Putting the pieces together...

Gold Follow-up

My experience is that when gold corrects for longer than two to three weeks it's going to build a new base for a lot longer in this ten year (so far) bull market. So I cut way back on "paper gold" positions on the rally starting a week ago. "Paper gold" is gold stocks and ETFs of both bullion and stocks. I've still kept about 25% of the paper gold and as always I kept 100% of the real stuff in storage. I basically broke even or made a small amount on the additions I made in October and November.

 

I'm not really clear on what's happening, but with sentiment ripe for a stock and gold decline and a bond rise, I feel more comfortable with about one-third cash, one-third all types of yield vehicles, and one-third various  gold and inflation hedges including the hedged stock funds I've talked about here. Year end is a logical time for changes for many human reasons, so I prefer to see what "everyone" decides to do for 2010 before I decide if they are right or wrong.

The 2CS, Terry Laundry, and Don Wolanchuk

Technical analysis of prices has been around for a long time, but it did not start to become popular until the 1970's. Most people got their opinions from the retail brokerage houses, and technical analysis was NOT believed or tolerated there for the most part. Good economic and banking work was done by Bank Credit Analyst in Montreal, and it was affordable by serious investors. They were the first people to talk about Elliott Wave, in my experience, and Jack Frost, who was Prechter's co-writer  for the famous book of 1978 and beyond, was BCA's Elliott man.

Then came the era of Joseph Granville as a celebrity guru and volume expert. Donald Wolanchuk, who worked with Granville and developed some of his advanced volume work, still uses it very well, and he is one of the few survivors of that period whom I admire. Unfortunately for many, Don Wolanchuk is available only at pay or restricted sites (Silicon Investor and a CrystalBall-Forum subsite called "Wollie World"), and he isn't publishing a regular letter at this time.

Another analyst who emerged from the late 1970's, but who wasn't a celebrity like Prechter and Granville, is Terry Laundry (TL). He was an engineering graduate from M.I.T.  in a period when many engineers and mathematicians got involved in mathematical technical analysis with rate of change oscillator studies. Unlike the others, Laundry was and is primarily interested in time trends rather than price per se. His idea of matched trends with the time duration of the decline predicting the time for the next advance was similar in concept to a sine wave period without the sinusoid smooth wave. I subscribed to TL's Magic T Theory news letter for a year or more in 1979 or 80 and kept track of him over the years. For some time now he has provided a weekly audio download free of any charge together with one or more charts which he discusses at http://www.ttheory.com/

Currently he is tracking the upswing from the dual lows of November 2008 and March 2009. The decline of the NYSE Advance/Decline line from its peak in early June 2007 to midway between the two lows projects to August 2010 for a final top to the stock market rise. The momentum top could be in early May. Listen to his two recordings for this week, and look at his charts.

My potential problem is reconciling the current 2CS bullish exuberance with an extended bull move into May to August next year. In 2003 the 2CS went into the 70's by June 17, and except for intermittent stock market pullbacks stayed bullishly exuberant for most of the time from June 2003 to July 2007. It's hard now to remember just how very bullish people were then: much more so than in the late 1990's and for a longer time. Even when the market fell apart in July and August 2007 and 2CS went from 63 to 198, it wasn't believed that anything had changed. Even though breadth was falling, the SPX went to new highs by October and the 2CS back to 63!

This year nearly everyone has been bearish or temperate at least, and you hear no one, except Don Wolanchuk, calling for new all-time market highs and a continuation of the bull market. And it has taken nine months to get to the 70's compared to three months in 2003. The pain that many have felt and the amazing collapse of the world economy has certainly captured everyone's imagination, to say the very least! But as the saying goes in sentiment studies, "everyone is usually wrong", and the bear rally hypothesis could be totally wrong. Very few expected this much of a rally this year, and many well-known pundits were calling for SPX under 500 this year.

