We're Damn Lucky Life's Not "Fair"

We're Damn Lucky Life's Not "Fair"

I can't tell you how many times one of my girls has said, "But that's not fair."

My standard reply is, "Life's not fair. It's not fair that you're a double threat, cute and smart. It's not fair that your parents love you, care for you, and are well-off. It's not fair that you were born in the United States and live in a town that values education. You better hope that life never becomes fair."

One of the things that has made America such a great country is that it is not fair. Fairness sucks. Fairness breeds mediocrity. 

Sure we may think it's OK that all the 1st graders get equal playing time on the soccer field, but I can assure you that the "fair" team will be mediocre versus the team that gives more playing time to its best players. 

The world has largely developed because it was not fair. Those men and women with superior intelligence, skills, or just work ethic, created products and services that improved the living standards of all of those around them. From the first basic stone tools to arrows, and the wheel, these visionaries were celebrated and praised. Thank goodness our farmers have learned how to produce much more than they themselves can consume, imagine a world where we all got to grow our own crops. That would be fair, but stupid.

Can you imagine a world where those blessed with intelligence and vision had no incentive to use those talents. A world where they were treated just like everyone else, fairly. Just look at the great advances in health care and technology that have come out of Cuba, Venezuela, or Russia over the years.

Lets look at some of those 1 percenters that are being persecuted for not being "fair." Henry Ford didn't invent the automobile, but he did invent a way to make them affordable. He became wealthy, and we all saw our standard of living increase. Sam Walton didn't invent grocery stores, but he did invent a way to make groceries much more affordable for all of us. He became wealthy, and we all saw our standard of living increase. Bill Gates developed software that made the worlds businesses and households more productive. Steve Jobs has created so many products that have enhanced our lives in ways we've never dreamed of. Jobs was the antithesis of fair, he strived for perfection, not mediocrity. 

The cell phone Gordon Gecko used in "Wall Street" retailed for $3,995 in the early '80's. I just purchased a new iPhone 3Gs for my daughter for $0.99. Is it "fair" that AT&T and Apple are generating enormous profits, am I better off today than I was in the early '80's? 

Many people in our society seem troubled about the unfairness of economic success. They should watch what they wish for. Sure we could take more money from those who have been successful, via higher taxes on income and capital gains, but if we did, what new and exciting advances would there be in medicine, technology, and energy? These people want to penalize those blessed with talents, if they use them and become wealthy. What perverse incentive is that? When did the politics of envy ever advance a society?

Romney and Obama are both 1 percenters. Is it fair that they are smart, that they have exceptional speaking and political skills, and that they live in a country that generously rewards such skills. How a President so blessed by unfairness can run on a platform of fairness is mind boggling. Obama had better hope that life never becomes fair for him.

Many of us have suffered from unfairness. Our families have been touched with illnesses, untimely deaths, and unemployment. Life isn't fair, it has never been fair, and will never be fair. But let's not confuse life's inherent unfairness, with economic unfairness. Economic unfairness has done more to lift the world's standard of living than anything known to man. We shouldn't envy those blessed with talents, we should praise them and thank them, the world would be a much colder place without them.

Our Rapidly Approaching Fiscal Cliff:

This amazing quote came from Fed Chairman Bernanke this week, "The size of the Fiscal Cliff is such that there is NO chance that the Fed could or would have any ability whatsoever to offset that effect on the economy." Wow, that's saying something. When a man printing trillions says he can't help you, you had better hold on.

The Fiscal Cliff that we are faced with on January 1, 2013 is a combination of tax increases and spending cuts that could shave 2% off of GDP, and GDP is growing at just a tad over 2%. The extension of the Bush tax cuts expires at year end, as does the temporary cut in the payroll tax. The Alternative Minimum Tax also needs its annual adjustment to avoid a tax increase for millions of tax payers. Meanwhile, $1.2 trillion in spending cuts take effect at the end of the year, a result of last summers debt-ceiling debacle. We'll also have another debt-ceiling debacle this fall. 

Obviously the elections will have a massive impact on how these issues get resolved, or not. Clearly investors will start to worry about these issues as the summer wears on, and it would not be unusual for stocks to sell-off. Markets hate uncertainty, and the second half of this year will be filled with uncertainty. Buckle up. The only positive about uncertainty, and a market sell-off is that it will turn the heat up in Washington to actually do something. We'll see, but prepare for a rough ride.

Shit Happens:

It's not often when economic humor can make me chuckle, here's a rare moment... dlvr.it/1V95XM

Be careful out there, and keep the lights on,

Chris Wiles, CFA

412-260-7917

www.rockhavencapital.com

For prior Rockhaven Views visit:

www.rockhavencapmgmt.blogspot.com

This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management.  The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

And Where Do We Go From Here?

