State Of The Union - What Condition My Condition Is In

I just dropped in to see what condition my condition was in.

Kenny Rogers & The First Edition - Just Dropped In

Tonight is our annual update on the State of Our Union, otherwise known as "What condition my condition is in."  To be truthful, most of these annual updates have very little to do with our current state, and have much more to do with where our President would like us to be heading. With a sitting President running for reelection, we can expect to hear about a few successes (very few), but mostly we will hear about how much better the future State will be if he's just given four more years. We'll probably hear something like, "We've made progress, the State of our Union is strong, but we still have work to do." 

Heading into his second term, President Obama has a 44% approval rating, which is higher than Jimmy Carters 37%, and just a bit below Reagan's 47%. Unemployment is falling from lofty levels, and in spite of government ineptitude the economy is improving ever so slightly. Intrade has the odds of an Obama victory this November at about 55%. 

As an investor, here are some of things I'll be listening for:

1) Class Warfare - This will be a big part of the presidents campaign. He is putting Warren Buffett's secretary next to Michele in order to emphasize the injustice in our tax code that has a lowly secretary paying more (as a percentage) in taxes than her billionaire boss. This is also a nice way to jab at Romney's 14% tax bill. Now most investors know that dividends and long-term capital gains are taxed at a lower rate of 15% versus 35% for short-term gains, and higher wages. What many fail to realize is that these dividend payments have already been taxed once at the corporate level, and are now being taxed a second time at the personal level. Also, many wealthy help subsidize their local schools, hospitals, and other state endeavors by purchasing tax-free bonds. This allows these organizations to borrow at below market rates. A strong case can be made for encouraging long-term capital investment through attractive tax rates.

Clearly our President believes that his voters would like a "fairer" tax where the wealthy are not encouraged to invest. It will be interesting to see how strong his rhetoric is when it comes to the tax treatment of dividends, capital gains, and municipal income.

2) The Housing Crisis - Housing has been a major drag on the economy for the last several years and is finally showing some signs of stabilization. Listen for any major promises on mortgage relief or foreclosure relief. Depending on the size of the promises this could lead to another down leg in bank profitability and share prices.

3) Energy Independence -  This should be interesting after recently shooting down the Keystone pipeline, and the failure of Solara Solar. Don't expect much if you're an energy bull.

4) Manufacturing - While US exports have been growing, they are still growing at a slower pace than US imports, hence a growing trade deficit. Last year the President promise to double our exports by 2014, they were up 11% last year. See if he sticks to his double by 2014 pledge. This should be mostly lip service, nothing major from an investing perspective.

5) Spending - Oops - Investing - The President is a pure Keynesian, he believes that increased "investing" (he won't use the word spending), by a knowledgeable leader, will get our economy growing at a more rapid pace. If $3 trillion got us 2% GDP growth than $6 trillion should get us 4%. Don't expect to hear anything substantive in the way of spending cuts. If we did hear anything about reducing spending that could be perceived as positive for the markets. 

Now I realize that some of you might struggle through the address. One popular method of making the SOTUA more enjoyable is to make it into a drinking game. Whenever you hear the President say one of the following, take a shot. 

- "Fairness" or "fair share"

- "Income inequality"

-"Investing in..."

- "Middle class"

- If you hear "debt" or "deficit" borrow a drink from your neighbor

Be careful, and enjoy.

Candidate Match Game:

If you're curious to see which candidate agrees with your views of the issues follow the attached link to the USA Today Candidate Match Game: (Remember to slide the scale next to issues to adjust to what you value most)

http://www.usatoday.com/news/politics/candidate-match-game?loc=interstitialskip

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.

Superstitious

Very superstitious, writing's on the wall

Very superstitious, ladders bout' to fall

Thirteen month old baby, broke the lookin' glass

Seven years of bad luck, the good things in your past

When you believe in things that you don't understand

Then you suffer

Superstition ain't the way

Stevie Wonder ~ Superstition

Happy Friday the 13th, nothing scary here, just keep moving along. So far in 2012 the S&P 500 is up 2.2%, Emerging Market stocks are up 3.6%, and Gold is up 4.6%. A few scary happenings over in Europe as investors struggle with the term "voluntary haircuts". EAFE stocks down 0.02%, and International Bonds down 3.22%.

We've made some big changes to our allocations this year, here's an update:

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

The big change from the end of the year were the increases in US stocks (VTI) now bullish, US real estate (VNQ) now bullish, the total elimination of Developed Market International Bonds, and a swap out of the Total US Bond market (BND) into the US Long-Term Treasury Bonds (BLV). Cash was lowered slightly to 29.5%. Exposure is similar to a barbell; US Equities & US REITS on one end and US Long-Term Bonds on the other, with very little in the middle, other than cash. 

US Equities -- 20% Bullish,

 we are now at our full US equity weight.

Int'l Equities -- 5% 

Bearish, we are now at our minimum International equity weight. 

