This is the market’s “strong season.” Flush with cash from bonuses (some ill-gotten, some well-deserved), New Year raises (small for most of us in the real world, absurd for those who pump out the "news" on Wall Street) and new-found stock gains for the past 12 months, the market “should” do well in the rosy glow of all this for another month or two.
But. Even as a tree given artificial growth stimulants grows ever fuller, with new limbs, branches and pretty bright green leaves, if the roots and trunk havn’t had time to grow in circumference apace, it gets weaker. It still looks better than it did before all that artificial stimulus, but it is now more subject to the vagaries of wind, rain, lightning and infestation. You must strengthen the roots and trunk, or the tree may be prettier but it is also weaker and more susceptible to unexpected damage.
I think of the tree’s roots and trunk as the actual US economy, which I define as 200 million + adults each working to improve their lives by exchanging their labor and/or brain power for money from an employer or, if they are entrepreneurs, from their client base. As an example, our personal contribution to the economy is to exchange our experiences, research ability, and analysis for money clients pay us to do our best to increase their net worth in a conservative and intelligent manner.
That’s the roots and trunk of the tree; the real economy. Government can paste on some phony branches and leaves, as they do in election years, or they can take our money to pump a bunch of artificial stimulants that green up the tree but do nothing for the root system or the trunk. It can provide artificial stimulants like $8,000 for first-time home buyers, $6,500 for any home-buyer, $4,500 to stimulate car sales, and sundry social engineering like 30% credits for installing various energy-saving devices, but that is just something the government has taken from one set of citizens to sprinkle around the tree to benefit other citizens.
That doesn’t mean that one shouldn’t take advantage of these credits. If you happen to be buying any of these items right now, your timing is propitious, albeit through no planning or particular brilliance of your own. Besides, that $8000 pales next to the bought-and-paid-for votes to give $700 billion to Wall Street. (“We search for the guilty in order to find and punish the innocent…”)
I happen not to consider myself among the group “eligible” for any of this largesse. Of course, if I were a Wall Street type, I would have considered myself not only eligible but entitled. Since we are building a vacation home and need a car to leave there, I could have gamed the system and bought any old clunker so I could turn in “my” old car (owned a month or so) and gotten the $4,500. Or I could have made the vacation home our primary residence for a couple years and gotten the $6,500. (Our business is quite fungible and can be run from just about anywhere.) But both seemed a little too smarmy to me. If I can afford to build a vacation home, why take money from my fellow citizens to do so? Did anyone bother to tell the overpaid architects of these stimulus plans there was a recession outside The Beltway?
I don’t care who inside The Beltway says it’s all over now and things are just hunky-dory. It doesn't matter what you call it: if it looks like a duck and it waddles like a duck and it quacks like a duck, it’s a duck. Are we still in a recession? If you use the commonly accepted definition of two quarters of “negative growth” (an obtuse term economists use to avoid saying the words “a loss”) well, then, it appears we are out of the woods. Lots of pretty leaves fluttering in the breeze.
But if you are more concerned about the effects of a recession like, say, people losing their jobs because of declining sales at numerous companies; spiraling household debt that makes consumers reduce their spending; a US dollar that the administration wants to weaken in order to pay off the country’s foreign creditors with ever-more-worthless paper (and is quite nonplussed that everyone else’s currency is weakening faster than ours therefore making it appear that ours is gaining in strength); the worst housing sales and starts in 17 years; bonds rated AAA that are really BBB; and a monthly paycheck that only covers you through the 25th of the month, then, yep, we’re feeling the effects of a recession.
What to do? I think it’s time to trim back the tree. Since the government is too clueless to do so, I say it’s time to protect your portfolio and mine from the worst of possible events – wind damage, lightning storms, a hurricane, etc. If you have great profits, which by now you may, I believe you might want to take some profits off the table and plant the cash around your own money tree. (Cash is a great fertilizer for the root system…)
For what it’s worth, here’s what we are doing. We have already sold about half our positions in our most favored industries of energy, water, metals and mining, and agriculture. If we own companies with PEs higher than their internal rate of growth, we are now pruning them from our investment tree, as well. If a company is growing revenues and earnings at 9% a year and selling at 30 times earnings, it’s no longer welcome in our portfolios. If we are correct and the “market tree” is becoming increasingly unstable, we will buy these favorites back at a cheaper price after a correction. If we’re wrong, there will always be another opportunity. (If you don’t believe it, just watch what happens when you fail to buy one of your broker’s Can’t Miss Gotta Buy Now Deal Of A Lifetime recommendations –he’ll be right back next week with An Even Better One!)
That doesn’t mean we are out of the market. But we are now in securities that will benefit from volatility and toppiness, that will increase in value if interest rates rise and bonds therefore decline in value, and in lower-PE, PS and BV ratio income-producing firms whose cash flow continues through good markets and bad.
Against the probability that yields will rise and bonds will fall we’ve bought the iShares TIPS Bond ETF (NYSEARCA:TIP), some floating-rate senior note funds like NSL and PFL, and the ProShares UltraShort 20+ Year Treasury ETF (NYSEARCA:TBT) – yes, we do understand the inherent daily volatility of leveraged ETFs.
The way we’ve chosen to play the possibility of extreme volatility is via the iPath S&P 500 VIX ETF (NYSEARCA:VXX). Since most people will wait to sell until all others are selling, we’re betting, via VXX, that volatility will rise.
And we have kept a couple precious metals / crisis protection securities like Goldcorp (NYSE:GG), Kinross (NYSE:KGC), and Yamana Gold (NYSE:AUY), as well as the royalty firms Franco-Nevada (FNNVF.PK), Royal Gold (NASDAQ:RGLD) and Silver Wheaton (NYSE:SLW).
For income, we still retain our coal “royalty” firms like Natural Resource Partners (NYSE:NRP) and Penn Virginia Resources (NYSE:PVR), a smattering of our pipeline MLPs and a couple Canadian Royalty firms like Enerplus Resources (NYSE:ERF) and Pengrowth (NYSE:PGH), as well as utilities like Atlantic Power (OTC:ATLIF) and select foreign telecoms like BCE (the old Bell Canada – BCE), New Zealand Telecom (NZT), France Telecom (FTE) and Deutsche Telecom (DT).
This leaves us with slightly more than 50% in cash. We’ll bury that near the roots of our tree, keeping it handy for the aftermath of any storm…
Author's Disclosure: We and / or clients for whom these investments are appropriate, are long NRP, PVR, ATLIF.PK, NZT, FTE, TBT, TIP, NSL, PFL, VXX, GG, KGC, FNNVF.PK, RGLD and SLW – and a very large cash cushion.
The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.
Also, past performance is no guarantee of future results, rather an obvious statement if you review the records of many alleged gurus, but important nonetheless – for example, our Investors Edge ® Growth and Value Portfolio beat the S&P 500 for 10 years running but did not do so for 2009. We plan to be back on track on 2010 but then, “past performance is no guarantee of future results”! It should not be assumed that investing in any securities we are investing in will always be profitable. We take our research seriously, we do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.