From the Desk of David Gratke

Archive for the ‘Bear Markets’ Category

Dow 9800, What is one to do now?

Monday, September 28th, 2009

This posting is a more detailed look at my August 20, 2009 posting

Commentary | Where do the markets go from here?

I’ve recently begun crafting a short list of topics that have me concerned when viewed against the backdrop of current stock market valuations. This list will be a work in progress.

I could be wrong about market valuations and this may just be climbing ‘the proverbial wall of worry.” However, I think it is important to review these topics and possibly act upon them in some measured manner.

“And the list please”….

The Issues

New Normal.. What is the new normal? It can include any of the following topics,

Slower Economic Growth
Higher Taxes
Higher Government Regulation-i.e. as we now see with CEO pay and bank overdraft fees trying to avoid such regulation
Deleverging-Consumer Spending accounts for 70% of US GDP-Paradox of Thrift
De-Globalization-The flip side of protectionism
Protectionism-i.e. China/Tires Imports/Les Schwab, is it just starting?
Higher Inflation-The one ‘easy’ way to retire massive debt-Just don’t tell your grandchildren!
US Budget Deficits

Other concerns

US Government Policy: not a welcome place for risk-based capital: i.e. GM, UAW vs. Bondholders
Cap and Trade-good idea, poor execution so far.
Baltic Dry Index-Reflects shipping trade around the world, should be going up if trade is growing
China/US Relationships; trade, debt financing, oil to Iran
Commercial Real Estate defaults
US Dollar Decline
National Security-will tough talk work with rogue nation states?
Commodities are up-why, where is the economic growth? Is China just restocking its shelves?
FDIC hole-i.e. FDIC considers borrowing from banks to shore up its reserves
Bank Balance Sheets, how strong are they, now?
Sugar High, what happens when the stimulus quits?
State Balance Sheets-California.. Who’s next if voters don’t want to be taxed more? Is Oregon in the ‘batters box’?
Unemployment-not going away soon-strain on state funding mechanisms.

The Possible Outcomes

Excessive Government
Higher Interest Rates
Higher Taxes
Stagflation
Unemployment to remain high
Cap and Trade, USA at disadvantage to countries without such tax
Protectionist ‘trade wars’
What else? Let me know what’s on your mind?-Contact Me

Investor Solutions

Wealth Preservation Strategies
Absolute Return Strategies
Inverse Asset Class Strategies

What does your portfolio look like against this current economic, political and social environment?

Ask for a proposal or a review of your plan today.

“Required Reading”

As for the market, I think that the markets are overvalued given the prospects for economic growth. When I read articles about a possible, sizable correction (upwards of 20%) I don’t find too much to fault in those articles.

Stock Rally Could Evaporate Once Stimulus Ends: Algerian
http://www.cnbc.com/id/32688645

Commentary | Where do the markets go from here?
http://www.davidgratke.com/blog/?p=70

Insight: Equities carry too much risk
http://www.ft.com/cms/s/0/5e449072-a859-11de-9242-00144feabdc0.html?nclick_c
heck=1

Mohamed El-Erian: July Rally Was A “Sugar High”
http://www.businessinsider.com/mohamed-el-erian-july-rally-was-a-sugar-high-
2009-7

Are Stocks Still Cheap?: A Long-Term Look at Bear Market Valuation
http://mybackpagesbyjessefelder.blogspot.com/2009/09/are-stocks-still-cheap-
long-term-look.html

Economic Vandalism, A protectionist move that is bad politics, bad economics, bad diplomacy and hurts America. Did we miss anything?
http://www.economist.com/printedition/displayStory.cfm?Story_ID=14450332

The Oregon Travail, Driving business away with billions in tax hikes.
http://online.wsj.com/article/SB124545298617532789.html

Posted in 2009 Predictions, Balance Sheets, Banking, Bear Markets, Consumer Confidence, Credit Crisis, Economy, Emotions, Exports, Falling Dollar, Inverse Asset Classes, Market Recovery, Mohammad El-Erian, Mortgages, New Normal, PIMCO, Portfolio Strategist, Preservation Strategy, Recession, Taxes, The Economist, Unemployment, Volatility, Weak Hands Strong Hands, Wealth Preservation | No Comments »

Commentary | Where do the markets go from here?

