Preserving Independence

"I place economy among the first and most important republican virtues, and public debt as the greatest of the dangers to be feared. To preserve our independence, we must not let our rulers load us with perpetual debt." -Thomas Jefferson

Whose Line Is It?

"The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the U.S. Government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our Government’s reckless fiscal policies. … Increasing America’s debt weakens us domestically and internationally. Leadership means that ‘the buck stops here. Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better."

Whose line is it? Well, if you guessed Barack H. Obama you are correct. Here is the link to his Congressional testimony 3/16/06, just four years ago. 

http://origin.www.gpo.gov:80/fdsys/pkg/CREC-2006-03-16/pdf/CREC-2006-03-...

Now the Presidents economic advisor, Austin Goolsbee, say's that a refusal by the Senate to increase the government's debt ceiling would be "catastrophic" and a sign of "insanity". Well, which is it Mr. President, insanity or a sign of leadership failure? 

Rational Expectations:

In my last post "2011-2020 Prognostications" I shared my little excel spreadsheet for calculating future returns in the stock market. At the end of that post I said that investors might expect 2.5%-3.5% real annualized returns from stocks over the next decade. Some thought that this was an excessively bearish forecast, but the fact is that the US stock market has averaged an annualized real return of 1.95% from 1871-2010.

I've been working on getting some year-end performance numbers together and happened to stumble across an excellent web site, Visualizing Economics ( www.visualizingeconomics.com ). They had a series of charts showing the long-run performance of stocks and GDP growth. Excellent stuff if you are as addicted to chart porn as I am.

This is the first of a series of visualizations based on the stock market data used in Irrational Exuberance. Written by Rober Shiller, this book explores the reasons why bubbles form in stock markets and housing markets. You can find his data at IrrationalExuberance.com

Another stock graph similar to Exponential Growth Rate of US Stocks since 1871 except this one is plotted on a semi-log scale to help illustrate the price movement of S&P Composite Index. For example, the percent change in the index’s value during the 1990s “Internet Stock Bubble” (a little over  250%) was similar to the price change during the 10-years preceding the 1929 Stock Market Crash.

Log scale version of yesterday’s Real Growth of US GDP graph. If you look at the Long-term Stock Growth graph, the slope of the trendline looks similar to the US GDP trendline. However, when you calculate their annualized growth rate from 1871-2009 you get:

Annualized Real Stocks Price Growth    1.95%
Annualized Real GDP Growth                  3.47%

How could Real GDP grow 1.5% more than Real Stock Prices? The answer may lie in the fact that GDP includes all US businesses (public & private), and many non-public (sometimes smaller) businesses have much faster growth rates than their much larger publicly traded counterparts. 

I'll have another post in the near future going over 2010 performance for a variety of 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.

2011-2020 Prognostications

"Those who have knowledge, don't predict. Those who predict, don't have knowledge." - Lao Tzu 600BC - 531BC

'Tis the season for 2011 prognostications, the papers and blogosphere are filled with the hot air of market prognosticators pontificating on the future, which of course none of us know. This annual ritual of predicting what the new year will bring is relatively harmless, assuming investors take it as entertainment and not investment advice. I want to reiterate this point again, my predictions are for entertainment, we manage money based on what is happening in the markets, not on what we or someone else thinks is going to happen.

I've always been fascinated by magicians, their slight of hand, and their ability to make us see what they want us to see. This art of illusion is also practiced in the investment community. So called guru's bring out the charts and graphs, and try and show you what will happen if you only believe. But reality is a very different beast. The December 20 issue of Barron's brings together 10 market strategists and gets their opinion on 2011. Last year at this time these seers forecast an average gain in the S&P 500 of 5%, so far the actual gain is about 12.7%, so they only missed it by 154%. This year, emboldened by 2010's strong advance, they are forecasting the S&P 500 to gain an additional 8.5%. 

I'm not trying to diss these gurus, annual forecasts are incredibly difficult, there are just too many short-term factors that can derail the most diligent prognostications. I can draw up perfectly plausible scenarios that show why the S&P 500 should fall 10% or more (chief on the list would be a State's near default and subsequent bailout by the lowly US taxpayers), or why it might rise 10% or more (Congress repeals Obamacare and makes serious cuts in spending). But again, the reality is, no one knows!

