Based upon recent market action, I thought I should provide some more perspective on what is happening today. Today the market looks to be re-testing the 7500 level on the Dow which was reached in November. While we could go lower, I do believe that we're likely in a broad trading range between 7500-9500 for at least the next year.
Economic concerns are overwhelming the headlines, and today's signing of the "stimulus" bill, which is comprised of 65% government spending, and 35% tax "rebates" (extremely short term) also concerns the markets, as the U.S. current account deficit is now massive. The concern with our deficit is reaching a tipping point, since we have tremendous future obligations in the form of government pension funds, Medicare, and Social Security benefits. When the deficit is 4% of GDP, it is "ok", but we have now exceeded that number. I recently read a 2002 speech by Ben Bernanke in which he discussed how to fight deflation; he is now running this exact playbook to re-flate our economy. This will eventually mean a devaluation of our currency and/or higher inflation. Did you know that the dollar's value has been devalued by over 90% since the U.S. went off the gold standard? We've seen this movie, and we've been living this movie for some time. Scary as this sounds, it is instructive to think about, and then make conclusions as to what types of assets can compete effectively with inflation, which we had contained for some time. Let's take a look:
Short term Treasury securities paying .48% per year. No.
Cash under your mattress paying nothing. No.
Money market funds paying .4% per year. No. The safest assets short term are the riskiest asset long term, because their value will be eroded by inflation or devaluation.
High quality companies that pay 4-6% dividends, that are currently valued pessimistically. Yes. Long term growth plus dividend yield beats inflation long term, especially at these prices.
Treasury Inflation Protection Securities. Yes. These bonds re-set annually to account for inflation, thus maintaining purchasing power.
Commodity-related companies. Yes. Commodities are priced in dollars; if the dollar goes down, commodity prices rise, earnings rise.
Gold and gold miners. Yes. The oldest hedge on a falling dollar and inflation. I may be early, but would rather be early than late.
You will likely see some changes in your portfolio mix to account for the changing environment. Still, in looking at your accounts, you own strong companies with strong products and services, and many of these companies are quite defensive in nature. Most accounts contain huge doses of high quality health care companies, oil drilling, food, tobacco, alcohol, consumer products/staples. ACC Clients have the comfort that the companies invested in have a bright future, despite the short-term swing in prices.
One of the Warren Buffett maxims I try to adhere to is: own quality companies where we can sleep at night even if the stock exchange was closed for 5 years. Companies with solid balance sheets and big dividend payments look attractive, since there are many solid companies with dividends of 4-6% right now, which exceeds the yields on Treasury securities by a lot (granted not as "safe" as a Treasury, but still extremely attractive). With all the "flight to quality", many investors have flocked to money market and Treasury securities; this trade will eventually reverse as equity yields compete with bond yields. Select municipal bonds also offer good relative values at this time, especially relative to Treasury securities on a price and yield basis.
I know you have placed your trust in me, and I will continue to do the best job possible in this environment. Please give me a call or email if you'd like to discuss this.
Thursday, March 12, 2009
Tuesday, February 17, 2009
Still a Tale of Two Markets
Still “A Tale of Two Markets”
The market remains in a trading range between 7500-9000, albeit with less of the daily volatility we experienced in Fall 2008. Equity valuations appear much more enticing, with opportunities to purchase high quality equities with low P/E’s, high cash flow, and dividends between 4-6% (or 4-6% better than short-term Treasury securities), and we would argue strongly in favor of solid, dividend-paying companies at this time. The current environment has been deflationary, and the Federal Reserve is pulling out the stops to prevent deflation, because inflation is always preferable to deflation. The really difficult aspect of this is to stay “in the game”, and to realize that the long term prospects for Equities at these prices and valuations are very attractive. The short term looks deflationary, and the mid-term looks like we will eventually end up fighting strong inflationary head-winds once the effects of our massive money printing press takes hold. Therefore, you will begin to see some new defensive hedges in the portfolios as we attempt to be prepared for future market developments. Likely candidates are: commodity-related stocks, gold, gold miners, high grade corporate bonds, and inflation protection securities.
Market Climate
As of last week (Jan 13 ‘09), the Market Climate in stocks was characterized by favorable valuations but with deterioration to unfavorable market action recently. However, we do view stocks as relatively undervalued, but we have to be aware of the historical tendency for markets to overshoot on the downside in difficult conditions. As investors we need train ourselves to welcome market weakness because it allows us to establish greater investment exposure at a point where stocks might be priced to deliver higher long-term returns.
There is a possibility that the new Obama administration will address some of these issues fairly quickly – particularly in regard to immediate capital infusions to major money center banks. In that event, a recovery of more than a few percent in stock prices would put us in a position to moderately participate in market fluctuations. If we get the Dow Jones back down toward the 8000 level or below, we will likely begin taking on more market exposure on the basis of valuation, as we did in October and November. As always, we'll respond to market conditions as they evolve. Our tone regarding the stock market has taken a quick turn toward a defensive posture, but that quick turn reflects what we've observed in various measures of credit distress and market internals. This is why we generally avoid forecasts. We move as the evidence moves.
Finding Support
We have been in a full-fledged banking crisis, which will not be over until current international stabilization moves are completed. We have been witness to “panic selling”, hedge fund de-leveraging, and indiscriminate selling of every asset class. This is not the time to sell—it’s too late for that. The stock market has been bouncing around, appearing to find support between 7500-9000 on the Dow. This is the time to discriminately buy franchise businesses with strong balance sheets, strong dividends, and strong products at discounts to their intrinsic values. We believe that our stock holdings will retain their long-term value, and that the reasonable investment posture is to hold our diversified stock and bond positions. The stock market will likely remain erratic, it may trend further down before finally stabilizing, but we remain alert and know there will be, and are, good opportunities for the long term investor.
