This blog is written weekly by Dock David Treece, a registered investment advisor with Treece Investment Advisory Corp. It is meant to share insight of investment professionals, including Dock David and his father, Dock, and brother, Ben, with the public at large. The hope is that the knowledge shared will help individuals to better navigate the investment world.

Monday, December 28, 2009

Lessons from a Lost Decade

Very rarely does any one person receive the best and worst the life can throw at someone. Even more rarely is anyone exposed to completely opposite ends of the spectrum at the same time. I guess Fed Chairman Ben Bernanke must just be lucky.

While being chastised by Congressmen and loathed by a large portion of Americans, Bernanke has somehow been blessed with the love and admiration of many of his colleagues – big bankers – and the media, most notably Time Magazine, whose cover his visage recently graced.

Though Time praises the professor-turned-bureaucrat for his apparent victory over the free markets, a sense of foreboding is in the air. Well-read individuals will, of course, recall at the cover of Time once depicted the face of another banker – Alan Greenspan – right before the economy turned sour and the sky started falling.

Ben Bernanke’s tenure has Chairman has coincided with the second half of what may very well prove to be the worst decade in stocks in recorded history (Lauricella, Wall Street Journal). You read write; even the 1930s, home in history to the Great Depression, can’t hold a candle to the decade we’re just exiting. Great Recession, they say? Ya, sure.

But fear not, there’s still good news, for the last decade, terrible as it may have been, is now ending. And as any good investor knows, odds are that terrible decades tend not to gather in groups. Put more simply: expect better times in the 2010s.

Like the 2000s, the financial markets had a very difficult decade in the 1970s, culminating with Jimmy Carter. However, after a final shakeout in the markets during the late ‘70s, improvement came swiftly in the 1980s under Ronald Reagan – after all, they don’t lend popular economic terms like Reaganomics to just anyone.

While we can bet there are better times ahead, hopefully we can emerge from this decade with a few lessons learned; lessons that will make the next decade all the more bountiful. If the 2000s have taught us anything at all, hopefully they have left no doubt in our minds that the theory of buy-and-hold as an investment strategy is deader than a doorknob.

Hopefully investors can leave the 2000s with a greater respect for the financial markets, and for the knowledge required to use those markets to one’s advantage. Hopefully advisors, in their downtime, have finally gotten around to reading the last chapter of Markowitz’s pioneering work on diversification, Portfolio Selection: Efficient Diversification of Investments.

The chapter I’m referring to, as boring and academic as it is, specifically mentions that the principles discussed were not intended for real-world application.

Of course, the appeal of Markowitz’s work to the masses is at least partially due to laziness. Using concepts laid out in Portfolio Selection and developed even further by academics, the investing public fell in the love with the idea that they could somehow build a diverse portfolio spread across several classes of assets, and then stuff it in the back of a drawer until tax time.

Unfortunately for investors, this simply isn’t the case. The financial markets are not a beast that can be understood withr only occasional review. They require constant study and continual maneuvering in order to achieve any kind of profit. Anyone who thinks otherwise will likely experience many more decades of poor performance going forward.

Monday, December 21, 2009

Unclear Economic Data Makes Research a Must

As expected, the market has been relatively slow over the past week. Oil, which we had said was overextended, has since corrected; while the dollar, which we claimed to be oversold, has rallied over the same period. Earlier this week the stock market attempted to break out of its recent consolidation pattern, only to pull back into that trading range once again.

Meanwhile, ten- and thirty-year Treasury rates have been creeping up ahead of this week’s Federal Open Market Committee announcement. This would seem to suggest that, regardless of what the FOMC says, the market believes that the Fed should be raising rates in order to price risk appropriately. This recent action could also be hinting at a growing belief in the market that inflation could be on the way.

For the month of November, retail sales have been up slightly year-over-year, so while this holiday season hasn’t been great, it’s provided the economy with at least respectable numbers. However, the Empire State Manufacturers’ Index has been surprisingly weak, especially given retail sales.

This anomaly most likely indicates that holiday sales have thus far been working through pre-existing inventory. This, in turn, tell us that presently the economy is, for lack of a better word, “spotty,” meaning that while things aren’t getting worse, they really improving either.

With respect to housing, data remains mixed, partially because the market isn’t being given a full picture of current circumstances. As we mentioned last week, housing inventory numbers released by the government don’t include homes that have been foreclosed but are not being put on the market by lenders.

