Between Flesh And What's Fantasy

Outside the street's on fire in a real death waltz

Between flesh and what's fantasy

Possibly the best 10 minutes you'll spend today ... Bruce Springsteen - Jungleland (Live in New York 2001) 

One of the constants in money management is the battle between flesh and fantasy, fact and fiction; there is rarely a black or white position. We work in world with a complicated mosaic of fundamentals, technicals, valuations, and human emotions; certainty is simply not attainable when forecasting the future. 

Today's markets are dominated by macro news events that have led us to a Risk-on/Risk-off mentality, where all risk assets either rally or drop in unison. This manic behavior has forced many investors to take one of two views; step to the sidelines and sit on cash, or bury their heads in the sand and stick with their current asset allocation. At Rockhaven we believe that investors can, and should, aim for a more disciplined asset allocation. An asset allocation that is not betting all-in or all-out, and an allocation that is not ignoring the prevailing environment. We call it Global Tactical Asset Allocation, an allocation method that stays diversified, but also takes into consideration prevailing trends in all markets. 

Years ago, legendary investor John Bogle said, "We must base our asset allocation not on the probabilities of choosing the right allocation but on the consequences of choosing the wrong allocation." In other words, extreme positions of putting on or taking off risk (going all cash or all stock), are highly risky and can lead to negative consequences. Active allocations, even in times of uncertainty, are the more prudent portfolio management strategy. Getting it right is not being all in or all out.

We have been in an environment of crisis since 2008, and it does not appear to be ending any time soon. It is a very emotional environment that throws investors between fear and euphoria (OK maybe more fear than euphoria). 

Recently Barton Biggs suggested getting to know your emotional self to improve your investment results. "The investment process is only half the battle. the other weighty component is struggling with yourself and immunizing yourself from the psychological effects of the swings in the markets, career risk, the pressure of benchmarks, competition and the loneliness of the long distance runner...

Understanding the effect of emotion on your actions has never been more important than it is now. In the midst of this great financial and economic crisis that grips the world, central banks are printing money in one form or another. This makes our investment world even more prone to bubbles and panics than it has been in the past. Either plague can kill you."

It is exactly this type of environment that requires a disciplined, unemotional portfolio construction process.

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

US Equities -- 15% Neutral,

 The US equity markets have rolled over a bit (they are about 8% off their highs). At this point US equity markets are not showing any strongly bullish or bearish trends.

Int'l Equities -- 3% Bearish,

 both developed and emerging equity markets are in bearish territories. We remain at our minimal weight.

US REITs --  6% 

Bullish, we are still at our full US REIT target of 6%, but even they are trending towards neutral. REITs continue to be a huge beneficiary of the Feds ZIRP.

Int'l REITs -- 2% Bearish, international REITs have moved to bearish territory. After remaining in bullish trends longer than their international equity brethren they've finally succumbed. 

Gold -- 5% Bearish, Gold has moved into bearish territory. Gold's trading range has been very narrow, but also fairly volatile.

Commodities -- 5% Bearish, economic weakness has caused commodities to fall (DBC is down 16% since March)

. There are some signs of bottoming, especially in grains, but still in bearish territory.

US Fixed Income -- 22% Bullish, US Treasuries have rallied to near record low yields again. High-yield bonds & MLP's have moved into neutral territory.

Int'l Fixed Income -- 2% Bearish, Even emerging market bonds have moved to minimum weight. We continue to avoid all European bonds.

Cash Equivalents & Currencies -- 40%, cash levels have increased dramatically, and are divided between the US at 38%, and 2% in China.

In Summary - In trying to determine what's flesh and what's fantasy, don't let your emotions take over, stick to your disciplines. We're not all-in or all-out, but we have a definite tilt to the conservative risk-off side of the ledger.

If you'd like to sit down and talk about the markets, and your current risk exposure 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.

Don't Worry

"Don't worry about a thing,

'Cause every little thing gonna be all right."

Bob Marley - Three Little Birds

For the past couple of weeks the birds outside my bedroom window have taken the place of my alarm clock. The sunrise, and their chirping, coincide with my normal rising. It puts a smile on my face each and every morning. Some days that smile lasts all the way to 8:00 or 8:30. For a change of pace I thought it might be fun to see if maybe I could extend that positive vibration all the way to lunch.

 

We're all aware of the many negatives impacting our economy and markets; Europe's debt woes & untenable political structure, our debt woes & untenable political structure, China and India's slowing growth, our zero interest rate policy and currency devaluation that is robbing every saver, and persistently high levels of unemployment. But enough about that, this note is about positives, not negatives.