Looking Around the Corner
In December the stock market did something notable-- it rallied on extremely bad news. Retail figures were reported, they were horrible, and the stock market rallied. Then on Friday of the same week, the unemployment numbers came out, the worst in 35 years, and the market rallied 250 points. This is important, because it certainly looked like the market was "peeking around the corner" and trying to anticipate the state of the economy in late 2009. We expect the market to re-test the November lows of 7500 on the Dow during the first half of 2009, and would advise dollar-cost averaging into this market.
Perspective is Important
For the last 3 months, the stock market has varied between being priced for Depression (value stocks) and a deep Recession (growth stocks). A little perspective is in order here. Just as the peak of the 1999/2000 tech bubble looked like it was "different this time" in an optimistic sense, this trough of 2008 looked like it was "different this time" in a pessimistic sense. The only thing we can point to is that in both instances, the extreme view over time is not likely to be warranted; in other words, when the markets price assets for the extreme case, that is your point of exit or entry to either maximize your selling prices or minimize your buying prices. The truth is that a "normal" market is somewhere between the extremes.
Reasons for Optimism
The usual phrase that is used when we are near a top or bottom in the market is “this time is different”. Frequently this phrase is invoked as a reason to buy more at a top, or to sell out at the bottom. Both are wrong. Mark Twain had it right when he famously said “history doesn’t repeat itself, but it rhymes”. The message here is that we will get through this. We’ve been through worse, with higher unemployment, higher interest rates, and more misery. Just in recent history, recall that in October of 1987 the market dropped over 20% in one day, with no bottom in sight, leaving the S&P 500 Index at 224.84. This year, on October 1, the S&P 500 Index was as 1161.06, up 416% since the 1987 crash. This is a stunning advance through a whole series of crises: the savings and loan crisis, the Gulf War, the collapse of Long Term Capital Management, the Russian default, the dot-com bubble’s burst, the attacks of 9/11/01, and a brutal 2002 Bear Market. And now we have seen the Panic of 2008. The market appears to be bottoming somewhere around 7500-9000 on the Dow, and the market has rallied recently on highly negative news. Having said this, the recent market action has been a kick in the gut. We are down 40% from the highs of 2007, and the average Bear Market is down 42% from its peak. History may not repeat itself, but it rhymes.
When Will It Turn Around?
We are in a recession, and together with the Rescue Package needing to take hold, the real estate market needs to show some improvement. It is estimated that about 10 million homeowners are living in homes with no equity. The market needs the banking and real estate sectors to stabilize before we can make any real progress. The housing issue is complicated, and needs some new thinking.
Suppose that the borrower would be able to make regular payments on a principal amount of $100,000, and would even be willing to pledge $100,000 in future home price appreciation to the bank in order to make the bank whole. In that case, the present value of the loan need not be massively written off, since a stream of future payments can be allocated many different ways in order to preserve its present value. If the payment schedule of individual homeowners could be restructured, or even better, if some of the losses already taken on these mortgages could be, in effect, “passed along” to distressed homeowners in the form of principal reductions, the rate of foreclosure as well as all of the “add on” effects to the economy could be substantially reduced.
The problem is that there is no mechanism to make this happen in the private lending markets. So many of these mortgages have been securitized by cutting them into a million pieces that it is impossible to restructure the loans without consent of all of those security holders. What is needed is coordination from government. One possibility would be to encourage changes in foreclosure law at the state level, allowing judges in foreclosure proceedings the ability to reduce principal for homeowners in return for a property appreciation right (a claim on future appreciation of the home) to the lender. The other would be something along the lines of the original “troubled asset” plan of the TARP – but in this case, rather than purchasing mortgage securities in expectation of helping bank balance sheets (which is impossible unless the Treasury overpays), the objective would be to collect all of the pieces of various pools of securitized mortgages at a steep discount (say, through “all or none” auctions), and then actually have the government “pass along” those discounts in the form of mortgage principal reductions to the homeowners underlying those securities.
However the intervention occurs, it is clear that government coordination is needed here, in order to reduce the foreclosure rate and the associated economic spillover on consumption, credit markets, employment and other areas. Unfortunately, the fresh deterioration in market action and credit default spreads suggests that the need for intervention is becoming urgent.
Gold and Gold Miners
The funny yellow metal “might” be giving us an opportunity, and we've recently seen this opportunity discussed in Barron’s, Stansberry Research, and by select hedge funds. By tracking the actual price of Gold (we can use iShare symbol GLD) with the Gold Miners Index (GDX), there appears to be an enormous disconnect here. Gold at $750/oz is still quite profitable for the Gold Miners, whose average cost of producing an ounce of gold is around $380/oz. Even if gold prices were to fall in half from here, gold stocks would be fairly valued. The ratio of Gold to Gold Miners index is low. Current deflationary pressures are also keeping gold down, which could hold true during a recession, but lookout for inflation in the next 12-18 months during an economic recovery. The stock market often recovers before a recession has officially ended. And with all of the market uncertainty, questions about the massive debts the U.S. is creating, as well as all that money we are printing, gold and other precious metals could be an interesting insurance policy, particularly if the U.S. ends up de-valuing its way out of this current market weakness, or if inflation runs wild. A devaluation of the U.S.$ by definition means an increase in the price of gold, oil, and other commodities, since all of the above are priced in U.S. $. Whether it is currency devaluation or inflation, or both, all outcomes lead to gold.