Thursday, August 20th, 2009

Although world stock markets have made excellent ground in recovering past years’ losses as reported in the Financial Times article dated August 15, 2009,

S&P surge beats post-war record (click to read article)

I continue to remain cautious regarding the longer term outlook for the US and world financial markets. Since nearly 70% of the US economy is consumer based spending, I don’t think the US consumer has gone far enough to repair his/her balance sheet from the past 20 years of accumulated debt loads and diminished savings, hence I do not see a typical recovery from the consumer. There is plenty to be concerned about; I will not elaborate on those matters in this blog. But rather, reflect on the current buzz phrase, ‘new normal’, as I have discussed this topic in previous blog postings found here. What will the new normal look like going forward?

I have found the following work of interest:

“Courtesy of dshort.com, here is another chart that makes the case to be cautious. The pattern of the 1929 crash adjusted for inflation is surprisingly similar to what we have seen since 2000.”

“Recognize that you can’t use the chart to predict the future. But what you can do is use the chart to realize the possibility of a prolonged bear market.”

Personally, I am still very cautious. We all have yet to fully understand, and appreciate, the debt loads the US Government is taking on and the full impact on both business and consumer alike. Is this mounting debt load a concern? Of course it is, and for that reason Warren Buffet inked an Op-Ed piece on this matter in the August 18, 2009 New York Times found here:

The Greenback Effect (Click to read article)

Selected text from Buffet’s article

To understand this threat, we need to look at where we stand historically. If we leave aside the war-impacted years of 1942 to 1946, the largest annual deficit the United States has incurred since 1920 was 6 percent of gross domestic product. This fiscal year, though, the deficit will rise to about 13 percent of G.D.P., more than twice the non-wartime record. In dollars, that equates to a staggering $1.8 trillion. Fiscally, we are in uncharted territory.

An increase in federal debt can be financed in three ways: borrowing from foreigners, borrowing from our own citizens or, through a roundabout process, printing money. Let’s look at the prospects for each individually — and in combination.

Legislators will correctly perceive that either raising taxes or cutting expenditures will threaten their re-election. To avoid this fate, they can opt for high rates of inflation, which never require a recorded vote and cannot be attributed to a specific action that any elected official takes. In fact, John Maynard Keynes long ago laid out a road map for political survival amid an economic disaster of just this sort: “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens…. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

What is Buffet saying here? We need to quit our spending spree, but do elected officials have the will to get off the ‘drug of spending?’

By including the chart above, I am not saying that we are going to follow a 1920’s style market decline. First of all, this economic contraction has been much less (so far) than that of the early 20th century. Year-t0-date, this economy has shrunk 3.9% as compared to the 26.7% collapse of the 1920’s. See chart below.

jpmgdp20091

What gives me comfort for my clients within my practice, is that I have asset allocation strategies that have endured much better than the S&P 500 index during the past ten years where the S&P 500 index returned a negative -1.3% annually.

In coming months, I may be recommending client’s shift more of their assets to wealth preservation and absolute return strategies along with continued use of inverse asset classes for such possible ‘range bound’ markets.

As Buffet said in the August 18, 2009 NYT piece,

The United States economy is now out of the emergency room and appears to be on a slow path to recovery. But enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself.

With that quote then, the paddles are standing by, fully charged…..

Thanks for reading.

Sources: Morningstar Advisors, dshort.com, JP Morgan

Posted in 2009 Predictions, Bear Markets, Commentary, Consumer Confidence, Credit Crisis, Economy, Market Recovery, Market Views, New Normal, Preservation Strategy, Wealth Preservation | 1 Comment »

Investment Opportunities in a Down Market

Wednesday, June 10th, 2009

What to do? What to own? Where to invest?

How well are you managing risk these days?

Over the years, I have analyzed many a client’s 401k statements. A typical 401k plan allows for many investment options in the name of diversification. Oddly, almost all of these options will lead to a similar result when markets move in any direction. That’s not diversification at all.

Many years ago, I realized that I would need to create asset allocations much differently than what the herd of the marketplace offered. The garden-variety asset allocation of large-company, medium-sized company and small-company stocks was not going to cut it. This doesn’t reduce risk.

What the investor needs is an “inverse” asset class that moves up during sharp, major market declines. This asset class offers superior protection against downside risk when compared to traditional asset allocation models. Traditional asset classes are highly correlated offering little downside protection during major market declines.

Years ago I also realized that creating client portfolios one ‘stock pick’ at a time was a kin to the surgeon awakening the patient from surgery asking for approval to tie another suture. This cobbled-together approach was of no interest to me. Rather, my desire was to create portfolios in a holistic approach thus maximizing the client’s probability for financial success.

This led me to the direction that I have been practicing for years, using the services of professional ‘strategists’ (which is what our industry calls investment firms that create asset allocations).