And where do we go from here?

Which is the way that's clear?

Still looking for that blue jean, baby queen

Prettiest girl I've ever seen.

David Essex - Rock On   40 years ago this is what music videos looked like, cool. 

This can be a tough business at times. Managing other peoples money often involves a dichotomy between getting and keeping clients happy, and telling them the truth. Almost all investment firms put "career risk" ahead of the clients asset risk. By this I mean the main job is keeping your job. You keep your job by getting and keeping clients, and by not being wrong alone. It's OK to be wrong, as long as you are wrong in the company of your peers. When I started in this business we used to say, "No one ever got fired owning IBM."  Today the phrase would be, "No one ever got fired owning Apple." Apple is a great company, but like all great companies, there will come a day when they stumble and the stock will go down significantly, maybe even permanently (see Research In Motion (RIMM) the Blackberry makers). But for professional investors, that's OK, since all of their peers own Apple there is no career risk.

Limiting "career risk" has two interesting side effects. First, when professional investors spend an inordinate amount of time focused on what their peers are doing, we often have what is called herding. Herding often drives prices of individual securities, or asset classes, far above or below a fair price. This herding process explains much of the volatility in the market versus a much less volatile GDP. 

The second side effect is a consistent bias towards bullishness. Keeping clients often involves telling them things are going to be all right, just stay the course and everything will be fine. Tell the client what they want to hear. One of the side effects of this glass-half-full mentality is that inevitable corrections are much more dramatic than upward moves. In other words, downside volatility is more extreme than upside volatility.

The beauty of managing my own money is that I don't have to worry about "career risk," I'm not going to fire myself. I don't have to follow the herd just so I don't stand out from the crowd. And I don't have to lie to myself about how rosy the future looks. I have one focus, preserve, and protect my net worth. When I started Rockhaven my clients were told that their money would be run right along side of my money. Whenever I do a trade for the Wiles family, I'd be doing an equal trade in their accounts. We are all united in the common goal of preserving and protecting our net worth. As far as I know most of my clients are very satisfied with this approach. 

Some of my friends/clients often ask, "Why are you so bearish, things aren't that bad, rates are low, stocks are climbing, and the economy is improving, lighten up some!" I often chuckle, and mumble something about my job is to always watch the downside. It doesn't mean I'm bearish (we're currently 93% invested), but I have to continually look for what could go wrong. I may not have "career risk," but my lovely wife has often told me in no uncertain terms, "I don't ever want to be poor again." That's the beauty of growing up poor, you know what its like, and you know that you never want to go back there.

So, where do we go from here? Which is the way that's clear?

Here's where we stand today in our Global Tactical Asset Allocation Portfolios:

Unprecedented - Often an overused word, but apt when it comes to explaining our global markets. The unprecedented printing of fiat currencies in the trillions has seen government deficits grow to a level that makes sovereign debt suspect. In the old days we used to use government debt as the risk-free rate, how quaint. Today there is no risk-free rate. The Feds blatant manipulation of the credit markets (ZIRP, QE1, QE2, TWIST) has totally disguised the bond markets normal pricing mechanism. This allows our reckless/clueless Congress and Administration to ignore looming problems until they explode. The Fed has also forced savers out of safety and into risk assets in order to show the appearance of a healthier economy. This manipulation of the pricing mechanism has caused junk bonds and many other assets to be priced at levels that don't fully reflect their risk. Gold continues to be the only asset that is the reciprocal of the worlds confidence in central bankers.

While I worry, and I believe there is a lot to worry about, I am also a technician, and currently most of the assets we invest in are in bullish territory.

We will continue to diversify and take what the markets are giving us: 

US Equities -- 20% Bullish,

 we are now at our full US equity weight. The S&P 500 is only 2% away from its 52 week high.

Int'l Equities -- 20% Bullish,

 both developed and emerging equity markets are bullish, but both are starting to roll over.

US REITs --  6% 

Bullish, we are now at our full US REIT target of 6%. A huge beneficiary of Feds ZIRP.

Int'l REITs -- 4% Bullish, international REITs have moved into bullish territory, again benefiting from low rates.

Gold --7% Neutral, Gold is neutral and has been trading in a rather tight range.

Commodities -- 10% Bullish, the appearance of economic stability has caused commodities to rise, but some early signs of rolling over

.

US Fixed Income -- 26% Bullish, US Treasuries sold off briefly as the economy was showing some signs of strength, but yields have moved lower again. Our full bullish weight would be 30%.

