The Big Picture for the Week of July 1, 2012

Yesterday in the middle of the day I looked at a chart for the S&P 500 and noticed the following important formation as follows.

Ok, a humor attempt as the market blew off some steam and rocketed higher. Based on what I read and my twitter feed I would say the actual trading seemed far more euphoric than the sentiment that exists but that is hard to say. Going by the book, the more skepticism that exists the better chance the market can still work higher and if participants are giddy then it would probably go right back to where it came from. We'll know soon enough.

There is nothing in the previous paragraph that you have not read before somewhere. A point made here repeatedly over the years is that although the details might change, markets tend to behave the same which is hopefully comforting and might make navigating a market cycle a little easier. There are aspects of market movements that are reasonably predictable. There are no absolutes and no guarantees but understanding normal market behavior might keep you away from the herd mentality.

On an unrelated but positive note another firefighter and I performed CPR on a medical call yesterday and it worked!
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Fallacy of Explanation

Yesterday was a very interesting day for markets. US markets started noticeably lower then went quite a bit lower from there before retracing a meaningful chunk of the decline to close down 21 basis points. Nassim Taleb has talked/written about people's need for market moves to be explainable. He says that everyday they tell you the market was up such and such or down such and such because of this or that but that it is all noise. The market, he would have you believe, does what it does...period.

I agree only to a point. Sometimes the action in the market on a given day can be easily attributed to news of the day. That day in October 1997 when circuit breakers closed the US market early because of a large decline was clearly attributable to the Asian Contagion. Likewise in the first couple of days after September 11 when the market declined was pretty easy to understand. But not every day's trading can attributed to news.

Yesterday's step off was blamed on the Supreme Court ruling on Obamacare. Then the snapback was attributed to positive rumblings out of Europe. Whether that description is noise or a real explanation is up to each investor to decide for themselves.

Related to noise is a comment left by a reader asking bout our recent trade where we increased exposure to the healthcare sector shortly before yestrerday's ruling. My thought before, and this is still the case now, was that for most stocks in the sector this is more noise than anything else. It has been reasonably telegraphed that the stocks most exposed either way are the insurance companies and the hospitals which we don't own.

This sort of dynamic where the fear of the thing being bigger than the actual thing is a behavior that repeats over an over in market history. That the court would make a ruling was widely known well in advance and usually widely known well in advance means a faster reaction and faster than normal return to the status quo versus something that very few people see coming.

While there is plenty of hindsight bias around the financial crisis many did not see it coming. Think about all the commentary and speeches from government officials and Wall Street talking heads; most people said there was no serious problem. Four or five years later (depending on how you count) and we still have big problems. Of course time may prove me wrong about the lasting impact of yesterday's ruling but that goes with the territory of actively managing a portfolio.

The picture is a coffee house in Auckland and completely unrelated to the post.
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LIBOR Scandal

A reader left a comment yesterday noting the LIBOR scandal and he said "it never ends."

Yes, this is what I have been saying for years now in terms of other shoes will continue to drop. This will continue to play out, by this I mean bad news for the largest US and European banks. The totality of the banking crisis is still years from being solved.

Short post, big testing day for RRGR.
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Doom With a Healthy Dose of Despair

Yesterday was a tough day on the internet. There was this article by Paul Farrell wherein he says no matter what you do your retirement plan will fail, this interview with Jeremy Grantham detailing how short the world will be on food in a couple of decades and this quick interview with Mark Cuban who has little to no faith in the current state of equity markets and seems to be saying do it yourselfers have no shot of a level playing field.

The articles, especially the first two, are genuinely depressing  but of course the end of the world has always been a best seller. Much of the world is many years into some sort of financial deterioration that is unlikely to wrap up soon. There is also a stretching of the world's resources whose outcome is yet unknown.

With regard to Farrell's assertion that our attempts at retirement are futile, he focuses a lot on the extent to which Wall Street is out to get people (my words not his although he has probably said that before). Even if you believe that Wall Street is out to get people it is pretty clear that a much greater percentage of market participants (the ones who are left which is an issue for another post) do not rely on Wall Street advice or the more complex Wall Street products. I don't believe that ETFs that track baskets of stocks are complex Wall Street products.

The advent of simple ETFs and sites like Seeking Alpha give do-it-yourselfers who are willing and able to spend the time a decent shot of having enough money when they need it. The notion of 0% savings rates, $25,000 401k balances and financial illiteracy absolutely are problems for society at large but far less so for people who by whatever circumstance are engaged in markets.

People willing and able to spend the time (and save some money) can build a portfolio of a few dividend stocks, a couple of country funds and a broad index fund, then pay some attention to what is going on in the world and their portfolios and probably come out at least ok (no guarantees). This can occur with little to interaction with Wall Street in the way that I think Farrell is using the term.

There are a couple of rays of hope from the Grantham interview. He seems to believe the food shortage will be much less of an issue (maybe even a non-issue?) in the US. Yes that can be taken as being horribly selfish but if things are ok here then it will be easier for the US as the world's richest nation to be part of the global solution. The other thing is that whenever I read this line of thinking from Grantham there is never mention of technological advancements that could help stave off what might be coming. I tend to believe there is a Moore's Law aspect to all types of innovation and while the problem may not be solved by the time it needs to be there can be dramatic progress made.

Cuban uses the Flash Crash as a microcosm for what is wrong with capital markets. The argument as laid out in the interview linked above actually seems disjointed. He seems to be saying that high frequency traders are like hackers who are disadvantaging investors but as he acknowledges that spreads might be tighter it doesn't really matter for investors because they are buying for the long term.

It is very unlikely that HFT is a net positive but in the example above of a buying a few dividend stocks, a couple of country funds and a broad index fund it shouldn't impact your long term result. A point I have made before is that it would of course be better to not get hosed by a nickel a share when you buy a stock you plan to hold for many years but the difference in performance over your holding period is very unlikely to be measurable.

As far as the flash crash, it was a lightning fast panic that turned out to be a malfunction of some sort. It should have never happened but it did and some other type of malfunction could easily happen again. Recognize these for what they are, panics or as I said during the flash crash; puke downs. Also repeated from past posts is that a basket of stocks that was worth $50 a share at 2pm is not worth a penny 20 minutes later. Same with an individual stock where there is no deathblow news. Congress can try to figure out how to prevent past malfunctions, all we need to do recognize a malfunction and not panic into it. With the last few blowups people have not been made whole in anywhere near the fashion I would have expected. You don't have to be made whole if you don't panic in the first place.

On a philosophical note the best thing would be to leave yourself as many options as possible. Saving more, spending less, living below your means, staying fit and figuring a way to monetize a hobby would all be relevant here.

On a lighter note there will be a fourth Jason Bourne movie coming in August but it appears to be about someone else who went through either the Treadstone or Black Briar program and stars Jeremy Renner who is the dude from The Town and Hurt Locker. No word yet on how much camera time the safety deposit box gets in the film.
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Status Updates

There has been some level of interest over the last few months about our project with AdvisorShares (thank you). We've been working with July 11th as the launch date and so with that right around the corner the work load has increased dramatically.

