The Future's So Bright

"Things are going great, and they're only getting better I'm doing all right, getting good grades The future's so bright, I gotta wear shades."     Timbuk 3 - The Future's So Bright One of my most recent posts was on how forecasting is so difficult, if not impossible. It's amazing, even though we know it is impossible to forecast the future, we are still willing to listen to those willing to tell us what is going to happen. Nowhere is this more true than in the financial markets. We cling to their prognostications with the hope that they will enlighten our futures. I believe that part of this desire to know the unknowable future is simply part of our evolution. You see, one of mankind's most extraordinary talents is mental time travel, the ability to move back and forth through time and space in one's mind. We may take this ability for granted, but being able to envision a different time and place has been critical to our survival. This mental time travel allows us to plan ahead, to save food, and to endure hard work for a future return.  However, this conscious foresight came with a price...the knowledge that somewhere in the future death awaits. Most biologists agree that this awareness of our own mortality would have stopped human evolution in its tracks, unless something else intervened. If humans obsessed about their impending demise, they would have stopped gathering food and working towards the next day. What intervened was irrational optimism.   Humans are irrationally optimistic, we habitually expect things to turn out better than they actually will. Neuroscientists and social scientists agree that we are much more optimistic than realistic. We hugely underestimate our odds of getting divorced, of losing our jobs, or of getting cancer. While we overestimate the odds that our children are gifted, that they'll do better than their peers, or how long we'll live. This optimism bias is present in every race, religion, age group, and socioeconomic bracket.  You'd think that this optimism would erode under the constant tide of bad news; wars, high unemployment, political strife, terror, and the Pittsburgh Pirates. This is true to a point. Collectively we can grow pessimistic, but our private optimism, about our own future, remains incredibly resilient.  This wonderful irrational optimism has driven the human race to constantly move forward, to believe that they can overcome obstacles, and make the world a better place for future generations. Without optimism our ancestors might never have ventured out of their caves. But optimism can also lead us into making some pretty dumb decisions; not going to the doctor, not saving enough, or playing the lottery. When it comes to investing, our optimism bias and our selective memory, can get us into a world of hurt. As humans we have a strong tendency to believe that our specific investments will do well, especially when compared to those of the overall market. We tend to extrapolate past successes into the future, and we tend to forget about prior failures. In other words we overestimate the odds of positive outcomes, and underestimate the odds of negative outcomes. How can we overcome these evolutionary biases? Mathematics, and a willingness to expect the unexpected.  Mathematics, and more specifically an understanding of probabilities, can help many investors focus on "realistic" expectations vs. "optimistic" expectations. Over the last thirty years US Treasury bonds have been excellent investments, returning 9.2% per year. While this was fabulous, it was also what you should expect when interest rates fall from 12% to 2%. Realistic expectations for returns on US Treasuries today should be around 2%, with the added risk that they may be much lower (inflation adjusted). Jim Grant said it best, "US Treasuries have evolved from risk-free return to return-free risk!" The same holds true for US Stocks, which provided investors with a mouth watering 9.9% annual return over the last thirty years. Now of course stocks were extremely cheap back in 1980, yielding 5.14% with a P/E (price-to-earnings) ratio 7.4x. Today stocks have a current dividend yield of 1.9%, and a P/E ratio of 14x, a more rational expectation for equity returns going forward is about 5%. While our irrationally optimistic mind might expect future investment returns in the mid to high single digits, our rational mind says low single digits is more probable.  Our other safeguard from irrational optimism is a willingness to expect the unexpected. Just because it hasn't happened in our lifetimes doesn't mean it won't. One quote that constantly plays over and over again in my mind is, "The failure rate of all great civilizations is 100%".  Global Tactical Asset Allocation is the only investment strategy that I know of that systematically helps us overcome our optimism bias. By focusing our investments into those assets that are working, as opposed to those that we hope would work, we are in harmony with reality. And more importantly, by being willing to allocate significant assets to cash when things simply aren't working out as expected.  Keeping our irrational optimism in check is our specialty. The future may be bright, but we'll keep our shades handy. Be careful out there,   Chris Wiles, CFA President & Portfolio Manager  Rockhaven Capital Management, LLC  - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - For a FREE Investment Consultation with Chris Wiles, click here or call 412-260-7917 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -  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.

