Putting the pieces together...

2Cs Sentimeter Update

The red numbers are the extreme daily readings of 2CS for short to intermediate term SPX moves.

During 2007  there was marked bullish sentiment divergence from January to October. A bearish outcome was confirmed by the extreme bearish sentiment at the summer low (198) which was the most bearish market opinion since 2002. After the rally to October still showed declining bullish opinion compared to January 2007, the bear decline continued.

 

Rally tops after the October high could only generate bearish readings of 112, 124 and 125 followed by increasingly bearish readings on successive new lows in SPX. Technically the May 2008 rally top was a good place to short on moving averages and retracement percentages. But the 2CS reading of 72 at the May SPX top, far more bullish than any prior rally top  after October, suggested that the next new low might be the last.

 

True to that promise, the SPX low in mid August 2008 sported a 2CS of 161, showing bullish sentiment divergence. So far neither the action in SPX nor in 2CS has been very bullish, and that in turn suggests another revisit toward the lows for a re-test of bearish strength.

 

Retirement Income Portfolio Update

My current preferences of funds for retirement income portfolios are shown in the two charts below. I do also have several oil and gas trusts and one oil and gas infrastructure fund, all of which are paying 8% or more annually.

 

I also have small residual pieces of Vanguard's Energy Fund (VGENX) and Precious Metals and Mining Fund (VGPMX) and the Rydex Managed Futures fund (RYMFX) which is a long/short rules-based fund with about 50% in physical commodities and 50% in Treasury's and currencies. RYMFX can be independently long or short in each of the commodity sectors and in each of the non-commodity sectors. These and the oil and gas trusts mentioned above are only about 5% of total assets. Gold metal is about 10% right now.

 

The rest is in income funds. In taxable accounts the largest parts by far are in Vanguard's Limited Term Municipal fund (VMLUX) and Short Term Municipal Fund (VWSUX), not shown here. They pay much better than the municipal money market funds, and have an average duration of only 1.85 years.

 

Loomis Sayles Bond (LSBDX) Fund is the core income fund in tax-deferred funds with smaller, but still significant positions, in Vanguard's GNMA Fund (VFIJX) and Short Term Federal fund. The last two serve similarly to the muni funds above as a far better place than money market funds but are fairly short in duration risk. Since LSBDX primarily invests in investment grade corporate bonds, it has a "quasi-stock" quality in that it rises somewhat in price during stock bull markets and falls somewhat, but far less than stocks do, in stock bear markets. It currently pays about 7.25% annually.

HSTRX and PAAIX give a broad exposure to several other varieties of bond and other strategies, often called "alternative" or hedge fund-like strategies. They are both managed by astute people. HSTRX has a bit more price or capital gain return and PAAIX more in cash. One could substitute PRRIX or VIPSX, both TIPS funds, if one prefers index funds instead of managed funds. Both HSTRX and PAAIX have used TIPS for some considerable part of their portfolios. One could use PAUIX which identical to PAAIX but with an optional  a mandate to borrow and to take short positions in stocks. I prefer to use HSGFX instead which is a more conservative way to do that. PAUIX is a fund of funds with two layers of management and operating expense, totaling nearly 2.5% per year, including borrowing costs. If you use any PIMCO funds try to buy the institutional funds which are available through major mutual fund "supermarkets" like Charles Schwab, Fidelity, TD Ameritrade, or Vanguard/Pershing. The expense rates are far lower than for the retail versions,  as are the minimums for initial purchase.

HSGFX is usually classified as a "long/short" multicap fund, but it never shorts stocks. Instead it picks the best value stocks it can find and then hedges that portfolio variably depending upon Hussman's read of market and value conditions. You can see how well HSGFX did from 2000 to 2004. From 2000 to 2003 HSGFX was fully hedged short the major indexes and long value mid caps. This was a good choice for two reasons: indexes went down while mid caps, and especially value mid caps, went up relative to the indexes. From early 2003 to early 2004 HSGFX was only slightly hedged and captured most of the bullish gains of stocks. Thereafter they have tended to be more fully hedged as they felt most stocks were over valued and that the market not as strong. As you can see from the charts, their total return profile resembles that of an intermediate term bond fund from April 2004 to March 2008. So one will sit through dull periods with HSGFX when momentum investing is king. But as a retiree one is willing to accept such dullness and give up the risk of losing 10-20% in an exciting down year like 2008.

 

This first chart shows the period since the debut of PAAIX in my FastTrack data base (late 2002), and the second is from the debut of HSGFX in the same data base (late 2000). Bear in mind that "Ann" means annualized total return with all dividends reinvested for the entire period of the chart. Also recall that these are just my own personal thoughts about my own investing IN retirement. They may not be appropriate for all retirees, and are certainly not appropriate for people form 25 to 50 years of age, unless they are extremely risk averse. In any case I am a private investor only and not an investment adviser.