We have signed trading agreements with a couple of firms and set up what needs to be set up on the back end for trades to clear. We have a lot of testing to do starting on Thursday with my role being to submit fake trades almost everyday until the launch. The number of departments and personnel involved in supporting the fund at the custodian bank is far more than I ever imagined.

While this is all new to us it is old hat for everyone else involved which is very comforting. I'll try to share any news as we go along but things appear to be going smoothly.

Unrelated the fire season here in Northern Arizona won't quite go away yet. The humidity has gone up a little which is an early sign of our rainy season (which is the end of our fire season) coming but we are not quite there yet. Of course humidity is all relative, ahem, if we get an RH in the 20s during the summer we think of that as very humid but in Florida if their RH goes down into the 30s they consider that to be extreme fire danger.

Lastly Smitty, the dog I found on Walker Rd whom we fostered for a couple of months was adopted out last week. He's a great little dog.
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A New Bucket Strategy?

The other day the Yahoo Finance daily retirement article had a mention of something covered here many times; one-off expenses. There was also some discussion about health costs too. This makes a discussion about the bucket theory relevant. Buckets is the idea that is generally attributed to Ray Lucia (I assume he coined the term but am not 100% certain). At our firm we refer to it as the hierarchy of spending which for us is more about trying to pull from various accounts in the most tax efficient manner possible depending on a client's particulars. This really does vary from person to person and I would be cautious of generic advice in a magazine about pulling from an IRA first, second or last.

The bucket strategy seems to be more about time horizon with a short term bucket, a long term bucket and a mid term bucket that serves as a "bridge" between the two. The above linked article got me to wondering if buckets for different objectives as opposed to different time horizons might make more sense. Off the top, three such buckets might be regular monthly expenses, healthcare expenses that are above and beyond and a bucket for one-off expenses above some significant dollar amount. Significant relates to the retiree's budget. Chances are that a $20 on-off could be covered in the normal monthly income but maybe a $1000 one-off would be a different story or for some people maybe $500 is an issue or $2000; whatever is significant.

The normal monthly expenses (including health insurance) is typically the first thing that comes to mind with retirement planning. This is lifestyle and reasonably speaking a huge priority. Some of these expenses haven't been going up much in recent years like maybe the internet or cable TV. Some have probably gone up a lot like health insurance. Some others are probably pretty volatile like gas for the car and maybe groceries. We all have our own experiences here but headline inflation has been low for a while so at least some expenses have not gone up a lot.

If you live a $4000 monthly lifestyle in today's dollars before retirement then ideally you probably would hope for something like a $3000-$5000 lifestyle during retirement; $1500 would make for a very difficult adjustment and $10,000 is probably unrealistic. Either way it would be this bucket that would account for most retirement expenses and it would need to produce an income for hopefully a very long time. As the biggest bucket with a slightly more predictable time horizon this is where a "normal" asset allocation would come into play along with the 4% rule (for those who believe in the 4% rule).

If you have a $4000 lifestyle and believe you will get $2000 from social security then the other $2000/month would come from a $600,000 portfolio (again, if you believe in the 4% or less rule, and I do).

As for health care expenses this article from MarketWatch offers the unsubstantiated figure that each person will spend $240,000 on health care in retirement. This presumably includes health insurance so guessing $1000/month for 30 years then the $480,000 ($240k x 2) comes down to a $120,000 bucket. Maybe you want to pad that up to $150,000 in case you need an experimental, life-saving cuticle transplant (I make this same joke every time to keep things light).

Going along with this idea if you have the $150,000 already then it might be suitable to invest it in TIPs. The downside of course is that TIPs track CPI and health related expenses have been and probably will continue to go up at a faster rate than CPI. An asset allocation here is tricky because the money could be needed very quickly, not for decades or maybe never. One possible allocation strategy would be something "normal" and then if it is ever needed for a costly medical issue, raise a lot of cash so that a large market decline would not threaten paying for treatment.

Not only is picking an asset allocation for a one-off bucket difficult, just guessing how much is needed is difficult. In the past many readers have offered suggestions. Someone once commented $1000/month. That is hopefully too high for month in and month out but some one-off expenses will be in that neighborhood or even more (think home repair, car repair, vet bills as some examples).

If we go with a $500 monthly average and stick with the 30 year assumption noted above then in today's dollars the amount needed is $180,000. The inflation for these types of expenses seem to have a better chance of being covered by TIPs for someone who has that much.

Someone who is not quite there but who can seed this bucket with some amount of money might want to keep at least a year's worth of one-offs in cash, so in the example above this would be $6000. Keeping a year's worth in cash might seem high but this is money that is expected to be drawn upon regularly. As a general rule, money for any big expense that you know is coming should not be invested in something that can down in value for fear of not being able to go through with the paying for the big expense.

People with enough wealth might also have buckets for travel, helping family (think sandwich generation) or anything else that might come to mind. This entire idea may well be financially beyond most Americans  (based on whatever average 401k balance you read about) but is more plausible for people who care enough about investing to read stock market blogs.
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The Big Picture for the Week of June 24, 2012

As a followup to posts from earlier in the week about over confidence a reader asked for my take on how to avoid holding onto a stock, like Eastman Kodak, too long. There is no single answer of course or simple recipe for avoiding all of these. The best way to try to answer this is with various but different types of examples. Each incident like this will have unique aspects but there are things to learn from past Kodak-like stories to apply to future incidents.

One type of example is a seemingly obvious management goof. In the past I mentioned owning the old AOL stock personally when they announced their takeover of Time Warner. I was in a different part of the business back then and I was not blogging but it seemed like an obvious and ill-fated decision and I sold it right away. Although different at the detail level this seemed similar to Bank of America's (BAC) decision to take over Merrill Lynch which again seemed obviously ill-fated. Learning from the AOL news helped avoid most of the implosion at BAC as we sold it immediately after the Merrill news. Keeping on top of this requires having some understanding of a management's strengths and weaknesses and having an eye for the stupid.

Obsolescence is another thing to look out for. This is what Kodak was about. A reader left a comment about the old Digital Equipment in the same context. What about Polaroid? The stock market was pricing Apple (AAPL) like it was obsolete during the mid-1990s but the company figured a way to reinvent itself. Some companies do reinvent themselves which can make this more difficult but this happens. Sony (SNE) is trading like it is mostly obsolete. In Sony's case it seems like consumers no longer want to pay a premium for the brand. The TVs in our house are all very cheap, I've never considered buying a Sony. If we only get five years out of a $300 TV (we've done better than that) so what, it was $300. Keeping on top of this requires paying some amount of attention to trends in technology.

One example also mentioned here in the past is Bernie Ebbers having a $100 million margin loan against his Worldcom stock. There was a stretch were David Faber talked about this repeatedly and I would say he potentially helped a lot of people--those who were listening. Someone like this having outstanding margin loans was and still would be ludicrous. There is something that is kind of similar today with Aubrey McClendon and Chesapeake (CHK). I don't know the particulars here or whether McClendon still has margin loans but I don't own the stock so I don't need to spend time finding out but this is a warning even if CHK does not come anywhere close to meeting the same fate.

