Bears, Swans And Allocation

by: Emmet Kodesh

The markets are at an interesting inflection point. At the close Friday the DOW put in its fifth top near 13,650 since September 14th. Perhaps skepticism is barreling through optimism toward euphoria. If this is true, investing legend and billionaire Sir John Templeton, famous for the maxim, "Markets are born in pessimism, grow on skepticism, mature on optimism and die of euphoria," would be cautious. Here are highs set on

Sept. 14 -- 13,653
Sept. 19 -- 13,626
Sept. 21 -- 13,647
Oct. 05 -- 13,661
Jan. 18 -- 13,649

Following the long weekend, Tuesday saw a DOW 4+ year high at 13,712. The S & P also put in a post-November 2007 high at 1492.

It looks like last quarter saw consolidation and base-building for a renewal of the bull market. The S&P trend remains bullish with new tops forming and trending to higher highs.

Templeton emphasized that an investor "agressively monitor" their holdings. This is especially true in this period of pervasive manipulation and intervention in markets, social relationships and geopolitics. One must be alert for black swans while keeping in mind JP Morgan's dictum that "no one ever made money betting against the United States." Templeton also urged open-mindedness about investment allocation and diversification and this column encourages that view.

By mid-January pundits were beginning to tout a sudden positive inflow to equity funds. However, it was noted that this could be "a false signal of a rotation into stocks." Indeed, the latest Lipper reports confirm a continuing switch into bond funds, especially investment grade intermediate corporate bonds; even more funds are going into the pure liquidity of money markets. Here are their December figures:

• Mutual fund investors … for December padded the coffers of bond funds and money market funds (+$10.6 billion and +$82.9 billion, respectively). Meanwhile, they redeemed assets from stock & mixed-asset funds, withdrawing a net $13.1 billion.

• The U.S. Diversified Equity Funds macro-group experienced its 20th consecutive month of net redemptions (-$16.9 billion), with large-cap funds (-$13.4 billion) dragging down the group for the 43rd consecutive month.

• Exchange-traded funds (ETF's) posted their thirteenth consecutive month of net inflows at $26.4 billion, with $27.1 billion in net sales for stock & mixed-asset offerings.

• Bond ETF's (-$722 million) posted their first monthly outflow in 24 months as investors fled U.S. Treasury products. [Matthew Lemieux for Lipper]

After early January's one-week inflow to equities reported variously at $19 - 21 billion the pattern of the recent five years has largely returned. There has been a significant outflow from Domestic (U.S.) equities and a slightly larger move into foreign funds and ETF's giving a small net gain, about $280 million into equities overall. This hardly is a vote of confidence. The euphoria seems to be a media phenomenon and skepticism continuing among investors. By mid-January, over $2 billion had gone into hi quality intermediate corporate bonds while the search for yield in 'Junk' last week was down from $1.1 billion to $571 million. Most investors seem unenthused about Treasuries and Domestic equities: once bitten, twice shy; or perhaps its twice-bitten, thrice shy ...

It is good that people are abandoning Treasuries with their negative real return (another lesson of Templeton's was to be sure you are invested for positive real return, i.e. return minus inflation and taxes). People also should note that at currently depressed interest levels, investment grade bonds function like a cash fund that barely or almost barely holds its value. With all fixed income holdings remember that yields will rise and asset values fall, perhaps by late summer. If you're not prepared to hold for years lowering your cost basis by reinvesting the proceeds at lower prices be ready to trim your bond holdings. At that point cash and precious metals will be good alternatives, cash until good opportunities arise, precious metals to hold.

The sky is filled with the flutter of black swans and change one must believe in. The siege by "Al Qaeda" on the BP (NYSE:BP) - Statoil (NYSE:STO) natural gas facility in Eastern Algeria finally has ended with three Americans dead. This is blowback from the horror in Benghazi whose reality is and will remain buried. Other groups of "insurgents" in northern Mali have pushed into the center of that nation near Bamako and Timbuktu. France which retains oversight on its former French Equatorial Africa has sent troops and Germany feels pressured to contribute. "Trapped between France and War" reads a report in Spiegel online. France is "a partner" (not a debt burden, ahem); nor does the piece allude to Germany's hope to repatriate all of its 370 tons of gold from French banks in the next couple of years which will require cooperation despite irritation about the Euro project which exists as much to shackle as to empower Germany.

Two points: 1) "Oceania" as Orwell referred to the British Commonwealth plus America has put the Muslim Brotherhood into power or near power throughout H. Mackinder's "inner crescent." As Mubarak learned, everyone is expendable. All affected must deal with the wild card of crisis creation and management. 2) Major national banks, in this case Germany to be followed soon by the Netherlands are uneasy about the past decade of money creation / devaluation and want gold, the basis of fractional reserves on hand.

