Sunday, June 6, 2010

Underlying Cause of the Current Long Term Bear Market is Too Much Debt

Friday was a good test for measuring the volatility of my portfolio. I respect the power of the bear and view it as important to lose less than the market averages on down days and hopefully move up more on up days. The more appropriate measurement is the returns over cyclical bull and bear cycles. But those cycles are made up of days, so I start by looking at a day's performance. It is extremely important to avoid losses anywhere close to a year like 2008. Losing less is sometimes the best available option. Yes, this is easier said than done.

During a long term bear market, I would place an emphasis on how well the portfolio does during the down periods. Personally, when the current long term bear market comes to an end, which eventually will happen, I would view my management of the portfolio to be a success with anything over an annualized 5% return after inflation during that bear cycle which I start in 1997. To achieve that result, which I will do, it is important to participate in the frequently powerful up moves, which can be among the largest percentage moves over short periods of time in any market cycle, but I am always mindful of the defining characteristic of a long term bear market. It giveth those gains and then taketh them away. This happened fairly quickly for all of the market gains from 2003 to October 2007 in the period after Lehman's demise. This is a stock market version of this passage from JOB 1:21 (King James Version): "And said, Naked came I out of my mother's womb, and naked shall I return thither: the LORD gave, and the LORD hath taken away" Job 1:21 Ultimately, the buy and hold investor will end up going nowhere during these 15 or so year bear cycles and may end up worse off by investing at or close to the top of the range or panicking and selling at or near the lows. One thing is clear from history. The buy and hold approach, using the S & P 500 as a proxy, will end up losing around 1% per year after inflation with dividends reinvested over the duration of a long term secular bear market. (see data at The Roller Coaster Ride of the Long Term Secular Bear Market) This bear market will end up to be no different than the prior ones unless policy mistakes are made by governments to prolong it.

On Friday, the S & P 500 fell 3.15%. My retirement accounts were down less than 1%, and I am happy with that result. The taxable accounts fared less well, falling about 2%. I have been checking this data since late April on the major down days. This will cause me to make some shifts to lower risk and volatility based on how the portfolios due on down days. Recently, readers of this post would have noticed the purchase of several bond funds, which I really hate to do, Canadian ETFs that invest in Canadian government and corporate bonds, more individual bonds and preferred stocks, and a few dividend paying blue chips. Several securities viewed as having more risk, or paying negligible or no dividends, have been jettisoned. This included all of the mutual funds in the retirement accounts. I am disgusted with their overall performance in up and down markets anyway. The overall effect is to lessen volatility and to improve cash flow into the accounts. Those transactions are part of that ongoing process.

I did raise some cash on Friday and added a double short. SOLD: AMAT, ATVI, MRO, JPC, ZBPRA/Added Double Short as a Hedge My purchases over the remaining part of June will be extremely modest.

I may use the weakness in shares of certain exchange traded principal protected notes to add to my current positions. Also, assuming the dollar index continues its parabolic move and comes close to 90, I may start to slowly buy back shares in an international bond fund, having liquidated my positions in both WIP and BWX. The Dollar Index & Foreign Government Bond ETFs WIP & BWX I may just skip WIP and BWX, due to their low yields, and buy an international corporate bond ETF. The dollar index closed Friday at 88.26. DXY And, I am mindful that an opportunity exists to hedge my long term corporate bond portfolio with a a double short buy of TBT, which fell 5.35% in price last Friday to $38.73. I do not currently have a position but my last entry point was at $36.68 in December 2008: TBT

I hope to invest about $1000 in existing positions in the regional bank strategy. Several of the positions were pummeled on Friday. I also changed some positions in this basket to reinvestment of dividends from payment in cash.

Another possible add this month will be to increase by BMY stake from 50 shares to 100 shares, after seeing how the market reacts to the trial results, released over the weekend, for BMY's drug ipilimumab, used to treatment melanoma, as well as the use of Sprycel as a first line treatment for chronic myeloid leukemia in lieu of Gleevec, WSJ. The results look good to me but I will take my cue from how the market reacts. Science and medicine, while interesting to me, are topics where my knowledge is woefully lacking which is more than understatement. I mentioned in a post from last Thursday that the OG did not think the market was pricing positive results into the BMY share price: Bought 50 BMY at 22.95. The Old Geezer sort of understands valuation issues. (more on the trial results for ipilimumab: Reuters)

My only other purchase for the month of June may be JNJ. I almost purchased 100 shares near the close on Friday when JNJ fell to less than $58. I am targeting a possible 100 shares purchase. This will bring me up to 150 shares.

I view the best buys now to be large American multinationals with good balance sheets and stable businesses, selling at very low multiples and and near a 1 PEG. Item #3 Large Cap Valuation Strategy-A New Long Term Strategy The general idea is to try and use volatility to my advantage. When JNJ recovers to $65+, and eventually it will, I will sell the 50 shares bought at a higher price using FIFO accounting, and keep the lower price shares. This will require some patience. I will also change my dividend distribution option to reinvestment in additional shares once I exceed a 100 share position.