Bonds, Yield Curves
Gold, Money Market, and Treasury securities were the assets of choice in the Fall of 2008. Treasury securities have rallied since the Panic began, but now these asset flows are beginning to reverse, which is pushing prices on Treasuries down, and yields up. The bottom line is that the Fed has lowered rates to between 0- 0.25% and Treasury securities do not pay relative to other securities. As credit conditions have continued to thaw out, spreads on High Grade Corporate Bonds have been 6% better than Treasuries, spreads on High Yield Corporate Bonds (aka “junk”) have been 17-20% higher than Treasuries, and some high quality franchise stocks are yielding 5-6%. Should inflation rear its ugly head, or should other countries find Treasuries less than appealing, a sell-off in Treasuries could ensue. The implied returns of a 30 year Treasury Bond is ridiculously low, while the implied returns for the stock market at this time look much more attractive with a long term perspective. CA Municipal bonds have been volatile in price, but have stabilized significantly in recent weeks. With yields in the 5.1% range, double-tax-free CA Municipal looks extremely attractive. While CA Muni funds were down substantially in October, long term these securities receive 90% of their returns in the form of payments. Over rolling 10 year periods of time, there has only been one instance in 40 years when Municipal issues did not return 100% of principal; the normal default rate for Municipal issues in the 1991 recession was an extremely low .1%. The recent 5.1% yield on CA Municipals is a 10.2% Tax Equivalent Yield if you factor in the highest Federal bracket and CA state taxes. California is currently in the midst of its own crisis, though General Obligation bonds are backed by the state’s ability to raise taxes—which we anticipate will occur.
The trick going forward with bonds that are sensitive to interest rate changes will be to avoid any major steepening on the yield curve. In an inflationary environment (which we are not in right now, because of the deflationary forces of a recession) the yield curve could steepen on the long end of the curve, as well as steepen on the shorter end of the curve.
TIPS (Treasury Inflation Protection Securities)
The way to think about the relationship between TIPS yields and straight Treasury yields is that the nominal yield on a security is equal to the “real” yield plus expected inflation. At present, we have extraordinarily depressed nominal yields, but relatively high real yields, which means that the inflation rate implied in TIPS is extraordinarily low. Indeed, in order for TIPS to achieve the same total return as straight Treasuries over the next decade, we would need to observe a slight but sustained deflation over that period.
It does not appear that we are near the point where there is any real risk of inflation, and we may very well observe negative near-term inflation rates (which is why it is important to be careful with TIPS that trade at a substantial premium to par, since the apparently high “real” yields on near-term TIPS can be eroded by deflation). TIPS can't mature at less than par, but if there is a deflation, the accrued inflation adjustment on these securities can be whittled down. Suffice it to say that we are holding TIPS not because we anticipate a near-term resurgence of inflation, but because the real, inflation-adjusted yields available over the next decade are quite high on a historical basis, and will adequately provide for the maintenance and growth of purchasing power over time, regardless of the near-term course of consumer prices.
Retirement and the Required Minimum Distribution
When people retire, they have different philosophies on enjoying their retirements, leaving assets to children, leaving assets to charitable organizations, or taking the attitude that “you can’t take it with you”. Generally speaking, a withdrawal rate of between 4-6% is advisable on the corpus of your assets in order to create an annual income that is achievable over a long period of time within the context of your asset allocation. Over 20-30 years, a 4% withdrawal rate on your assets, using the correct allocation, should create a virtual perpetual annuity (i.e. at the end of 20-30 years your asset values would approximately equal the beginning value). This is achieved because the average annual return your portfolio would be “aiming for” would either match or exceed your withdrawal rate over time during retirement. As the withdrawal rate is raised to 5%, 6%, etc., the probability of your returns beating the withdrawal rate falls. This does not mean, however, that your retirement plan is flawed or will fail; it just means that your withdrawal rate would be eating into the corpus of the assets.
Due to the recent market panic and subsequent decline in asset values across the board, I have been busy meeting with recent retirees, or soon-to-be-retirees, in addressing the above consequences of withdrawal rates within the context of a proper asset allocation. So far, so good. If you would like to go over this same exercise, please give me a call and we can sit down and do so.
Thank you for your continued business and amazing referrals in this difficult period
I know this has been a very unsettling experience for all of us as investors. Please know that I am here to answer your questions, to go over your retirement plans, and to provide a sense of perspective in this market. It is a long term game that just got longer. There are incredible equity valuations now, and though risks remain, patience will be rewarded.
A.Charles Cattano
ACC INVESTMENT MANAGEMENT, INC.
1325 Howard Avenue PMB #433
Burlingame, CA 94010
ccattano@accimi.net
650-344-1600 (w)
415-215-0743 (c)
The market remains in a trading range between 7500-9000, albeit with less of the daily volatility we experienced in Fall 2008. Equity valuations appear much more enticing, with opportunities to purchase high quality equities with low P/E’s, high cash flow, and dividends between 4-6% (or 4-6% better than short-term Treasury securities), and we would argue strongly in favor of solid, dividend-paying companies at this time. The current environment has been deflationary, and the Federal Reserve is pulling out the stops to prevent deflation, because inflation is always preferable to deflation. The really difficult aspect of this is to stay “in the game”, and to realize that the long term prospects for Equities at these prices and valuations are very attractive. The short term looks deflationary, and the mid-term looks like we will eventually end up fighting strong inflationary head-winds once the effects of our massive money printing press takes hold. Therefore, you will begin to see some new defensive hedges in the portfolios as we attempt to be prepared for future market developments. Likely candidates are: commodity-related stocks, gold, gold miners, high grade corporate bonds, and inflation protection securities.