In the last 12 years there have been two huge mania (tech and then all things related to housing including bank stocks) and quite a few smaller ones (solar and Chinese solar come to mind). There will be other manias in the future. Recognizing these manias doesn't seem as difficult as recognizing obsolescence as much excitement is generated along with plenty of this time is different type of talk. Having exposure to a mania isn't the worst thing that can happen so much as having too much exposure to a mania. At one point a little over a year after First Solar's (FSLR) IPO the stock was up 1000%. If you are ever lucky enough to be on the right side of one of those don't be afraid to sell some every 100 or 200%. Someone selling some along they way would have made a lot of money on FSLR even if they held on to some shares all the way down in the stock's 95% decline since its peak.

One last type of example circles back to the financial crisis. I've joked a few times about how many times do you have to read that the housing market in Europe stinks before you sell the European banks? We sold Barclays (BCS) in December of 2007 and Allied Irish in March 2008. Neither was a top tick but both avoided catastrophe for the simple task of reading about them regularly. Note that these sales were months after early warning shot of Northern Rock's failure so there was plenty of time to process what was happening, not panic sell and still get out relatively early.

If there is a recipe here is seems to be a combination of different things including being lucky. An obsolete product wouldn't really be much help with the financial crisis so really this is a layer of investment process that we all need to figure out for ourselves. This can be done by taking little bits of process from others.
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Wait. There's Something Wrong With the Big Banks?

On Thursday the US equity market was down a lot with people blaming the lousy Philly Fed number and the Moodys downgrade of 15 global investment banks which was widely reported to be coming at the close. Credit Suisse was reduced three notches, several others were cut two notches and a bunch more were dropped one notch. You can click through to this link for the particulars. The ironic thing is of course that the downgrades makes it more difficult for these presumably weakened banks to conduct business which sort of interjects the ratings agency into the story.

The Philly Fed Index printed a negative 16.6 which was the second negative print in a row. In one of Bespoke Investment Group's emails yesterday they talked about negative Philly Feds being a harbinger of recession.

As for the financials this is simply another shoe that has fallen. I have been saying for years that there will be more shoes to drop for the big banks and I believe this continues to be the case and will continue into the future. Zooming out a little, the big banks still have all sorts of problems with future writedowns, gaining the public's trust, what still appears to be a lousy housing market and an economy that somehow still seems to have very little natural demand. We continue to avoid the big US and European banks. For our financial sector exposure we own a Canadian bank, Chilean bank, a foreign stock exchange, and index provider and recently we added a very small domestic bank that did not take TARP funds.

As for a recession on the horizons it has been several years since the recovery started and of course it has been shockingly anemic as recoveries go. For now the threat of fiscal cliff is still alive, Washington DC has not been functional for many years now but for whatever reason markets and the economy seem to be relying on something to come from DC to help "fix it." Regardless of what you think about that it does appear to be true; markets want government action from a government that cannot function and if Obama wins in November the stalemate could continue for the duration of his second term.

The longer term story is far more favorable in select foreign markets but this fact (if you even accept it as fact) has not mattered for stock prices in the short run. I have unyielding faith that better fundamentals do matter in the long run so part of the story here must be patience. For anyone new, select foreign markets does not include the Eurozone or Japan.

Last summer I thought we had headed into recession as some numbers did deteriorate. This go around either is a recession or it isn't but we know the current economic cycle will end because they always do. It is likely that the stock market will drop a lot whenever the next recession comes along and in so doing will breach its 200 DMA or any other defensive trigger point important to you. In this context you don't have to correctly predict a recession you simply need to be disciplined to your strategy. You might have an opinion but the fate of your portfolio does not have rely on your opinion, just your ability to be disciplined. Being disciplined should be easier than correctly predicting the timing of the next recession.


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Trade Executed

Earlier this week we bought the iShares DJ US Medical Device ETF (IHI) for most of our large accounts (large being defined as making economical sense for the client to own mostly individual stocks and some narrow based ETFs).

The first top down catalyst here is the idea of being late in both the economic and stock market cycles. The market is over three years from what appears to be the trough for both the S&P 500 and GDP growth combined with what for now is a still viable fiscal cliff. This makes the case for increasing exposure to more defensive sectors.

This is something I've been talking about for a while and started to implement quite a few weeks ago. We've brought the volatility down a little, increased the yield some and this trade although not much for yield does increase exposure to a generally defensive sector.

When the SPX briefly breached its 200 DMA a couple of weeks ago we were faithful to it but measured in only selling one very volatile stock that no longer really fits in with what I believe is going on with the market which is that we are muddling. There has been some volatility in the last few years of course but as a recurring theme to the blog we are not making much progress at the index level with the volatility and so now I think we will move to a stretch of little index progress but with a lot less volatility.

Perhaps this environment (if the thesis turns out to be correct) will then shed more light on the aging demographic theme that underlies many segments of the healthcare sector including medical devices. During the last decade plenty of things did very well and the index made no progress and so as we still appear to be in an era of no progress, there will be things that work. You know the population is aging and they will need more medical attention, even if it is getting more expensive, so there is a fundamental tailwind. I would note that this tailwind existed in the last decade without necessarily leading to Brazil-like (300%) returns.

We owned Stryker (SYK) in years past, this name is in the top ten holdings of IHI, but it was a very unremarkable hold, it did not hurt anyone but did not deliver much to the portfolio. The diversification available in the ETF has been a better way to access the space than a lower vol name like Stryker. More importantly is that I think it will be a better way to access the theme going forward due to the growthy nature of a couple of the larger holdings in the fund.

I expect we will move a little further into lower volatility and higher yield for the portfolio but will adapt if market action dictates.
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Beware Overconfidence!

Yesterday the comments on my post about yield on cost really blew up on the Seeking Alpha version. I noticed a recurring theme in a few of the comments that has popped on past posts related to overconfidence and hindsight bias.

One commenter was particularly dismissive of getting caught in a stock that ends up going the way of Eastman Kodak noting that stocks give a couple of years of warning for investors to get out. Many stocks do indeed provide warnings and some others are indeed obvious.

It does not take a forensic accountant to realize that typewriter company Smith Corona was doomed when Hanson PLC spun it off more than 20 years ago and likewise digital photography seemed like a pretty easy to spot threat for Kodak but there are plenty that have not been obvious that caught very smart people unaware and this will happen again in the future.

Fair to say that the financial crisis caught some very well regarded investors off guard. Perhaps Bill Miller and Chris Davis simply had the tide go out on them or not but think about how many people said that housing can't have a national decline, the yield curve inversion won't matter this time (here I mean 2007) and so on. Think about the iconic names that are now gone or just a shell; Bank of America (BAC), WaMu, Wachovia. Bear Stearns, Lehman Brothers, Fannie Mae Freddy Mac. Freddie Mac had serious accounting issues raised in 2003 which was a legit warning but it was not heeded by many.

As we have covered here many times before, stock market history is full of companies that could never fail but did and the confidence of some anonymous commenters notwithstanding, thinking this is easy is very hubristic. 

Anyone, I mean anyone, can get caught on the wrong side of one of these. This is why we generally have 2 and 3% target weights for individual stocks--if we get caught in one it will not cause any client to have to rewrite their financial plan.

Here's one that probably never gets talked about anymore; Boston Scientific (BSX). If you were involved with markets and individual stocks ten years ago you know how important the stock and its products were. I mention this because we used to own the name, we sold it in April 2005 at $28 and change. It is now below $6. You may or may not recall the buzz around this stock but the outcome up to now would have been unfathomable ten years ago.

