How a predefined strategy makes investing decisions easier for an investor.
I have a new article at MarketWatch.
The article looks at Annaly Capital Management (NLY), a common holding in our portfolios and how we manage to harvest its attractive 13%+ dividend and manage the risk.
I did an interview with Jay Cruz of healthylife.net. Jay does a financial advice show and our interview covered some general year end financial planning advice and a little bit of an outlook for 2012.
The interview will be broadcast between 10:30 – 11:00 am and 10:30 – 11:00 pm today!
I just wanted to pass along that I have been hired by The Wall Street Journal’s MarketWatch.com to write a weekly investment column for their website. Due to the success of our dividend investment strategy they have asked me to focus on dividend investing tips for their readers.
As we head into the holiday week I wanted to send out this quick note in an attempt to head off some post turkey indigestion.
All of our Seasonal Growth accounts, and 401(k)’s have been in cash, money markets, and/or bond funds for some time now. Today we are also selling our holdings in JNK and HYG. These are high yield bond index ETF’s that we hold to add dividends to our income portfolios. Simply put, credit spreads, the difference between interest rates for high quality and low quality bonds is widening. This shows that the bond market is much more worried about the economy than the stock market. But most times the stock market will follow these yield spread differences. In this case that would mean a lower stock market.
This means that even our conservative Dividend Value strategies have approximately 25% cash position. This is about as conservative as we get.
While no one should ever take broad based investment advice and assume it applies to their portfolio or strategy, it is my opinion that it is foolish to stay fully invested in the market. On Wednesday before Thanksgiving, the Debt Super Committee will announce how they will cut $41.5 trillion from government spending. There is no possible good outcome from this. Making the cuts means a drag on the near term economy. Not making the cuts means a drag on our future economy as we pay back the debt. Raising cash now, just gives us the opportunity to have one less thing to worry about when we should be enjoying the day with our families and loved ones.
Personally, I’m off to Annapolis MD for a weekend lacrosse tournament with my son, and then down to Kiawah Island SC where we will enjoy our Thanksgiving with my daughter. I’ll be back in the office on the 28th if you would like to call and discuss your investments.
The following piece came in my email this morning. I could have re-written it and put my name on it to sound really smart, but instead I will give credit where credit is due. This is from Steve Reitmeister Executive VP, Zacks Investment Research.
I really could not have described our investment policy at 401 Advisor, LLC any better than this. Added emphasis is mine.
Discretion is the Better Part of Valor
Italy’s senate approved a series of austerity measures on Friday. Investors were obviously pleased given that their 10 year bond rates continued to drop from a peak of 7.25% down to 6.45% in just two days. And this movement back from the brink = stocks up in Europe = stocks up in the US.
Unfortunately that is in the past. And it will not help us navigate the market this week. That is because for every problem solved, a new one emerges. Like…
• “Core” Euro nations are contemplating a breakup of the EU
• Slovenian bond rates cracked 7% intraday on Friday
• Spain’s GDP fell to 0%. Not good with 20%+ unemployment and staggering debt load
• French bond rates are steadily rising too
• Italian bond rates can ratchet back up as fast as they came down.
Given the whip-sawing action in Europe, I do not yet feel confident in moving away from my net neutral portfolio strategy. That’s because there are landmines on either side of the equation. Meaning if you step too bullish or too bearish you could be dead meat. This is a time when “Discretion is the better part of valor.”
For clarification at 401 Advisor, LLC our dividend portfolios are currently fully invested. However we are seeing some troubling movement in yield spreads between high and low credit bonds. This may cause us to go into a 25% cash position if the spread continues to widen. Newly acquired accounts, our Cyclical Growth and 401(k) accounts are either in cash or bond funds.
Originally posted on horsesmouth.com
As I have mentioned in prior posts, as have most writers commenting on the current state of the financial markets, Europe has been the 500 pound gorilla controlling weekly, if not daily market gyrations. With the announcement of a trillion or so Euro bailout, the markets were free to rally on a solid estimated domestic GDP growth rate of 2.5% for the third quarter. The unexpected part is the latter, despite what has been weak, (if not awful) economic data, GDP certainly indicates that we have sidestepped a double dip recession, as long as the European solution is in fact a solution, and not just a solid kick, kicking the can further down the road.
So let’s take a look at the charts and see where we are.
