Monday, August 23, 2010

More on Barron's and David Rosenberg/Gold As an Alternate Reserve Currency/FED Policy As Causing a Slower than Expected Recovery


The preceding table is a test of the prediction currently being made by David Rosenberg in this week's Barron's as explained in Item # 1 below. I am using the closing prices on August 20, 2010. The selection of the five stocks was done randomly from a list of 10 names that took about thirty seconds to compile. Those 10 names were selected based on their size, finances, and the fact that their dividend yields currently exceed the yield on a 10 year treasury. The purpose of this test is to see whether my nitwit selection process of 5 stocks will outperform Rosenberg's investment in long term U.S. treasuries over five and ten years.


1. Randall Forsyth Champions David Rosenberg While Fellow Ghoul Alan Abelson Is On Vacation (does Alan actually do any work from which a vacation is necessary?): Alan Abelson is on vacation from writing a few words once a week in the "Up and Down Wall Street" column in Barrons, where he mostly channels the negativity of like minded ghouls. I did not realize that Forsyth was the author of this column until I finished reading it and saw a note that Abelson was on vacation. This week's column sounded like Alan, replete with favorable references to David Rosenberg. While continuing to tout Rosenberg as a modern day oracle, Barron's has apparently forgotten that it was Rosenberg who recommended that investors avoid stocks in the March 9, 2009 issue of Barrons and later told investors the S & P was going to fall to 475 (April 2009) Doom and gloom forever, but then it occurred to me that the S & P is not at 475 but near 1100.

Unlike Barron's, I am attempting to track all of Rosenberg's forecasts. Item # 1 Barrons's & David Rosenberg Forsyth obviously agrees with Rosenberg's recommendations to buy 10 year treasuries yielding 2.5% and to snap up the 30 year's "juicy" yield of 3.6%, and agrees wholeheartedly with the Rosenberg's contention that any talk of a bond bubble is just foolish babble by the uninformed. Rosenberg expects 1 to 2% deflation. The 30 year year would make sense if a 1 to 2% deflation scenario was a reasonable forecast for years to come with no threat to long bonds whatsoever from inflation.

To test this latest recommendation, I put together two model portfolios. In one, I followed the advice of Rosenberg and bought $50,000 in TLT, which attempts to replicate the performance of the long term U.S. treasuries. iShares Barclays 20+ Year Treasury Bond Fund (TLT): Overview - iShares

The second portfolio was sort of randomly selected by a paper toss. I wrote the symbols of 10 blue chip companies on pieces of paper, threw them into the air, and randomly picked five names. I also invested hypothetically $50,000 in this portfolio, more or less equally divided among those names.

I am going to compare the performance of the two portfolios at 1 year, five years and ten years intervals. It is impossible to know which portfolio will perform better today, or this week or over the course of 2010. I would not hazard a guess which one will outperform after just one year. I am confident that the stock portfolio will win trounce the TLT over a ten year period.

I am not going to reinvest the dividends in this test due to the difficulty of making those calculations. Instead, I will only add the totals to the total value of the shares at the end of each period.

Alternatively, I will also allow the Forsyth-Rosenberg combo to buy the 10 year treasury note, hold it until maturity, and then compare the 2.616% yield generated by that 10 year note to the stock portfolio's change in value plus dividends. There seems to be some emphasis by Forsyth in receiving one's principal back in 10 years. So, I will credit him now with $63,080 and that is the bogey the five stock portfolio has to beat at the end of ten years. I would emphasize that the five stocks selected have a current dividend yield greater than the 10 year treasury. So, even without any dividend raises at all over the next 10 years, I would receive more income from the stocks than from the 10 year treasury, assuming no dividend cuts. With the exception of GE, the other firms did not cut their dividends during the Near Depression period and continued to raise them. Any dividend raises, a reasonable assumption, will increase the current yield of the five stock portfolio over the 10 year bond. Thus, even without any price appreciation in the stock portfolio, I would be reasonable to forecast that the stocks will provide me with more yield than the bond.