 

 

A Vacation from Inflation

World wide demand for all goods (commodities to finished goods) and services isn't over and won't be for a long time. Demand everywhere is up and especially in those civilized places which slept the sleep of the centuries: all parts of Asia leap to mind. Add on natural increases in the established economies of Europe and the New World, and you have customers increasing everywhere. Then we have the real fact that demand was slower from the late 1970's to the early years of this century, so supply was allowed to run down. Supply and infrastructure of all kinds became simply inadequate  to meet increased demands or just wore out or became obsolete. The recently resurgent pro-deflationist economic "winter-ists" miss the large picture on demand and the inability to service it.

 

Since July 2nd the CRB Index of  Commodity futures (CRB) is down about 25% of its rise from 2001, or about 50% of its rise of the preceding two years. My guess is that a larger correction than we have seen since 2001 is underway and that perhaps 50% of the rise will be given up. It simply got overdone and exhausted demand temporarily. It will take a while to get back into balance.

 

 

The chart exhibits the Andrews division of the 2001 to 2008 range from the 1980 high and the simple Fibonacci division of the same range. They come out to about 390-410 on the chart. I didn't label the Elliott waves, but wave 4 of the 5 wave rise is also very nearly at that level of 400, and it is common to retrace down to wave 4 of the prior larger wave. If I am correct, I would expect one to two years of correction before a final low.

 

For investors it's best to keep our gold coins or other physicals but not be quick to buy commodity funds or stocks at this stage. Traders are another story and always have opportunities short or long. Sharp rallies will occur and grinding declines. Enjoy it while it lasts before inflation comes roaring back. Wait for the bargains.

 

 

PAUIX: A High Yield Bond Fund Hedge Program versus "Stealth Annuities"

The folks at my blog server are doing a lot of "improvements" which are making my life difficult. At the moment I can't reply to comments in the comments section, so I'm replying here to a comment on the recent blog post "A High Yield Bond Fund Hedge Program versus "Stealth Annuities"". The comment is from Steve B.

 

""....Many junk bond funds lead me to this conclusion, based on price-only: most got halved in 2000-2002 equity selloff/economic recession/rising default enviro and never recovered. I assume that they will do the same or worse this time around. It is good of you to share Loomis long-term success.

Please direct me to your immediate annuity post.

Getting any closer to Rob Arnott's PIMCO AllAssetAuthority, which can go 20% equity short and uses TIPS, commodity, currency and high yield? I have been happy with its' performance and 7% yield since 02-08 purchase.

 

Posted by: Steve B. | August 21, 2008 at 05:42 PM""

 

Steve:

 

Here is the annuity article. http://twocents.blogs.com/weblog/2007/08/annuities.html

 

PAUIX has some real interest for me, and I may add it to the mix of LSBDX, HSGFX and HSTRX. Here are some charts:

 

http://screencast.com/t/urSbPsqbaX  

 

http://screencast.com/t/ZwDCNZ4Ded  

 

http://screencast.com/t/d38fLgsqUzw 

 

It hasn't been around too long, but I think PRRIX would be a good proxy for what PAUIX, PAAIX, and especially HSTRX would have done from 1999 to 2002:

 

 http://screencast.com/t/DZQobKy3GPN

 

Tom

VERY Long Term Andrews Pitchfork of The Dow 30 Stock Index

In the late 1990's and up to 2003 I was trading with a group we called "No Brain University". The compelling idea was that we just did technical analysis of price and left our thinking brains "at the door". Since there was and had been so much dopey market thinking , bullish and bearish, in that era, 'No Brain' made a lot of sense to us.

 

One of the favored approaches in that period of great volatility was to use Andrews' pitchforks to identify the median line (as Andrews called it) or "bisect" line where a previous range was drawn through from its own prior price extreme. The concept is easier to show graphically than to describe in words. See below.

 

I was and am very interested in market sentiment as well as chart analysis, so at some point after 2000 I looked for a way to combine pitchforks/bisects with sentiment. I own(ed) Richard Russell's big NYSE A/D Line book from the late 1920's. I learned from that large book that the all-time high in the daily NYSE Advance/Decline  line was in 1965 and the all-time low was in 1982. As a fun study I thought it would be interesting to use the 1965/66 high and 1982 low on a logarithmic as the range to be bisected from the 1932 Dow Jones low.

 

I was amazed to find that the upper boundary of a standard Andrews pitchfork with those three points was where the January 2000 Dow 30 price peak hit. Looking back from that point, the median or bisect line had constrained price from 1987 to 1994 after which price had raced up to the upper boundary.