First a look at SPY shows that we have not only broken out of the trading range established in August, but have also broken through the very key 200 day simple moving average (SMA). With the year’s previous high just 6% away look for a new 2011 high in the very near future, if the market’s reaction to the Euro deal remains positive. Anew trading range between the current level and prior high around 136 would be a healthy pause leading to a Santa Claus rally to finish the year. At the same time keep an eye on the former resistance line around 123. Any drop below, would likely come from the Euro agreement falling apart.
Chart 1. Spy 2011 YTD
Source: www.freestockcharts.com
Next a quick look at JNK shows a similar pattern. A slight negative is that JNK actually turned negative on Friday the 28th, while SPY was able to follow through on through on Thursday’s news. This could have more to do with the drop in Treasuries as much to the positive GDP release then any lack of follow through to the Europe news. While a move to new highs for SPY would not be a surprise, JNK will likely be pressured by the potential for inflation/rising rates brought on by the bailout. JNK looks way over bought relative to its 30 SMA (Yellow Line) and a current yield of 8.55% (yahoo.com/finance as of Sept 30, 2011) seems fair to low depending on any further rise in Treasury rates.
Chart 2. JNK 2011 YTD
Source: www.freestockcharts.com
In Chart 3 you can see that the VIX also gapped down to coincide with Thursday’s big up day. While way down from its recent trading range, it is still at the top of the range established in the first half of the year when we saw a solidly rising market.
Chart 3. VIX 2011 YTD
Source: www.freestockcharts.com
Next a quick rundown of fundamentals. In Chart 4 you can see a history of the Kansas City Financial Stress Index (KSFSI) and the Chicago Fed National Activity Index (CFNAI). While both are in “bad” territory (Positive financial stress and negative activity index) they are not quite at the levels that have predated the last two recessions.
Chart 4 KSFSI,CFNAI and U.S. Recessions
Source: St. Louis Federal Reserve FRED
However, when we zoom in, in Chart 5 you can see that the two indicators are heading in different directions in terms of indicating an improving economy. While the Chicago Activity index rose over the last month, so did the financial stress index. The theory behind the two indexes is that economic activity will be pulled lower if financials stress continues to increase.
Chart 5 KSFSI and CFNAI January 1, 2011 – September 30 2011
Source: St. Louis Federal Reserve FRED
On this note, I have to throw in one slightly troubling chart. While earlier I noted that the absolute drop in JNK could be the result of rising level of interest rates. However, in Chart 6, we see that the bond market was not as enthralled with the Europe Solution as the stock market. The TED spread is the difference between the interest rates on interbank loans and on short-term U.S. government debt (“T-bills”). In Chart 7 you can see that the spread continued to rise through the market rally of the last week. The implication is that banks are even less reluctant to lend to each other now, then they were a week ago. This is not a good omen for future releases of the KSFSI.
Chart 6 TED Spread
Source: Bloomberg.com
But not to end on a sour note, I’ll finish with the prior graph of the CFNAI and KSFSI, but this time throwing in GDP in Chart 8. This is the source of my renewed optimism. GDP is at the highest level it has ever been.
Chart 7 CFNAI,KSFSI, and GDP
Source: St. Louis Federal Reserve FRED
And yet, as we see in the final Chart 9, SPY is still well below prior peaks in both 2000 and 2007. In fact we are at levels first seen in 1999.
Chart 8 SPY Monthly from 1996 to present
Source: www.freestockcharts.com
Putting it All Together
Not surprisingly the Europe Solution is being scrutinized and the analysis is not as positive as the initial reaction. There are certainly some big holes. Seriously, who is going to step forward and “voluntarily” accept a 50% haircut on Greek bonds? And while there is to be a trillion Euros available to recapitalize European banks, where exactly will it come from, and at what price? At this point the stock market is only a couple percent positive on the year and trading at a modest 13 times earnings. Not where you’d expect a “euphoric” market to be.
But what this appears to have accomplished is to buy significant time. Time for Europe to put its financial house in order. And as long as we can see some sort of begrudging movement, it leaves room for the U.S. to move up (or down) based on our own fundamentals
Investment Policy
With the important 200 SMA breached to the upside for SPY, our modified trading signal will have us wait a few days to see if it holds. If so I will move our ETF Growth Cycle Portfolio into higher beta ETF’s to take advantage of the seasonality cycle that favors the November to May period. Our dividend portfolios have been fully invested since around the time JNK crossed above its 30 day moving average. For new accounts in cash, I will be scouring our targeted dividend stocks for stocks that have not fully recovered from last quarter’s sell off. Even if ( and it is a big if), Europe is out of the way for now, a muddle through economy still looks probable. I like the idea of generating return through dividend yields.