Even if the 2CS at 70 (on December 24, 2009) means a pullback is coming soon it does not promise a return to the devastation from May 2008 to March 2009. Many of the same people who were and are so bearish now were saying the same things in 2003 and 2004. But the market got bullishly exuberant for four years before it went down.

TL talks a lot about the cumulative A/D line. In his world the A/D breaking out to new all-time highs means that the market will have to go  down for a long time after the current T expires next year. But that might be the wrong way to look at it. Cumulative A/D went sharply down from March 1998 to June 2000 before SPX and NYSE even  started their major declines.

What does the A/D really represent anyway? It's not commonly known that the daily cumulative A/D line (the cumulative daily ratio version) which the NYSE began tabulating in 1928 actually topped in 1956! And it has only recently surpassed that level in 2009. This comes from Richard Russell's big A/D ratio book. Is it just another oscillator or sentiment measure, or is it something else? Why did it top out in 1956 after a big run from its April 1933 all-time low? It bumped along its lows until 1940 as it did from January 2000 to March 2003. Obviously it means that when it is making new highs enough money is buying more stocks than is selling. I think it may mean that a lot of newer or better run older stocks are drawing the money. Whether that's because of money being extremely available for speculation--think 1933 and 2003--or that the stocks that are rising are actually better values isn't clear. Perhaps it's both, or perhaps it doesn't matter. For a speculator or investor it may not matter....unless it's a sign of improving fundamentals or improving long term sentiment. That latter idea would be very important information indeed. From reading his comments for most of this decade, I know that is Don Wolanchuk's view, or something like it.

My view is that we need to ignore current events as much as we can. I often get swept up in it as most of us do, but for really good success the goal is to learn to ignore it as much as possible. 2CS may be suggesting a pullback, but that doesn't mean we go back to 2008. Nor does TL's top in May or August mean that either. Maybe Don Wolanchuk really is correct. In any case let's use our eyes and our common sense in approaching markets. That's a good rule for 2010 and for every year. Happy New Year!

Comments

For some reason I am unable to post a comment the past two days. :))))

Thanks to all for the comments.

Tom B., I got the charts you sent me and they are great, especially the long term examples. I want to go through them again this afternoon.

Pierre,

Thanks for the followup on VIXEE. I'd be happy to post a chart of it again if you'd like. Here is the original post from late August of Pierre's indicator and some comments: http://twocents.blogs.com/weblog/2009/08/pierre-berniers-vixee-and-the-2cs.html

Peter, 

Your comment is thanks enough for what I do here. There is very little cost for this site, and I have no desire to go commercial.

Tom D

2CS Alert

The 2CS US stock market sentiment indicator is at 77 tonight. This is down to the lowest value (the most bullishly exuberant level) since May 19th 2008 when SPX had its highest close on the rally back to 1426.65 and was on the 400 dma.  http://screencast.com/t/MGVkMjY1YzEt

For newcomers, 2CS is the running five day total of each day's product of the CBOE total Put/Call ratio times the CBOE VXO (old VIX). During bear market rallies the mid 70's is about as good as it gets for SPX highs. During rampant bull markets 2CS can get as low as the 60's or even 50's, so this is a good test of market "intentions".

If this is still a bear market rally since March, we must be prepared for a possible larger pullback than we've seen since March. Also this is the time of year for a seasonal decline in stock markets. Neither the 2CS nor the seasonal are guaranteed to lead to a nearby large decline, but the odds are greater now.

Axel Merk's New Home

Axel Merk runs the Merk Funds which specialize in unleveraged currencies. Although I own several of them I don't promote anything here, so you'll have to look up his fund website.

 

Merk has also written a recent book, a very sensible outline about managing your financial life. One of his long-term beliefs has been that renting a home makes more sense than buying for many people, and he and his wife have rented for years with four children, aged 2-12 years. However, we all know that buying a home isn't always just a financial decision. So it's very interesting to read his current discussion of how he came to buy at this time. http://www.sustainablewealth.org/buying-a-house-a-risky-proposition I know that some of my readers have bought or are considering buying homes at this time, so I thought Merk's story might be of some more than general interest.