The Death of Democracy

The Death of Democracy "A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves largesse from the public treasury. From that moment on, the majority always votes for the candidates promising the most benefits from the public treasury with the result that a democracy always collapses over loose fiscal policy, always followed by a dictatorship. The average age of the world's greatest civilizations has been 200 years."  - Alexis de Tocqueville 1805-1859 September 17, 2012 marked the 225th anniversary of the signing of the US Constitution, and it reminded me of the above quote by Alexis de Tocqueville around 1840, "The average age of the world's greatest civilizations has been 200 years." Now we all know that America is above average, so it is of no surprise that our democracy has lasted 225 years, but how much longer do we have? I recently wrote a piece about our nation's $16 trillion budget deficit. While $16 trillion is clearly a huge number, I failed to include the additional $40 trillion in unfunded Social Security and Medicare obligations. Clearly we have long passed the point of no return, as Tocqueville so eloquently stated 170 years ago,"The American Republic will endure until the day Congress discovers that it can bribe the public with the public's money."  Recently Mitt Romney made some comments that were "not elegantly stated" about 47% of Americans not paying Federal Income Taxes, and 49% of Americans receiving some form of government benefit. While he may not be correct in lumping all of those receiving government support as self-perceived "victims", he is pretty close when it comes to the math. The Census Bureau stated that 49% of Americans in the second quarter of 2011 lived in a household where at least one member received a government benefit, up from 30% in the 1980's. The data broke down like this:   26.4% receiving Medicaid 16.2% receiving Social Security 15.8% receiving food stamps 14.9% receiving Medicare 4.5% receiving rent assistance 1.7% receiving unemployment benefits Where Mr. Romney was mostly wrong is that most of these Americans do not perceive themselves as victims, since many paid payroll taxes for decades to qualify for these benefits. But the amount of taxes paid does not come close to covering the benefits promised. Mr. Romney was more accurate in his statement regarding the nearly half of all Americans that pay no federal income tax. About half of these people pay no federal income tax because they are low-income earners. According to the nonpartisan Tax Policy Center the other half benefit from targeted tax breaks (from both Republicans & Democrats), such as:   - Elderly tax benefits - Credits for children - Tax-exempt interest - Itemized deductions - Education credits - Other credits While political parties and concerned citizens can argue about the value and validity of entitlements, and the structure and fairness of taxes, we can't argue with the math. There is simply not enough revenue under any tax reform to support the tens of trillions in entitlement promises. Simply stated, all politicians (including Romney) realize that their odds of being elected are extremely slim if they tell Americans the truth, that if elected they will take away your current or future benefits/entitlements. The result has become a tax and entitlement web so complex that it is nearly impossible to navigate. Tocqueville's more elegant observation, "Society will develop a new kind of servitude which covers the surface of society with a network of complicated rules, through which the most original minds and the most energetic characters cannot penetrate. It does not tyrannise but it compresses, enervates, extinguishes, and stupefies a people, till each nation is reduced to nothing better than a flock of timid and industrious animals, of which the government is the shepherd." My lovely wife often admonishes me not to write about politics, but I simply can't help myself, what happens in geopolitics has a profound impact on nearly all investments. It may even be the biggest factor. From an investment perspective, it almost doesn't matter who is elected in November. The entitlement problem is much larger than either man or their parties, and to be truthful I don't believe either party has the stomach to handle the massive reforms that are necessary. Again, you can't get elected by promising to take away benefits. The election will impact investments, but not that much.  A huge portion of any investments return is based on investors beliefs of its future worth. For stocks, we look at what we believe the future value of earnings growth will be. For bonds, we look at what we believe our interest and principal reinvestment might be. For commodities, we look at future demand. All of these investments depend on future economic growth, and the value of our currency in the future. Some politicians may implement policies that foster more robust economic growth, and some politicians may work for a sounder dollar so our investments are worth more in the future. Our current political environment (both parties) does neither.  