Keep Your Job

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Unless you are extremely well off ($10 million or more in liquid assets for individuals or families), fight the urge to retire in this era of great financial uncertainty.  The United States and much of the world has embarked on an unprecedented venture to absolve the financial sins of the current and immediate past generations with promises that future generations will pay our bills.  As I have written frequently on this site, that strategy is not only financially irresponsible but profoundly immoral.

Whether from a recognition of the financial folly or from pangs of conscience, increasing numbers of Americans are turning their backs on the concept of further bailouts.  The latest polls show that a majority in this country want the Fed to discontinue its stimulus efforts.

The largest and most aggressive bailout program in world history put at least a temporary floor under a plunging economy.  The recovery it stimulated, however, has been one of the weakest on record.  Recent economic readings increasingly point to the growing potential for a renewed slowdown or even a double dip recession.

The Fed acknowledged in its recent statements that it has been surprised and disappointed with the recovery’s lack of progress.  Chairman Bernanke has expressed concern about the unusually uncertain economic outlook.  It is that uncertainty and the still precarious economic condition that prompt my strong suggestion that you maintain your employment income stream.

A great many people retired over the last decade with a million to several million dollars in investments, fully expecting that their various retirement income sources would allow them to live their “golden years” as planned.  The behavior of the financial markets over that most recent decade, however, has introduced unexpected speed bumps and has turned many golden dreams to dust.

I have vivid recollections of non-clients coming to our office in 2002-03 somewhat in shock, having seen as much as half or more of their nest-eggs disappear in the market decline that followed the bursting of the dot.com bubble.  Several were literally in tears as they evaluated their economic alternatives.

Although we made money for clients in each of those difficult early years in the new century, we remained cautious. We warned listeners that the economic and market excesses had not been solved by the largesse of the Greenspan Fed, which brought interest rates down to 70-year lows.  Those historically low rates furthered the real estate boom and precipitated the bubble from which we still suffer.  Unfortunately, we lost some clients at that time who decided our cautiousness was out of touch with new era opportunities in both residential and commercial real estate.  We readily admitted that we had no real estate expertise. Nonetheless, we repeatedly warned that leverage in real estate was extreme and that, notwithstanding recent experience, real estate was a cyclical commodity.  When any financial commodity is overleveraged at a historical price extreme, the danger is serious.  Unfortunately, the risk was realized, and latecomers to the real estate party were punished severely.

Whether because of the collapse of the real estate bubble or merely coincident to it, common stocks were again battered from 2007 to 2009.  Despite the price rally into the end of the decade, stocks lost money over the full span of this century’s first ten years.  Because of the historically typical tendency for investors to buy high and sell low, most investors in equities did far less well than did the weak stock market indexes themselves.

So far bonds have proven to be the new century’s most profitable securities investments, largely because government rescue efforts directly lowered short-term interest rates and because the Fed purchased well over $1 trillion of fixed income securities.  Once the Fed effectively promised not to let financial institutions fail or hurt investors, bonds of all types leaped in price.  Junk bonds, rated barely above default levels, returned over 100% in their first twelve months of recovery.  As is typical of investors in every era, they project recent results into the indefinite future.  Because bonds have beaten stocks and cash over the past decade, investors are pouring money into bonds, notwithstanding interest rates at or near historic lows.

Bonds, at least Treasury bonds, could continue to be profitable if the economy remains weak and especially if deflationary tendencies become more dominant, which looks increasingly probable in the short run.  Corporate or municipal bonds, however, are likely to be good investments only if rates stay low, yet we skirt deflation or a significant recession.  Should deflation or a significant recession occur, prices of municipals and all but the most secure corporates would likely be hurt by the threat of default.

Whatever is left in retiree portfolios after this difficult decade is now earning precious little.  The Fed has pushed risk-free rates virtually to zero.  If you’re willing to lend the U.S. Government money for two years, you’ll receive an annualized return of just about one-half of one percent.  You will receive about 2.7% per year from a ten year U.S. Treasury bond. If retirees choose to avoid risk, their investment income is far below what they had anticipated.

Retirees face difficult choices.  They can seek higher returns in equities that continue to face strong headwinds.  The problems that led us into the unprofitable last decade remain:  excessive debt and excessive speculation.  Those problems have been compounded by severe unemployment and an extremely weak real estate market.  The potential long term success of government rescue efforts is unknown but increasingly questionable.

The retiree can stretch for yield in corporate or municipal bonds but assumes the risks listed earlier.  On a risk/reward basis, there is far more room for rates to rise and hurt bondholders than to fall and provide benefit.