Market Climate
As of last week (Jan 13 ‘09), the Market Climate in stocks was characterized by favorable valuations but with deterioration to unfavorable market action recently. However, we do view stocks as relatively undervalued, but we have to be aware of the historical tendency for markets to overshoot on the downside in difficult conditions. As investors we need train ourselves to welcome market weakness because it allows us to establish greater investment exposure at a point where stocks might be priced to deliver higher long-term returns.
There is a possibility that the new Obama administration will address some of these issues fairly quickly – particularly in regard to immediate capital infusions to major money center banks. In that event, a recovery of more than a few percent in stock prices would put us in a position to moderately participate in market fluctuations. If we get the Dow Jones back down toward the 8000 level or below, we will likely begin taking on more market exposure on the basis of valuation, as we did in October and November. As always, we'll respond to market conditions as they evolve. Our tone regarding the stock market has taken a quick turn toward a defensive posture, but that quick turn reflects what we've observed in various measures of credit distress and market internals. This is why we generally avoid forecasts. We move as the evidence moves.
Finding Support
We have been in a full-fledged banking crisis, which will not be over until current international stabilization moves are completed. We have been witness to “panic selling”, hedge fund de-leveraging, and indiscriminate selling of every asset class. This is not the time to sell—it’s too late for that. The stock market has been bouncing around, appearing to find support between 7500-9000 on the Dow. This is the time to discriminately buy franchise businesses with strong balance sheets, strong dividends, and strong products at discounts to their intrinsic values. We believe that our stock holdings will retain their long-term value, and that the reasonable investment posture is to hold our diversified stock and bond positions. The stock market will likely remain erratic, it may trend further down before finally stabilizing, but we remain alert and know there will be, and are, good opportunities for the long term investor.
Looking Around the Corner
In December the stock market did something notable-- it rallied on extremely bad news. Retail figures were reported, they were horrible, and the stock market rallied. Then on Friday of the same week, the unemployment numbers came out, the worst in 35 years, and the market rallied 250 points. This is important, because it certainly looked like the market was "peeking around the corner" and trying to anticipate the state of the economy in late 2009. We expect the market to re-test the November lows of 7500 on the Dow during the first half of 2009, and would advise dollar-cost averaging into this market.
Perspective is Important
For the last 3 months, the stock market has varied between being priced for Depression (value stocks) and a deep Recession (growth stocks). A little perspective is in order here. Just as the peak of the 1999/2000 tech bubble looked like it was "different this time" in an optimistic sense, this trough of 2008 looked like it was "different this time" in a pessimistic sense. The only thing we can point to is that in both instances, the extreme view over time is not likely to be warranted; in other words, when the markets price assets for the extreme case, that is your point of exit or entry to either maximize your selling prices or minimize your buying prices. The truth is that a "normal" market is somewhere between the extremes.
Reasons for Optimism
The usual phrase that is used when we are near a top or bottom in the market is “this time is different”. Frequently this phrase is invoked as a reason to buy more at a top, or to sell out at the bottom. Both are wrong. Mark Twain had it right when he famously said “history doesn’t repeat itself, but it rhymes”. The message here is that we will get through this. We’ve been through worse, with higher unemployment, higher interest rates, and more misery. Just in recent history, recall that in October of 1987 the market dropped over 20% in one day, with no bottom in sight, leaving the S&P 500 Index at 224.84. This year, on October 1, the S&P 500 Index was as 1161.06, up 416% since the 1987 crash. This is a stunning advance through a whole series of crises: the savings and loan crisis, the Gulf War, the collapse of Long Term Capital Management, the Russian default, the dot-com bubble’s burst, the attacks of 9/11/01, and a brutal 2002 Bear Market. And now we have seen the Panic of 2008. The market appears to be bottoming somewhere around 7500-9000 on the Dow, and the market has rallied recently on highly negative news. Having said this, the recent market action has been a kick in the gut. We are down 40% from the highs of 2007, and the average Bear Market is down 42% from its peak. History may not repeat itself, but it rhymes.
When Will It Turn Around?
We are in a recession, and together with the Rescue Package needing to take hold, the real estate market needs to show some improvement. It is estimated that about 10 million homeowners are living in homes with no equity. The market needs the banking and real estate sectors to stabilize before we can make any real progress. The housing issue is complicated, and needs some new thinking.
Suppose that the borrower would be able to make regular payments on a principal amount of $100,000, and would even be willing to pledge $100,000 in future home price appreciation to the bank in order to make the bank whole. In that case, the present value of the loan need not be massively written off, since a stream of future payments can be allocated many different ways in order to preserve its present value. If the payment schedule of individual homeowners could be restructured, or even better, if some of the losses already taken on these mortgages could be, in effect, “passed along” to distressed homeowners in the form of principal reductions, the rate of foreclosure as well as all of the “add on” effects to the economy could be substantially reduced.
The problem is that there is no mechanism to make this happen in the private lending markets. So many of these mortgages have been securitized by cutting them into a million pieces that it is impossible to restructure the loans without consent of all of those security holders. What is needed is coordination from government. One possibility would be to encourage changes in foreclosure law at the state level, allowing judges in foreclosure proceedings the ability to reduce principal for homeowners in return for a property appreciation right (a claim on future appreciation of the home) to the lender. The other would be something along the lines of the original “troubled asset” plan of the TARP – but in this case, rather than purchasing mortgage securities in expectation of helping bank balance sheets (which is impossible unless the Treasury overpays), the objective would be to collect all of the pieces of various pools of securitized mortgages at a steep discount (say, through “all or none” auctions), and then actually have the government “pass along” those discounts in the form of mortgage principal reductions to the homeowners underlying those securities.