Since they refuse to govern (make tough choices), our unelected Central Bankers are running the show. Central Bankers don't have nearly enough tools to do an adequate job in spurring economic growth, but they have become very creative in using what they have. One thing that Central Bankers understand (unlike politicians) is math. Since they can't cut spending, and the politicians won't, and since they can't raise revenues, and again the politicians are loath, they are forced to use their one tool...currency devaluation. We are deeply in debt with little hope of paying off these debts. With a total vacuum of leadership in Washington the Fed has taken it upon itself to try and work through the problem. Step one is ZIRP (Zero Interest Rate Policy), which simply transfers money from savers to debtors. Step two is QEternity, which seeks to inflate assets and devalue our currency. If you have $16 trillion in debt and $40 trillion in entitlement promises, you only have a couple of choices. Increase your revenue (Taxes). Drastically cut your spending (yucky Austerity). Default on your debt (unheard of, we're not Mexico, Argentina, Russia, or Greece, are we?). And lastly, devalue your currency via inflation.  Our path is much clearer than it may seem. Devaluing our currency spreads the pain broadly to our creditors, savers, and citizens. At present it is our only option. I'm Bullish. I'm bullish on assets that will benefit in an inflationary world with competitive currency devaluations. I'm bullish on gold, oil, and agricultural commodities. I'm bullish on higher yielding securities (they have shorter durations), like REITs, MLP's, and High-Yield bonds. I'm bullish on equities that can pass rising costs on to consumers. I'm bullish on taking out a long-term mortgage. I'm Bearish. I'm bearish on assets that can't adjust to increases in inflation. I'm bearish on long-term fixed income (especially sovereign debt like treasuries). I'm bearish on slow growing equities. I'm bearish on companies that need access to the debt markets. I'm bearish on Democracy. I'll leave you with one last quote from Tocqueville, "It is indeed difficult to imagine how men who have entirely renounced the habit of managing their own affairs could be successful in choosing those who ought to lead them. It is impossible to believe that a liberal, energetic, and wise government can ever emerge from the ballots of a nation of servants."  Be careful out there,   Chris Wiles, CFA President & Portfolio Manager  Rockhaven Capital Management, LLC  - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - For a FREE Investment Consultation with Chris Wiles, click here or call 412-260-7917 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -  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.

Special Update - Easy Like A Sunday Morning

Know it sounds funny but I just can't stand the pain Girl, I'm leaving you tomorrow Seems to me girl, you know I've done all I can You see I begged, stole and I borrowed, yeah Ooh, that's why I'm easy I'm easy like a Sunday morning      Lionel Richie - Easy like Sunday morning 1996    Please watch the video above. Now picture Ben Bernanke, with shades, singing the exact same tune to his compatriots at the Fed. Can't you see it, "Know it sounds funny but I just can't stand the pain, that's why I'm easy..." So the Fed has surveyed our economic landscape and found it to be unsuitable for growth, therefore they are launching QE3. It seems that they believe since QE1, QE2, and TWIST haven't been able to reinvigorate economic growth, QE3 should do the trick. The Feds biggest issue is the stubbornly high unemployment rate. Not just the 8.1% headline rate, but the full U6 unemployment rate of 14.7%. Basically, the Fed said that they don't see the economy growing at a fast enough rate to substantially lower unemployment unless they intervene in the markets. And intervene in a massive way. The highlights of QE3, or more aptly QEfinity: The Fed will buy $40 billion per month of agency mortgage backed securities. They will also continue TWIST, their $45 billion monthly purchase of long-term treasuries. So the Fed will spend$85 billion per month buying long-term securities! The Fed also said that they expect to keep interest rates at ZERO until mid-2015. One of the major differences in this announcement is that the purchases are open-ended...they will continue until unemployment improves substantially, or until the patient dies. To QEfinity and Beyond - The Fed is boldly going where no central bank has gone before. Chairman Bernanke clearly stated that he is trying to blow bubbles in risk assets. He is trying to reflate the housing market so homeowners will feel wealthier. He is trying to inflate the stock market so shareholders will feel wealthier. He is trying to force investors off of the sidelines. His stated belief is that if he can make wealthier people feel even more wealthy, than they will spend more freely, and eventually this will lead to job growth. Financial repression continues.  Collateral damage - Savers will be robbed for the benefit of debtors. Millions of retirees, pension plans, and foundations will receive negligible returns on their lower risk fixed income. Inflation will raise its ugly head. Rents will rise. Commodities, especially gold and oil, will rise. The value of the dollar will fall. The average unemployed American will be faced with a rising cost of living while he waits for that hoped for job offer.  