The safest approach for those for whom this is an option is to stay employed and keep the stream of income flowing.  It broadens the scope of future options.

Should deflation take hold, even for as little as a year, it could leave a deep scar on the psyches of consumers.  Once people begin to expect lower prices, they defer purchases and the economy slows.  That can easily become a self-reinforcing cycle.

Fed Chairman Bernanke has vowed that he will not allow the economy to fall into deflation. But should it begin, he may not be able to control it.  He has already poured an unprecedented amount of money into the banking system, but there it remains.  For a variety of reasons it is not being loaned out.  More money does the economy no good if it just sits.  It is only of benefit if it circulates, and the Fed Chairman can’t force that to happen.  On the other hand, Carmen Reinhart and Ken Rogoff pointed out in This Time Is Different that over the past 800 years, inflation is the normal response to excess debt and monetary crises.  Government almost invariably tries to print away excessive indebtedness.  Whether deflation affects us initially or not, it is a relatively safe bet that inflation, possibly even virulent inflation, lies somewhere in our future.

As inflation and deflation battle one another, investing will continue to be a complex and difficult endeavor.  Should inflation become severe, it will likely do serious damage to the assets of retirees heavily dependant on fixed income.  Employment incomes rise over time to compensate for inflation. For most people, having that regular paycheck is likely to be the safest defense against uncertain conditions.  Keep your job.


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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Conflicting Signals

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ISI Group technical analyst Jeff deGraaf highlighted a negative volume trend in the stock market’s decline from the April highs and in the recovery from the July lows.  The declining markets saw trading volumes in May and June climb to 116% and 113% respectively of their longer-term averages.  When the markets rallied in July, volume fell to 96% of the decreasing longer-term average.  This trend is usually symptomatic of a weakening market structure.

Ned Davis Research’s studies show a more bullish short-term picture.  Investors around the world are increasingly demonstrating a preference for riskier assets, with volatile emerging markets leading the world’s more established markets.  Such trends are typically bullish until investors reach an extreme level of confidence, which often marks a market top.  Current international readings do not yet look extreme, however, which bodes well for the short-term.

On the domestic front trader optimism, a contrary indicator at extremes, has grown steadily over the past several weeks.  Elliott Wave International reported that the Daily Sentiment Index jumped from just 10% bulls on the S&P 500 at the July 1-2 lows to 73% bulls five weeks later with the index more than 10% higher.  That’s the highest bullish percentage since May 3, just days before the May 6 “flash crash” which saw the Dow drop more than 1000 points intraday.  The ISE Sentiment index, which measures sentiment in the options market, is showing readings almost identical to those leading to the April market peak that preceded the 16% decline to the July lows.

With these various indicators pointing in opposite directions, they obviously can’t all accurately forecast the market’s direction, at least in the same time frame.  They are, however, consistent with the conflicting picture we’re also seeing on the fundamental side of the ledger.  Second quarter corporate earnings continue to come in above expectations, while weekly and monthly economic statistics continue to deteriorate.

This is not a normal environment.  Governments around the world have provided more stimulus than ever before and might provide even more.  At the same time there are countries and banking systems on the verge of default.  We can’t know how this will ultimately work out, nor how intermediate chapters will unfold.  The range of possibilities is huge, and the prudent investor will remain far more flexible than normal to facilitate moving rapidly should events play out in an unanticipated manner.

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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More Heat Than Light

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Trading volume remained subdued during another summer week, enabling professional traders to dominate market activity with their ultra-short-term orientation.  We experienced several strong market price moves through the week: up about 150 Dow points, down 100+, up 100+, down almost 200, up almost 150, down 175, up 150, down 100, up 100, before drifting off to a 41 point gain for the week.  Traders pushed prices to nine moves of 100 points or more in five days, yet the net gain was a mere 0.4%.  The S&P 500 went through essentially the same frenetic back and forth exercise to close the week with the loss of a single point.  All other major indexes were similarly just above or just below the flat line for the week.

The week’s activity settled nothing by way of offering greater insight into the market’s likely next direction.  As we have indicated in prior posts, a great deal of technical damage was done in the decline from the market’s April highs.  Then surprisingly a significant amount of that damage was repaired in a strong early July advance.  Prices stalled this week near earlier June highs, which lent encouragement to the bears.  The fact that this week’s attempts to decline failed to gather much strength provided equal encouragement to the bulls.  The week closed with the Dow Jones Industrials and the Russell 2000 small cap average just above their respective 200-day moving averages.  Many analysts view this average as the line of demarcation between a strong or weak market.  To complicate the picture, however, the S&P 500, the Nasdaq Composite, the New York Stock Exchange Composite and the Dow Jones Total U.S. Stock Market Index all closed slightly below their 200-day moving averages.  Neither bulls nor bears appeared strong enough this week to move prices convincingly, despite both positive and negative economic and corporate earnings news.