However the intervention occurs, it is clear that government coordination is needed here, in order to reduce the foreclosure rate and the associated economic spillover on consumption, credit markets, employment and other areas. Unfortunately, the fresh deterioration in market action and credit default spreads suggests that the need for intervention is becoming urgent.
Gold and Gold Miners
The funny yellow metal “might” be giving us an opportunity, and we've recently seen this opportunity discussed in Barron’s, Stansberry Research, and by select hedge funds. By tracking the actual price of Gold (we can use iShare symbol GLD) with the Gold Miners Index (GDX), there appears to be an enormous disconnect here. Gold at $750/oz is still quite profitable for the Gold Miners, whose average cost of producing an ounce of gold is around $380/oz. Even if gold prices were to fall in half from here, gold stocks would be fairly valued. The ratio of Gold to Gold Miners index is low. Current deflationary pressures are also keeping gold down, which could hold true during a recession, but lookout for inflation in the next 12-18 months during an economic recovery. The stock market often recovers before a recession has officially ended. And with all of the market uncertainty, questions about the massive debts the U.S. is creating, as well as all that money we are printing, gold and other precious metals could be an interesting insurance policy, particularly if the U.S. ends up de-valuing its way out of this current market weakness, or if inflation runs wild. A devaluation of the U.S.$ by definition means an increase in the price of gold, oil, and other commodities, since all of the above are priced in U.S. $. Whether it is currency devaluation or inflation, or both, all outcomes lead to gold.
Bonds, Yield Curves
Gold, Money Market, and Treasury securities were the assets of choice in the Fall of 2008. Treasury securities have rallied since the Panic began, but now these asset flows are beginning to reverse, which is pushing prices on Treasuries down, and yields up. The bottom line is that the Fed has lowered rates to between 0- 0.25% and Treasury securities do not pay relative to other securities. As credit conditions have continued to thaw out, spreads on High Grade Corporate Bonds have been 6% better than Treasuries, spreads on High Yield Corporate Bonds (aka “junk”) have been 17-20% higher than Treasuries, and some high quality franchise stocks are yielding 5-6%. Should inflation rear its ugly head, or should other countries find Treasuries less than appealing, a sell-off in Treasuries could ensue. The implied returns of a 30 year Treasury Bond is ridiculously low, while the implied returns for the stock market at this time look much more attractive with a long term perspective. CA Municipal bonds have been volatile in price, but have stabilized significantly in recent weeks. With yields in the 5.1% range, double-tax-free CA Municipal looks extremely attractive. While CA Muni funds were down substantially in October, long term these securities receive 90% of their returns in the form of payments. Over rolling 10 year periods of time, there has only been one instance in 40 years when Municipal issues did not return 100% of principal; the normal default rate for Municipal issues in the 1991 recession was an extremely low .1%. The recent 5.1% yield on CA Municipals is a 10.2% Tax Equivalent Yield if you factor in the highest Federal bracket and CA state taxes. California is currently in the midst of its own crisis, though General Obligation bonds are backed by the state’s ability to raise taxes—which we anticipate will occur.
The trick going forward with bonds that are sensitive to interest rate changes will be to avoid any major steepening on the yield curve. In an inflationary environment (which we are not in right now, because of the deflationary forces of a recession) the yield curve could steepen on the long end of the curve, as well as steepen on the shorter end of the curve.
TIPS (Treasury Inflation Protection Securities)
The way to think about the relationship between TIPS yields and straight Treasury yields is that the nominal yield on a security is equal to the “real” yield plus expected inflation. At present, we have extraordinarily depressed nominal yields, but relatively high real yields, which means that the inflation rate implied in TIPS is extraordinarily low. Indeed, in order for TIPS to achieve the same total return as straight Treasuries over the next decade, we would need to observe a slight but sustained deflation over that period.
It does not appear that we are near the point where there is any real risk of inflation, and we may very well observe negative near-term inflation rates (which is why it is important to be careful with TIPS that trade at a substantial premium to par, since the apparently high “real” yields on near-term TIPS can be eroded by deflation). TIPS can't mature at less than par, but if there is a deflation, the accrued inflation adjustment on these securities can be whittled down. Suffice it to say that we are holding TIPS not because we anticipate a near-term resurgence of inflation, but because the real, inflation-adjusted yields available over the next decade are quite high on a historical basis, and will adequately provide for the maintenance and growth of purchasing power over time, regardless of the near-term course of consumer prices.
Retirement and the Required Minimum Distribution
When people retire, they have different philosophies on enjoying their retirements, leaving assets to children, leaving assets to charitable organizations, or taking the attitude that “you can’t take it with you”. Generally speaking, a withdrawal rate of between 4-6% is advisable on the corpus of your assets in order to create an annual income that is achievable over a long period of time within the context of your asset allocation. Over 20-30 years, a 4% withdrawal rate on your assets, using the correct allocation, should create a virtual perpetual annuity (i.e. at the end of 20-30 years your asset values would approximately equal the beginning value). This is achieved because the average annual return your portfolio would be “aiming for” would either match or exceed your withdrawal rate over time during retirement. As the withdrawal rate is raised to 5%, 6%, etc., the probability of your returns beating the withdrawal rate falls. This does not mean, however, that your retirement plan is flawed or will fail; it just means that your withdrawal rate would be eating into the corpus of the assets.
Due to the recent market panic and subsequent decline in asset values across the board, I have been busy meeting with recent retirees, or soon-to-be-retirees, in addressing the above consequences of withdrawal rates within the context of a proper asset allocation. So far, so good. If you would like to go over this same exercise, please give me a call and we can sit down and do so.