We are in a full-fledged currency devaluation war. In response to the Fed's action Japanese financial minister Azumi said," I will not rule out any measures and I will take decisive steps when it is deemed necessary." While the ECB has said they will print as much as the Germans can bear. Chairman Bernanke believes that he has a mandate to do whatever possible to lower the unemployment rate. Unfortunately, monetary policy is not always effective in lowering unemployment. Our current ongoing unemployment dilemma is not a result of tight monetary policies (policies have been extremely loose for years). No, our current unemployment plight is the result of a government (both parties) over-regulating, over-taxing, and misallocating capital, for decades. I feel for Ben, he's using the only tool he has, unfortunately it's the wrong tool. "I wanna be high, so high. I wanna be free to know the things I do are right." OK, enough pontificating on whether or not this is the right strategy, I'm paid to manage money...period. Where We Stand: At Rockhaven our philosophy is to stay in harmony with the markets, and right now those markets are clearly moving into risk-on mode. The reason doesn't matter as much as the reality. Here is how our three strategies were positioned as of September 1st: Our more balanced Global Tactical Asset Allocation (GTAA) had about a 15% allocation to cash and a 10% allocation to Treasury bonds at the beginning of the month. With the Feds recent moves, and the subsequent moves in the markets, we would expect to see those allocations reduced; while the allocations to gold, commodities, and stocks increases. Our Focused Tactical Asset Allocation (FTAA) is already positioned to take advantage of the Fed's voyage into uncharted waters. The portfolio is ideally positioned for a yield hungry, inflationary environment. REITs, both US & International, are at a 40% weight, Master Limited Partnerships are at 20%, and commodities are at 20%. I would expect Gold to replace either Bonds or TIPS in the near future. Our diversified tactical high-yield portfolio is weighted in all the areas where the Fed is chasing investors, yield and risk. The portfolios current yield is approximately 6.5%. So this is where we stand, our heart and head tell us the Fed's strategy of open-ended easing will not be effective in substantially lowering unemployment, but it will be effective in inflating bubbles in risk assets. It is not an "All Clear" signal based on the long-term fundamental strength of the US economy, it is a "Temporary, Central Bank Orchestrated All Clear" that may or may not lead to economic strength. The big risk is rapid inflation and currency devaluation. Participate, but be wary of the risks! Be careful out there,   Chris Wiles, CFA President & Portfolio Manager  Rockhaven Capital Management, LLC  - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - For a FREE Investment Consultation with Chris Wiles, click here or call 412-260-7917 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -  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.

A Trillion Here, A Trillion There

"A Trillion Here, A Trillion There, Pretty Soon You're Talking About Real Money!" Austin Powers - 100 billion dollars Dr. Evil is not alone when it comes to getting his head around large numbers, we all struggle to some extent. Million, billion, trillion, they just seem to roll off our tongues with very little effort, and unfortunately for some, very little thought.  On Tuesday, September 4th our national debt went over $16 trillion, that's $16,000,000,000,000. It took the United States government over 200 years to accumulate its first trillion dollars of debt. It took only 286 days to accumulate the most recent trillion dollars of debt. 200 years vs. 286 days! We've become desensitized when it comes to talking about our national debt. Its similar to the threat of a nuclear winter throughout the Cold War. We stopped putting our heads under our desks many years before the Cold War actually ended. It didn't mean that the threat dissipated, we'd just grown tired of it. We've spent so many years hearing about debt that even $16 trillion is a desensitizing stat. It's now not so much, "$16 TRILLION?! HOLY S*^#" as much as, "$16 trillion. Oh...that sucks." This is the scariest part of this story, we've become so accustomed to throwing around large numbers without really understanding their scale. It's a testimony to our cynically apathetic times, but also, a reminder of how unbelievably fragile this economy is.  