Monday begins the seasonally weak period that on average extends into late October.  While no single year needs to conform to long term seasonal patterns, it is potentially helpful to be conscious of what has occurred with some frequency over the decades.  There remain a great many conflicting technical and fundamental conditions, and this market could yet move strongly in either direction.  An overriding consideration, however, is that stocks are still selling at well above average valuations, from which levels stocks have historically earned far below average subsequent returns.

We cover a broader array of investment subjects in our mid-year commentary, which is posted below this entry.

QUARTERLY COMMENTARY
Second Quarter 2010

July 23, 2010

The comfort of the prior four quarters was sharply shaken in the June-ending quarter as the stock market, measured by the S&P 500, declined by 11.4%.  For equity holders there was no place to hide except for a few emerging markets, generally too small and risky to attract traditional investment money.  Most declines were in double digits.  In our domestic market, all sectors declined with only the defensive utilities, telecom and consumer staples avoiding double digit losses.  The S&P 500 closed 2010’s first half down by 6.7%.

Bonds continue to be the most productive asset class, as the Federal Reserve has kept short-term rates just above zero.  Virtually all bonds have done well during this period of Fed largesse.  At the short end of the fixed income curve cash returns are practically non-existent.  By dropping rates to all-time lows, the Fed has forced investors to take risks to earn any return whatsoever.  So far that risk-taking has had positive results.  As yields have come down, however, risk levels have risen.  And a great many investors, who have already lost considerable personal wealth over the past decade, can ill afford having that risk realized and losing yet more money.  This is especially true of retirees and institutions that cannot easily replace lost capital.

In this environment in which most investors have experienced losses, we are pleased that our clients have earned small positive returns both for the quarter and for the year-to-date.  Great uncertainty still exists, however, both domestically and internationally.  There exists a broad range of potential outcomes for the world economy.  Several countries are arguing strenuously for the imposition of austerity measures to rein in loose monetary and fiscal policies that have characterized the worldwide rescue effort.  The U.S., among other countries, is still leaning toward further stimulus despite the massive debt that has already been created.  How this debate and many other economic uncertainties unfold will have profound effects on the securities markets in the quarters and years ahead.

In his July 21 appearance before Congress, Fed chief Ben Bernanke categorized the economic outlook as “unusually uncertain.”  Because the Fed normally attempts to keep investors and consumers confident, such words likely betray a far greater concern about possible economic outcomes than have any recent Fed releases.

There are clearly conflicting indicators for the probable direction of stock prices over the remainder of the year.  Generally, second quarter corporate earnings are coming in better than had been expected.  While a great deal of technical damage was done to stock indexes in June, surprisingly strong repairs were accomplished so far this month.  On the flip side, the housing crisis remains severe, and unemployment will likely drag on the U.S. economy for years.

There’s an old saying in the investment business:  In the short run, the stock market is a voting machine; in the long run, it’s a weighing machine.  In other words, investor sentiment controls markets in the short run, while the fundamentals prevail over time.  We don’t have a strong feel for how sentiment will develop over the next few quarters.  On the other hand, debt levels, because of rescue efforts, have gone from dangerous to extremely perilous throughout major sections of the world.  We do not yet know whether the concerted efforts of world governments and central banks will effect a lasting recovery.  We do know, however, that our children, grandchildren and their grandchildren will be burdened with the greatest debt legacy in world history.

A second major fundamental concern is valuation.  As indicated in our last quarterly commentary and on my blog site (www.ThomasJFeeney.com), contrary to the contentions of most financial analysts, stocks are not cheap.  Measures of price to dividends, book value, sales or cash flow are at or near all-time highs except for the bubble period from the late-1990s to 2007.  Price to earnings is less extreme, but still above long term averages.  From valuations at or near these levels, stocks have historically performed far worse than average.

We urge clients to remain conscious of where markets are in their long term cyclical patterns, which we have discussed intermittently over the years in commentaries and at our seminars and conferences.  As we have frequently explained, the latest long weak cycle began in 2000.  The two century-old pattern of alternating long strong and weak cycles reveals that both strong and weak cycles tend to last on average about a decade and a half, although with considerable variation.  That this current cycle has so far lasted only about two-thirds as long as the average is far from determinative by itself.  A far more important indicator that we probably remain in the long weak cycle is the fact that all prior weak cycles have continued until investors largely gave up on stock ownership and valuations plummeted to extremely low levels.  In this cycle, not only have stocks not descended to such valuation depths, valuations have actually remained closer to historic highs than lows.  While this does not mean that stocks won’t rally from here, it is unlikely that we are yet at the beginning of the next long strong cycle.  Should markets head higher in the short run, such an advance would likely retrace before a more lasting bull market rally could evolve.

