is certainly not easy.  It takes years of work.  Recognize, however, that if you try to invest without putting in that effort, you will be at a distinct disadvantage competing against those who have done the work.  The investment world has no minor leagues in which you can hone your skills against less developed competitors.

In your ongoing education, I encourage you to find sources of guidance that don’t try to justify their own investment outlook.  Attempt to gather data that both confirm and challenge your own expectations.  Find data sources that evaluate pros and cons in both the economy and the markets.

If you don’t have both the time and the interest to do a thorough job of economic and market research, hire an investment advisor who evaluates data as you want them evaluated.  Don’t simply select a manager based on past performance.  Make sure the manager’s philosophy and investment process are in synch with your risk tolerance and comfort levels.  In an environment like ours today, make sure also that the manager fully appreciates the broad spectrum of possible economic and securities market outcomes.

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 or call (520) 529-2900 to speak with one of the Portfolio Coordinators.


Interview With GoBankingRates.Com

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Earlier this week I was interviewed for another blog site, Go Banking  A transcription of the initial portion of that interview follows.

1. You have very extensive experience in investing and finance.  Can you talk briefly about your background in asset management and financial services?

Interest in finance and investments dates back to my MBA program at the University of Santa Clara.  Upon concluding that program, I taught for a few years at the college level before gravitating to the securities brokerage industry in the late-1960s.  From that initial exposure, investment consulting and asset management particularly captured my attention.

Having worked extensively with religious, charitable and other not-for-profit organizations in those early years, in 1978 I decided to establish Thomas J. Feeney & Co., an investment consulting firm, to serve that not-for-profit clientele.  At the urging of several consulting clients, in December 1985 we began the asset management function and founded Marathon Asset Management Co.  The two companies were based in La Jolla, California.

In 1994 my wife Carmen Bermúdez founded Mission Management & Trust Co., a full service trust company, in Tucson, Arizona.  After three years of commuting weekly from Tucson to La Jolla, I opted to relocate Marathon to Tucson.  Mission’s initial chief investment officer retired in 1997, and I assumed that role.  Since that time I have served as chief investment officer for both Mission and Marathon, and we run the firms side by side in the same offices.

2. When it comes to investing, what is the strategy that you generally favor for your clients?  What factors do you consider when determining the right investment strategy?

I have long disagreed with the investment industry’s two-part prescription for investment success: 1) Set an appropriate asset allocation mix and regularly rebalance to it; and 2) Buy and hold stocks and bonds for the long run.  Instead our investment staff and I work daily to identify securities that represent real value.  We rely on quantitative processes that evaluate current securities data and relate those data to valuation ranges that have prevailed over most of the past century.  Unless precluded by client inability to withstand the risk of concentration, we are willing to invest large percentages of our portfolios in either stocks or bonds, when they present compelling value.  At the other extreme, we are equally willing to shun stocks and bonds and hold portfolios largely in cash equivalents, when compelling valuations are absent.  I strongly agree with Warren Buffett’s comparison of investing to a baseball player taking batting practice: You can’t be called out on strikes; you can let as many pitches go by as you wish; you can wait just for pitches that are particularly attractive.

We also differ from the common wisdom of our industry by not benchmarking to any market index.  We pursue absolute, not relative returns.  That approach has been especially valuable over the past dozen years or so.  We have not felt compelled to hold large allocations of common stock in an era of historically high valuation measures.  That stance was extremely helpful through the destructive stock market decline from 2007 to 2009.  Our Controlled-Risk Flexible Allocation investment approach, which most of our clients employ, has earned positive returns in 23 of our first 24 years.  We barely missed a clean slate by suffering a minimal loss of a fraction of one percent in 2008, when the S&P 500 lost over 37%.

3. For investors who saw half their portfolios disappear during the recession, putting their money back in the market again can be very scary.  This is especially true if they’re nearing retirement.  How do you recommend investors cope with that fear of the market?  Is that fear justified?

Fear is as justified today as it has ever been.  While government and monetary authorities rescued our financial system from imminent implosion less than two years ago, a great many domestic and international risks remain.  Subsequent to the massive rescue efforts applied to our domestic economy, dangers of default have been recognized in Dubai, Portugal, Italy, Ireland, Greece, Spain and Hungary.  In our own country numerous states and municipalities are in precarious financial shape.  At the individual level foreclosures and unemployment are at or near modern historic highs.  The average household balance sheet has been badly damaged in recent years and portends little resilience should the economy not recover soon.  Notwithstanding the myriad dangers which legitimately justify concern, investment markets could still do well.  The government and the Federal Reserve Board may succeed in rescuing and stimulating the economy, and investors may rediscover lost confidence and push securities prices higher.  Much depends on whether or not confidence can be rekindled.  Investment markets have advanced nicely over the past year and a half on the back of inventory rebuilding and capital expenditures.  That advance will grind to a halt, however, if we consumers don’t start to spend regularly.  Because consumer balance sheets are still well below where they were three years ago, it is an open question as to whether a new-found frugality will constrain such spending.

There is no easy answer for investors, especially those in or near retirement.  While they can ill afford to lose more capital, they need income in an atmosphere in which safe income is hard to come by.  Almost anything an investor or saver does in this environment has the potential to be very wrong.  Assets invested in equities could do well if the government and Fed rescue efforts succeed and especially if printing massive amounts of new money should float financial asset prices far higher.  On the other hand, if QE2 or another round of stimulus efforts should fail to raise consumer and investor confidence, stock prices could retreat significantly from current levels.

Investors and savers will be rewarded for taking the more conservative path in highly secure bonds or cash equivalents if the economy continues to slow and especially if collapsing debt and deleveraging lead to deflation.  Those same investors and savers, however, could be seriously damaged if the flood of new rescue money should lead to runaway inflation.  Which scenario might unfold will be determined by many future actions of governments, regulators and private citizens.  Many of those actions are simply unforecastable.

Although hardly satisfying to investors seeking guidance, I offered my strongest recommendation in the August 13 post titled, “Keep Your Job,” on Thomas J. Feeney’s Measure of Value at

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 or call (520) 529-2900 to speak with one of the Portfolio Coordinators.