US REITs --  6% 

Bullish, we are now at our full US REIT target of 6%.

Int'l REITs -- 2% Bearish

. The sell-off in Europe has knocked these stocks down.

Gold --6% Neutral, Gold is neutral but the gold miners have been acting poorly.

Commodities -- 5% Bearish, we are now at our minimum target of 5%

.

US Fixed Income -- 24.5% Bullish, a flight away from European debt continues to benefit US bonds, both Treasuries and High Yield.

Int'l Fixed Income -- 2% Bearish, We've totally eliminated our exposure to European & Japanese bonds. Still maintaining a minimum exposure to Emerging Market bonds.

Cash Equivalents & Currencies -- 29.5%, divided between the US at 30%, 5% in China, and 3% Australia.

President Hits Head On Ceiling:

In case you missed it we've hit our debt ceiling again, and President Obama is asking his colleagues in Congress to bless another increase. Here is an excellent video that puts the Debt Limit in perspective. Enjoy:

http://www.youtube.com/watch?v=Li0no7O9zmE&sns=em

Another nice graphic of just how volatile 2011 was compared to the prior decade. Even though the S&P 500 ended the year basically unchanged, it was a hell of a ride:

When it comes to investing I think  Stevie Wonder said it best, "When you believe in things that you don't understand, then you suffer."

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 I Think It's Going To Be A Long Long Time...

And I think it's going to be a long long time...

Elton John - Rocket Man

This is going to take a long long time. No quick fixes, no rabbits in the hat, no Mars to the rescue, no easy way out. "Mars ain't the kind of place to raise your kids, in fact it's cold as hell." 

Our problem started in earnest in 1971, when the US and the world abandoned the gold standard and adopted a debt-based credit standard. Some call it the dollar standard, but it is really a credit standard based on dollars. For the next 30+ years countries around the world learned how to grow through the expansion of credit. The creation of credit grew so rapidly that it significantly overtook the creation of real goods. Money has been printed, interest rates lowered to zero, assets have been securitized to the point of no return, but finally in 2008 the wheels began to fall off. The worlds central banks rode to the rescue with even more credit, substituting sovereign credit for private credit. Now it appears that this trend may also be nearing its end, at least in Europe. The financial markets are slowly imploding (delevering), because there is simply too much paper and very little trust. 

Some say the US will be OK because we have already started down this delevering path, unfortunately that couldn't be further from the truth. Sure corporate America has delevered, and US households have cut back a bit, but the US government is actually banging on the debt ceiling again. The following chart shows how debt exploded after 1970, and how recently the government has simply taken over the credit expansion reigns:

After 30 years of credit exploding, and with our built in entitlement promises, it is hard to see a rapid delevering ensuing. Not that a rapid delevering is something to wish for. Rapid delevering happens in depressions. No, this process we are entering will take time, a long long time. Economic growth will be muted at best, and interest rates will be held at extremely low levels. These facts have caused us to make some rather substantial changes to our Global Tactical Asset Allocation model. The first such changes we've made in two years. 

First, when it comes to fixed income investing, investors need to worry about credit risk (will I get my principal back) and interest rate risk (will interest rates change dramatically by maturity). In the old days we could check our credit risk worries at the door when buying sovereign bonds (developed nations don't default, they don't even get downgraded), that's not the case any longer. No, today we have to worry about both credit risk and interest rate risk. Just look at those wonderful Greek government bonds that were trading near parity with German bonds just a few years ago, now they are 80% lower. The same scenario is unfolding in Italy, Spain, Portugal, and even France, credit risk is front and center. It's one thing to loan money to a relative and not expect to get paid back, it's entirely different thing to loan money to a government and worry about getting paid back. The perverse part of ZIRP is that with rates at zero there is no incentive to loan governments money and take on the credit risk. Liquidity dries up. 

That being the case we see no reason to allocate assets to European or Japanese government bonds, and are therefore eliminating our exposure to International Government bonds (IGOV). We still have some exposure to emerging market fixed income since their balance sheets are much better than the developed worlds. Those holdings were reallocated to our other fixed income holdings.

The second big change we made was to eliminate our US Total Bond market exposure (BND), which buys bonds all along the yield curve, and replace it with a purely Long-Term US Government Bond holding (BLV). If deflation continues to be a risk then these bonds should continue to do well. Alternatively, if inflation becomes a risk our holdings in TIPS and higher yielding bonds should do well. This is much more of a barbell strategy, to take advantage of what appears to be fatter and fatter tail risk.

 

Finally, we did a little house cleaning by eliminating one of our redundant commodity holdings (CRBQ), and reallocating the proceeds between (DBC) & (MOO). Overall we are still fairly defensively positioned with 37.5% in cash equivalents, and a total portfolio correlation to the S&P 500 of 0.38.

Investing is not rocket science, its about understanding and managing risk, "It's my job five days a week. A rocket man, a rocket man." 

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.