Given unprecedented debt levels throughout the world and speculation common about first world countries in danger of default, the risks to economic progress and to common stock holdings are at historic highs.  Investors must recognize that this is not a “business as usual” scenario.  We can’t know for certain that the risks will be realized.  It would be foolhardy, however, not to recognize the potential for huge losses in risk-bearing assets should government rescue efforts fail to achieve long-term success.  The financial system was essentially broken just a year and a half ago but for government rescue. From that point the economic recovery has been significantly substandard by comparison with prior recoveries from recessions, despite the greatest stimulus effort in history.  If consumer and investor confidence cannot be sustained, it is highly improbable that governments will be able to restimulate their economies with anything like the same firepower that they unleashed in their initial effort.  We are at an extremely tenuous point in the recovery.  Continuing success is dependant upon lasting consumer and investor confidence.  The outcome is unknowable.

Many of the same considerations affect the fixed income markets as well.  As mentioned earlier, the Fed has pushed the return on risk-free securities essentially to zero.  Safe cash equivalent yields are non-existent.  Bonds, which have been wonderfully profitable for the past three decades, are inevitably approaching a point below which yields will not go.  The possibility exists that bonds could remain productive, despite current low yields, if business conditions remain weak and especially if deflationary forces prevail.  On the other hand, with 10-year U.S. Treasury notes yielding less than 3%, there is far more room for interest rates to rise than fall.  Few current investors know how dire conditions can be for bondholders once rates begin a rising cycle.  For more than four decades from 1941 to the early 1980s, rates rose and the total return on bonds was considerably less than the return on risk-free cash equivalents.  In a highly uncertain environment, conditions can change dramatically and quickly.  Should foreign lenders to the United States turn squeamish about sending more money to this country, rates could rocket upward and bonds would take big losses.  While not likely in the short-run, that outcome is certainly possible and should impose discipline on those inclined to blindly stretch for yield.

Conditions are likely to change rapidly over the next several quarters.  I have attempted to keep clients and other interested readers in tune with our shorter term thinking through weekly posts on the blog site mentioned earlier.  I encourage you to take a look.


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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Get Used To Volatility

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Another week of striking volatility closed on a high note today. The Dow was up 102 points after relatively benign news came out about European banks following their “stress test.”  Only seven of 91 tested banks were said to have “failed”.  Some cynics suggest that not much stress was applied.  Details of the testing procedure are coming out gradually, and there will undoubtedly be a great deal of commentary and speculation in the weeks ahead.  It does seem curious that the banks holding the majority of the bonds of countries seen to be in danger of default are given a clean bill of health.  I’m sure that decision will be widely discussed and analyzed. 

Back to volatility.  The five days of this week saw the Dow Jones Industrial Average make seven rallies or declines of more than 100 points. Obviously this is not investors changing their opinions from hour to hour.  Well more than half the market’s daily volume now comes from computerized trading, much of it of the “high frequency” variety that depends on physical proximity to the trading posts.  Physical proximity shaves nanoseconds off order transmission time and provides a slight, but measurable advantage.  An IBM executive recently explained that it takes about half a second to click a mouse.  The new exchanges are being designed to execute a million trades in the amount of time it will take to click a mouse.  That’s not investing, folks.  I suspect that inadequately controlled high frequency trading was largely responsible for the 700 Dow point drop-then-recovery within about 30 minutes on May 6.  These operations, which have no long-term orientation, can severely exacerbate normal market fluctuations.

Another major force in today’s markets is the big investment bank trading for its own account.  Some of the biggest banks can move markets on their own for a while.  They know what they want to promote for their own profitability, and they are capable of influencing markets to a measurable degree.  The Volcker rule is designed to eliminate banks’ trading for their own accounts.  Eventually authorities are going to have to do something about high frequency trading as well. 

I am certainly not an advocate of unnecessary regulation.  On the other hand, Wall Street has proved over the decades that its primary focus is profit – its own.  Customers come a distant second.  Wall Street firms will argue long and hard about how their great new systems provide tremendous liquidity.  Don’t believe it.  Where was the liquidity on May 6?  These are tools solely for Wall Street profit.  Their functions need to be better understood and controlled before they do serious harm.


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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Should Government Promote Greater Private Sector Risk Assumption?