Int'l Fixed Income -- 3% Bullish, We continue to have zero exposure to European & Japanese bonds, but Emerging Market bonds are bullish.

Cash Equivalents & Currencies -- 7%, cash levels have fallen to our lowest levels in some time, and are divided between the US at 3%, 2% in China, and 2% Australia.

In Summary - We are pretty bullishly invested over a wide range of assets, but we are extremely worried about the fiscal imbalances that will come to the forefront in the not to distant future. "Still looking for that blue jean, baby queen, prettiest girl I've ever seen..."

If you'd like to sit down and talk about the markets, and your current asset allocation in more detail, please give me a call.

Be careful out there, and keep the lights on,

Chris Wiles, CFA

412-260-7917

www.rockhavencapital.com

For prior Rockhaven Views visit:

www.rockhavencapmgmt.blogspot.com

This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management.  The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

Keeps Me Searching For A Heart Of Gold

"I've been in my mind, it's such a fine line

That keeps me searching for a heart of gold

And I'm getting old."

Neil Young - Heart Of Gold

Note: Pretty cool to see a musician in his prime, playing instruments, singing his own lyrics, and just enjoying himself.

Something has been bothering me for some time now (OK, a lot of things bother me, or as my daughter says, "I have issues"). In this particular case what bothers me is the following graph:

Over the last 6 years Gold bullion (GLD) is up about 150%, while Gold Mining Stocks (GDX) are only up 30%. 

Historically gold and gold miners would move in tandem. In fact the miners were seen as a beta play on gold, when gold went up the miners would go up more, and when gold went down the miners would go down more. Clearly something is amiss, especially over the last year. Gold miners have significantly underperformed the glittery metal they are supposed to track...why? Well, like most things in the investment world there are no perfect answers, but here are a few observations:

--In the last few years several gold ETFs have been launched, and have become the de-facto way to own gold without taking physical delivery of the metal. The GLD ETF has assets of about $70 billion, which ranks it as the worlds 6th largest holder of gold, just behind the French and ahead of the Chinese and Swiss. Historically when investors wanted to invest in gold they had to use futures, or take physical delivery of the bullion. But with the creation of gold backed ETFs investors now have an extremely liquid and inexpensive way of owning gold. With the availability of gold ETFs, gold miners have lost a major support to their stock price.

--Gold mining has always been a tough business, and it certainly hasn't gotten any easier in recent years. Increasing environmental, social, and government challenges have made it tougher and tougher to replace supply. Just look at Randgold and the recent coup in Mali. 

--Gold mining isn't always very profitable. Significant increases in energy and mining costs have squeezed profit margins even while the gold price has risen.

For me gold is an insurance policy against government stupidity. We own it to protect ourselves from currency devaluation. We used to own a combination of gold ETFs (GLD) and gold mining ETFs (GDX), but since gold miners are no longer acting in unison with the gold bullion we are eliminating our mining ETF and sticking with the bullion. Gold is currently at a neutral weight of 7%.

Is Ballooning Federal Debt Killing The Feds Independence? 

March saw another record fall, and unlike our beautiful weather this record was not a pretty one. Our federal government spent $369.37 billion in March, or about $1,190 for each American man, woman, and child. I know it's hard to figure out where your family of four's $4,760 went last month, but I'm sure it was put to good use.

The more troubling part of the release was that our federal government only collected $550 from each American in taxes. That means they had to borrow more than half of what they spent. It's a good thing so many around the world seek to fund our extravagant ways in return for 2% interest.

Its kind of funny to look at all the press coverage the Presidents Millionaire Tax is getting. By taxing all of those nasty millionaires at a minimum 30% the President hopes to raise $5 billion a year. That $5 billion a year in additional revenue is about 10 hours of spending!

A common man may look at this and say, "It can't continue." And he'd be right (eventually), but it has continued for a while now. Since 2000 our federal debt has grown from $5.7 trillion to $15.2 trillion currently! Thats 166% growth in debt. Over the same time period our expenditures have grown by 101%, GDP has grown by 52%, and revenues have grown by 14%. 

Fortunately for our government, one expense that did not increase by much over the last decade has been interest costs. Even though debt ballooned 166%, interest expense barely moved. Thanks to the willingness of investors and the Fed to purchase Treasury securities at minuscule yields. 