I'm sure there are plenty of people who can hindsight bias their way around BSX and every other stock that has failed one way or another but this is a behavior that will do people in.

One personal note, it looks like launch date is still slated for July 11.
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Bizarre Reader Comment

In yesterdays blog post I mentioned Pfizer's (PFE) travails of the last few years and thought that a reader at Seeking Alpha would make a comment about being happy that their stocks stayed down. As requested;

In regards to your Pfizer example, I personally hope the DG stocks I own lag for ten years at a low share price - so I can scoop up even more shares for a better price! 

My (unedited) reply to this person that is as of yet unanswered;

what about PFE? It, like quite a few others cut its dividend several years after it peaked. What forward looking analysis do you do to avoid this happening to your holdings? PFE had fallen 50% behind XLV before it cut its dividend. Your comment implies you don't care about this scenario (even if you never owned PFE), is that what you are saying? Lagging for ten years will very frequently imply there is a problem (not every time of course) but you don't care until the dividend is cut?

I doubt that is what you mean but that is what your comment says and maybe you do mean that.  

Buying a stock at a relatively good value is different than hoping a stock performs poorly for a decade as this one commenter appears to be hoping for. 



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New Label for an Old Concept?

Over the weekend there were a couple of articles at Seeking Alpha (here and here) that very favorably discussed the concept of yield on cost investing. Here is the Investopedia definition which seems to differ slightly from what the Seeking Alpha articles were about.

The two SA articles seemed to focus on similar examples whereby holding a stock for many years and reinvesting the dividends lead to a much larger share position which then results in a much larger dividend payout when it comes time to start living off the portfolio. Part of the equation here is that the stocks selected grow their dividends reliably over time.

Taking an example from the first article on Proctor & Gamble (PG) as follows;

If you'd purchased $10,000 worth of the stock back in 1982, three decades ago, and reinvested dividends, you'd have 8,964 shares of stock today. Each pays $2.25 per share, so your income would be more than $20,000 per year.
That means every single year, you're collecting twice what you originally put into the stock - a yield to cost basis of 200%+. Oh, and your shares are worth more than $500,000, which is an extra bonus.

The second article had an example with client holding Johnson & Johnson (JNJ) that somehow ends up with a $53,000 annual dividend on a $275,000 position. You may have better luck understanding that example than I did.

Anyone feel free to correct me if I am wrong but all that seems to be happening here is assigning a statistical measure to the compounding benefit that goes with reinvesting dividends into companies that survive. Surviving is an important word as one reader commented on the survivorship bias embedded in the stocks chosen to make the point. This reader noted Eastman Kodak as an example of a former dividend grower gone bust. The author replied in the comments that he did the work on Kodak and despite what the stock has done, the 30 year result isn't a disaster.

The second article also devotes a lot of space to why the financial services industry doesn't like this strategy because it leads to fewer commissions generated. Commissions at the wire houses have been on the way out for many years. I left Morgan Stanley nine years ago and most of the office and products available were fee based not commission based back then. There may be plenty of reasons to question where any financial advisor is coming from but generating transactional commissions stopped being one of them in the mid 1990s.

As a quick side note the business of financial advice is not much different than most other professions. Some are crooks, some are incompetent and the vast majority moderately proficient or better. For what it is worth an advisor who stays reasonably close to the market (even if they never beat the market) and prevents their clients from doing anything truly stupid is at least moderately proficient.

No strategy is without drawbacks. If you don't understand the drawbacks of your favored strategy then you don't understand your strategy as well as you should and you're making an uninformed decision. Yield on Cost might be as great as the two articles assert but it has drawbacks. It relies on stock picking with the drawback there being choosing the wrong stocks. Also there is a certain amount of work that must go into following a stock holding and being correct about whether a decline is just a normal pullback or when something has changed permanently like many of the US banks in 2008.

There also needs to be ongoing forward looking analysis of the holdings. Not that anyone can be correct 100% of the time of course but taking an example from a reader comment on one of the YOC articles was Pfizer (PFE). This was a darling stock for a long time. Over the last eight years it is down 36% on a price basis compared to a 20% gain in price for the Healthcare Sector SPDR (XLV). The dividend kept being increased as the stock was going down until 2009. Then the dividend was cut in half and has been on the way up since.

If this article makes its way to Seeking Alpha someone might say that they had a chance to buy PFE at cheap prices although the 50% lag versus the sector is very meaningful IMO. All the more so when factoring in that XLV does have some yield of its own. I wrote a bearish piece on PFE for Motley Fool in May 2004 which is why I targeted the eight year time period.

The other issue is record keeping for taxable accounts. The dividend is paid which is a taxable event of course and then used to buy some number of shares at some price. This occurs every three months (for a domestic stock) and these records must be maintained for the occasion that the stock must be sold. Presumably the gain or loss must be calculated for each reinvestment that has occurred (I'm not a CPA, if there is an out for this somehow please leave a comment).

The intention might be to never sell but if something you've held in this strategy for 20 years becomes Kodak and you recognize it early you're probably going to want to sell. The record keeping issue is not necessarily a reason by itself to avoid the strategy but it is a drawback.

And again, all strategies have drawbacks.
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Sunday Morning Coffee

The Barron's cover story took a stab at Social Security and Medicare. The conclusion seemed to be that in a couple of decades the payouts/expenses will exceed the government's revenue unless something changes soon. There was also a pretty good explanation about how the trust fund is a series of IOUs. The article did not offer much in the way of ideas of what to do so much as seeming to support what the Ryan Plan (as in Paul Ryan from Wisconsin) is supposed to do.

Although I have not read the Ryan Plan there was one detail in Barron's that caught my attention in relating that medicare and medicaid would revert to the states. People would get a voucher that would go toward buying private health insurance which seems fine conceptually but that "its value would increase at the rate of GDP growth plus 1%." Hopefully there is more to it than that but as most of us have experienced firsthand, medical-related expenses go up much faster than that.

There was also some detail about the CBO baseline scenario (where it is assumed everything stays as is) and the alternative fiscal scenario which hopefully would be more realistic although Barron's believes that assumptions of future medical cost inflation is too low.

There was one very funny comment from a reader who noted that his senator believes no major changes are needed to which the reader said that "everyone should move to Pennsylvania because Social Security is safe here." Pretty good stuff.

We've gone over this here before, I believe the obvious is some sort of meaningful change to the program as we know it that will upset a lot of people. I have never thought that those in retirement or on the verge will face meaningful change but that people who are now somewhere between 45 and 55 will. It seems as though the situation is worsening slightly, but continuously as time goes on but that is open to debate as is the whole topic I suppose.

I get pushback on my belief that my wife and I will get nothing, our combined benefit would be a little more than $4500 month if we wait until age 70, but I do expect to get means tested down to zero and think it is prudent to plan accordingly.

Unrelated was an editorial in Barron's about a big evolutionary step in college level education. Read the editorial but basically there is network infrastructure whereby most or maybe all classes could be online and free (or much cheaper as time goes on). For now, completion of courses results in certificates not accreditation but the article says that can change.