Thank you for your continued business and amazing referrals in this difficult period
I know this has been a very unsettling experience for all of us as investors. Please know that I am here to answer your questions, to go over your retirement plans, and to provide a sense of perspective in this market. It is a long term game that just got longer. There are incredible equity valuations now, and though risks remain, patience will be rewarded.
A.Charles Cattano
ACC INVESTMENT MANAGEMENT, INC.
1325 Howard Avenue PMB #433
Burlingame, CA 94010
ccattano@accimi.net
650-344-1600 (w)
415-215-0743 (c)
Tuesday, December 23, 2008
Merry Christmas
Two weeks ago the stock market did something notable-- it rallied on extremely bad news. Two Mondays ago the retail figures were reported, they were horrible, and the stock market rallied. Then on Friday of the same week, the unemployment numbers came out, the worst in 35 years, and the market rallied 250 points. This is important, because it certainly looked like the market was "peeking around the corner" and trying to anticipate the state of the economy in mid/late 2009.
For the last 3 months, the stock market has varied between being priced for Depression (value stocks) and a deep Recession (growth stocks). A little perspective is in order here. Just as the peak of the 1999/2000 tech bubble looked like it was "different this time" in an optimistic sense, this trough of 2008 looked like it was "different this time" in a pessimistic sense. The only thing we can point to is that in both instances, the extreme view over time is not likely to be warranted; in other words, when the markets price assets for the extreme case, that is your point of exit or entry to either maximize your selling prices or minimze your buying prices. The truth is that a "normal" market is somewhere between the extremes.
While it doesn't look like we're going to get a Santa Claus rally in the stock market, let us remember that the purpose of all of our getting is understanding. A year like 2008 makes us reflect on those things which are truly important-- our friends, our families, our children, our health. Merry Christmas.
For the last 3 months, the stock market has varied between being priced for Depression (value stocks) and a deep Recession (growth stocks). A little perspective is in order here. Just as the peak of the 1999/2000 tech bubble looked like it was "different this time" in an optimistic sense, this trough of 2008 looked like it was "different this time" in a pessimistic sense. The only thing we can point to is that in both instances, the extreme view over time is not likely to be warranted; in other words, when the markets price assets for the extreme case, that is your point of exit or entry to either maximize your selling prices or minimze your buying prices. The truth is that a "normal" market is somewhere between the extremes.
While it doesn't look like we're going to get a Santa Claus rally in the stock market, let us remember that the purpose of all of our getting is understanding. A year like 2008 makes us reflect on those things which are truly important-- our friends, our families, our children, our health. Merry Christmas.
Thursday, November 13, 2008
Break Out the Dramamine
Break out the Dramamine, because we're in a market see-saw. October absorbed the full force of the Panic of 2008. The Dow Jones Industrial Average over a 6 day period lost over 20% in market capitalization. However, having said that, the last week of October we experienced a powerful rally, taking the Dow Jones from 8175 to 9625 on Election Day (a 17% rally from the recent bottom). So as of October 31, 2008account valuations will look bad, but recall that just 3 weeks ago it was much worse in terms of market sentiment at the height of the Panic. Fortunately since that already infamous time, the credit "freeze" has thawed considerably, and it "appears" that the market has been creating a range of price support in the Dow 8200 range. This range could drift lower in the next few months (short term), and the market has a great deal of price support in the 7700 range, which we actually visited, albeit briefly, intra-day on October 10.
This will all eventually pass.
By focusing on the long term, and being patient, we will eventually get through this mess, and the markets will eventually recover. For most accounts, where appropriate, recently I raised some cash from assets that I estimate will take longer to recover than U.S.stocks. I will be focusing very selectively and patiently on making purchases in the low 8000 price level on the Dow, during times of pessimism, and raising cash in subsequent Bear market rallies. By doing this, I hope to bring some additive returns to your portfolios on the margins as we look forward over the next (at least) 2 quarters. The next 2 quarters of earnings will be bad, though the trick is realizing that the stock market will eventually look past the short term earnings announcements and begin to look for signs of recovery. This is what the stock market does; it acts as a time machine looking at the future. So eventually, when the gloom and doom looks pervasive, as it did just 3 weeks ago, something will improve.
-ACC
This will all eventually pass.
By focusing on the long term, and being patient, we will eventually get through this mess, and the markets will eventually recover. For most accounts, where appropriate, recently I raised some cash from assets that I estimate will take longer to recover than U.S.stocks. I will be focusing very selectively and patiently on making purchases in the low 8000 price level on the Dow, during times of pessimism, and raising cash in subsequent Bear market rallies. By doing this, I hope to bring some additive returns to your portfolios on the margins as we look forward over the next (at least) 2 quarters. The next 2 quarters of earnings will be bad, though the trick is realizing that the stock market will eventually look past the short term earnings announcements and begin to look for signs of recovery. This is what the stock market does; it acts as a time machine looking at the future. So eventually, when the gloom and doom looks pervasive, as it did just 3 weeks ago, something will improve.
-ACC
Volatility Reigns Supreme
We will get through this volatile market. Today the market had its biggest 1-day rally in 75 years. However, the markets have been in a free-fall over the last 4 weeks, with seemingly no end in sight. With all the fear and uncertainty, we have blood in the streets, and we are approaching the point of what Sir John Templeton would call “maximum pessimism”, which traditionally has been a good time to invest (even when we are not sure where the bottom is). Some high quality institutions are trading at less than the cash value on their books. We are all long term investors, even those investors who have just started, or are about to enter, retirement (since the average retirement lasts 20 years). On Friday markets were at a price level last seen in the 2002/2003 time frame. Since we have been in a very technically driven negative environment, in technical terms we have a lot of “price support” between Dow 7500-8500. This was hardly comforting on Friday, and despite today’s rally, we may touch these levels again as the market attempts to create a “bottom”, and we have all become even longer term investors due to this violent price volatility.