In order to help Dr. Evil get his head around the difference between a million, a billion, and a trillion I offer the following visuals: A million dollars worth of $100 bills fits comfortably in a briefcase. A billion worth of $100 bills would fit in a semi-truck. A trillion worth of $100 bills would fill a skyscraper. The US Bureau of Engraving and Printing produces 38 million notes a day, so printing one trillion new notes from scratch and working seven days a week, would take just over 72 years. Stacked in one pile, one trillion one dollar notes, each 0.0043 inches thick, would be 67,866 miles high...the same as 12,344 Mount Everest's (29,029ft). And this is only 1 trillion not 16 trillion! Rick Santelli of CNBC went on air last Wednesday to try and bring some enlightenment to this weighty issue. One fun stat was that if you were to put every human being on a scale and weigh them you'd get about a trillion pounds. He also went on to comment on the first lady's speech, while not dissing her he notes that unlike her "money's not important to Barack" comment, "when the number gets this big, it better matter to someone." Watch his excellent rant here: Rick Santelli Quantifies One Trillion OK, you get the picture, a trillion of anything is a lot. Why this matters is simple. Eventually those who have loaned us this money might actually expect to get it back, and not in newly devalued dollars, but in something more tangible. Even at these extremely low interest rates Uncle Sam is paying out $340 billion in interest payments on our $16 trillion. The interest income that China receives on its US Treasury debt is enough to fund its entire military budget. I always thought it was funny how our Government says we'd defend Taiwan from a Chinese invasion. Funny because we'd first have to borrow the money from China! Last year the US Treasury brought in $2.57 trillion in tax revenue, and they spent $3.83 trillion, for a one year deficit of $1.27 trillion. Of that $2.9 trillion was spent JUST on mandatory programs like Social Security, Medicare and the Defense budget. In other words we're $330 billion in debt before we even pay a dime in interest.  Fortunately, the world is still willing to fund our deficit spending and fund it at very low interest rates. That doesn't always have to be the case. Someday they may require higher rates of return to fund our profligate ways. Heck, they may not want to fund us at all. In the 19th century, the Ottoman Empire was facing a similar debt crisis. In just 11 years the Ottoman Empire went from spending 17% of its tax revenue on interest to spending 52% of its revenue on interest. Then came default, devaluation, and the end of the Ottoman Empire. Today the US is spending in excess of 10% of its revenues on interest payments. Things happen much quicker today then they did in the 19th century...how much time does the US have? Sovereign debt is a giant confidence game. Investors buy bonds on the belief that the governments will pay. When that confidence is chipped away (i.e. Greece, Spain, Italy), the cost of capital becomes debilitating. $16 trillion is a number that will make a few lenders take notice.   Be careful out there,   Chris Wiles, CFA President & Portfolio Manager  Rockhaven Capital Management, LLC  - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - For a FREE Investment Consultation with Chris Wiles, click here or call 412-260-7917 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -  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.

Forecasting Is Very Difficult

"The only function of economic forecasting is to make astrology look respectable." - John Kenneth Galbraith   "Forecasting is very difficult, especially if it's about the future." - Nils Bohr   "Those who have knowledge, don't predict. Those who predict, don't have knowledge." -Lao Tzu 6th century BC Everyone wants to know what the future holds for them; what type of person their kids will grow in to, what will our country look like, will I have enough money to retire, will I remain healthy? As far as we know, the business of forecasting the future goes back at least a few thousand years. Over the years the tools used for forecasting have changed; from tossing bones, reading tea leaves, entrails, palms, cards, and crystal balls, to new and improved computer generated models. While the methods may have changed, the results are still the same...no one can forecast the future! I gave up trying to read the markets entrails many years ago, and have adopted a more zen-like approach of "being in harmony with the markets". This is not as easy to do as it sounds. We are constantly bombarded with noise. What do you think will happen if X wins the election? What will happen when we run over the fiscal cliff? What will happen if the Euro dissolves? Who will Tom Cruise marry next? Will the Steelers make another Super Bowl run?  While it may be fun to prognosticate and debate the many unknowns the future holds, it is sheer folly to manage an investment portfolio based on prognostications, no matter how educated.  The best that investors can hope for is a thorough understanding of our current environment; what is working, whats not, and why. Understanding the present and positioning our portfolios appropriately is the soundest investment policy. An active tactical asset allocation strategy is all about being in harmony with the markets. A static portfolio (i.e. 60% Stocks/40% Bonds) based on historic returns amounts to hiding your head in the sand and hoping that history repeats. While building a portfolio based on the future's unknowns is simply folly.  