The give-up of course is the college experience which has come under a lot of fire in the last few years as simply being too expensive of a tradeoff for the cost involved. While I view my college days as priceless, I only graduated with $3000 in debt (San Diego State was very inexpensive in the mid and late 1980s). Facing tens of thousands in debt for an undergrad degree from someplace that is not Harvard or Stanford should cause people to look for alternatives and the concept laid out in the article seems plausible and it was a fascinating read.   
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One Way To Implement A Low Volatility Portfolio

This article at Seeking Alpha looked at some data that shows that lower risk stocks when given enough time lead to more reward which is contrary to more risk to get more reward. The specific data may or may not have some sort of bias that skews the conclusion but there is something to this as evidenced by other studies of things like the various buywrite indexes, the putwrite index and the back testing of some of the newer low volatility ETFs that have become popular over the last year or two.

On this sight we have referenced John Serrapere's work on what he calls the 75-50 portfolio (he targets 75% of the upside with only 50% of the downside) quite a few times and I believe that someone who saves enough can have a reasonable chance of having enough when they need it by going the low volatility route.

Before getting to the meat of the post, let me say that this is not easy to do mentally. Going low volatility is to accept ahead of time there are going to be a lot of short time periods like quarters and individual years where  a low volatility portfolio has no shot of outperforming the broad market. These things should only be expected to win over long periods of time. How difficult is it to remain focused on the long term? In the last two weeks I spoke to one client who was concerned we don't have enough equity exposure and another who was worried we have too much.

For someone who wants low volatility, really can think long term and only wants to spend a little time (not a lot of time and not no time) I think the equity portion of a portfolio could be constructed with two or three low volatility ETFs and two or three individual stocks that would give a good saver a pretty good long term result. Not a market beating result in a given year but a reasonable shot of having enough when they need it while enduring what should turn out to be a smoother ride.

The point with the following names is not to pick the best funds or the best stocks but to explore the concept for the few people with the right temperament.

The PowerShares S&P 500 Low Volatility Portfolio (SPLV) has come out of the blocks with $1 billion in AUM and so far has been doing what it is supposed to do. For foreign I would still want a fund that avoids Western Europe and Japan. The EG Shares Low Volatility Emerging Markets Dividend ETF (HILO) obviously avoids Europe and Japan and has pretty much done what it is supposed to do since it launched. SPLV shows a 12 month yield of 3.25% and HILO shows an index yield of 6.44%. Where ETFs are concerned you cannot be certain that future dividends will be the same as past dividends. Both SPLV and HILO are in our ownership universe for smaller accounts.

In trying to pick a couple of low volatility stocks to go with the low volatility ETFs consideration needs to be given to the make up of the ETFs. Utilities make up 32% of SPLV and consumer staples is 29%. HILO allocates 29% to telecom stocks. These sectors tend to have high dividend yields which makes them susceptible to rising interest rates. In this context it probably doesn't make sense to pair these two ETFs with some giant regulated utility stock or ma bell because there is no reasonable chance of capturing any sort of zigzag in the portfolio.

There are stocks in the other sectors that have lower volatility and decent/safe yields. From financials I think Chilean and Australian banks can fit the bill, for energy there are plenty of high yielding integrated oil companies from all over the planet to look at, we own Johnson & Johnson (JNJ) for clients and hope to be able to hold it forever as an example from healthcare and there are others. The industrial and materials sectors might be difficult for find low beta but there is some yield to be had.

Generically speaking a mix of funds that have little to no financial exposure and a bank stock in a suitably sized position is not an unreasonable blend at the sector level.

This is not buy and forget. Work must still be done on all the holdings. As mentioned a couple of weeks ago the Australian banks face the threat of some sort of housing market problem. This has not necessarily been reflected prices thus far and may never be but the situation must be monitored. Likewise with the ETFs; with that much in just a couple of sectors you need to pay attention there as well. If an announcement was made that next week all regulated utilities were going out of business selling SPLV might be a good idea (I realize the silliness of the example).

Again, for the right temperament and for people willing to put in a little effort this could easily work.
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Iceland Raises Rates, Again

Iceland's central bank raised rates yesterday for the third time since March as "the domestic economy continues to recover with robust growth in demand and growing signs of a rebound in labour and real estate markets."

This is noteworthy because Iceland ripped the band aid off in the financial crisis allowing its banks to fail. Most of the rest of the developed world bailed out their banks (many of them anyway) and in some cases continue to bail--zombie banks.

Now, a few years later and Iceland has "robust growth" which is not how anyone could reasonably describe the US or the Eurozone. Iceland by virtue of being so small does not make for an apples to apples but they did the more difficult thing at the time in a way that other countries were not willing to do.

Actually the US is still unwilling to do the difficult thing. This point was captured on CNBC the other day and Zerohedge jumped all over it; why would politicians allow the free-markets to work and expect to be re-elected.

This is a point made here many times in the past which is that our political cycle does not seem conducive to solving the country's various structural threats. How can congress devise and implement a strategy to fix it when their seat is up in two years and they care more about re-election than anything else? The same dilemma probably even exists for senators and their six year terms.

While I have no societal solutions to offer I continue to believe that like Iceland, had the US taken more difficult, free market action we would be starting to see how we come out of this but that is not the case.
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Bond Market Twilight Zone

Bloomberg had a lengthy write up looking at the extent to which many sovereign bond markets have been distorted by a long list of variables including policy measures to promote growth and fear-based buying. The article attempted to explore whether this is a bubble or not and whether yields will remain low or go much higher, hurting investors. The article even includes "new normal" talk from PIMCO.

My take has been that prices are very high but could stay high for quite a while. I believe the fundamentals call for much higher rates which I would have thought would have started by now but obviously that has been incorrect. The Fed is planning to keep rates low for awhile still and no one should be surprised if low rate policies continue to be extended.

Germany, Japan and Switzerland have lower rates than the US does. Someone tweeted out yesterday that Swiss five year paper had a negative yield. While I could not find a quote on five year paper, this page from the SNB seems to have the Swiss ten year yielding 0.58%.

Many are calling this a bubble which is probably not the best word but the article had a great line from Blackrock noting that bubbles are about greed and the current bond market is about fear, people want to preserve principal.

This makes a lot of sense in terms of helping to understand the current dynamic but doesn't necessarily provide a look forward. If bubble is the correct word then that implies it will end badly with yields going way up and bond prices (and bond funds) going way down. If Blackrock is correct then they are obviously describing a fear based trade and at some point the fear subsides. When fear does subside does that not also result in yields going up a lot? That is obviously the debate and of course desperate policy in many countries are going to be around for a very long time so there may be no consequence either way for years.

Desperate policy can end before we get to 4% GDP growth and when it does end then it would make sense to expect fundamentals to matter and if the fundies to ever come to the fore then yields should go higher. This is the obvious risk, it may or may not ever matter but it is the obvious risk and avoiding the obviously risky is not the worst thing you will ever do.

One amusing note, the world is very worried about Spain, and rightfully so. At one point yesterday the yield on Spain's ten year was 6.8%. In the summer of 2006 there was a brief window where the US two year yielded more than 5%.
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European S&%# Storm

When I first read that the bailout of the Spanish banks was $125 billion it seemed like a massive number but based on the deterioration in markets as Monday went on, it apparently is nowhere near big enough. The story in Europe is of course ongoing and there does appear to be a contagion going from country to country although it is happening slowly.