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I corresponded this week with a business associate who is running for the U.S. House of Representatives from another state. First, I sent a contribution to his campaign, because he is prepared to push for term limit legislation. I have long argued that legislators will not concentrate major efforts on the solutions to our country’s top long-term priorities until we reduce the frequency of standing for reelection. The rest of the communication, which follows, addresses the question of the wisdom of encouraging the private sector to take risks in the interest of promoting economic growth.

We must be willing to assume certain risks if our economy is to grow. On the other hand, assuming additional risk is not a guaranteed prescription for success either for businesses or for individuals. Over the decades one can observe a cyclical pattern of alternating insufficient risk assumption and excessive risk assumption.

For businesses, too much risk assumption leads eventually to excess inventory, excess capacity and excess debt. When that becomes prevalent in an economy, recessions result. The most excessively indebted go out of business as inventories and excess capacity are worked off. That natural selection process is short circuited if government intervenes, as it did recently by bailing out banks, insurance companies and automobile companies. Moral hazard results when companies no longer fear the consequences of their own mistakes. The current disgust of the populace is clearly understandable when profits are enjoyed privately and losses are borne on the backs of taxpayers.

While risk assumption takes many forms, one of the most easily measured is debt. The first of the graphs below, both from Ned Davis Research, is one I have pointed to frequently over the past dozen years. The explosion of debt that began in the 1980s had a salutary effect on the economy for many years. It reached excessive levels, however, eventually exacerbating the decline that began in 2000. What we have been experiencing for the past decade has been far worse than a normal cyclical inventory recession. Rather, it has been a credit crisis involving massive deleveraging and monetary crises in many parts of the world.

totalcreditdebt

The Bush administration initially and the Obama administration over the past year and a half have attempted to solve a problem caused by too much debt by creating massive quantities of new debt.  I have objected vociferously to government attempts at solving economic problems our generation created by issuing promises to pay that will have to be borne by future generations.  It’s a moral issue.  The rescue attempts may or may not succeed, but the undeniable consequence will be a huge anchor weighing down the economic ship to be sailed by our grandchildren and their grandchildren.

An additional moral question attends the Federal Reserve’s attempt to promote risk- taking–and hopefully business growth–by reducing short-term interest rates effectively to zero.  All else equal, such a rate reduction will reduce business costs, improve profitability and hopefully lead to increased employment and greater general prosperity.  We see very little comment, however, about the intergenerational inequity that such actions produce.  A growing number in our society are past their income-producing years and are dependent largely on fixed incomes to live.  If they choose to accept no risk with their savings, they will earn essentially nothing in a money market fund comprised of U.S. Treasury securities.  If they let the government borrow their money for two years, they will be paid the royal return of 0.61%.  They can earn slightly more each year, 1.74% and 2.98% respectively, in five and ten year U.S. Government notes.  With all the new debt the government has recently created, however, many are worried that inflation over those time periods might exceed the nominal returns, leading to negative real returns.  The government has effectively said to a vulnerable segment of our society that you must take risk if you want to earn any return.  Unfortunately this group has little capability of rebuilding capital should the risk-bearing investments fail.

A few years ago I had dinner with Robert Parry, then President of the San Francisco Fed.  I made in essence the same observation about the highly negative effect on retirees from what was then an even less aggressive Federal Reserve interest rate stance.  He acknowledged such a negative effect with some distress but justified it as a form of unintended collateral damage in the war against business stagnation and unemployment.  The elderly, unfortunately, have a far weaker voice than that of the business community.  And they contribute far less to political campaigns.

When most people talk about the desirability of risk assumption, they are typically speaking about businesses.  It applies also to individuals as consumers.  For individuals there are obviously times and conditions more appropriate for risk-taking than others.  As a populace we have become increasingly more risk-bearing over generations.  Perhaps the quintessential example of excessive risk assumption was the past decade’s mania in which a greater percentage of our population than ever before opted to own homes.  This, of course, was good for business while the surge was in full bloom.  Only in its aftermath did the extent of foolish risk-taking become apparent.  A great many bought homes that they could afford only if prices continued to rise and mortgages could be serially refinanced.