I have detailed this approach within my practice through a blog posting date July 11, 2008 titled “Dave, How Do You Construct Portfolios?” Therefore I will not spend time on this matter here. What I was looking for years ago, and thankfully found, was a portfolio strategist who exhibited forward thinking in portfolio construction. Simply, it was not good enough to just use past performance for asset allocation design.

A part of the forward thinking is the use of inverse asset classes to manage and mitigate short-term market declines. Although client assets were down in 2008, the use of an asset allocation design to include inverse asset classes reduced the size of decline compared to the broad market. Let me review and focus on the asset allocation tools inside my ‘virtual’ toolbox that have offered superior risk mitigation in 2008 and well in to 2009.

What are these Inverse Asset Classes?

Let us look at the asset class that is at the heart of the inverse asset class strategy as described above. This tool is called AMP for Actively Managed Protection. AMP is a tool managed by a 150-year-old international asset manager, Credit Suisse Asset Management (CSAM). CSAM was hired to manage put options, an asset class that has been available to institutional investors for decades. Put options, which give the holder the right to sell a security at a fixed price, move in the opposite direction of the broad market indices. Put options have received a bad rap over the years, as many individual investors have been attracted to options for mere speculation. However, placed in the hands of professional institutional asset managers, put options serve their intended purpose, which is to mitigate large losses inside of one’s portfolio.

As can be seen from the chart below, when the markets fell in 2008, the cumulative return of AMP rose significantly. This is the design of AMP. A cynical individual might opine, why not just invest in AMP entirely last year? That would be speculating, and that’s what many ‘retail’ investors do with the asset class, and lose.

By the end of 2008, the conversation was no longer theoretical

As you can see in the chart below, the highest value of AMP in 2008 was on November 20th, the market low for 2008. AMP was doing exactly as it was required to do; move up in dramatic fashion while the broad markets plunged. Until this year, the idea of AMP inside a client portfolio was mainly a theoretical discussion as to how it could work in a severe declining market. By the end of 2008, the conversation was no longer theoretical.

amp1

The use of inverse asset classes can be found in a number of strategies available through my firm. Two of the strategies inside my ‘virtual’ toolbox that continue to offer superior risk mitigation in 2008 and well in to 2009 include:

Preservation Strategy (PS)

Risk Mandate: One downside risk objective

Active Return Opportunities (ARO)

Risk Mandate: Includes six downside risk objectives

A quick graphic review of the strategies during fourth quarter 2008 follows:

Below you will see 4QT 2008 (green) and full year (blue) 2008 performance of the Preservation Strategy compared to a 60/40 mix of S&P 500/Barclays Aggregate Bond Index as well as the S&P 500 Index.

During the fourth quarter (green), the Preservation Strategy declined a very modest 0.2% as compared to a 11.9% decline for the blend and a 21.9% decline for the S&P 500 Index.

For the full year (blue), Preservation Strategy posted a negative 4.7% as compared to -22.1% for the 60/40 blend and -37.0% for the S&P 500 Index.

wp1

Below you will see 4QT 2008 performance for three risk profiles for the Active Return Opportunities (ARO) Strategies. For each of the risk profiles, there are three asset allocation strategies, Domestic, Global and Current Income. The grey bars reflect the returns for the S&P 500 Index and the 60/40 index blend.

In all ARO profiles, fourth quarter return was much less negative for all strategies when compared to comparable unmanaged indices.

gfam2

I offer those of you who are not David Gratke Wealth Advisors, LLC clients the following:

A Cup of Coffee and a Second Opinion

When the markets turn as volatile and confusing as they have over the past year, even the most patient investors may come to question the wisdom of the investment plan that they’ve been following.

At David Gratke Wealth Advisors, LLC, we’ve seen a lot of difficult markets come and go over the past twenty-three years. And we can certainly empathize with people who find the current environment troublesome and disturbing. We’d like to help, if we can, and to that end, here’s what we offer, a cup of coffee, and a second opinion.

By appointment, you’re welcome to come in and sit with us for a while. We’ll ask you to outline your financial goals – what your investment portfolio is intended to do for you. Then we’ll review the portfolio for and with you.

If we think your investments continue to be well-suited to your long-term goals – in spite of the current market turmoil – we’ll gladly tell you so, and send you on your way. If, on the other hand, we think some of your investments no longer fit with your goals, we’ll explain why, in plain English. And, if you like, we’ll recommend some alternatives.

Either way, the coffee is on us. Thanks for reading.

David Gratke

Disclosures:

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