We have been out of any meaningful European exposure for about four years ago. We have always been very underweight the region but we owned Telefonica from January 2006 until August 2008 which was our last exposure. We sold an Irish bank in March, 2008. From the top down I can't envision any sort of end to the crisis which if correct means Europe is years from getting right which is plenty of reason to continue to stay away. Long time readers might recall this as an going theme here.

All of the ten big SPX sectors were down yesterday (based on the sector ETFs I watch to keep tabs) but there were a few pockets here and there that were up. Not surprisingly tobacco stocks is one such group. This is a good reminder for a few things. Right here right now there is obvious uncertainty about various aspects of Europe and what that might domino into for other countries including the US

That a tobacco stock (or a drug stock or any other stock) could go up yesterday is a good reminder even just as a microcosm that there is demand for all sorts of things. People need to consume things in order to live and the companies that sell what must be consumed have needs that get fulfilled by other companies.

This is not a rah rah hold on no matter what post but in terms of thinking about the big picture and speaking to people whose goal is simply to have enough when they need it (proper asset allocation is crucial too), a good company is probably selling a lot more thingamajigs (to pick a topical word) than they did five or ten years ago and will be selling a lot more in the future. This should lead to earnings and dividend growth which will be reflected in stock prices when things normalize if it is not already reflected.

Obviously I believe in trying to manage the short term (something that may or may not be right for you) but it is important to understand and remember the long term. If you have a diversified portfolio of individual stocks it is very likely that at least a few of them have done quite well by any measure during the last ten years.
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Sunday Morning Coffee

The money quote from the Barron's 2012 Mid Year Round Table came from Fred Hickey talking about Zynga (ZNGA);

It is dangerous when a virtual hammer sells for more than a real one. 

There was also an ETF Round Table that intended to focus on alternative ETFs but a lot of pixels were devoted on exemptive relief which is probably not too helpful of a topic for investors as opposed to industry insiders. Perhaps most interesting was that there were no comments on the ETF Round Table article.

I meant to put this picture on yesterday's post about infrastructure but just as I was finishing up we got dispatched for a medical call that involved carrying a very large patient up hill in a Stokes basket for about a quarter of mile so when I got back I just spell checked and published.
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The Big Picture for the Week of June 10, 2012

IndexUniverse had a good writeup on investing in the infrastructure theme through ETFs. I used to write about the theme a lot. The theme is quite tangible and the money is being spent but obviously has not been a one way trade for the various stocks and funds targeting the sector.

There is a cyclical element to many of the stocks in the segment like ABB (ABB) which we sold recently or as another example Leighton Holdings in Australia is also down a lot over the last few years. Industrial stocks is one slice of the theme; the companies that make equipment used to build roads and airports and the like. Although they are part of the theme, from the top down they are industrial stocks first and will get hit hard when the market is worried about an economic slowdown. Conversely most of these stocks should do well during a meaningful lift for the overall market.

Another slice to seek out in the theme are stocks that behave a lot like utilities. This can include toll roads, airports, seaports and lately I've seen some coverage where people include pipeline MLPs in with this group. A couple of examples here include Auckland Airport (ACKDF) which yields 3.6% and whose chart for the last five years looks a lot like the iShares Utilities ETF (IDU), Aussie toll road Transurban (TRAUF) which got hit very hard during the early days of the crisis and has been pretty steady for the last couple of years yielding 4.69% and of course there are a bunch of toll road stocks from China and other countries but they are not always that similar to each other.

I've written quite a few times in years past about Jiangsu Expressway (JEXYY) which I have owned personally for a long time now. In the last five years Yahoo Finance has it down 7.9% (Google has it down 2%) compared to a more than a 40% decline for the Shanghai Composite. Several years ago I theorized that the right Chinese toll road might be a way to access China while avoiding the full brunt of the cyclicality and that has been the case I believe for Jiangsu but not with one of the other relatively big stocks in this space; Zhejiang Expressway (ZHEXY) is down 31%. Both have high yields, Jiangsu yields 5.6% and Zhejiang yields 7.1%.

It is not clear that MLPs should be considered as part of the theme but if you think so then there are plenty of individual companies to choose from along with an ever-increasing number of funds. For anyone unfamiliar, the work here with taxes can be cumbersome. If you own MLPs and don't know what I mean, I would advise you make a priority of finding out.

One thing I try include in picking a stock is trying to understand how it will trade but the financial crisis kind of skewed this. Several in the theme were crushed, I mean really crushed, because the capital markets stopped functioning for a while and there is a reliance for some companies on accessing debt markets. Those that needed access to debt markets when those markets were not functioning are the ones that got crushed and you can see that in some stock charts if you look. Some others went down in a guilt by association as I believe was the case with Transurban.

Anyone really worried about another market malfunction (note that this is different than a large decline) should probably avoid the theme although if you really expect a malfunction then you probably wouldn't be long anything.

In trying to look forward I would expect the industrial stocks in the theme to be more volatile than US big caps because of the more specialized nature of their respective businesses. On the way up this is probably a good thing but on the way down probably not. With the utilities-like stocks it really depends on which ones you choose. ACKDF and JEXYY do seem to have low volatility compared to some others. It would be reasonable to split a portfolio's utilities exposure between one "regular" utility like maybe a domestic regulated utility and a narrower theme oriented name.

We have two ETFs in our ownership universe; the iShares Global Infrastructure (IGF) and iShares Emerging Markets Infrastructure (EMIF). Both are a mix of industrial and utility stocks as opposed to the SPDR Infrastructure (GII) which is about 87% utilities or the PowerShares Emerging Markets Infrastructure ETF (PXR) which is a split between industrials and materials.

We have also owned the PowerShares Water ETF (PHO) for many years which also plays into the theme.
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Interesting, But Not Unusual, Observation

One way think about the market's decade and a half round trip to nowhere (the SPX first got to 1314 in April 1999) is as one big consolidation. Certainly some stocks have done very well but plenty of names have muddled along without making much progress price-wise but have gotten much cheaper valuation-wise.

One example of this is client holding Northrop Grumman (NOC). In the last ten years the stock is up less than 1% although there has been some volatility along the way. But in that time the PE ratio has gone from about 20 down to just over 7.5 and the dividend has gone from $0.20 to $.055.

This is not unique, Johnson & Johnson (JNJ) which is another client holding has tripled its dividend although there has been less in the way of multiple compression.

The message here is about stocks being relatively cheap when compared to modern history, like the last 20 years. I don't think this means much at all in the short run and maybe not even in the next couple of years but someone with 20 year time horizon is probably building a fantastic long term portfolio at these PEs and yields--this needs to include foreign stocks as well.

The obstacle is still the short run. NOC at 7.6 times and yielding 3.8% might be very cheap at $59 but if Europe implodes (further?) and the full brunt of the fiscal cliff comes into play in 2013 then NOC could easily trade at $45. Obviously that would be a much better price to buy for anyone favorably disposed to the name but what about the person who bought "cheap" in the mid or high $50s? If they bought low can they stomach the stock going lower?