Here is a picture of where the growth in federal outlays has come from since 2000:

Clearly the Fed has been working overtime to keep interest rates near zero (ZIRP), that is the only part of the pie that the Fed can control. The rest of the pie is controlled by those elected officials in Washington. We all know how to balance a budget; cut your spending and increase your income. Sounds simple, but in order for cuts to be made that means promises must be broken, and broken in a big way. There are very few in Washington with the backbone to do this (except for Ron Paul). Raising revenue is also an alternative. But lets take a quick look at the following chart:

The US is aging rapidly, and with this aging comes an increase in expected benefits, and a decrease in those working to pay for them.

The economic collapse in Greece is a good case study. Employment statistics are often manipulated, sort of like corporate earnings. When analyzing corporations we often look at revenues, since it is much harder to manipulate revenues than earnings. When looking at a countries employment statistics I've found that it is far more telling to look at total employment than the governments unemployment rate. In Greece the official unemployment rate is 21.8%, while not a pretty number it pales in comparison to the actual number of Greeks employed. In Greece the number of people working is 3,880,120, out of a population of 10.8 million. That's right, only 35.9% of all Greeks are working! In other words, 35.9% are working to support the other 64.1%, and pay off their debts. No economy in the world can service a mountain of debt that is 160% of GDP with only 35.9% of the population working.

Our numbers here in the US are certainly better than in Greece, but the trend has been the same. In 2000 64.7% of Americans worked. Today, only 58.5% of Americans are employed. That 58.5% must take care of the other 41.5%, as well as service that massive $15 trillion debt. Again, the demographic graph above shows that this situation will not be improving in my life time.

Investment Implications:

The Fed, like the Central Banks in Europe, have lost a significant part of their independence. Their number one job is now to keep government interest rates as close to zero as possible. Our economy can not handle an explosion in borrowing costs. We've seen what happens when borrowing costs explode (Greece, Portugal, Ireland, Spain, Italy, etc), and it's not pretty. All the Fed can control at the moment is our borrowing costs, and they can only do that as long as foreigners are willing to accept our zero yielding bonds or our devaluing dollars. Sure we might have periods where interest rates rise because the US economy is showing signs of strength (like the move a couple of weeks ago from 2% to 2.4% on the 10 year bond), but those will prove fleeting (10 year rates are already back below 2%). 

There is only one person running for President that is willing to seriously tackle our proliferate government spending, and his name is not Romney or Obama, and unfortunately the odds of him being elected are only slightly better than mine. Therefore, expect our debt situation to worsen, and expect rates to stay near zero for the foreseeable future. Financial repression will continue. Savers will be beaten until moral improves.

Be careful out there, and keep the lights on,

Chris Wiles, CFA

412-260-7917

www.rockhavencapital.com

For prior Rockhaven Views visit:

www.rockhavencapmgmt.blogspot.com

This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management.  The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

1st Qtr 2012 Review

"When the facts change, I change my mind. What do you do sir?"

-John Maynard Keynes

The first quarter of 2012 is in the books, and overall it was a very good quarter for risk assets (the riskier the better), but performance varied widely. The S&P 500 was up 12.66%, which was the best performance since the Tech bubble in 1998. Of course 2012 is very different than 1998. In 1998 risk-free Treasury Bills yielded 5%, real GDP growth was 4%, housing markets were strong, and unemployment was below 5%. 2012's rally is much different.

This years rally is led by last years losers. Bank of America (2011's worst Dow performer) was up 72% in the first quarter, while Sear's Holdings was up 108%, even though they don't expect to make money this year or next. In the S&P 500 low-quality stocks outperformed high-quality stocks by 5%. And in the Russell 1000, high-volatilty stocks outperformed low volatility stocks by 9%. Safer, higher-yielding stocks were the quarters laggards; with utilities down 3%, telecom flat, energy MLP's up 1%, and staples up just 5%. We used to call this type of rally "low quality," it is also known as a "dead cat bounce." When the fear of total collapse fades, those companies that were priced for failure have the biggest bounces.

This "low quality" rally was global in nature. Japan, one of the worst equity markets for 20 years, was up 19%, its best 1st Q since 1988. Emerging markets were up 13%, and even Greece managed to gain 7% while defaulting on their debt.

One quality asset did soar...Apple. Apple was up 48%, and accounted for nearly 20% of the appreciation in the S&P 500. It is now 4% of the S&P 500 and 11% of the NASDAQ. Even more startling, the S&P 500's year-over-year earnings growth is estimated at 7.8%, if you exclude Apple's 117% earnings growth, the overall market's growth drops to 2.7%! (It's only a matter of time before our President discovers these obscene profits and taxes the innovation out of them, its hell being successful in the USofA).