Seriously, without belittling the magnitude of these issues, many of them are solvable with a little action, and finally we have some signs that a little action is beginning to happen. The American people seem to realize that "austerity" isn't some dirty nine letter word, it simply means living within your means. Last week we saw American's send a strong message to their elected officials, that its time to start living within your means. First, we saw the overwhelming defeat of Wisconsin Governor Walker's recall. But more importantly, in one of the nations most liberal states, we saw both San Diego and San Jose vote for serious public pension reforms. 

The dirty word is not "austerity", it is "entitlement". Americans know that the only "entitlement" any American should have is a fair shot at getting ahead...not a check from Uncle Sam. No crony capitalism, no "too big to fail", no government picking winners and losers, just a fair and level playing field where the smart and hard working move ahead. This is the message being sent to Washington, live within your means, and get out of our way.

It can be done. Ronald Reagan came to power with an economy in shambles and inflation running wild. He had an air of confidence about him. He believed that all we needed was a clear and coherent fiscal plan, a plan for tax reform that would encourage capital to be put to work. It worked, and it can work again. Investors (we're all investors, we invest our mental or financial capital to get ahead) want some clarity as to what the rules are. What's our tax code going to look like for the next decade? Can our governments show a credible plan to lower our deficits and live within its means? Can we get some clarity on long-term "entitlement" reform? Each of these questions can be answered positively, all it takes is political will and resolve. Of course, with our current deep political divide we'll need one party in power to make anything happen. American's know this, and I think they'll vote with this in mind. Until recently I really didn't think Romney had much of a chance, it's very hard to unseat a popular sitting President (especially one who is constantly fundraising), but it feels like the tide is shifting.

We may also get some clarity on healthcare reform in the next week or two. Again, whether its upheld or repealed isn't the biggest issue, just knowing what it is will allow us to move forward. 

A coherent fiscal policy may also allow the Fed to stop manipulating interest rates and the market. The market may be allowed to function like free capital markets are supposed to act. Savers may even be rewarded for saving. Who knows, with one party in charge we may actually give some serious thought to backing our currency with something real, other than just promises.

I used to love gridlock in Washington because neither party could do anything too stupid, but unfortunately gridlock is no longer a viable option. We need one party in charge so serious decisions can be made. Fortunately it appears to me that the American public realizes this and is ready to act. It will still be a very close race, but there appear to be some nice rays of sunshine.

None of this means the markets or the economy will be off to the races. In fact, all of this means the economy will probably slip into a recession in 2013, but we'll be making progress, progress to a new future where entitlement means opportunity, not handout. Cutting government and their promises means that initially economic growth will slow. We don't have to do this overnight, we just need to make clear and steady progress. Hopefully over the next several years we'll be on the way to real growth, not some government manipulated semblance of growth.

We've got a long tough road ahead of us, but I think I'll keep signing, "don't worry, every little thing gonna be all right." At least until noon. 

In the meantime, stay defensive and liquid, there will be opportunities to put money to work in the coming months. We're currently near 40% in cash, with another 20% or so in fixed income, and less than 40% in risk assets.

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.

Interest Rates May Remain Low Much Longer Than You Think, And It's Not Necessarily Bullish For Stocks

Interest Rates May Remain Low Much Longer Than You Think, And It's Not Necessarily Bullish For Stocks

Long title, but very important subject. It is common knowledge that low interest rates are bullish for stocks...right? Wrong, or at least not always. Sure it seems pretty elementary that if US Treasuries yield 1.6%, and high grade corporate bonds yield 2%, than a stock yielding 3% or 4% seems pretty attractive. Well, this is certainly the reason almost every pundit on CNBC (especially those selling dividend paying equity funds) is touting buying dividend paying stocks. This logic assumes that investors simply look at relative yields and buy the most attractive, without asking why. The problem with this logic is the simple fact that it fails to question why Treasuries yield 1.6%.

The why is more important than the relative yields. Treasuries are low for two main reasons; 1) the Fed and their Central Bank colleagues have manipulated rates as low as possible to try and stimulate some semblance of economic growth, and fight off the deflation monster, and 2) investors are fearful and have therefore run to the perceived protection of Treasuries, Bunds, and JGB's. It's just plan silly to hear some people talk of Treasury Bonds as being in some sort of bubble. Bubbles are all about greed. No one is running to Treasuries (and their negative real returns) thinking they're going to get rich. People buy Treasuries here out of fear, not greed.

The thing that the Fed and the western worlds Central Banks fear most is not inflation, but deflation. Inflation is the monster lurking in the basement. Deflation is the monster under the bed, breathing on the back of your neck. Deflation is the immediate threat, and it is why the central banks are doing all they can to reflate their economies. You see, our central bankers are fully aware that in a world where the G10 has $70 trillion in debt that is collateral for $700 trillion in derivatives, deflation is the immediate risk, not inflation. In an inflationary world those enormous debts are paid off with cheaper and cheaper currencies. Inflation is the friend of the debtor. Consider a home purchaser. They purchase a $300,000 home with 20% down, borrowing 80%, they owe $240,000. In an inflationary world the value of their home appreciates over the life of the loan, making the debt as a percent of the equity value decline. In a deflationary world the value of the home declines, making the debt as a percent of the equity value surge. This is the environment we live in today, many homeowners underwater, owing more than the home is worth.