The deflation predicted by Rosenberg is not exactly a common phenomenon in the U.S., as shown by this chart of yearly CPI going back to 1913: Consumer Price Index, 1913- | The Federal Reserve Bank of Minneapolis After the Great Depression and starting with 1941, there was deflation in the following years out of 70:

1949: -1.2
1955: -.4
2009: -.3

I thought that I would copy again some of the inflation numbers:

1966
32.4
2.9
1967
33.4
3.1
1968
34.8
4.2
1969
36.7
5.5
1970
38.8
5.7
1971
40.5
4.4
1972
41.8
3.2
1973
44.4
6.2
1974
49.3
11.0
1975
53.8
9.1
1976
56.9
5.8
1977
60.6
6.5
1978
65.2
7.6
1979
72.6
11.3
1980
82.4
13.5
1981
90.9
10.3
1982
96.5
6.2
1983
99.6
3.2
1984
103.9
4.3
1985
107.6
3.6
1986
109.6
1.9
1987
113.6
3.6
1988
118.3
4.1
1989
124.0
4.8
1990
130.7
5.4
1991
136.2
4.2
1992
140.3
3.0
1993
144.5
3.0
1994
148.2
2.6
1995
152.4
2.8
1996
156.9
2.9
1997
160.5
2.3
1998
163.0
1.6
1999
166.6
2.2
2000
172.2
3.4
2001
177.0
2.8
2002
179.9
1.6
2003
184.0
2.3
2004
188.9
2.7
2005
195.3
3.4
2006
201.6
3.2
2007
207.3
2.9
2008
215.2
3.8

The number in the right hand column is the annual rate of inflation. Looking at those numbers, it is hard to see the wisdom behind recommending thirty year treasury bonds yielding 3.6%, assuming the investor would like to have some kind of real rate of return.

Without a doubt, bonds are performing well and I am up about 9% in 2010 due in large part to my long corporate bond positions. And there is unquestionably a stampede into longer dated maturities since there is almost no yield at all now in shorter term securities. For the nimble trader, the long bonds may continue to work for several more months as the Fed maintains the federal funds rate near zero and continues its policy statement of keeping the rate at 0 to .25% for an extended period of time. When the worm turns, and it will with a vengeance, then one of the worst investments will be those long term bonds bought with 2.5% to 3.5% yield. (see discussion starting at page 9 at individual.troweprice.com Spring 10.pdf on how a rise in interest rates impact the value of existing bonds with treasuries the most sensitive to a rise)

2. Gold as the Alternate Reserve Currency to the U.S. Dollar: I have always thought of gold as the alternate reserve currency for the world. Gold- U.S. Treasury Note and Bond Prices-U.S. Dollar The U.S. dollar took that the mantle of the world's reserve currency from the British pound after WWII. U.S. dollar is still the world's most trusted currency - USATODAY.com

Gold will do well in periods where there is mounting concern about the value of the reserve currency. In this view, I would expect the US Dollar to be negatively correlated with gold. The negative correlation is not perfect. There will be days when both rise or fall in value. Over the weekend, I read a column in the WSJ that there is a negative correlation between the dollar and gold of -.45, using month end data going back to 1973. A perfect negative correlation would be -1, and a -45 is a strong negative correlation.

3. Greta Morgenson's Column: Ms. Morgenson is one of the few financial writers who have focused on the severe costs of the Federal Reserve's Jihad against savers and other responsible Americans. In her weekend column in the NYT, she references an estimate that the Fed's zero interest rate policy is costing savers about 350 billion a year. I believe the number is much higher than that estimate referenced by Greta which apparently includes only yields on debt issued by the U.S., the GSEs (Fannie and Freddie) and municipalities. While the savings yield has collapsed, the interest paid on credit cards has not fallen. This makes it harder for consumers to work their way out of debt by saving more. And, as I have pointed out, the primary beneficiaries of the Fed's Jihad are the Masters of Disaster who played the pivotal role in creating the financial meltdown. While that later point is a moral issue, and it is without question egregious, the economic policy issue is the deflationary impact of the Fed's policy, as it dampens spending by consumers and lengthens the period that it takes consumers to repair their balance sheets. In short, I would submit that the Fed policy is actually aggravating the potential for deflation and causing the slower than expected recovery.

The Fed policy does allow the Federal government to borrow even more money at abnormally low rates which may be another reason for keeping the federal funds rate near zero for an extended period. It does help to facilitate the U.S. continuing along a path of gross fiscal irresponsibility.

No comments:

Post a Comment