 

Then the 2002-2003 lows showed up at the median/bisect! All I got were yawns when I posted the chart widely on internet chat sites in early 2003 as the Iraq war pressure was building and market sentiment was almost as bad as it is now.

 

I had forgotten about this chart for a year or more recently due to loss of older data bases and an old version of Meta Stock which went bye-bye due to a Windows XP "upgrade". But look how the rise from 2003 to 2007 topped out near the 3/4 range line which was support for the lows of 1997 and 1998.

 

Then the crash, or drop, from October 2007 to March came very close to the median line as it did in 2003. And market sentiment is quite similar today.

 

Approximately Dow 11100 is very important to this whole concept. A monthly close under 11000, or two closes, would pretty much seal it for the bears down to ~8300 or even ~5750. If the bears can't break it down then we are headed back up to far greater new highs. Or so the theory of Andrews and later interpreters goes. So far, so good.

 

Keep in mind that the Andrews logarithmic median/bisect line represents a percent per period increase in price of the Dow 30 since the 1932 bear market low at 41! So a breakdown would carry some weight.

 

In case the chart here does not show well for any of many possible reasons, this URL may work better:

http://www.screencast.com/users/Twocents/folders/Jing/media/52cb44fc-8d9a-4b38-8cc3-7186f4f94963

 

A High Yield Bond Fund Hedge Program versus "Stealth Annuities"

My largest single position in IRA's/401K's is Loomis Sayles bond fund, LSBDX or LSBRX. According to Morningstar today, LSBDX has paid 7.28% on a trailing twelve months basis. It pays monthly, and has a very strong team running it who have most of their own money in it.

 

All bonds trade on interest rates, of course, but they also trade on the "faith in the credit" of the issuer, or on "how likely are they to pay back the whole face value of their bonds". On a AAA rated bond one has no fear of repayment default, but the lower one goes on the credit ladder the more of a premium the issuer must pay to get you to buy and hold their bonds.

 

LSBDX has been very skillful, since it started in 1991, in picking higher yield bonds which it feels are mispriced or have greater value than the market realizes. Nonetheless, high yield bonds trade price wise more like stocks than bonds. The first chart shows LSBDX, VWELX (a balanced Vanguard fund), and the Dow Jones Transports (DJT) all without dividends reinvested. All three made price tops between 1998 and 2000 and all bottomed in 2002 and/or 2003. All three rose from 2002/2003 until 2007/2008 and have turned down. So LSBDX (price only) trades like a stock fund although somewhat muted in range like a balanced stock/bond fund.

 

Let me show you another reason why LSBDX on a price only basis is my favorite high yield fund:

 

  

Three of these high yield funds substantially under performed LSDBX between 1993 and August 2008. With LSBDX you are getting the yield without too much sacrifice of capital. LSBDX is up on price alone ~23% from 1993 to present while the other three funds are down from 15-45%! That's important! I would recommend that you look at any bond funds you are thinking of buying on a long term price only chart and also on a total return chart (with all dividends reinvested). I pay http://fasttrack.net/ about $400 per year for their total return fund (including ETF's and CEF's) database and software which is well worth it for my continuing research. The following chart is a FastTrack total return chart for the same four high yield funds from 2000 to the present.

 

 

After looking at both the price only and the total returns charts for these funds, choosing LSBDX is a no-brainer. With LSBDX you get high yield but you also get a quasi-equity price return. For long term investors living off their bond funds, this is extremely important. Most high yield bond funds are like an annuity in that they are returning principal to you and running down. There is nothing wrong with an immediate cash annuity. I own such an annuity, as I have written about last year. But with a high yield fund I don't want a "stealth annuity" masquerading as a bond fund. I want to spend the dividends for my monthly budget and still have a bond fund left in twenty years.

 

That said, even LSBDX lost 25% of its price (without dividends) from 1998 to 2002 because it is a quasi-equity as well as a bond fund. On the FastTrack total return chart LSBDX was higher at the 2002 lows than at the 2000 highs, and that is because of its dividends. A reasonable way to hedge the equity-like part of LSBDX in a bear market is with Hussman's HSGFX which hedges a select mid cap and large cap portfolio with short index futures options. HSGFX was up 19.75% from late 2000 (FastTrack inception date) until October 10, 2002 while the SPY (total return) ETF was down 23.16%. LSBDX lost about 10% of its price only return from the end of 2000 to October 10, 2002. So HSGFX would have completely hedged the LSBDX price only decline if bought roughly at 50% of the holding of LSBDX. Nor would one need to own $1000 of HSGFX to hedge every $2000 of the value of LSBDX. Figure out your own comfort zone on hedging your bond fund, but see (on both charts) how HSGFX has also hedged the price of LSBDX over the past year.