To a lesser degree the same principle applied to consumer purchases generally.  We became increasingly enticed to purchase whatever we wanted.  Not having enough money was no barrier as long as new credit card applications appeared regularly in our mailboxes.  Because the government fought with a vengeance any semblance of a recession, we became convinced by personal experience that tough times and unemployment were things of the past.  In such an environment, there was little need to save.  We could buy with abandon and take other risks and a favorable future was our birthright.  Unfortunately, the bankruptcy statistics of the past few years are the sobering testimony to the folly of that behavior.  The second Ned Davis Research graph below shows how dramatically leveraged the average household remains.  My concern is that promoting additional risk assumption, which might provide a short-term economic lift, could intensify long-term negative economic consequences in an economy still highly overleveraged.
HouseholdLiquidity

It is far from clear what the optimum level of leverage is for either businesses or households.  Almost certainly, the appropriate level will vary over time depending upon a great array of conditions.  Certain conditions create a situation which some have called the paradox of thrift.  If the individual is overindebted, it may be prudent to cut back on consumption and reduce debt.  What may be wise for the individual may, however, be destructive to the overall economy, which relies on the expansion of consumption and risk-taking.  There is no easy answer.

If You Want To Promote Term Limits

While not a highly political person, I am a strong advocate for term limits.  If you would like to support the campaign of a candidate for whom the first issue addressed on his website is term limits, email us and we will be pleased to pass along contact information.  You can then decide whether you agree with the candidate’s positions and whether you wish to contribute.


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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Stocks Bounce Back

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We are in the process of working on our quarterly commentary letter, which we will send out soon.  It will be posted on this site after we have sent it to clients.

As we suggested last week, the stock market went into the long Independence Day weekend significantly oversold and in need of “at least a brief recovery rally.”  This holiday-shortened week saw that rally begin.  Each day produced gains, albeit on rather tepid volume.  This week’s rally recovered slightly more than half the decline of the prior two weeks. It has served to work off the short-term oversold condition and has forced many shorts to cover.  The weak volume signals a rally that was largely an internal affair for Wall Street firms with minimal public participation.  While that could, of course, change, most lasting rallies begin with a more enthusiastic sendoff.

The rally has also partially repaired some of the technical damage done since late-April. A great deal more needs to be done, however, to prove that this is anything but a relief rally in a more extended down leg.

Next week begins the second quarter earnings announcement parade.  Expectations are for strong year-over-year growth compared to the very weak results of second quarter 2009.  There is room for disappointment if earnings are less than great or if guidance for future quarters reflects diminished enthusiasm.

Bond yields ticked up this week, and next week’s new issue calendar is heavy.  Analysts will be looking to see whether that bond supply will divert money from the equity market.  We are eager to see whether the public returns to equities next week to sustain this week’s rally or whether this proves to be no more than a technical bounce from a severely oversold condition.


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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A Week of Bad Technicals And Fundamentals

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Last week’s post concluded with the statement: “The next week or two could go a long way toward determining the market’s direction for the summer.” Earlier in the post we indicated: “This week has not been pretty, but neither has it done any significant technical damage.” By contrast, this week’s negative market action has clearly done some significant technical damage and may well indicate that the summer price direction for stocks is likely down.

We described last week the S&P 500 having found support after its May and June declines at the 1040 level. Earlier this week all major equity indexes fell convincingly through 1040 or their equivalent levels. Prices ended the week at levels seen early last August, nearly a year ago.

The equity markets, down more than 8% over the past two weeks, remain seriously oversold on a short-term basis. That condition normally leads to at least a brief recovery rally, but buyers have so far remained conspicuously absent. Market analysts anticipate hefty corporate earnings gains to be reported over the next several weeks. Those expectations, however, have been so universal that it’s unlikely they will provide significant market support. Optimistic outlooks released in conjunction with quarterly earnings announcements may be needed to resurrect buying interest. Unfortunately the recent tendency has been for companies to ratchet down their optimism about prospects for the next few quarters.

Besides the technical damage to stocks this week, the equity markets also suffered from a spate of weak economic data. Reports came in below expectations on vehicle sales, pending home sales, domestic and Chinese manufacturing, consumer confidence and employment levels.

Jobless claims have stopped declining and have begun to rise. Average hourly earnings declined for the first time in seven years. Considering the number of unemployed whose jobs have been eliminated, plus those now unemployed for more than six months, this is currently the worst job market since the Great Depression of the 1930s.

New negative reports come out every week about the condition of state and local finances. The decline in municipal fortunes is forcing large numbers of layoffs, which look likely to grow even larger through the remainder of this year. This will continue to put downward pressure on consumer spending.

Market bulls have been strongly encouraged over most of the past year by improving manufacturing data, which resulted from a needed rebuilding of depleted inventories. Now that this has been largely accomplished, additional growth in business-to-business commerce will depend heavily on renewed spending by end consumers. We made the point several times over the past year that the economic recovery would be short-lived unless consumers came back with renewed vigor. We also thought such renewed vigor improbable given the highly leveraged consumer balance sheet. While the consumer has shed some of that debt, its level remains near historic highs. With unemployment likely to remain very high for several years and normal retirement age fast approaching for the Boomer generation, the consumer is apt to reduce spending and add to savings. Consumer conservatism does not bode well for a continued recovery.