This is about staying in touch with the suitable time horizon, remembering that markets occasionally go down a lot and realizing no one times all of them perfectly. The next recession/bear market will take stocks down a lot and then they will recover. A stock bought at $40 that goes to $90 ten years from now while doubling its dividend but does all of that by going to $27 first is not going to hurt a long term financial plan.

I realize most of this post should be an Investing 101 type of things but the above is easily forgotten at a time of emotion and will come more into focus on the next big downturn. Buying at a good price doesn't have to mean buying at the absolute lowest price.
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Wednesday Tidbits

Yesterday I was prepared  to take defensive action in our midsized accounts but it did not quite work out. Yesterday the SPX' 200 DMA was 1285.68. My plan, similar to Monday, was to wait until late in the trading day and place the trade if it was below the moving average. It was below for most of the day and then shortly before the close it went just above.

I figured I could wait until 3:58 EDT to place the trade, two minutes should be enough to complete a trade--a partial fill for an across the board trade is not a desirable outcome. The SPX stayed above until about 15 or 20 seconds before the close and ended the day 0.18 points below so same plan for tomorrow.

If the market takes back the 200 DMA and stays above then no further defensive action would be needed and in fact we would look to deploy cash in the large accounts with a tilt toward less volatility and more yield as mentioned in past posts in the last few weeks. The two recent sales have served to reduce the volatility.

Monday I had an article published at theStreet.com about the new AlphaClone Alternative Alpha ETF (ALFA). The fund "clones" hedge funds by investing based off of 13-f filings. Despite what would appear to be stale information the results the firm has published at its website are surprisingly good.

On the heels of ALFA Global X launched a similar product; the Global X Top Guru Holdings Index ETF (GURU). GURU is cheaper, has fewer holdings and all the holdings appear to be equal weighted. ALFA can allocate more to a stock if more managers report owning that stock. For example ALFA has about 7% in Apple while GURU as about 2%.

I was not able to find any sort of back test-like result for GURU on the fact page or investment case presentation but ALFA published a result of 17% annualized since 2000. If these funds do well going forward then a big part of the reason why will be that the ETFs won't have to overcome the 2 and 20 fund fees. And as far as the lag in reporting, apparently in AlphaClone's history it hasn't mattered enough to hurt returns.  

The other day I mentioned one off expenses by joking about razors but being serious about new tires in noting that a friend is probably going to have to spend $900 to replace tires. Yesterday I bought new razors at Costco and they were $43.99 for a pack of 16. I forgot I was due when I mentioned them the other day. The inflation here has been brutal. A few years ago 20 of them was $29 or $30. While I will probably joke about this again at $43 (presumably more next time) it's not that funny anymore.
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Defensive Action Started

True to our pre-planned strategy we started taking defensive action yesterday late in the trading day. Our initial step was for "large" accounts where having 30-35 holdings makes economic sense. We have not yet implemented defense for mid sized accounts (these use mostly sector ETFs) or small accounts (mostly broad based asset class funds). The idea here is that because mid and small accounts have few holdings there are fewer potential defensive trades to make so we move a little slower but will be taking action this week if the SPX is still below its 200 DMA.

For anyone new we take defensive action when the S&P 500 goes below its 200 DMA. Specifically if it looks like the SPX will close below for a second day, we trade late in that second day. We start small because true bear markets give plenty of time to get out; look at how 2000 and 2008 both started slowly with more of a rolling over. 

In our large accounts, the majority of our clientele, we sold ABB (ABB). From the top down we wanted to remove volatility and reduce sector exposure to a sector that would be especially hard hit if we are headed into a recession or bear market or both. The industrial sector is a good place to take this type of action for an account built at the sector level.  We covered this before but in the face of downturn this sector tends to get crushed. You can look at a long term chart of Caterpillar (CAT) to see this in action, CAT epitomizes the point.

From the bottom up ABB was a tough hold that went down a lot. In the time we owned the company has grown its business but the stock has endured a pretty meaningful multiple compression. I don't think the company is by any means broken but it is a good source of funds for trying to reduce the portfolios' volatility.

Not every single account had ABB so for those we reduced industrial sector exposure in other names. 

As I usually say on these posts the market is either going to go down a lot or it won't If it does then this will have been the correct trade and if not then it will have been incorrect. Right here right now in the middle of it we can't know what comes next we can only have an opinion. But it is easier to be wrong by sticking to the strategy laid out ahead of time than being wrong by making it up as you go.
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New Tires, Damn!

In past posts I've talked a lot of one off expenses that come along for everyone but which can be especially difficult to plan for in retirement. One specific example I use regularly in a joking fashion is new razors but a more serious one is new tires.

A friend of ours here who is retired found out her SUV needs new tires and got an estimate of $900. She will do a little comparison shopping and either fund a better deal or not but this is a great example of the one off problem. A $900 expense, or something close, is not by itself a deathblow but it is very inconvenient. These sorts of things are never convenient but they come along pretty frequently.

Look back at your Quicken for the last year, what do your one offs add up to? Is that a good number to budget going forward? A reader once commented about budgeting $1000 per month for one offs, is that the right number? What about a $25,000 segregated bucket for one offs? Maybe an empty HELOC is a solution for some folks. There is probably no single answer but it does seem to be a universal problem. Anecdotally it seems that some folks have worse luck with this than other folks and so being self-aware to this dynamic is also important in trying to plan for this.

Many financial plans overlook this issue as do rules of thumb like needing 75% of your pre-retirement income after you retire but it is an obvious and real issue that like retirement itself requires a unique solution.

Of course if you have a set of trax then you don't need to worry about tires. Short post, busy start to the week.
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Sunday Morning Coffee

MarketWatch had an article the other day called 10 Overlooked Retirement Tips with the article's callout describing the as list essential.

1) Forget the number

The includes a quote from Wade Pfau about focusing on how much income your nestegg can produce as opposed to focusing on a dollar figure to accumulate. This seems to be saying that while saving $1 million or $4 million or some other figure would be great ultimately we all end up with some number and that is what we have to make work. You're probably not going to have a $100,000 lifestyle with $1 million in your account.

2) Don't rely on the 4% rule

The 4% rule gets a lot of coverage here but my take on it is whatever you got; 4%. Of course this means that the income taken will fluctuate which is difficult to manage but I believe increases the odds that the nestegg will last as long as it needs to. The main focus on this point in the article was that the withdrawal rate be realistic.

3) Think tax efficient income

This is about allocating between tax deferred accounts, taxable accounts and Roths such that you pay the least amount of tax. For example there is a difference between how dividends are taxed versus bond interest...for now anyway. My experience here is that people tend to view this differently as a function of their own sense of logic. The best thing I think most people could do is learn the ins and outs of this and then decide for themselves what seems the most logical. Learning the ins and outs could mean doing this on your own or talking to a CFP or other type of planner.

4) Social security is a household decision

The main takeaway on this one also cam from Pfau who said it is not a good idea for both spouses to start their benefit at the same time. Presumably both waiting until each benefit is maximized is ok but the article didn't address that point. One nugget that is getting more attention is the start and suspend feature which allows for the higher earning spouse to start the benefit so that the lower earning spouse can also start (assumes the lower earner takes 50% of the higher earner's benefit). Then the higher earner suspends their benefit which allows them to qualify for a larger payout depending on when they start back up again.