You've probably heard the term, "Pushing on a string". The Fed's efforts to stimulate the economy via massive injections of liquidity have been like "pushing on a string," in other words, not very successful. 

The chart below shows the velocity of money. Wikipedia defines the velocity of money as "the average frequency with which a unit of money is spent on new goods and services produced domestically in a specific period of time. Velocity has to do with the amount of economic activity associated with a given money supply."

As you can see the velocity of money has collapsed. In fact it has been in a rather steady decline since the mid-90's, and is now at record lows. The demand for money is simply dwarfed by the supply of money.

The best sign that the deflationary monster is being beaten back is wage increases. Inflation in wages is a sign of a healthy, expanding economy. Unfortunately wages have been in a long-term secular decline for decades. The median wage level in the US today is about $50,000, if it had just kept pace with inflation it should be about $90,000.

The suppression of wages has come from both a rise in productivity and a large labor pool. This decline in real wages contributes to the lack of aggregate demand, and feeds the deflationary monster. 

Why aren't low rates positive for stocks?

Let's take another peak at the Velocity of Money chart above. If you look at the period coming out of the 1982 recession the velocity of money went from about 1.7x to 2.1x in 1997. Interest rates fell throughout that period from about 11% to 4.5%, and stocks had their best decade on record. The S&P 500 actually returned 19.2% annually in the ten year period ending in 1998. As rates continued to fall from 1998 to 2008 from 4.5% to 2.5% the S&P 500 actually turned its worst ten year annualized return with a negative 1.3%. 

The moral: Low rates don't automatically equal higher stock prices. The key is, why are rates low.

Lets look at the Japanese experience, another country with ballooning deficits. 

Japanese interest rates have been below 2% since the late '90's, and Japanese stocks yield more that Japanese Government Bonds, so stocks are attractive versus bonds...right? Wrong. Since 1998 when Japanese yields broke below 2%, Japanese stocks have fallen from about 15,000 to their current level of about 8,600, a decline of 43%.

Summary:

A low rate environment does not automatically mean stocks are attractive. Sometimes low rates are indicative of an economy that is struggling to grow, and may even be fighting back the deflationary monster. Stock returns are simply a reflection of a country's ability to grow its economy. Corporate profit margins may be near record levels, and dividend yields may exceed bond yields, but if the fear of deflation is in the air P/E's will contract. These are tough times to make money investing. Stay defensive, diversified, and most importantly vigilant and flexible.

High-Yield Portfolio:

After my May 24th Supermodel Revisited post I've received several inquiries regarding our High-Yield portfolio. Attached is a pdf that goes into some more detail regarding this product. If you would like to talk in more detail about how this portfolio may help you achieve your income goals 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.

It's A Wonderful Life

It's A Wonderful Life:

GEORGE: Now, please! Now, now, please, folks! Now, just a minute! Just a minute, now, please!
CHARLIE: Tell us about our money, George? Where's our money?
GEORGE: Now, please! Now, wait a minute! Listen to me! Now, you're thinking about a building and loan all wrong. Your money's not here!
PEOPLE IN THE CROWD: What?
GEORGE: Wait a minute, now, let me tell you. Let me tell you. Your money's in people's houses! In the Kennedy house, and the MacClaren house, and in your house, and a hundred others. You all put your savings in here and then we make loans to people to buy homes and cars and other things. Now, what are you going to do? Take their homes and cars and things from them?!

How quaint, and how times have changed. In George Bailey's time, even though banks didn't actually have money in them, they at least knew where that money was. Today the system has morphed into something so large and unimaginable I often question why I even play along. The problem is not Government debt per se. The real problem is that $70 trillion in G10 debt is the collateral for $700 trillion in derivatives, that equates to 1200% of Global GDP. So none of us should be surprised when JPMorgan's Jamie Dimon wasn't aware that his risk management unit had a few hedges that were a bit more directional than they'd like, and losses totaled a few billion. A few billion is a rounding error, or as my accountant wife was fond of saying, "mice nuts."

Bank runs are scary, scary things. In a world built on the backs of currencies, backed by nothing but the full faith and credit of the issuing nation, faith is the most precious of all commodities. People work hard for their money, and when they have a few extra bucks they've been enticed to save for that rainy day, college, or retirement. But sometimes things don't go as planned. Governments screw up, and citizens start to question their faith in their financial institutions. Faith that they'll get their money back, and faith that it will be worth what they thought.