 

Keep in mind that HSGFX also has risen 10.59% annualized since late 2000 of which about 4% is a cash dividend earned on its hedge. In a tax-deferred retirement fund which you are drawing down, you might want to take the cash dividend and reinvest the capital gain dividends in HSGFX. To carry this line of thought even further, if you had $500,000 in a tax-deferred retirement fund you could put $400,000 in LSBDX and $100,000 in HSGFX which would have returned 6.08% based on retailing twelve month dividends. That would pay you $30,435 per year or $2536 per month. It's true that an immediate annuity would pay you probably $3300 per month for life, but you have no equity left. Whereas with 80% LSBDX and 20% HSGFX you have an equity-like premium in the package and it is hedged. It's something to think about. 

Short Term Sentiment

It's certainly not my intent, as a private retirement income analyst, to become a trendy market timer, but I do my market homework each day, particularly with regard to sentiment. I use it primarily these days as an assist in entries and exits of longer term positions. My "stuff" uses market information, not polls. It looks pretty awful as of tonight for "generic" US Index stocks for the near term. Also gold is imploding under $800 as I write this. Be careful! It might be that someone knows something we don't.

Gold in the Long Wave: Keep Your Eye on the Ball

 

Long Wave analysis established the demand/supply cycle of 25-30 years up in prices and in money rates and 25-30 years down. This is explained by sentiment in part, but primarily the lengthy cycle is due to lag times, inherent in human societies, in responding effectively to increases  in demand and then to lack of demand.

 

When world demand picked up, as it began to do in 1998-99, the suppliers of crude and finished goods were not synchronized to that demand and were ill-prepared to fill the new demand. They had kept inventories low and not adequately renewed sources since 1980 because demand for crude goods had been shrinking for two decades.

 

It takes a very long time even to accept that the new demand is really here to stay, and then to budget for it, plan new projects, get the land, get the permits, engineering, logistics, personnel and all the rest to bring in adequate new supply to meet the continuing demand. We've all been watching it, particularly in mining and energy production and refining, and in power production. 

 

This process has been going on for 7-10 years in various crude goods (commodities), and it has that long or longer still to go. Prices ran up wildly the past two years after rest periods in 2004 and 2006. This more recent price escalation puts a floor under prices so that new supply development can go forward with confidence it will pay off.  Producers and consumers alike are now convinced and committed.

 

Approximately half way through the up cycle in price inflation is a "good time" for a correction, just as approximately half way through the disinflationary down cycle was a good time for an equity correction in 1987. The perma-deflationists and those who are unaware of the economic Long Wave are now already calling for the economic "winter" or the resumption of flat out deflation. Get used to it, and "keep your eye on the ball", as they say in baseball.

 

Gold has been in correction already for five months and could have another year or more of sideways to down action. My long term gold price analysis has not really changed much in the past 15 years. Gold is a monetary, an industrial, and a collector commodity, so gold's price is a good monitor of the overall cycle, and it is fairly predictable. My educated guess is that gold will come down **at least** to 720-750 which was the true end of the last bull market in 1980.

 

Develop patience. Avoid leverage during a period of de-leveraging. Trade it or buy gold and other inflation beneficiaries in small pieces at a time on down drafts. Relax. Enjoy. It's a vacation for inflation, not the end.

Media Blather Versus Reality: Wordless Economics

 

 

Gold Update

Gold Update

As regular readers know I became skeptical or nervous about the runaway commodity moves, including gold, several months ago, and I cut back somewhat (33-50%) on commodity-related funds and stocks but NOT on gold bullion. The expectation was for a typical pullback or consolidation�under the gold highs and that most other commodities had either already or would soon do the same. And they did and have.

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A friend sent me today an update of the gold to XAU (Philadelphia Gold & Silver Stock Index) ratio:

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This ratio of nearly 6:1 is very high for gold and indicates that gold stocks are quite undervalued compared to gold bullion. A longer comparison chart back to 1994 was published on this blog in 2006:

Each of the other times when the gold:XAU ratio was above 6 has been a good time to buy gold stocks. This is discussed by me in passing in this 2006 blog post here:� http://twocents.blogs.com/weblog/2006/10/waiting_for_gol.html

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On this basis I bought ASA today of a steep decline at $67.19. ASA was chosen due to its severe recent decline, partly exacerbated by a forced tender for the shares, and due to the fact that it holds quite a large percentage of platinum stocks. Platinum has been in a precipitous decline which erased as of today one-third of its entire bull market move since 1971! However, platinum reversed up from its London AM fixing price and closed up on the day.� This is last night's chart but shows the platinum history: http://www.screencast.com/users/Twocents/folders/Jing/media/24929255-57a4-4bba-b520-48919e26eccd

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We'll have to see whether I will have caught a falling knife and lose a metaphorical finger. I won't stay around very long if I'm wrong.

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