5) Asset allocation matters

This seemed to be a repeat of number three. I would add be careful to not get too conservative. Assuming 3% inflation, your expenses will go up about 50% in 15 years and retirement for more and more people will last longer than that. Yes things like health care are going up at more than 3% while the "official" rates of inflation have been lower than 3% lately.

6) "Through" not "to" retirement

Very similar to number five but a little vague in the article. Being too conservative will yield the same result as being too aggressive which is running out of money or having a much more modest lifestyle than probably hoped for.

7) Get multiple quotes

This about shopping for investment products and various forms of insurance. A lot of these products are very expensive.

8) Plan for a long life

The article points out that life expectancies for people who make it to 65 are going up and I have to think most people would want to avoid being 87, very fit and out of money. This of course ties in with some of the items above about proper asset allocation.

9) What's the point

This is about planning other aspects of retirement besides finances. What do you want to do or accomplish? What will your day to day be like in retirement? Are you and your spouse on the same page about these aspects of retirement?

10) Control those fears

This is about communication between spouses and what they fear about retirement. This could potentially cover a lot of ground depending on individual circumstances. For some this could include caring for parents financially, caring for adult children financially or both (the sandwich generation). There are obviously unlimited variables here which makes the key point here being effective communication.
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The Big Picture for the Week of June 3, 2012

I was away from the market and haven't checked any numbers, did anything interesting happen? That is a humor attempt--I was not away and I know what happened in yesterday's trading. Obviously the goings on in Europe stink and the jobs situation in the US stinks as well and explanation fallacy notwithstanding these two things contributed to yesterday's decline.

That Europe stinks is not new information but certain aspects of the situation are clearly deteriorating. The shock is long gone but the news keeps getting worse and the market is held hostage to the situation. There appears to be an influence on markets that are mostly disconnected from Europe or otherwise are not overly dependent on Europe. Part of this equation means that non-European foreign has been struggling as well. Long term this does not have to be significant but in the short term it does effect returns.

Last summer I thought we had rolled over into a recession and while something happened in August an actual recession was incorrect. The current jobs data and the trend of fewer jobs created in successive months going back a while now is bad and brought out some recession talk during the day on CNBC. Maybe there will be a recession before the fiscal cliff, during the fiscal cliff or not at all but I believe it is correct to say that we are muddling along without making much real progress. This is mostly what I expected for domestic markets for the new decade but things have been more volatile than I thought up to this point.

With yesterday's decline the S&P 500 closed below its 200 DMA which very significant for us. If it stays below in the next day or two we will begin to take defensive action. That the 200 DMA is pointed upwards is one reason to think this breach will be like the last few breaches in that the market won't end up going down a lot but that remains to be seen. In the mean time we will be disciplined to a strategy we laid out long before the market got into trouble. The best thing any investor can do is be disciplined and the worst thing is to succumb to emotion.

If we need to take defensive action then generically speaking we will look to reduce volatility while maintaining or even increasing the yield in larger accounts with large being defined as being large enough for it to make economic sense to have 30-35 holdings most of which are individual stocks. We've already done a little of this in the last few weeks. For mid sized and small accounts the focus will probably be on reducing volatility.

As mentioned many times in the past, as a matter of investing philosophy, our objective is to try to avoid the full brunt of large declines, small declines go with the territory. If you are able to avoid the full brunt of a large decline that is good but if you don't then at some point markets come back. We are still not back to the 2007 high but the market did retrace a very meaningful portion of the financial crisis decline even after this most recent drop. This of course speaks to the patience that is required with investing regardless of the strategy.
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Gary Shilling's Advice On Austerity Investing

Earlier in the week we looked at a Paul Farrell post about austerity and economic depressions on an individual level. Paul had a follow up on how to invest in an age of austerity with ideas about what to do from Gary Shilling. The follow up piece offered six buys and seven sells.

Buys;

Income Producing Securities

Treasury Bonds

USD versus EUR, AUD and JPY

Rental Apartments

Medical Office Buildings

North American energy

Sells;

Developed country stocks

Developing country stocks

US major and regional banks

Commodities

"Junk securities"

Home builders

Your house, your second home and your investment property

You can click through on the link above to get a little color on all 13 ideas, below I offers some thoughts on the list. For income producing Shilling mentions a lot of the usual suspects like utilities, telecom and MLPs, presumably he means just domestic. Seeking out yield is usually a good idea but the near term threat would be if somehow the Bush tax cuts are not extended. I can't envision this being allowed to sunset but if it does then a lot of dividend payers are going to endure a fast decline.

As for treasury bonds, this one is complicated. Yes, against some sort of austere and/or deflationary environment treasuries should go up in price (down in yield) but at 1.58% already we are in uncharted waters for the ten year and at some point people are going to get hurt owning treasuries.

Anyone wanting to follow Shilling on the currency ideas in a brokerage account could buy puts on the currency shares ETFs for the respective countries or sell the ETFs short; Euro (FXE), Australia (FXA), Yen FXY. Although the US fundamentals are not great they are better than the euro and the USD does still benefit from flight to safety bids. Shilling's suggestion though assumes a ongoing flight to safety in an age of austerity/deflation and I don't think that would exist perpetually.

For apartments he suggests REITs and there are quite a few apartment REITs out there. One niche in this group that has always intrigued me but we've never owned (I've mentioned these before) has been apartments that specialize in college campuses. American Campus Communities (ACC) is one and Education Realty Trust (EDR) is another and they've done quite well. A new risk to these might be the extent to which the recent theme about not going to college gains traction. Shilling notes that there are REITs available for medical office properties. If anyone knows of any please leave a comment.

North American energy is interesting. The long term fundamentals look good but energy stocks in general have been hit hard lately. I like foreign energy stocks but Shilling's theme here is the extent to which the US can reduce imports.

The idea of selling foreign stocks is one I disagree with to a point. If he means avoid eurozone countries and Japan then I agree. Shilling appears to not like China as he sees a hard landing. There may be some recency bias here in that I wonder if Shilling believes these countries are in for secular events like are going on in the US, Europe and Japan. It is not clear that China and by extension Australia are going to be in for the same type of thing the US has been but there will be countries that do well, maybe country selection will become more difficult--that seems plausible. 

Avoiding big banks is one I can get behind. As disclosed yesterday we bought a very small bank that generally avoids the problems that the big banks seem to have. We took a 2% weight and won't be going any heavier with domestic banks. Whatever you might do here, I would urge caution and small weightings.

Several years ago Mike Shedlock spelled out why he thinks gold would go up in a deflationary environment. Gold obviously went up a lot early in the crisis and now has fallen meaningfully. The PowerShares Commodity Portfolio (DBC) has had a rough couple of months as well. Anyone believing in a true debt deflation might want to go light on the commodities.

For junk securities Shilling believes default rates will skyrocket in a global recession. If you agree then avoid junk--we don't do much with high yield debt. Sell homebuilders? Fine with me. Selling your house and other property is obviously about getting in front of an other meaningful down leg in real estate prices. He believes increasing inventories will push prices down 20%. If you've been in your house for a while then selling now is selling after a large decline plus you probably get utility from your house that you may not want to give up. If your house is paid off do you want to sell at a reduced price and start paying rent?
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