Transcript Slide 1

"It is impossible for a man to learn what he thinks
he already knows.“
-Epictetus
March 8th Announcement
9:30am Market Outlook SIG
Alice and I will do a program on High Yield Bonds
(Junk Bonds)
A YEAR IN REVIEW
Did you notice the record, gravity-defying, streak of the last couple of
years? The market remained in the black for two consecutive years, a
feat it accomplished just once before in modem history, in 1975 and 1976.
(That would have been right in the middle of the go nowhere streak from
February 1966 to August of 1982.) You didn't see too much about it in the
press, nor on television. It was rather like Jeff Somer said in the New York
Times: "It was a string of no- big-deals, Steady Eddie
achievements - much like ... Cal Ripkin Jr. who showed up at the baseball
park every day for so many years that people finally realized that they
were staring at acts of unprecedented, monumental proportions."
So, are stock valuations being stretched? (Is the Pope Catholic
and Argentinean?) You can count on it! As many of our loyal
advisors know, we have written about the Ben Bernanke equity
markets as well as the Bernanke bond market of 2013.
Quite the show.
Interesting to note that this streak ended when trading began for
the year on January 2nd and as of this writing, is down more than
a point for the first few days of the year. But what a streak! What
a stealthy rally! Can't argue with that, but what RISK was taken
and what's the risk going in to the future? What are the
implications of that streak?
Well, for advisors and investors who are focused on risk, "a rally of
the dimensions of the last two years has consequences", says
Somers. The first consequence is that the increase in stock market
prices outstripped corporate earnings. They were cheap in
the beginning but expensive today. Paul Hickey and
Justin Walters of Bespoke Investment Group put it this
way in their report: "2013 really marked the year
where investors recognized that equities were
attractively valued." But then, that realization
changed the market: Investors bid up prices, and by
year-end, valuations had shifted sharply. In other
words, let's all jump on the bandwagon! Whoopee!
The Bespoke analysis focused on price-to-earnings
ratios and when coupled with Bernanke's
pronouncements, that valuation shift accounted for
nearly all of the market's gain. Many analysts have
noted that stocks may no longer be a bargain; that
investors now will be taking on greater risk. (Risk: not
our cuppa tea, as you know.) Another way of looking
at it is the market is not now a bargain. (Surprise")
Do we expect a reversal? No.
Markets sometimes rise after they are overvalued. Do we
expect more of the same rally to continue? No,
although markets can expand further at the end of a
rally and maybe even further than they should, they
also have a tendency to overshoot. Do we expect the
markets to extract punitive damages such as they did
beginning in January of 2000 or what came after July
of 2007? Let's just say we respect the ferocity of an
unbridled market. As those of you who have been
reading this column for many years realize, WE
DON'T WORRY about the market rising or falling.
We advocate using non-correlated, tactical managers
who have the ability take advantage of both sides of
the market, or at least use cash in a downturn.
Unfortunately, it is not as easy to assess the
risk investors are taking in their portfolios as it is to
look at performance. Weare all being bombarded by
performance, performance, performance in the press
and TV. It's hard not to focus just on performance
because quantifying risk can be a difficult process.
That's the best reason that our advisors use a
measurement of semi-standard deviation, to better
define how much downside protection an investment
has had.
So, look carefully at the risk in the markets. Again: not just
performance, but market risk! That's definitely the focus
in 2014 and brings up the question: Are buy-and-ho1d investors
counting on a third year of abnormal returns?
At this point in the narrative, we are reminded of the Dos Equis
TV advertisement where the roue says
"Stay thirsty, my friends." Our take on that is "Stay vigilant, my
friends, and tactical."
GENERAL MARKET COMMENTARY
The stock market had an amazing year in 2013 with the S&P up
32.1%, but the consistency of the gains throughout the year in a
lackluster economy raises some questions. What do these strong 2013
returns mean, if anything, for the 2014 outlook? Although economic
reports have shown recent improvement, and bearish technical
warning flags are absent, this is not the time to get complacent. One
reason for concern is that 2014 is a mid-term election year. In the 4year presidential election cycle, the year of presidential elections has
been the strongest, but the mid-term election year has been the
weakest as well as the most volatile. The chart at the right shows the
average quarterly performance for each year of the cycle since 1940.
Looking at year two (where we are now) shows a small gain of .7%
for the first quarter, but losses for the second and third quarters.
Then, the 4th quarter finishes the year out with the largest quarterly
gain of any of the entire cycle. Actually, the S&P has finished the
4th quarter with gains about 90% of the time with an average gain
of 7.8%.
Based on the overbought condition of the current market and the
optimism among investors, the most likely path may be a pause
until later in the year.
As far as the bond market is concerned, although the Federal
Reserve will continue buying smaller amounts of bonds back to
keep liquidity in the system, short term interest rates may have
another two years before they actually start rising. We will continue
to watch for signs of inflation which may accelerate the efforts of
tightening monetary policy
STOCKS, BONDS, AND INFLATION
Sometimes it is a good idea to take a few steps back to gain the big
picture perspective when evaluating investment alternatives. While over
the short run it is easy to get caught up in investment opportunities, it is
important to keep expectations in check. Gold, for example, has been
used as a fiat currency, and when uncertain times arise, many investors
flood the market and have unrealistic expectations. Over the long term,
gold has appreciated at about the rate of inflation, with big movements
that eventually play out, and prices that revert back to the mean over
longer periods of time.
This chart is an interesting study of the rate of appreciation of various
assets since 1934. The S&P Stock Index has appreciated at an
annualized rate of 10.7%, or about 7% after adjusting for the inflation
rate. At that rate an investor’s assets will double every 10 years, even
after adjusting for inflation. However, there are some years when there
are losses even when investing for a decade, causing investors to lose
heart and many times do the wrong thing. ,
High yield bonds have produced a return averaging about 3% less
than stocks but with much lower volatility or losses. This makes
them ideal lower-risk vehicles for people who don’t want to ride the
investment roller coaster. They also trend much more consistently
and can be easier to trade when the time is right.
Three-month treasury bills or short term CDs have returned only
the rate of inflation, causing no net investment gain, yet investors
must pay tax on the privilege.
Study this chart and ask yourself what kind of investments may be
suitable for your future.