If you are at all interested in a serious forecast, let me let you in on a little magicians secret formula. I've developed a simple excel spreadsheet that will tell you exactly what return you will get by investing in the stock market over the next ten years. Stop laughing, I am serious here. This spreadsheet is 100% accurate, all you have to do is provide me with two inputs; 1) what will the annualized earnings per share growth be over the next ten years, and 2) what will the Price-to-Earnings (PE) ratio be at the end of our ten year period. That's it, two simple inputs and you too will be a market guru.

Seriously, let's take a closer look at this. The markets future returns are made up of several factors; the current price, the current earnings and future earnings growth, the current dividends and future dividend growth, and lastly what investors will be willing to pay for that earnings and dividends ten years hence. If we break this down you can see that we already know some of the variables.

First, the starting price is today's S&P 500 $1,256.77.

Current year estimated earnings are $71.86.

Which gives us a starting Price-to-Earnings (PE) ratio of 17.49x (1256.77/71.86).

And, lastly our current dividend yield is 1.87%.

Now that we have a starting place we can attack the unknowns. First, ten year annualized earnings growth. Over the last 82 years S&P 500 earnings have grown at about a 6% annualized rate, do you think earnings growth over the next ten years will be greater than, or less than 6%? Clearly there are numerous variables that will impact your decision, but the most important one is your estimation of GDP growth and inflation. For brevities sake lets assume that since the US and most of the developed world is caught in the early stages of a generational de-leveraging earnings growth will be less that the debt fueled historic 6%. Let's say 4%-5%.

Next is the hard part, what will investors be willing to pay for those earnings and dividends in the year 2020? A lot goes into PE ratios; expected earnings growth, expected inflation, and expected interest rates are the main factors. The higher the earnings growth, the lower the inflation and interest rate expectations, the higher the PE ratio. And conversely, the lower the earnings growth, and the higher the inflation and interest rate expectations, the lower the PE ratio. Since it is impossible to know with any semblance of certainty, what these variables will be in 2020, we use history as a guide. The average PE ratio over the last 82 years has been 15.95x. We are currently at 17.49x. At earnings peaks the PE ratio drops to 12.94x, and at earnings troughs the PE ratio is at 18.82x. Now what do you think will happen to the current PE ratio of 17.5x over the next ten years, will it expand or contract? Your guess is as good as mine, but if we assume it contracts a bit from 17.5x to the historic average of 16x, then we can expect an annualized total return of 4.95%-5.94% between now and 2020. Not outstanding, but not horrible either in a world of 3%-4% interest rates. Now this is nominal total return, before inflation. If we assume inflation of 2%-3%, then our real return falls to 2.5%-3.5% range. 

That's it, that's how simple it is to become a stock market guru.

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.

Let It Snow!

Let It Snow!

by Santa Ben (aka Ben Bernanke)

Oh the economy outside is frightful,

But the printing press is so delightful,

And since no one can tell us no,

Let It Snow! Let It Snow! Let It Snow!

We won't show any signs of stopping,

And we'll blow some bubbles for popping,

The rates are set way down low,

Let It Snow! Let It Snow! Let It Snow!

When we finally turn the press off at night,

How I'll hate going out in the storm!

But if you'll hold me and tell me I'm right,

All the way home I'll be warm.

Our currency is slowly dying,

And, my dear, we're still trying,

But as long as consumers say no,

Let It Snow! Let It Snow! Let It Snow!

Wishing you a Christmas & New Year filled with delight,

The Wiles Family

As we enter the year-end stretch, we do so on a high note. Since 1928, December has been one of the most profitable months of the year, up 1.8% on average. And December 2010 is turning out to be one of the best Decembers for equities in the last 82 years. The S&P 500 is up about 6% month-to-date, and 14% year-to-date. 

This bullishness and increasing bullish sentiment is setting us up to enter 2011 a tad over-bought, which naturally makes us nervous, but I guess over-bought is better than over-sold. 

So, in the Spirit of Christmas, I'll accept Ben's money falling from the sky, and not worry about the consequences until next year.

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 Ask Me No Questions, And I Won't Tell You No Lies

So, don't ask me no questions
And I won't tell you no lies
So, don't ask me about my business
And I won't tell you goodbye

Listen to the song here: Lynyrd Skynyrd - Don't Ask Me No Questions (studio version)

The Federal Reserve is meeting today, and in all likelihood will not make any substantive changes in their recently enacted quantitative easing policy. It has been too short a period for the Fed to reverse course, even though interest rates have gone in the exact opposite direction than they'd wished...up. That's right, the Fed's hope was that by printing money to buy nearly all of the Treasury bonds being issued they would drive interest rates lower thereby stimulating the economy. Unfortunately the exact opposite has happened. Interest rates on 5 and 10 year treasuries are up about 60 basis points, while 30 year treasury yields are up about 30 basis points.

