Tuesday, July 8, 2008

Long awaited update

The markets remained fairly stable through most of 2007 and so this blog simply watched the unfolding events.

You will however wisely note that "the times, they are changing", and I feel obliged to provide my very few readers with some tidbits of commentary.

I may recall that I wrote my very first prophecy, on November 11, 2006, when the S&P was trading at 1,380:

"Without regard to political views or macro-economic factors (e.g., fiscal deficit), I suggest that the S&P will see a reversal back to 1,200 during 2007. This correction will be triggered by the opposite factors that brought the 2003 rally - higher rates and JGTTRA sunset. Moreover, I suggest that the concomitant stock and housing market corrections will be catalyst to a mild recession, one which will last through the 2008 election"

Well, little did we know... the S&P is now hovering at 1,250, from the correction that started in October, 2007, even if JGTTRA is now set to expire in 2010 (JGTTRA by the way is also commonly known as the "Bush tax cuts").

The question that many of my friends have asked is what am I doing next?

I suggest these new prophecies, absent an unforeseen macro event:

- The U.S. credit crunch may not have necessarily hit bottom, but a floor seems to have been established by the FED actions in rescuing Bear Sterns and in providing emergency loans. Do I then buy Financials? I tend to avoid specific names, but am considering Vanguard's Financial Sector ETF, VFH, which is trading at 36.40, down from a 52-week high of 65.37, and paying a dividend yield of 3.11%.

- Municipal bonds are offering compelling historical valuations with a 10-year tax-exempt bond yielding about the same as a taxable Treasury. Some would counter with the risk from the monoline bond-insurers, but I have long ago given-up trying to perfectly time the markets, and so am fairly happy with the current 20-year rate of about 5%, even if I tend to only buy individual, high-quality (underlying as opposed to insured rate) bonds to full maturity. I could also argue that if the current favorable taxation of dividends at 15% were to expire with JGTTRA, then muni-bonds may see very significant appreciation.

- Hybrids: see "my preferred investment" post. Hybrids have lost about 20% in value and some are now paying over 8% in a dividend yield that is (still) taxed at 15%. This 20% loss is far better than the decline in the Financials ETF, and perhaps better than the overall S&P, when factoring the dividend yield. I also find an 8% dividend very attractive, even if I very carefully check special conditions that may trigger payment stops as I continue to actively manage my positions.

- S&P: so, let's get to the bottom of it, the place where significant percentages of portfolios are typically invested. Further declines, back to my predicted 1,200, or perhaps even lower, are acutely possible. My S&P investments are however for the long-term (at least 15 years), and thus I find that the current valuation levels may prove to be a decent entry point. I do find solace in knowing that we have seen declines that have lasted over 10 years in the past but never a decline lasting over 20+ years. Furthermore, even if past performances are no guarantee of future returns, I also look at our nine recessions since 1953, and the declines in equity markets from peak to bottom was an average 25.6% with a best case of 13.9% and a worst case of48.2%. Moreover, the number of trading days for stocks to hit bottom was an average 108 days, with a best case of 30 and a worst case of 261. In comparison, the current decline started last October when the S&P traded at 1,576.

- Bubbles: my daughters truly love making them... I tend to stay away... Internet in the late 90s, housing in the early 2000s, and now commodities and certain emerging markets... They may be a great way to make outlandish profits but who am I to guess the bubble of the moment, as well as, the right entry and exit points... I am just a prophecist, not a financial markets whiz...

See you soon...

1 comment:

mario said...

Dear Blogger
although i tend to agree with most of your thoughts, i also have to play the devil's advocate,
1) Financials may be finding an artificial floor, but keep in mind that this floor is being set, or sponsored by, as you mentioned, the Fed. Effectively, that means the Fed will be printing money to cover up losses from irresponsible lending practices - which is directly converted into inflation. Inflation means the dollar in your pocket has less purchasing power. Therefore, YOU, and me, and all of the tax payers and USD holders are buying BSC, and eventually LEH, MER, C(?), etc. Well, if you are already buying, indirectly, the financial sector, by simply holding your USD, why do you want to increase your exposure? you ARE already long Financials - so if banks recover, USD recover, and you make $$. Don't double the trades that are losing, but the ones that are winning.. that s one of my first trading rules.

2) Munis: I also like the munies, and although you have been looking into project bonds - which may not be directly affected by the Real Estate burst, municipalities are, by nature, highly correlated to the Real Estate market. So, when buying munies, aside from the tax incentives, you have to have a clear oppinion that the Real Estate prices will not decline more. Sure that, if MTM is not an issue (as you plan to hold it to maturity), then the risk becomes more binary (will they be solvent and pay at the end, or not). Also, if you don't make mark to market of the positions, the pain and suffering from mark losses decreases a lot. The downside is that you may decide to reconsider it when it might be too late!

3) Hybrids: falls into the same category of 1), and i do have the same thoughts. Altough the Fed intervention makes debt much safer then equity - as we've seen with BSC. However, you may have the coupons cancelled for a while - if they decide not to pay dividends.

4) SP: agree. But also agree that "past performances are no guarantee of future returns". Since i am not traditionally an equities investor, i can't add any valuable thoughts here..

by the way, love the comments on the Bubbles. i guess that summarize really what i think - and how i am invested right now (as i think we are through an economic - not sector - bubble burst). My main concern right now is not to find nice returns, but to maintain wealth. To finalize, here is a good quiz: What was the only asset that didn't lose value during the WW2?

a) Real Estate/Land
b) Gold
c) Oil
d) Wine

well, let's just say that we tried few of the best examples of the answer the last weekend...
Have a good one!