Economists have the unenviable task of trying to forecast something as complex as the worlds economic performance. Their task is simply to try and determine what all of the worlds inhabitants are going to do; how many will have jobs, how many will buy, what will they buy, how long will they live, will their governments remain stable, will they act rationally, and about a million other factors. Not a small task, but a task that their hubris allows them to willingly embrace. And it doesn't hurt that many are also paid handsomely for their prognostications.  Historically this was all well and good, and as investors we could simply choose to ignore their entrails reading, and instead focus on things like company fundamentals. But, what has become troublesome is that the worlds economies are now being driven by these soothsayers. Central Banker economists have evolved, from trying to steer the economy by setting short-term interest rates, into full-fledged Central Planners. These Central Bankers/Planners now intervene in a variety of markets (commercial paper, mortgages, and long-term Treasuries) as well as "nontraditional" interventions that allow the Fed to allocate credit to specific markets and institutions.  Stocks, bonds, gold, oil, and commodities all moved dramatically this week as unelected European Central Bank president Mario Draghi told the world that he would indefinitely continue printing money to buy up the bonds of Europe's most beleaguered country's. These unelected Central Bankers expose tax payers to increased risks, and they have also become gargantuan regulators. We've put these Central Bankers/Planners economists in charge of our currencies, and by default, our economies. This is extremely scary. The Fed has crossed the line. We are fully aware of the dismal track-record that Central Planners have. And we are right to be worried about the hubris of a few individuals, and their belief that they can forecast the future...no one can forecast the future! Now I have nothing against Ben Bernanke, I'm sure he's an OK guy just doing his job. My problem is that his job, forecasting the future, is doomed to fail. Unfortunately his increased power, and certain failure, will have a significant impact on you and I. These are the cards we've been dealt, and as investors we have to realize that the game has changed and our playing style must change with it. Adapt or die. Think I'm being a bit harsh. Here is a brief video of some of the Chairmans prior clairvoyance. Ben Bernanke was Wrong Bernanke's fail blog, video power mix Be careful out there,   Chris Wiles, CFA President & Portfolio Manager  Rockhaven Capital Management, LLC  - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - For a FREE Investment Consultation with Chris Wiles, click here or call 412-260-7917 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -  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.

There's Always a Bull Market Somewhere

"There's Always a   Bull Market Somewhere" That may be a cliché, but like most clichés there is also more than a grain of truth in it. For generations, investors have been implored to diversify in order to participate in that bull market, wherever it happens to be. Diversification was considered the closest thing to a "free lunch" that the markets could offer you. By allocating your portfolio among various asset classes (i.e., stocks, bonds, real estate, etc.), investors wouldn't get killed when one sector collapsed - hopefully another sector would be rising. And for generations this advice predominately worked: don't put all your eggs in one basket.  The chart below shows how various assets performed over the last 13 years. In any given year, different asset categories would rise to the top or sink to the bottom. A diversified portfolio made up of equal weights of all assets (the dark green), was never at the top or bottom, but over 13 years it was the third best performing asset, and did so with less risk.  DIVERSIFICATION - The Only "Free Lunch" in Finance has been Eaten But what happened in 2008? Look again at the chart above and the returns for 2008. The dark green Diversified Portfolio was down -25.67%! While not as bad as the S&P 500, which was down -37%, or emerging market stocks, which were down by -53%, a -25% loss in your defensive diversified portfolio is still a pretty tough pill to swallow.  What happened is Systemic Risk, risk that impacts entire markets, not just individual asset categories. The uncomfortable fact is that we now live in a world that is predominately driven by systemic events. Events that have nothing to do with capitalism or fundamentals, such as;  Crony-capitalism that misallocates resources and keeps some favored corporations alive long past their "Best-by Date" (i.e. TBTF Banks, auto companies, solar companies, etc). The precarious balance between massively over-leveraged governments that can't begin to live up to their promises, and the growing restlessness of citizens faced with generations of lower living standards. Central Banks setting rates at zero and buying their own government's bonds, while engaging in a race of competitive currency devaluations. The investment world is not oblivious to these changes. If anything, the investment world is highly adaptive. The market continually evolves, and the most recent evolution has led to a bifurcation of assets into Risk-On and (a scarce few) Risk-Off havens. Risk-On assets include equities, commodities, REITs, emerging market bonds and currencies, and high-yield credit. Risk-Off is limited to a few sovereign bond markets deemed "safe" for the time being like the US, Germany, and Switzerland, and gold.  