Growing regulation and increased taxes are both likely in the year ahead, and each will tend to depress equity prices. For both technical and fundamental reasons, intermittent rallies notwithstanding, the path of least resistance for common stocks looks to be down.


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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A Tough Week

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The stock market rally from March 2009 reached a peak at about 1220 on the S&P 500 in late April of this year.  A 15% decline brought prices to 1040 a month later.  A short rally was followed by a retest of 1040 early this month.  When that level held, traders were emboldened and pushed prices up by about 8% over the two weeks through this past Monday morning.  This week has not been pretty, but neither has it done any significant technical damage.  It has, however, issued a few warning signals.

Though still not strong, volume has risen on this week’s declining days compared to the low volume that characterized last week’s rally.  That rise continues a longer pattern of weak volume on rallies and rising volume on declines, the opposite of what normally occurs in healthy markets.  Today’s volume was extremely high on a day with some market averages up and some down.  The extraordinary volume resulted from the annual rebalancing of the numerous Russell stock indexes and had nothing to do with a bullish or bearish market tendency.

Monday, Tuesday and Thursday saw aggressive selling into the closing bell.  In each instance a short-term oversold condition was created that normally leads to a relief rally for a few days.  That no such rally was able to take hold indicates an unusual lack of short-term buying interest.

Fear has become a prevalent emotion, and is becoming evident in the world’s bond markets.  Short-term U.S. Treasury Bills have provided yields just above zero for the better part of the past two years.  When the financial crisis was at its peak in December 2008, the 10 year U.S. Treasury Note reached a low yield of 2.08%.  As rescue efforts rekindled investor confidence, yields almost doubled to 4% just three months ago.  As fear has reemerged, yields have dropped to 3.11% and seem to want to go lower.

Foreign markets reflect a similar condition.  Money is pouring into bonds of the most secure countries with Germany at the top of the list.  Spreads between German yields and those of riskier countries are widening.

In both the equity and fixed income markets, investors are backing away from risk and are seeking the shelter of risk free securities, even if yields are miniscule.  For many, the prime objective is the return of their money, not the return on their money.

Having experienced a rocky week in the stock market, investors are looking to next week with some trepidation.  G20 leaders are meeting in Toronto this weekend and may attempt to bolster investors’ spirits with a positive statement.  There are, however, major differences among G20 countries.  Some are attempting to introduce new austerity programs, while others, the United States included, want to add more stimulus despite monumental government debt levels.  We’ll see whether common ground can be found.

The U.S. stock market remains somewhat oversold and in need of a rally.  If new buying power does not soon materialize, however, prices might retest the double bottom around 1040 on the S&P 500 as early as the coming week.  A bounce off that level might be enough to produce more confident buying.  A break below 1040 would likely magnify the level of fear and could initiate a much larger round of selling.

The next week or two could go a long way toward determining the market’s direction for the summer.


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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Double Dip Potential Increases

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Economists and investment strategists have been nearly unanimous in their belief that the current economic recovery is fated to last at least several more quarters.  It is accepted wisdom that economic expansions last longer than the immediately preceding contractions.  Double dips, or one recession quickly following another, are extremely rare.  While that may yet be the prevailing outcome in the current instance, there is an increasingly amount of data calling the continuation of the recovery into question.

In “The Short View” in today’s Financial Times, James Mackintosh raised the red flag regarding a possible double dip recession.  He pointed out that the Economic Cycle Research Institute’s (ECRI) weekly indicator, designed to forecast economic growth, has been plunging since the beginning of May.  Last week’s level of minus 3.5% has successfully forecast a recession seven of the ten times it has occurred over the past 42 years.  One of the three misses, in 2002, was followed by zero growth, but not a technical recession.

A few hours ago ECRI announced that its reading for the week of June 11 declined again to minus 5.7%.  While the index is clearly headed in a negative direction, ECRI Managing Director Lakshman Achuthan indicated that: “…its downturn has not been sustained enough to signal an imminent recession.”

Despite still strong corporate earnings growth, a number of very significant areas of our economy are demonstrating persistent weakness.  Housing and unemployment woes are longstanding and barely improving.  We have warned about excessive debt levels for both consumers and governments for more than a decade.  Those excesses continue to grow.  Adding to fears of sovereign defaults in parts of the world is the well-publicized potential inability of many of our 50 states to balance their budgets, even with the inflow of huge amounts of federal stimulus money.  Such stimulus will be politically much more difficult to find in the months ahead.  Financial problems of our states and other municipalities are likely to become a major story over the next year.