 

Another good feature of Merk's approach in life is something I have always instinctively done and is applicable to all investment decisions, namely scenario building. Merk writes, "I am a big believer in scenario planning; if a scenario has a sufficient enough probability, then I take it into account in my investment allocation. The big advantage of scenario planning versus merely forecasting the most likely outcome is that one takes boundary conditions / black swans / flat tails / call them what you want, into account. Is a crash in this or that market likely? Possibly no, but is it a risk you can afford to ignore? It’s important to move beyond analyzing, to implementation, otherwise the exercise can be worthless, or worse, you may incur significant downside costs."

 

I was reminded of this approach today since I use it instead of using "stop loss" orders.  When I buy a security I always have a scenario which entails situations in which the investment will work out. If the picture changes, I will often take profits "too soon". Alternatively I will not allow a position in which I have been well ahead EVER turn into a loss, so the scenario of losing is a part of every buy decision. I would rather use my discretion  than a rigid price for a stop, but the discretion is bounded by an absolute rule of not letting a gain turn into a loss.

 

The phrase "selling too soon" I believe comes from Bernard Baruch's quip that he got rich by getting out "too soon" in 1929. Also Steve Selengut's approach of taking frequent 15% profits instead of waiting for rare "big killings" fits into this scenario. If you make a lot of small profits and rarely endure a loss, it's hard not to make money in the short or long term.

 

 

Decision Time 2009 for the IRA and Portfolio

All year I have debated with myself on what to do about a large IRA account which is in the mandatory retirement draw-down window.  I considered just closing out the whole account and paying the Federal income tax all at once. Another alternative was to withdraw one-fourth this year, one-fourth next year and then convert the rest to a Roth IRA in 2010 with the  special attraction of being able to pay the tax in equal installments in 2011 and 2012. http://tinyurl.com/ycm5z33 http://tinyurl.com/yaf2q28

 

The mandatory withdrawal period is based upon an IRS annuity table such that the required distribution (RMD) increases each year until one has run out of money. For many people this makes a lot of sense in that it could allow for keeping up with inflation. See Hugh Chou's excellent calculator  for how this works.The bad part of the RMD schedule is that one can get pushed into higher income tax percentage brackets. Just to give you a feel for the annual increases, starting at my age I would have an increase each year until age 95! At age 95 I would be removing two and one-half times as much (262% to be exact) as in the first year. After that the amount would begin to decline but would last in some amount until age 115! At age 111 the withdrawal would still be more than in the first year. All this is based upon a fairly conservative estimate of a nominal annualized yield (or gain) of 6.5%

 

After considering all of the advantages, disadvantages, strong possibilities of higher US Federal income tax rates, income tax bracket "creep", future inflation and more reasons you can read about  in those earlier posts, I have come to a decision. I am going to leave the IRA in existence but double the required withdrawal (RMD) for each year and keep it at that level. Under the same 6.5% return assumption the IRA would last until age 93. This smooths out the taxable income and permits concentrating on long term capital gains in the taxable accounts instead of municipal bond tax-free income as I have done for the past few years. (Munis have done pretty well given the serious declines in local and state tax revenues. This was largely due to support from the Federal Stimulus programs. I thought this would be a quick way to spend the stimulus money since localities states always have projects "on the shelf" and ready to go if they can sell bonds or have increased tax revenues. There are several in my neighborhood going on now which have been waiting for money to do them for years. but I'm not sure the states can rely on that continuing.)

 

I'll have more to say about the taxable accounts in a future post, but I'll show you the IRA portfolio now.
It is pretty simple and geared toward income but still with some inflation hedges. Vanguard Wellesley Income VWINX/VWIAX is back. I owned it up until 2007. I sold it when I got nervous about the stock market. Also the portfolio manager who had been there for decades announced he was retiring, and I thought that was a "sign". VWIAX was down at an annualized rate of 17.8% from it's 2007 high to March 9, 2009, something good to miss even though not nearly as bad as the Vanguard SP500 Fund VFINX which was down at an annualized rate of 45.3% for the same period. Through December 11, 2009 VWIAX is up 1.9% annualized since that 2007 high whereas VFINX still has an annualized return of -11.4% since that same date.