The graphs below show how the correlations between developed market equities (DM) and emerging market equities (EM) have increased in the last several years, as well as the increasing correlations between different sectors and even individual stocks.  Global markets used to be divided, where risks in one part of the world would not affect others. Today, valuations are driven by coordinated monetary policy decisions, globalization of supply chains, and capital and labor flows, while investors use algorithmic trading to instantaneously move between Risk-On and Risk-Off. Markets resemble a game of musical chairs played by sumo-wrestlers using fragile chairs.  Here is JP Morgan's view on rising correlation: This [correlation] trend has been caused by the globalization of economies and financial markets. We believe this globalization, and hence the high cross-regional correlation trend, is not reversible. While region-specific events such as the recent earthquake in Japan may soften cross-regional correlations, markets are not likely to revert to the levels observed in the mid-1990s, when the average correlation between EM benchmarks was close to zero and EM/DM correlation was only ~25%.  This trend of rising cross-regional correlation significantly diminished the once-important diversification benefit of investing across emerging and developed markets. It appears that in the case of cross-regional investing, 'the only free lunch in finance' (a common reference to diversification) has been eaten.  The recent increase of equity correlation has largely been driven by the increased macro volatility since 2007. However, other structural reasons contributed to increased levels of equity correlation. The widespread use of index products (e.g., futures) and high-frequency trading strategies, such as statistical arbitrage and index arbitrage, are likely contributing to increased levels of correlation. We Don't Make The Rules - But We Play The Game So this is the New Normal: a world where assets are more correlated, more volatile, and more prone to systemic risks. The investing world is always changing and always evolving, and it is not our job to question whether it is right or wrong; it is our job to figure out a way to adapt and survive. As Charles Darwin said, "It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is the most adaptable to change."  For me, the best way to be a successful investor is to constantly adapt, and the best way to adapt is to follow the money. Money will always flow to where it is treated the best, and one of the most proven investment strategies is following that money via relative strength. Relative strength or trend following has been around for hundreds of years, and a multitude of academics and researchers have proven that it simply works. Relative strength is price following: when prices of assets increase, that means that money is flowing into them; when prices fall, that means money is flowing out.  Relative strength investing will not get you out at the top or in at the bottom. There is no strategy or guru that can consistently call market tops or bottoms. None. But as asset classes start to deteriorate, a relative strength strategy will rotate your portfolio away from those areas and into something showing strength. This is active asset allocation, also known as Global Tactical Asset Allocation.  Another way to look at relative strength investing is with the old adage that there's always a bull market somewhere. A relative strength strategy seeks to help us identify and allocate assets into those bull markets. Simply shifting assets from areas of weakness into areas of strength greatly enhances returns.  Rockhaven's Focused Tactical Asset Allocation Process (FTAA) In today's investment world, static diversification simply does not work. Investors need to think of assets in their Risk-On/Risk-Off states, and actively allocate into those areas that are working. Investors also have to be aware of the fact that major systemic shocks (Black Swans) can and will happen, and during those periods the best strategy is often to simply step away from the table (go to cash).  At Rockhaven, we've broken the investing world into the following Risk-On/Risk-Off categories using measures of correlation, volatility, and liquidity: Risk-On: US Equities  International Equities  US REITs  International REITs  Commodities  Emerging Market Debt  High-Yield Debt  Risk-Off: US Government Bonds  Gold  Cash  Once we've divided the investing world into its Risk-On/Risk-Off segments, we then rank each security by its respective relative strength. We then buy the top ranked securities and eliminate the lower ranked securities. If a security's relative strength is lower than the relative strength for cash, we simply own cash. In a period of systemic shock like 2008, we went to 100% cash for 10 months.  