Over the past two months consumers have retreated from their free-spending ways.  Banks are continuing their restrictive lending standards, and bank credit statistics are extremely weak.  As layoff numbers remain high, it is logical that consumers will retrench and rebuild their personal balance sheets.  That paradox of thrift may be wise for the consumer, but could prove destructive for the broader economy.  Compounding that deleveraging tendency with a contraction of money supply in many parts of the world increases the potential for a double dip.

Despite a $1 trillion rescue pledge for weak Southern European nations, great fears remain that some of the suspect governments will still default on their debts.  Banks around the world hold that debt in their portfolios.  Fear of such default is making European banks suspicious of lending to one another.

Hope abounds that China and other emerging nations will stay robust and become the engines that continue to fuel the world recovery.  The fact that emerging nations have never before been able to carry that responsibility when first world economies have been weak should make us at least skeptical of their leadership potential.  Add to that the recent cautionary comments by Chinese regulators about the growing risks from that country’s credit excesses and the skepticism intensifies.

There is no perfect correlation between economic growth and stock market performance.  Current expectations, however, are very high that the economy will remain strong and lead to enduring growth in corporate earnings.  Any disappointment in those expectations would likely lead to a significant retreat in stock prices.


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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Dollar Advance Stalls

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The value of the U.S. dollar significantly influences economic prospects in this country and in many other nations around the world.  A stronger U.S. dollar makes the products of countries with weaker currencies cheaper to U.S. consumers.  Conversely, a weaker U.S. dollar makes our products more affordable to consumers in other nations.  U.S. exporters love the weaker dollar, which magnifies profits earned overseas.  A weaker dollar has a deleterious effect, however, on U.S. consumers who face higher prices on imports.  In general a weaker dollar exacerbates inflation.

The graph below illustrates the value of the U.S. dollar compared with a basket of the world’s major currencies since 1983.  The graph is one of hundreds produced daily for a very reasonable subscription price on DecisionPoint.com, a wonderfully rich site for a great variety of economic and securities market data.

Graph

From its peak in 1985, the U.S dollar plummeted in value over the next three years.  The dollar then traded in a range from about 80 to just over 100 until the turn of the century.  It jumped by about 20% from Y2K to early 2002 as stock prices around the world fell precipitously.

Then began more than a 40% loss of value from early 2002 to early 2008, interrupted by only one decent 15% rally in 2005.  As the dollar reached the low 70s in 2008, expectations were nearly unanimous that U.S. economic conditions were so weak that lower dollar values were almost inevitable.

Confounding the majority, dollar values today are more than 20% above 2008’s lows.  As typically happens, sentiment follows price.  Unlike the misplaced pessimism rampant when the dollar was at its lows, more than 90% of currency analysts today expect the dollar to continue higher despite its recent strong rally.  We share their confidence, but not in the short run.  Too many optimists make us suspicious that this leg of the dollar rally has probably run its course.  At extremes, optimism and pessimism are excellent contrary indicators.  While we believe the prospects decent that we could eventually see another dollar rally of 10% or more, we think it likely that the dollar price will pull back for a few weeks to a few months to correct the past half year’s strong rally.

Long-term skeptics of the dollar’s prospects point to our country’s horrible and worsening debt condition.  While we share that long-term concern, we see some intermediate-term dollar advantage as described in PIMCO CEO Bill Gross’s analogy of the dollar as “the least dirty shirt” in a closet of soiled clothing.

Regardless of U.S. economic prospects, there is a demand for dollars to satisfy maturing world debts, a disproportionate number of which are denominated in dollars.  In a world still locked firmly in a deleveraging cycle, there will likely remain a significant demand for our currency for at least a few more years.

The consequences of dollar value changes are obvious for importers, exporters and people who move frequently between countries.  They are less obvious for those whose lives are mainly domestically oriented.  Dollar fluctuations will, however, affect all of us to one degree or another.  And an accurate anticipation of dollar direction will certainly give investors an advantage.

While there are a great many variables and very few one-to-one correlations, a strong dollar generally helps stock and bond prices.  A weak dollar, often accompanied by inflation, rewards owners of hard assets like gold, commodities or real estate more than owners of paper assets.

There are infrequent periods, of course, in which virtually all asset prices fall.  A deflationary debt collapse, for example, would damage the prices of all assets except the most creditworthy bonds.  While we are not forecasting that outcome, the world’s monumental debt overload brings its potential into play.  For that reason, we have warned repeatedly of the tremendous danger to stock and municipal and corporate bond investors should the various government-crafted rescue programs fail to maintain a high level of investor confidence.


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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