The 1st Q also saw some better economic numbers trickle out. US manufacturing is stronger, and employment is showing slight signs of improvement. Some of this may be due to the warmest winter in a hundred years, and it will be interesting to see what happens when weather is more normal. Signs of an improving economy are leading some to believe that the Fed's days of all-out liquidity and ZIRP are nearing their end. If this is the case than there will be one less massive buyer of Treasury debt, and interest rates will head higher. We started to see some signs of this in the late stages of the 1st Q. Long-term US Treasuries were down 3.5% on the quarter.

Overall most balanced investors should have had a fairly positive 1st Quarter, with their gains in equity markets offsetting their losses in the fixed income markets.

Here is a closer look at how the specific assets we invest in at Rockhaven performed:

Rockhaven Global Tactical Asset Allocation Model:

Our average client account was up about 4% on the quarter, even with a very defensive portfolio that began the year with 29.5% invested in cash and currencies. 

US Equities were strong performers in the 1st quarter, the S&P 500 was up 12.66%, and the Vanguard Total Market ETF (VTI) that we use was up 12.85%. We have been at our maximum bullish weight in US Equities of 20% for the entire quarter.

International Equities were also stellar performers this quarter. Our EAFE Index ETF (EFA) was up 10.82%, and the Vanguard Emerging Markets Index (VWO) was up 13.76%. We started the year at minimal weights in these two assets of 3% and 2% respectively, but ended the quarter at our maximum allocation of 10% each.

Gold and Gold Miners were extremely volatile during the quarter, with Gold (GLD) finishing up 6.66%, and Gold Miners (GDX) falling -3.68%. Gold began the quarter at a neutral 4% weight and has ended the quarter at 4% also. Gold Miners have remained at a bearish 2% allocation the entire quarter.

US REITs, specifically the Vanguard MSCI REIT Index (VNQ), was up 10.60% for the quarter and our allocation remained at a maximum weight of 6%. International REITs, specifically the iShares FTSE-NAREIT Index (IFGL), was up 14.68%, and our allocation grew from a bearish 2% at year-end to a bullish 4% at quarter-end.

Commodities also did well during the first quarter. The broad based DB Commodity Index (DBC) was up 7.30%, and our allocation rose from a bearish 3% at year-end to a bullish 6% at quarter-end. The more narrowly focused equity agriculture index appropriately named (MOO) was up 12.04%, and again our exposure increased from a bearish 2% at year-end to a bullish 4% at quarter-end.

Fixed Income is the asset category that struggled the most, with long-term interest rates spiking up and 10-20 year US Treasuries falling -3.48% for the quarter. Our main fixed income holding, the Vanguard Long-Term Bond ETF (BLV) did slightly better and was down -2.73%. We started the year at a maximum 13% weight and ended the quarter at a neutral 9%. 

Treasury Inflation Protected Bonds (TIP) managed a slight gain of 0.82%, while our allocation remained at a bullish level of 4.5% the entire quarter.

Due to their equity sensitivity, High-Yield Bonds (HYG) managed a gain of 2.63%. Our allocation increased from a neutral 3.5% at year-end to a bullish 5% at quarter-end.

Our Energy Master Limited Partnerships (AMJ) were up 1.61%, while the allocation remained at a bullish 3.5% for the entire quarter.

Our allocation to Emerging Market Bonds (ELD) was up a strong 7.50%, and our weight increased from a bearish 2% at year-end to a bullish 4% at quarter-end.

Our currency allocations were slightly positive. The Chinese Yuan (CYB) appreciated 0.63%, while the Australian Dollar (FXA) increased 2.11% for the quarter.

Our cash allocation decreased from 21.50% at year-end to 4% at quarter-end.

Here is how the portfolio looked at year-end:

And here is how it looks at quarter-end (These returns are for a 1 year period ending 3/31/12):

What is obvious from reviewing these graphs is that as riskier assets have performed better in the first quarter our allocation has shifted from a more balanced Risk-Off to a Risk-On position. We've seen a big reduction in cash and a subsequent increase in international equities.  

Our goal at Rockhaven is to try and stay in harmony with the markets. We want to avoid big secular declines, and participate in big secular rallies. Our diversification helps protect us during periods of cyclical noise. We're not trying to forecast the future, we're just trying to participate and protect our assets. We'll only know after the fact whether or not this equity rally has legs, or whether the recent sell-off in bonds is the beginning of a longer-term decline. One thing you can be sure of is that we'll continue to adapt and change to survive.

Be careful out there, and keep the lights on,

Chris Wiles, CFA

412-260-7917

www.rockhavencapital.com

For prior Rockhaven Views visit:

www.rockhavencapmgmt.blogspot.com

This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management.  The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.