What gives? One explanation is that the markets anticipated the Feds QE2 and yields declined prior to the official roll-out of the program. Another explanation is that the economy is improving and rates are rising to reflect that. A third explanation is that the bond vigilantes see the Fed's policy as dollar de-basing and long-term inflationary, and are therefore requiring higher yields to lend to the US. The truth is probably a combination of all of the above. Whatever the reason, the fact is that rates are higher, mortgage rates are rising, municipal borrowing costs are higher, and inflation is higher.

We have been lightening up on our fixed income holdings as our indicators have moved to neutral territory, but we are not at minimum weight yet.  

Even with rates headed up there is still a strong case to be made for lower rates in the near future. The reason for this is the continued de-leveraging happening on both the consumer and government levels (especially state and local governments). As consumers and governments retrench, and attempt to live within their means, economic growth slows and deflationary forces take hold. This is exactly what Chairman Bernanke fears...a deflationary spiral. 

  

Last week Fed Chairman, Ben Bernanke, needed to go on 60 Minutes to explain to the American public why quantitative easing was necessary (unemployment is not going down anytime soon), and why all the naysayers were wrong about the Fed printing money. He was also bold enough to say, with a straight face, that he was 100% confident that the Fed will be able to raise interest rates at the appropriate time to prevent inflation. Wow, 100% confidence from the same man who in March of 2009 said, "It's hard to forecast where we're going." This 100% certainty from the same man who told Congress in 2007 that the impact of the subprime crisis is "contained". The most glaring statement came when Bernanke said, "We're not printing money. What we're doing is lowering interest rates by buying Treasury securities." This statement was in sharp contrast to what he said on 60 Minutes to the same reporter 21 months ago. Asked if its tax money the Fed is spending, Bernanke said, "It's not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed. It's much more akin to printing money than it is to borrowing." "You've been printing money?" Pelley asked. "Well, effectively." Bernanke replied.

OK, maybe Bernanke believes that the American public doesn't understand the creation of money out of thin air, or maybe as Jon Stewart of The Daily Show says, "I guess Bernanke was looking at the average age of a 60 Minutes viewer and betting anyone who saw him last year is dead now."

Please watch this excellent video clip that catches Bernanke in his bold faced lie; The Big Bank Theory 

And, if you want to watch the 60 Minutes videos the links are here; for 2010 60 Minutes Video - Fed Chairman Bernanke On The Economy - CBS.com  and here for 2009 Ben Bernanke's Greatest Challenge - 60 Minutes - CBS News

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.

Buy & Hold Is Dead...The Trend Is Your Friend

The chart above shows 12 years trading history of the S&P 500.

I often find it rather refreshing to remind myself about why I manage money the way I do. So much of our industry (mutual funds, pension plans, etc.) is built on convincing investors to "stay the course", or "buy and hold". This is because the entire industry is set up to grow assets under management (AUM), if AUM grows then fees grow. AUM won't grow if we have investors trade out of our funds and into cash! 

On December 31, 1998, the S&P 500 closed at 1229.23. Today, nearly 12 years later it is at 1243, basically unchanged. But over the course of those 12 years we've had a few opportunities to make money, and a few opportunities to protect the money we've made. We started with a 68% rally to the 2000 top, then a 50% sell off to the March '03 lows, then a 104% rally to the October '07 top, then a 58% drop to March '09, and lastly an 83% move up to our current highs. Yeah, stocks haven't done anything over the last 12 years, if you are a buy & hold investor! 

Fortunately, our style of managing money is to be in harmony with the markets; participate on the upside, and get out of the way on the downside. While we can't forecast the future, we can at least determine the type of market (bull or bear) we're in today.

The beauty of Global Tactical Asset Allocation (GTAA) is that these dramatic bull and bear markets occur in all assets, (stocks, bonds, commodities, and currencies) on a global basis. A disciplined allocation process helps you find those assets that are rising, and avoid those that are falling. And in my world, if nothing is working, cash is just fine.

The most important AUM to me is my own Assets Under Management. My job is to protect and grow them, while generating the highest risk-adjusted return possible. My clients all have the same objective and portfolio as me, our goals are the same, as are our expenses. No conflicts of interest, no ulterior motives. If you would like to talk about my process in more depth, 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.