I was interviewed for an article in this month’s issue of the Wall Street Journal’s SmartMoney Magazine. The article is titled,”The Big Delay in Your 401(k)” The article discusses how investors are discovering that their options for reacting to market swings are limited and goes on to discuss how to avoid feeling “trapped” by your 401(k) plan.
Article originally appeared on October 20th at www.HorsesMouth.com.
After a solid market rally, sentiment seems to have changed from financial Armageddon to Rally Time. But is the exuberance warranted or irrational?
Looking at Chart 1 below of SPY the SPDR’s S&P 500 ETF, shows reason for caution as we go forward. Even though the markets have regained positive territory on the year (10/14/2011), a look at SPY clearly shows that we are only at the top of the trading range that we entered in August. A peak that we have seen equaled twice before, only to be turned back on negative sentiment. So is this time different?
Chart 1 SPY April 13- October 14 2011
Source: freestockcharts.com
The one thing to consider as we hit resistance is that in each of the past instances the market has schizophrenically bounced back and forth between resistance and support based on the news from Europe. Last week was very quiet on that front, and news centered on the U. S., specifically earnings. So for a minute, let’s assume that the big Europe bailout comes through and all is good in the (financial) world once again. Is a rally through resistance warranted by U.S. fundamentals?
The most worrisome evidence to the contrary comes from the St. Louis and Chicago Federal Reserves. The KC Fed publishes a monthly Financial Stress Index and the Chicago Fed a National (business) Activity Index.
The two are shown in Chart 2 along with recent recessions in grey. The indices have longer track records and details can be found here: pdf download and pdf download.
To sum the Fed literature, the two indices when taken together have predicted the last 7 recessions. The indicator is when the KCFSI is positive (indicating above average financial stress) and when the CFNAI 3 month moving average is below -.7 we have had a recession. While the CFNAI is not quite there yet at -.43, what is troubling is that a positive KCFSI will drag the economy into a recession if it stays positive, as it did in the late 90’s and early 2000 before the CFNAI dropped to the -.7 level – at the start of the 2001 recession.
Chart 2 CFNAI 3 month Moving Average and the KCFSI
Source: St. Louis Federal Reserve FRED
Currently the KCFSI is heading into positive territory with a September reading of .44, up from .37 in August, as seen in Chart 3 below.
Chart 3 Kansas City Federal Reserve Financial Stress index
Source: Kansas City Federal Reserve
Simultaneously the Chicago Activity Index is in negative territory, showing a large slide from July over August as seen in Chart 4 below, from +.02 to -.43. However the 3 month moving average was virtually unchanged. The September data is due out October 29th.
Chart4 Chicago Federal Reserve Activity Index – 3 month moving Average
Clearly, the data from these two indices show that the U.S. economy is on the ropes, all by ourselves, without an implosion over sovereign debt in Europe. Unfortunately the Chicago data is about a month and a half old, and although the Kansas City data is fairly fresh let’s look at some more recent fundamental and technical data.
The first is the Economic Cycle Research Institute (ECRI), which has already announced that we are in fact in a recession. From the N Y Times, “Relying on a series of proprietary indexes, the institute…Over the last 15 years , has gotten all of its recession calls right, while issuing no false alarms.” In other words things are about to get worse, giving added gravity to the St. Louis Federal Reserve and the Chicago Federal Reserves’ Indexes.
Using the logic behind combining the two Fed indexes- that financial conditions govern economic activity, let’s look at some other financial indicators. Using JNK, the SPDRS Barkley’s High Yield Index ETF as a proxy for the spread between low and high rated corporate securities, clearly JNK has been in rally mode for the past week. However, unlike SPY, while it has re-entered its trading range, it has yet to push up to its resistance level.
Chart 5 JNK
Source: freestockcharts.com
Next, in Chart 6 is XLF, the SPDR Financial Sector ETF. Again, while it has regained its trading range, it has not followed the broader market up, to challenge its resistance level.
Chart 6 XLF
Source: freestockcharts.com
I’ll finish this series with VIX, the CBOE Volatility Index ETF. While it has –barely, broken through support, it is still well above its range from the beginning of the year through July. Volatility is not consistent with healthy markets.