My main concern is what happens after the fiscal stimulus winds down in the U.S. Over 100,000 jobs have to be created per month just to handle new entrants into the work force. An increase in private sector employment of just 41,000 is just inconsistent with a self-sustaining economic recovery at this point in time. This has occurred after almost 1/2 of the 700 billion stimulus package has been spent (CNBC) and after a prolonged period of the federal funds rate being kept at zero. It has occurred after a large quantitative easing program implemented by the federal reserve, and numerous other programs to spur economic growth. And, when the nation is running budget deficits in the 1.3 to 1.5 trillion dollar range, the option of spending more money to jump start the economy is just not practical. So, with the fiscal bullets nearly spent, we are at a crossroad, either the private sector will start to pick up the slack soon or the likelihood of a another recession is likely. With another sickly jobs report next month, I would put the odds at 75% of a double dip recession starting within the next year.

Part of the problem is the incompetence of politicians. The nation is in need of massive infrastructure spending on bridges, roads, water and sewer plants, and other projects. Instead of spending most of the 700 billion in "stimulus" on these projects which would have long term benefits, and would provide jobs for years, the Democrats barely scratched the surface in funding these projects in their stimulus bill, and instead focused on temporary transfer payments to states and individuals. Maybe the states needed to downsize their workforce anyway. And, it would be helpful for many of those state employees falling victim to the budget ax to get out in the fresh air and receive a free tan, learn to use a shovel and to help build something.

The lesson to be learned from the past decade has not been learned at all in developed nations until recently and now only grudgingly by certain governments and only a portion of their population experiencing an awakening. For the most part, large segments of the population believe that they are entitled to all of their benefits even when the government has no money to pay them.

Even now, I suspect most Democrats are just paying lip service to the need for fiscal responsibility and belt tightening. Nothing was gained over the long term by the profligacy associated with spending an ever expanding amounts of borrowed money by governments and individuals. At most, the over leveraging process created an illusion of self-sustaining growth and has left a debt induced hangover of massive proportions.

The underlying problem causing the long term bear market which started around 1965 was inflation. The problem was allowed to fester and to grow, until finally the federal reserve quashed it in the late 1970s and early 1980s. Reagan received most of the credit for the Federal Reserve's work. Once inflation was tamed, then, and only then, could the market start a long term bull cycle.

The problem now is too much debt, almost entirely by self indulgent developed nations in Europe and the U.S. of course. The problem was obvious when the Asian contagion started in 1997, one of the reasons why I date the current long term secular bear market as starting then. Dating the Start of the Current Long Term Secular Bear Market The developed nations failed to learn anything from what happened in 1997 and again in 1998, perpetually willing to indulge their population by spending ever increasing sums of borrowed money. Instead, they accelerated their borrowing as did their citizens. In the U.S. millions bought homes that they could not afford and debt reached an almost unimaginable 130% of disposable income in late 2007, after being in a narrow range of around 60% between 1961 to 1985. (first Chart at www.invescoaim.com/pdf)

At least the problem is starting to be recognized in the Western Democracies, at least by the governments. It is interesting to watch the Greeks complain about any sacrifice by their bloated government workforce when their government was obviously broke. Eventually, sovereign and individuals exhaust their credit line. This has occurred in Greece and started to occur in the more vulnerable nations in southern Europe. None of the developed nations are immune from the problem of dealing with a population unwilling to make sacrifices and lenders unwilling to finance their generous benefits, with Hungary being just the latest example of a nation dealing with this conflict. NYT There are a few exceptions among western democracies, such as Canada, Germany, Australia and the Netherlands who have been far more sensible in spending borrowed funds than the other western nations and their citizens. Bill Gross has an excellent discussion of this growing problem in his February 2010 "Ring of Fire" newsletter.

I am actually not worried so much about Europe, where there is at least a recognition of the problems and some baby steps have already been taken to reign in out of control spending. The big problem is not Europe but the U.S. government and its citizens who have shown no voluntary restraint in spending. Sure, a large number of individuals who spent more than they earned, used their homes as ATMs, or bought a home beyond their means, or hit the maximum limits on their multiple credit cards, have had their spending restrained involuntarily, as in forced upon them by having the credit spigot turned off. But, it is hard to characterize the federal government, running over 1 trillion dollar budget deficits, as having learned anything -yet- from the past 30 years, starting with Reagan's presidency when fiscal discipline started to break down in a major way. What Will Produce Growth after the Age of Leverage? The end game of what started in 1980 has yet to be played. Taleb may be right in predicting that the mother of all Black Swans will be the day the U.S. tries to sell more debt and the auction fails. ITEM # 5 The U.S. budget deficit was 1.4 trillion for the fiscal year ending in September 2009 and is currently projected to top that horrendous number for the fiscal year ending in September 2010: Reuters (this site has a table of the historical numbers of the U.S. annual deficits as a percentage of GDP since 1900: US Federal Deficit As Percent Of GDP in United States 1900-2010)

When looked at objectively, the politicians of both tribes are irresponsible, though in somewhat different ways from time to time. Hopefully, before Taleb's fear is realized, worldwide growth will resume, spurred by the growing middle class in emerging countries and modest inflation will gradually erode the potential seriousness of excessive debt levels. Paying creditors back in debased currency is always an option for profligate spenders of borrowed money.

1 comment:

  1. Speaking of "learn[ing] to use a shovel and help[ing] build something," thousands of people could be put to work cleaning up that oil spill nightmare down in the Gulf states. It will take years. All the oil companies (but mostly BP) should pay for it out of their bloated coffers. I wish.

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