In looking through Client accounts, you own strong companies with strong products and services that were purchased attractively, and many of these companies are quite defensive in nature. Most accounts contain huge doses of high quality health care companies, oil drilling, food, tobacco, alcohol, consumer products/staples, since I typically try to diversify “away from” undue risks in trouble areas. Over the years I have been sometimes questioned for being too conservative in the choice of business enterprises in which to invest, though ACC Clients have at least the comfort that the companies invested in have a bright future, despite the short-term swing in prices. Despite this, the spillover effect from the financial companies is what we are currently swimming in. This weekend’s G7 meeting has resulted in a coordinated global effort to prevent large institutions from failing, and to inject capital directly into banks; this is very positive in the sense that it will help to prevent a situation of fewer and fewer counterparties to absorb “counterparty risk”.
One of the Warren Buffett maxims I try to adhere to is: own quality companies where we can sleep at night even if the stock exchange was closed for 5 years. Had I the foresight of hindsight (i.e. crystal ball), we would of course all be sitting in cash in the beginning of September and starting to buy in here with a 5 year outlook. I still continue to make slight changes in portfolios to take advantage of current prices where possible with a long term perspective, and with new cash am slowly building positions. Companies with solid balance sheets and big dividend payments look attractive, since there are many solid companies with dividends of 4-6% right now, which exceeds the yields on Treasury securities by a lot (granted not as “safe” as a Treasury, but still extremely attractive). With all the “flight to quality”, many investors have flocked to money market and Treasury securities; this trade will eventually reverse as equity yields compete with bond yields. Municipal bonds nationwide have had a tough September and October, but are good relative values at this time, especially relative to Treasury securities on a price and yield basis.
All investors, including myself, have been disappointed with the current economic and market situation, and please know that I am here piloting the ship through these troubled waters. I know you have placed your trust in me, and I will continue to do the best job possible in this environment.
-ACC
In looking through Client accounts, you own strong companies with strong products and services that were purchased attractively, and many of these companies are quite defensive in nature. Most accounts contain huge doses of high quality health care companies, oil drilling, food, tobacco, alcohol, consumer products/staples, since I typically try to diversify “away from” undue risks in trouble areas. Over the years I have been sometimes questioned for being too conservative in the choice of business enterprises in which to invest, though ACC Clients have at least the comfort that the companies invested in have a bright future, despite the short-term swing in prices. Despite this, the spillover effect from the financial companies is what we are currently swimming in. This weekend’s G7 meeting has resulted in a coordinated global effort to prevent large institutions from failing, and to inject capital directly into banks; this is very positive in the sense that it will help to prevent a situation of fewer and fewer counterparties to absorb “counterparty risk”.
One of the Warren Buffett maxims I try to adhere to is: own quality companies where we can sleep at night even if the stock exchange was closed for 5 years. Had I the foresight of hindsight (i.e. crystal ball), we would of course all be sitting in cash in the beginning of September and starting to buy in here with a 5 year outlook. I still continue to make slight changes in portfolios to take advantage of current prices where possible with a long term perspective, and with new cash am slowly building positions. Companies with solid balance sheets and big dividend payments look attractive, since there are many solid companies with dividends of 4-6% right now, which exceeds the yields on Treasury securities by a lot (granted not as “safe” as a Treasury, but still extremely attractive). With all the “flight to quality”, many investors have flocked to money market and Treasury securities; this trade will eventually reverse as equity yields compete with bond yields. Municipal bonds nationwide have had a tough September and October, but are good relative values at this time, especially relative to Treasury securities on a price and yield basis.
All investors, including myself, have been disappointed with the current economic and market situation, and please know that I am here piloting the ship through these troubled waters. I know you have placed your trust in me, and I will continue to do the best job possible in this environment.
-ACC
Tuesday, September 30, 2008
Congress To The Rescue
Oh great, we're all waiting for Congress to "save us" from ourselves in terms of a Bailout Package to deal with bad mortgage paper.
The history of where we are is long and undistinguished. It all started with Jimmy Carter's signing into law the Community Reinvestment Act of 1977, expanding the charter of Fannie Mae and Freddie Mac to increase home ownership. Bill Clinton also got into the act in 1995 and 1998, pushing for further home ownership, as well as the beginnings of the "sub-prime" segment of the market. George W. Bush called for further home ownership for lower income people in 2005. Along the way, efforts to put a lid on Fannie Mae and Freddie Mac were thwarted-- bills to address the oncoming threat posed to the system failed in Congress in 2003 and 2005.
With all of this, we now see the disastrous effects of relaxing the loan underwriting process, including "no doc" loans to people who were under-qualified to make a home purchase. Then we saw the rise of the "zero down payment interest only Adjustable Rate Mortgage", followed by the "negative amortization ARM". These work fine as long as home values are rising, and as long as interest rates do not rise; unfortunately the exact opposite occurred.
The United States is a country built upon credit, and periodically we undergo a financial crisis, a credit bubble, irrational exuberance or whatever other term we want to use. But the reality is that it is *not* irrational to borrow heavily when interest rates are so low; the Fed was basically begging people to borrow. In fact, on a 6% fixed rate mortgage, once you subtract the tax savings on the mortgage, and then subtract the inflation rate, the government is practically paying us to own a home. When home values go up, local tax revenues go up too; when people quit their jobs to flip houses, Federal tax receipts go up. Our long history of pushing the "dream" of home ownership has finally caught up with us, and the message is: there's no free lunch.