Over the last two weeks, gold has fallen more than $100 from its high near $1210. Weekly readers will remember that we have recently been bearish on gold, as it has undergone a substantial rally that we believe unjustified by current fundamentals. Utilities, where we’ve been positioned for some time, have been gathering momentum over the same period. Utilities as a sector have been gaining popularity among investors seeking higher yield than can be found in most fixed-income investments.

We have stressed repeatedly, and feel the need to remind readers that this market is not conducive to a hands-off approach. Unlike the last few years, today’s economic environment requires constant study, and investors trying to manage their own portfolios need to understand the amount of time required to sift through information, determine what’s relevant, and have the background to interpret information and apply it to the markets.

Those investors who lack the time or ability to commit to their investments need to at least put in the time to find an advisor who is willing and able do the job for them. Even more importantly, advisors need to be sufficiently knowledgeable to use pertinent information to make sound investment decisions on behalf of clients.

All too often the investment world is plagued by fads, either in the form of burgeoning sectors or money managers with so-called “hot hands.” It is absolutely necessary for investors to ensure that they are picking an advisor with the knowledge to add value to client portfolios over the long term. In the short term, get-rich-quick schemes come and go, and flavors of the week all eventually turn sour.

Monday, December 14, 2009

End of Year Conditions Blur Trendlines

With 2009 drawing to a close, the market is now heading into end-of-year trading, typically characterized by lower trading volume and, as a result, increased volatility.

Towards the end of every year there are variables aside from market conditions that come into play which can have drastic effects across any and all asset classes.

At the end of each quarter, and even more pronounced at year’s end, many traders and investors undergo strategies of window-dressing and/or profit-taking. Window-dressing is a strategy where professionals, especially financial advisors, begin purchasing assets that have been performing well, with the intention of making end-of-year statements of client portfolio holdings appear more attractive.

Conversely, profit-taking is just what it sounds like; traders, investors, et al sell assets that have been performing well in order to lock in gains and decrease exposure to market risks. There are many reasons for profit-taking, but the underlying theme is that investors see market risks as outweigh any potential gains.

Historically speaking, window-dressing tends to bolster market returns as an influx of cash pours into already-high prices. Contrarily, profit-taking acts as a negative effect on prices, since many market participants are rushing to unwind positions before a perceived deadline.

Each year the battle rages on between these two counteracting forces, and while this year has seen remarkable returns among a wide range of investments, we feel there is a much stronger argument that profit-taking will dominate window-dressing.

One such argument is in regards to tax policy. With the likely repeal of Bush capital gains tax cuts during 2010, investors who choose to take profits before the New Year will be taxed at current rates, while those who wait run the risk of those tax rates increasing over the next reporting period.

On the other hand is the argument that we are in the beginning of a significant economic recovery, and for that reason window-dressing could be much more likely that profit-taking, and the market will likely advance.

Those who make this argument point to falling housing inventory numbers. They conveniently forget that many November home sales occurred because it was not immediately announced that the government would renew the first-time homebuyer tax credit. This had many Americans moving up their closing dates to ensure they received their tax credit.

Even more importantly, housing inventory, as it is reported, does not include the more half-million homes in foreclosure, which lenders may or may not choose to dump on an already-saturated market.

Market bulls also point the recently reported improvement in employment numbers. However, few realize that this so-called “improvement” is almost entirely due to seasonal adjustments made by Federal Reserve and Bureau of Labor Statistics. They also do not include Americans who have given up their search for work.

Fortunately, some Americans have undoubtedly found part-time seasonal work, and employment numbers may very well recover in the future, given the right government policies. In fact, a new article on CNNMoney discusses President Obama’s recent hints at changes in tax policy may provide incentive for small business hiring (Obama Touts Tax Breaks to Boost Small Business Hiring, Clifford).

According to his speech given Tuesday at the Brookings Institute, the Obama administration has recently begun considering a program for instituting tax breaks for small business who hire new employees.

Additionally, there have reportedly been talks to cut capital gains taxes for small business, also as an effort to spur employment. While the link between capital gains from company investments and employment is so far unclear, any tax incentive would certainly be an improvement.

For a brief market update, the last week has seen the US dollar strengthening and the prices of commodities simultaneously weakening. While it is unclear whether these two events are directly connected, and even more importantly, whether the dollar is beginning a significant rally.

There can be no doubt that recently the dollar had reached oversold levels, but it remains to be seen whether the currency has reversed its recent trend. However, it has certainly been showing signs of life.