Lets look at Greece, Spain, and Italy. Savers and investors sense that maybe, just maybe, the money they have invested in the local bank might not be worth as much in the very near future. Greeks especially are afraid that they may awaken one day soon to find that those Euros they had in savings are suddenly called Drachmas, and are subsequently worth much less than they hoped. Not surprisingly they've been pulling hundreds of billions of euro's out of their local banks and transferring it to Switzerland and Germany. The trend has spread from Greece to Spain and Italy, not a run, just a brisk walk for the exits. 

Who can forget the images of bank runs from the Great Depression, people lined up around the block hoping to get their money back. Today's bank runs are not nearly as photogenic. I remember reading about a Greek news station sending a camera crew to the local bank to see if they could get some footage to use on the nightly news. No such luck, today's runs are mostly electronic, money is transferred over the internet to banks in other countries with a few strokes of the key. Nothing to see. We simply must trust the reports we're getting from the banks and the governments as to how much is being withdrawn. There we go again, that trust word. Trust the government to tell us the truth about how many citizens don't trust the safety of their deposits. Government officials lie. Especially when they can lie under the guise of preventing widespread panic. 

There is nothing like a national bank run to get the attention of politicians. Not just a run on a specific bank, but a run on the nations currency. Citizens pulling all money out and saying, "sorry, I'm not going to play any more." We're reaching this point in Europe today. What they do to stop the run will be interesting. Believe it or not, the United States is seen as a safe haven, or at least the least dirty shirt in the laundry. You know things are crazy when pundits say that at least our government isn't as dysfunctional as Europe's. In the 1930's our government stopped the bank runs by stepping in and guaranteeing all bank deposits. Of course back then our currency was backed by gold. Today in Europe the bank runs are because the citizens don't trust their governments currency. The trillion dollar question now becomes, how do you instill faith in a currency that you have actively been trying to devalue for years? As my daughters say, "Good luck with that."

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.

Crazy

I remember when

I remember, I remember when I lost my mind

There was something so pleasant about that place

Even your emotions had an echo in so much space, yeah

Does that make me crazy?

Cee Lo Green Crazy Music Video

Months like May, and days like today, make me question my sanity. Tough markets are an understatement, the markets have been downright brutal. The only place to make money has been in Treasury bonds, we've been at our full allocation, and with 10 year yields now at 1.47%, it's hard to get excited about committing more capital there. 

Here are some performance (if you want to call it performance) numbers for May:

US Treasuries +4.93%

TIPS +1.95%

S&P 500 -6.01%

Gold -6.34%

EAFE -11.14%

Commodities -11.16%

Fortunately our defensive positioning (currently 40% cash) has mitigated the pain somewhat, but losing less isn't anything to write home about. Today's a good example, with the S&P 500 currently down a whopping 2.25% on the day, our average account is down only 0.50%. Great, we're outperforming the market by 1.75% on the day, but we're still losing money.

Reasons for the selloff:

Where do we start? There are so many. I have a good friend that likes to remind me that markets love to climb a wall of worry, but I'm constantly reminded of the Pink Floyd lyrics, "Mother, did it need to be so high?"

Here goes the wall, in no particular order:

Europe; the unraveling of Greece, the contagion spreading to Spain & Italy, Bank walks (not yet runs, just walking fast), the fear of the collapse of the Euro.

China; growth slowing to a point where the world takes notice, again fear that their banks are significantly over-levered.

The United States; growth slowing again, few bullets in the Fed's bazooka, paralysis in DC, no long-term plan to address debt.

And one big overriding fear...fiat money backed by the full faith and credit of the issuing government looks crazier and crazier every day.

Reasons to be hopeful:

I'm not trying to be pollyanna here, I really have a bit of faith that we can work our way out of this mess. It won't be easy, and it won't be painless, but it is much better that the alternatives.

Citizens (individuals & corporations) need clarity. We need to know what our taxes will be. We need to see a concrete plan being implemented that works us towards a balanced budget. It doesn't matter if it's a ten or twenty year plan, the key is that we have a plan.

We need to get back to a currency backed by more than the full faith and credit of the government, it needs to be at least partially backed by something tangible (gold, silver, etc). The main reason for this is that it will help keep the printing presses in check, it offers a certain level of discipline to monetary policy. The forty year fiat currency experiment has failed, time to reboot.

We need to shrink the size of government, and increase the level of personal responsibility.

The reason I'm hopeful is that these fixes are not secret, we just need the right groups of citizens to implement them. 

Come on now, who do you, who do you, who do you

Who do you think you are?

Ha ha ha, bless your soul

You really think you're in control

But maybe we're crazy

Does that make me crazy?

Does that make me crazy?

Probably

I'm not going to comment much on today's economic numbers, they were miserable and will remain miserable, until we start to see some reforms implemented. Here's a couple of charts that keep things in perspective:

That's enough for a Friday afternoon, enjoy your weekend.

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.