Germany plans to repatriate 300 of the 1500 tons of its gold from New York by 2020. Note it's 20% of the total and stretched over 8 years. Some say it's difficult to move the metal more quickly. There are, however, such things as ships. It is as likely that the gold has been leased and perhaps bought elsewhere. The Bundesbank may not want to push the Fed and American government. No need to embarrass or irritate a friend. The Chinese continue to buy 60 - 90 tons of gold/month and have set up their own exchanges at Hong Kong and Shanghai. Soon they will launch their own gold ETF's. If the RMB - yuan is backed by gold that would be constructive for Chinese assets and its economy and for gold. Still, Templeton did not like to invest where there was lack of transparency, a quality ingrained in some nations. But gold shines: here are still more reasons that the spider Gold ETF (NYSEARCA:GLD), Silver (NYSEARCA:SLV) or Sprott Physical silver (NYSEARCA:PSLV) look appealing.

There are numerous reports of shortages of silver from wholesalers and for whatever reasons the US Mint for the second time in recent weeks has suspended its issuance of Silver Eagle coins. Based on price action since May 2011 and trends there still may be some erosion in this essential industrial metal (its wide use in jewelry actually straddles the line between discretionary and basic consumer spending). There also is its role as a default currency to gold, 'the poor man's gold'). Despite the seemingly endless volatility, it is difficult to quarrel with those who buy silver around $30/oz or lower after a coming spike prompted by the reports of shortages…

Two other potential black swans: 1) Japanese PM Shinzo Abe's administration plans to accelerate devaluation of the yen, setting a 2% target for Japanese inflation. As a major exporting economy, a devalued yen would help Japan, at least its balance of trade and markets and let it pay down its staggering debt level (240% of GDP) in devalued money. The effects on other economies, major and emerging are unclear but the trend of continual digital money creation, debt and currency war persists. Short term this could boost markets as well as trade but some analysts think investors in Japanese stocks are "picking up dimes in front of a bulldozer." Mid and long-term maybe; for now, not so though the markets are not liking the plan so far. But the writing is on the wall: Japanese pension funds like many central banks are acquiring gold. Its price will continue to be manipulated but its position is strengthening near and long term despite the low ball forecast by Citigroup one of the largest recipients of bail out funds.

2) Gridlock will continue in DC unless the Republicans surrender completely on reducing government size and spending. The State of the Union address indicated continued government by perennial campaign and a commitment to, 1) fighting "climate change," 2) more tax funding for "green energy" and 3) revising the U.S. Constitution whose laws and principles "don't execute" sufficiently to suit this administration. It seems that what remains of an opposition to government-managed economics is being shattered. Most major media prefer central planning and global solutions and cheer progress toward this end. Reporting on administration initiatives will have a euphoric tone until a systemic breakdown. This will occur either for fundamental economic reasons and/or blowback from foreign affairs. But as noted in a previous piece, the 1933-37 bull market emphasized the disjunction between markets and economies. The indices look like they will run for months albeit with several significant chasms. It will be good to have cash on hand for buying when this occurs.

Everyone has entry and exit points; they vary only in duration between entrance and exit from a holding or from the markets altogether. This depends on life circumstances as well as major changes in the macro situation. The markets' trend is strong but the fundamentals are not there and actions at the top do not inspire confidence. Investors have the right idea in exiting treasuries even if they have been overplaying the flight into money markets.

Whatever allocation fits your life, an over-weighting in equities still is wise with a 20-25% portion in foreign and emerging markets. Consider China Large Caps ETF (NYSEARCA:FXI), China All-Cap Index (NASDAQ:CHI), the China Small Cap ETF (NYSEARCA:HAO) and the Wisdom Tree Japan Total Dividend Fund (NYSEARCA:DXJ) to catch the initial bounce from devaluation and increased exports. The Vanguard Wellesley Income Fund (MUTF:VWINX) is rock solid for capital preservation with a 58% weighting in investment grade corporate issues. It is a good alternative to excessive flight to cash. It's beta is so low that one has plenty of time to trim a holding and it yields about 2.5% with ability to grow while equities rise. For most people, 10% liquidity seems right for now; be ready to shift to 20-30% when things get ugly in Washington or a black rider appears. So many wild cards have been shuffled into the deck and so many black swans loosed into the sky that the bull market seems unsteady. Templeton's famous formula on the trajectory from pessimism to euphoria is another way of saying that eventually small investors are sucked into strength and then hung out to dry ...

The mid and long term sees small fry being seduced onto a cresting wave so their money can be scooped in oncoming troughs by 'strong hands.' The macro plan is for a pyramidal society, a new age hi-tech feudalism that is an ominous undertone to slogans about "the 99%."

Disclosure: I am long SLV, GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.