Helping to fuel the dollar’s recent decline, a huge carry trade has lately built up as investors have borrowed dollars and purchased foreign assets, only to pay back borrowings later with weaker dollars.

If the dollar really has turned a corner and this trend reverses, a large rally in the dollar would eliminate this carry trade and leveraged traders would be forced to unwind their positions, making the reversal quick and violent.

This rapid change in market direction would create rampant demand for dollars as investors scramble to shed other assets to pay back borrowed dollars before they are wiped out by leverage.

So far the dollar’s strength is little more than a flash in the pan. Only time will tell whether the tides are changing or the dollar will continue its already-substantial decline.

Dock David Treece is a stockbroker licensed with FINRA. He works for Treece Financial Services Corp., The above information is the express opinion of Dock David Treece and should not be used without outside verification.

Monday, December 7, 2009

Golden Goose Eggs Rarely Hatch

Lately it seems nearly impossible to turn on the TV or radio without hearing another pitch to buy gold. And why not? After all, it’s the easiest story in the world to sell. In this economic and political climate, everyone has fears and doubts that a good salesman can exploit for profit.

Between the bailouts that have recently caused Washington to speed up the printing presses, the prospects of future policies coming down from Capitol Hill that will lead to only greater spending, and the declining value of the dollar in foreign exchange, it’s pretty hard to be an optimist when it comes to the greenback.

Not to mention that lately gold has been making all kinds of headlines, setting new highs on almost a daily basis. In fact, the price of gold has advanced almost every day for the past two weeks.

But one man’s treasure is still another man’s trash. In other words: The same reasons that gold is being touted lately as a great investment idea for the same reasons we as contrarians intend to avoid it, at least for the time being.

Gold’s recent rally, while remarkable, is not unprecedented. One comparable run occurred in the NASDAQ during March of 2000. Of course, that was right before the tech boom ended and the market came crashing down.

One of the favored lines among gold dealers is that the declining value of the dollar will continue to push gold higher. While that is obviously one trend, history has shown us that it is not always true. Several times, even during the 1980s and ‘90s, both the dollar and gold fell at the same time.

And yet radio and TV are flooded with ads from the likes of Goldline, Lear Capital, et al. People just don’t seem to get it: Those companies running commercials are trying to sell you THEIR gold in exchange for YOUR dollars. What exactly does that tell you about their outlook for the price of gold, much less the dollar?

Right along with those commercials, Aaron Regent, the CEO of Toronto-based Barrick Gold, the largest gold mining company in the world, has been running around lately pushing gold because his company recently unwound the last of its hedges.

What that means is that Barrick is no longer protected from a falling gold price. Of course, if Barrick is really so omniscient, it’s curious that they didn’t unwind those hedges ten years ago, before gold quadrupled in price. Instead, they waited until gold reached all-time highs to start participating.

Mr. Regent has also been peddling the idea that the world currently at peak gold. His argument is that production has been decreasing since 2003, so the world must be running out of gold. How strange, then, that production numbers have lately increased in China, Russia, and Australian in reaction to gold’s increased profitability as of late.

Gold, like any other commodity, responds to supply and demand. Take oil for example, particularly the tar sands in Canada, where oil is drilled on the occasion that it is a sufficiently profitable operation. Production has to be profitable in order for miners, drillers, etc to ramp up production.

Even more disturbing is that the demand for gold recently is not for physical bullion, but paper gold. The world’s largest consumer of physical gold is India, where gold is used extensively in jewelry, especially during wedding season. But Indian brides aren’t exactly scrambling for the yellow metal.

Instead, the vast majority of demand for gold is among traders, and that is for paper gold in the form of futures and options contracts. Speculators (i.e.: traders in the gold market who do not represent miners, refiners, dealers, bullion banks, or central banks) have recently been piling into gold – at least on paper.

On the other side of those contracts, commercial traders (read: smart money, traders representing those companies intimately involved with the precious metals industry) have been amassing record-setting short positions.

It’s understandable why, in today’s climate, people are nervous and want some kind of insurance policy, or even some investment that can help propel their portfolios back to pre-crash levels. However, put plainly, investors ought to know that if they are buying gold, realize that the smart money is lined up against you. Further, know that those traders have the kind of balance sheets required to prove themselves right.

This is neither a test of wills, nor a question of right versus wrong. The gold market is, on a relative basis, extremely small, and its workings understood by a very small group of people. Outsiders would do well to tread very, very lightly, if at all.