The performance of this model has been outstanding. Here are the return numbers since 2008:  The table below shows some Risk/Reward statistics for the period of 2008 through July 2012. While the raw performance numbers are very impressive, what is most impressive is where that performance came from...namely downside protection. The maximum drawdown is the worst trade that you could make over the time period, buying at the high and selling at the low. For the FTAA model, the max. drawdown was only -9.6% versus a max. drawdown of -31.7% for a buy & hold balanced portfolio. Also, the worst one-month return was only -4.55% versus a -11.45% return for the balanced portfolio. But this portfolio is not just about defense; it also performed very well in the strong up markets of 2009 and 2010.  Buy & Hold & Hope is a quaint notion that served us well decades ago, but in today's world of macro risks and manipulation you are exposing yourself to massive drawdowns. Asset allocation is still an appropriate way to manage risk in your portfolios, as long as it is active asset allocation, and as long as you are willing to step to the sidelines during periods of systemic shock. Obviously, none of us know what the future may bring, but at least with relative strength driving our decisions we have the opportunity of finding that bull market wherever it may be. Be careful out there, and keep the lights on, Chris Wiles, CFA  President & Portfolio Manager  Rockhaven Capital Management, LLC  - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - For a FREE Investment Consultation with Chris Wiles,  click here or call 412-260-7917 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -  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.

Welcome Back My Friends

"Welcome back, my friends, to the show that never ends"  Karn Evil 9 - Emerson, Lake & Palmer   Welcome, to the new and improved Rockhaven Capital Management. It's been nearly three years since I founded Rockhaven Capital Management and I felt it was time for a few improvements. The most obvious, visual, change is to this Newsletter, our Blog, and our Website. All have been reformatted to make them easier to read, and easier to move between one and the other. On the business front of Rockhaven we are making our services available to a much wider audience. We are lowering our minimum investment for actively managed accounts from $500,000 to $100,000. We are also offering free initial consultations. If you'd like to have a professional look over your investment portfolios, even if its just your 401-K, please give me a call, I'd be happy to offer my advice.  On the investment side of Rockhaven we have also made some significant enhancements. First, we've made some meaningful improvements in technology to help in both account management and asset allocation. These improvements make it easier for me to offer my services to a much larger audience of investors, but more importantly they've enhanced the accuracy and timeliness of our asset allocation process.  We can do a lot of things at Rockhaven, but we will not try and do everything. What truly makes Rockhaven unique in the investment management industry is the simple fact that, if we're not willing to put our own money into an investment, right along side of you, then we simply don't make the investment.  Currently we offer the following three Investment Strategies (including the new Focused Tactical Asset Allocation): Global Tactical Asset Allocation (GTAA) - This is our core strategy, it is a defensive portfolio designed to protect assets during bear markets while still participating on the upside. It offers broad global diversification among the following markets: U.S. equity, international equity, gold, real estate investment trusts (both U.S. and int'l.), commodities, fixed income (both U.S. and int'l.), and cash. We use our proprietary screens to determine the appropriate weight to be allocated to each investable market. These weights change as markets evolve. Focused Tactical Asset Allocation (FTAA) - This focused strategy is similar to GTAA in broad global diversification, but differs in the weights allocated to each asset. We focus our investments into those assets that have the best relative strength, and have zero weight in those that are currently less attractive. In broad systemic bear markets, like 2008, it would not be unusual to be 100% in cash. High Yield Portfolio - This portfolio is designed to offer investors high current income by tactically investing among various high-yield markets, such as; high-yield corporate bonds, preferred stocks, mortgage REITs, master limited partnerships, and emerging market bonds. Our proprietary relative strength screens are used to determine appropriate weights and cash levels.    What has not changed at Rockhaven is our goal of preserving and increasing the purchasing power of our investors in constantly evolving markets. We will continue to manage your assets along side of our own with total transparency.  These can be stressful times for investors. If I can help alleviate some of that stress, please give me a call. Be careful out there,   Chris Wiles, CFA  President & Portfolio Manager  Rockhaven Capital Management, LLC  - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - For a FREE Investment Consultation with Chris Wiles, click here or call 412-260-7917 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -  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.