 

There are several reasons I have gone back to VWIAX. For one thing I have all my trading or investing accounts at Vanguard now for simplicity. All in one place is good, and they have very low fees, very low commissions, and very good banking and money moving services. But to get some of those desirable services I need to have a certain amount in Vanguard funds. That wasn't a problem when I had all the muni funds and short duration bond funds from 2007 to 2009, but is a bit more of a challenge now. However with Wellesley paying a little over 4% now on its 58% bonds and 42% stocks it's a prime candidate. Plus VWINX and VWIAX are fairly low volatility funds. VFIIX/VFIJX has been in the IRA portfolios for a long time. It is 100% in Ginny Mae's with a duration of two years and paying about 4% now. It has very low volatility. So Wellesley and Ginny Mae are the low yield steadies at about 4% and are nearly one-third of the IRA portfolio.

 

Next, in terms of yield, is Bill Gross's PIMCO Total Return Bond Fund PTTRX at about 28% total. This fund has been a winner for decades and is currently paying 5.25% with a duration of 4.8 years. Although Gross has retired as chairman of PIMCO and has been making retirement "noises", this is really the firm's fund in a shop run by strong and talented central direction. And who knows, perhaps they'll hire Jeffrey Grundlach  from just up the road in Los Angeles.

 

So I have about 4% from VWIAX and VFIJX and about 5% from PTTRX. Coming in at about a 9% yield is a package of eight approximately equally weighted securities, some of which I've owned for a while. This totals just under one-third of the entire portfolio as well. The eight are Alliance-Bernstein Global High Income Fund (AWF); Annaly Capital Management Preferred A (NLYPRA); Anworth Mortgage Asset Corp, a mortgage REIT (ANH); Capstead Mortgage Corp Preferred B (CMOPRB); Eaton Vance Risk-Managed Diversified Equity Income Fund (ETJ) a "buy write" closed end fund using both calls and puts; Gabelli Global Gold, Natural Resources & Income Fund (GGN), a buy-write leveraged fund; ING Risk-Managed Natural Resources Fund (IRR),  another but unleveraged buy write fund; and PIMCO Income Opportunity Fund (PKO), a lightly leveraged multi-source income fund. All these skirted total disaster last year with dividends intact, and some like AWF have been around for decades. This is a riskier package if course, and I will play this by ear and experience. The alternative to this group was a traditional junk bond fund, but I thought this group might be better. Some have an inflation "flavor" (GGN, IRR); some are straight fixed income preferreds (from NLY and CMO); one is a mREIT thought to be the most conservative (ANH); and the others are all different.

 

With these three groups (Vanguard, PIMCO and the "Group of Eight") I have 90% of the portfolio yielding approximately 6% currently. The remaining 10% is 6.6% in Central Fund of Canada for a little inflation hedge and a small 3.4% in the Vanguard money market fund. These yield virtually nothing.

 

On the total return chart from 1988 I put some of the larger funds plus Vanguard's Junk Bond Fund VWEHX as a proxy for the "Group of Eight" and the SP500 Fund for comparison. Note that VWINX and VFINX are running neck and neck after 21 years but VWINX has much, much lower volatility which is important for a retirement drawdown account, not to mention the dividends. This may not be a "set and forget" portfolio, but it's workable for a low interest rate environment and needn't be looked after daily. I don't expect capital gains by any means. In fact quite the opposite. Except for the stocks portion of VWIAX, and perhaps a few of the others, and CEF's gold and silver holdings I expect capital erosion over time if (when) interest rates rise. I do have the taxable funds and gold to work on capital gains. One has to face the fact that IRA retirement funds are, after all, wasting assets in the drawdown era of life. They are saved and grown to be used up and our partner, the US IRS, wants their share as well.