And as much as I am opposed to a bailout or rescue package, the alternatives look pretty grim. If the Paulson plan were implemented, Congress would basically take hold of $700 Billion of bad mortgage paper, create a market for it, buy credit-starved institutions some time and liquidity, and eventually (probably) sell the mortgage paper at a later date for a profit. The estimate is that the $700 Billion would buy about $2 Trillion in bad paper (i.e. 30 cents on the dollar). To a market guy like me, this looks like the "trade" of a lifetime, and one that could not only work, but put a huge positive number back into the Treasury at a later date. However, it has to work politically, with checks and balances (not a bad thing). But we're 34 days away from a Presidential election, and therein lies the rub.
The history of where we are is long and undistinguished. It all started with Jimmy Carter's signing into law the Community Reinvestment Act of 1977, expanding the charter of Fannie Mae and Freddie Mac to increase home ownership. Bill Clinton also got into the act in 1995 and 1998, pushing for further home ownership, as well as the beginnings of the "sub-prime" segment of the market. George W. Bush called for further home ownership for lower income people in 2005. Along the way, efforts to put a lid on Fannie Mae and Freddie Mac were thwarted-- bills to address the oncoming threat posed to the system failed in Congress in 2003 and 2005.
With all of this, we now see the disastrous effects of relaxing the loan underwriting process, including "no doc" loans to people who were under-qualified to make a home purchase. Then we saw the rise of the "zero down payment interest only Adjustable Rate Mortgage", followed by the "negative amortization ARM". These work fine as long as home values are rising, and as long as interest rates do not rise; unfortunately the exact opposite occurred.
The United States is a country built upon credit, and periodically we undergo a financial crisis, a credit bubble, irrational exuberance or whatever other term we want to use. But the reality is that it is *not* irrational to borrow heavily when interest rates are so low; the Fed was basically begging people to borrow. In fact, on a 6% fixed rate mortgage, once you subtract the tax savings on the mortgage, and then subtract the inflation rate, the government is practically paying us to own a home. When home values go up, local tax revenues go up too; when people quit their jobs to flip houses, Federal tax receipts go up. Our long history of pushing the "dream" of home ownership has finally caught up with us, and the message is: there's no free lunch.
And as much as I am opposed to a bailout or rescue package, the alternatives look pretty grim. If the Paulson plan were implemented, Congress would basically take hold of $700 Billion of bad mortgage paper, create a market for it, buy credit-starved institutions some time and liquidity, and eventually (probably) sell the mortgage paper at a later date for a profit. The estimate is that the $700 Billion would buy about $2 Trillion in bad paper (i.e. 30 cents on the dollar). To a market guy like me, this looks like the "trade" of a lifetime, and one that could not only work, but put a huge positive number back into the Treasury at a later date. However, it has to work politically, with checks and balances (not a bad thing). But we're 34 days away from a Presidential election, and therein lies the rub.
Thursday, September 11, 2008
Fannie and Freddie In Conservatorship. More Moral Hazard Ahead?
Since July 2007, the financial system has been an absolute mess. This of course has led to liquidity concerns among certain banks, and most recently to the virtual collapse of Fannie Mae and Freddie Mac. This is truly unprecedented. We now have two publicly traded companies (Fannie and Freddie) that were both "implicitly" backed by the U.S. Government, and due to the latest round of liquidity concerns and bad loans, the U.S. Government has made it an "explicitly" backed relationship.
While I decry bailouts and moral hazard, I honestly do not see any other options with this. And the lawyers actually made a smart move too, putting Fannie and Freddie into Conservatorship, rather than Receivership. Why is this important? Well, the distinction is that in receivership, a company continues operations until it completely winds down its commitments (i.e. this would have led to a run on the banks, institutions that trade mortgage backed products would have been destroyed, or in other words, the entire system would have frozen up). By putting these entities into Conservatorship, they continue operations with U.S. Government oversight, the Government backs the paper, liquidity continues, and the market for mortgage backed products continues, though sluggishly.
Famed investor Jim Rogers noted that "the U.S. has become more Communist than China". What he means is that we have virtually created a system where Risk has been Socialized for the benefit of wealthy people, and Rewards are still benefiting wealthy people. I absolutely agree with this assessment, and the risk premium is a big factor in investing. If investors and Wall Street types continue to have their risks socialized via de facto government bailouts, what's to stop them from taking even more undue risks in the future? This is just a reward for moral hazard in the system.
While I decry bailouts and moral hazard, I honestly do not see any other options with this. And the lawyers actually made a smart move too, putting Fannie and Freddie into Conservatorship, rather than Receivership. Why is this important? Well, the distinction is that in receivership, a company continues operations until it completely winds down its commitments (i.e. this would have led to a run on the banks, institutions that trade mortgage backed products would have been destroyed, or in other words, the entire system would have frozen up). By putting these entities into Conservatorship, they continue operations with U.S. Government oversight, the Government backs the paper, liquidity continues, and the market for mortgage backed products continues, though sluggishly.
Famed investor Jim Rogers noted that "the U.S. has become more Communist than China". What he means is that we have virtually created a system where Risk has been Socialized for the benefit of wealthy people, and Rewards are still benefiting wealthy people. I absolutely agree with this assessment, and the risk premium is a big factor in investing. If investors and Wall Street types continue to have their risks socialized via de facto government bailouts, what's to stop them from taking even more undue risks in the future? This is just a reward for moral hazard in the system.
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