Chart 7 VIX
Source; freestockcharts.com
Then there are a couple more fundamentals indicators to look at. First is the TED spread which shows the difference between the 10 year Treasury and the LIBOR rate. As the spread widens it shows that banks are charging a higher premium to lend to other banks. Clearly from Chart 9 below, banks faith in other banks credit worthiness is declining, not increasing. The TED spread is an indicator used in the KCFSI, so this does not bode well for the next release.
Chart 8 TED Spread
Source: http://www.bloomberg.com/quote/!TEDSP:IND
The next Chart shows the level of M2, which skyrocketed in July – August during what, so far, has been the peak in pessimism over the European sovereign debt crisis. While the climb has paused over the last month, the overall level has continued to climb higher. The common explanation is that money has fled Europe and has been deposited in “safer” U. S. banks.
Chart 9 M2 Money Supply
Source: Source: St. Louis Federal Reserve FRED
Putting it Together
My investment thesis has been that the U. S. market would live or die with Europe. If Europe can pull itself together and stave off a major crisis, the U S markets would rally based on solid corporate earnings and balance sheets. However, the data outlined above is painting a different picture. With Europe out of the picture for a week the markets did in fact rally – but so far, are still within their trading ranges. In fact key sectors, High Yield Bonds and Financials have yet to pressure their upside resistance levels. The VIX is slightly below support, but well above levels we saw in the first half of the year when the market did rally.
Fundamentals concur. The ECRI and the Federal Reserve generated KCFSI and CFNAI, all have accurately predicted recessions in the past. While the Fed indicators aren’t quite at recession levels yet, more current date like that from the ECRI and the TED Spread do not provide much room for optimism from future releases.
While any rally is welcomed, this is definitely one to be wary of. While I still expect a significant rally if we get good news from Europe. For it to last we need to see a market turnaround in many fundamental indicators.
I ran across a couple articles in the news this week and thought I’d pass them on. Then finish with a quick market outlook for this week.
In the, “I have some good news…and some bad news…” category, this is from Seeking Alpha,
Strategists See Biggest S&P 500 Gain Since ’98
Wall Street strategists say the Standard & Poor’s 500 Index, after falling within 1 percent of a bear market this week, will post the biggest fourth-quarter rally in 13 years even after they cut forecasts at a rate exceeded only during the credit crisis.
The benchmark index for U.S. stocks will climb 14 percent from yesterday to end 2011 at 1,300,according to the average estimate of 12 strategists surveyed by Bloomberg. The last time they were this bullish in October was 2008, when the group predicted a 27 percent gain and the index lost 18 percent.
So analysts just cut the crap out of projected third and fourth quarter earnings, but still predict a huge rally. Wow, and you wonder why people support the “Occupy Wall Street” rallies?
On a lighter note, there was this from MarketWatch: “Why Geezers Give the Best Investment Advice” In the article they site another article entitled “What is the Age of Reason?” that concludes that “…middle-aged people make fewer mistakes with finances than those that are younger or older. The research even pegged the optimal point in life for handling money-related decisions: 53…so the next time you talk with a financial advisor …instead of asking about investment performance, you might want to ask, ‘How old are you?’” Interesting to note that of the four authors, the oldest was forty.
Must say, although I’m a bit offended at the “geezers” reference I couldn’t agree more with the study’s findings. (note: I was born in 1957)
What to Expect from The Week Ahead
Looking at a chart of SPY (the S&P 500 Index ETF), there are three things to take note. First, the fairly horizontal yellow line is the 200 day moving average. Very simply we are still in a secular, or long term bear market until the market crosses back above this line. History shows that it is prudent to be careful while the market is trading under the 200SMA. The two horizontal lines show the trading range the market has been in since this spring. While SPY broke through the bottom line (support) for a day it did finish the week back within the trading range. However, the yellow arrow shows where the rally last failed to rise up to prior resistance (the upper line) and headed downward again. The last set of parallel lines slope downward and may indicate the start of a new downward movement.
Looking ahead for the week, what we don’t want to see is SPY dropping below the horizontal support line –around 112 for SPY or 1120 for the S&P 500. Breaking below 107 would be a likely confirmation of the new downtrend. Ideally we rally a little on the week and head back up to the 122.50 range, and at least confirm the trading range. Earnings season kicks off on Monday. The Kansas City Fed also releases its financial stress index for September, (more on that after the release).
Bottom line? Defense still rules, until the market rallies above the 1225 level on the S&P 500.
