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The Q1 2010 Market Rush Review

By

Mark [email protected]

April 3rd 2010

Copyright © 2010 by Mark A. Rush

mailto:[email protected]

PrefaceOnce again, it is once again time for my quarterly market review, where I examine world events and attempt to understand their implications on the market. This is my time to reflect on current events, portfolio performance, and event scenarios, and their subsequent implication on world equity markets and my investment strategies.

As you read through this review, even if you don’t agree with my thoughts or analysis, please take the time to think about your financial choices and ways to improve your returns. It is my goal in life to have my money working for me instead of me working for my money.

Please email me with your thoughts, questions, and insights on the opinions that I present. The purpose of my effort is to stimulate a dialogue around current events and their impact on the markets.

This document may be distributed to anyone free of charge as long as it is provided in an unaltered form. I reserve all Intellectual Property Rights of this document.

Regards,




Please read this important notice

Disclaimers As you read this document keep in mind that I do not have any special insights into the markets nor do I have any type of training or experience in any kind of investments. I am not a financial advisor nor do I have a degree in economics or finance. Remember these facts as you read and ponder my unprofessional opinions.

This document should not be construed as investment advice; you and your financial advisor are responsible for making your investment decisions. The purpose if this document is for me to “think out loud” and stimulate thoughts regarding my investment ideas for my portfolio. I am asking you for your feedback about my thoughts, strategies and conclusions.

Nothing in this document should be construed as tax advice or estate planning. Tax laws are complicated and change often. I do not have the time to follow changes in tax codes; therefore, any thoughts I may have on the subject are very likely to be obsolete or, at the very least, dated. Before you attempt to implement any tax strategies you should consult a tax professional or financial advisor.

All thoughts and strategies are based on the fact that I invest money from the United States using US dollars and pay US taxes. All comments and views are from my American investment perspective. Many of my strategies consider US tax implications and currency exchange rates that may not be valid when viewed from outside the US.

The views and opinions in this report are strictly my own based on publicly available information. I do not have any special perspective into the markets. Opinions stated are my own and do not reflect the opinions from any current, past or future employer.

I will/may change my strategy and investment ideas radically and suddenly between reports without notice to any receivers of this report. My own investment strategies can be extremely aggressive and my portfolio should not be replicated by anyone, including me.

I am an amateur investor and this document is a hobby for me. Any thoughts and concepts should be treated as such. Please consult a professional financial advisor before you make any investment decisions regarding your investment ideas, goals, and strategies. Continue reading this document at your own risk…

This report is subject to considerable error and the opinions can change without notice. Neither the information nor any opinion expressed constitutes a solicitation to buy or sell any securities or investments. Do NOT ever purchase any security or investment without doing your own and sufficient research. Past performance is not an indication of future results.


Introduction

I would like to take a moment to thank Trader Wasteland for allowing me to publish my report on their website. It’s about time I joined Al Gore in embracing the internet. Please take a moment to check out their website, I find the opinions expressed in Trader Wasteland insightful and they are one of the sources that are used in making this report.

Other big news here at the Review… this item just in… I did it… I bought a house. I purchased a log home in Yellow Spring, West Virginia (pictured on cover) and quite happy with my little mountain home. I didn’t buy this for an investment; I bought it because I wanted it. To be clear, I still think housing prices may fall a bit more but I like where long term mortgages rates are and feel like that this is a good time to buy a home since total payments may be near a low for a long term purchase. This is part of my strategy to stop owning virtual pieces of paper and owning tangible assets and accumulating tax advantage debt.

This issue will be a “small report”, if you can call twenty-eight pages small. I am staying with the theme that I will write two larger reports in January and July and smaller reports in the spring and fall to avoid repetition. A smaller Q1 Review will also allow me more time to pull out my hair and figure out how much money I need to send to Washington so they can at least make interest payments on the debt necessary to make my life better.

The next issue may not get published or may be significantly reduced. I recently banged up my rotator cuff and may need to get some “work” done. The next issue will likely be either very long (sitting at home bored) or very short (not being able to use my right arm for a while). So, if you don’t get a Report by July 11th you will know why…

One other house keeping item, I would like to reiterate the objective of this report, it is to talk about “big picture” subjects and may not contain details sufficient for some yet at the same time may provide too much superfluous information for others. Please remember this report is circulated to a very wide audience and I am trying to strike a balance between the big picture and still back it with some substance. In others words, I don’t expect every section to appeal to everyone so feel free to skip around and read the sections that appeals to you. I won’t be offended if the readers don’t read every section, and if you did, I would be very shocked. My goal is that everyone who reads this report comes away with at least one thing to think about no matter how much (little) of your time you spend on investing.

Please feel free do drop me a line to let me know what I can change to make more articles appeal to you. Many articles are responses to questions/comments from the readers.

Regards,

Mark RushYellow Spring, West Virginia


Chapter 1The Basics

Muni Bond list

In the last report I received more questions about municipal bonds than any other subject in the history of the Review. The principal question was what municipal bonds are available to exempt people from their state income tax also. I don’t have any specific information but I was given this link. This link is a good place for people to start their own research and a good starting point when you meet with your financial advisor.

http://seekingalpha.com/article/30356-a-guide-to-municipal-bond-etfs-and-closed-end-funds

What were the causes for the housing bubble?

In my opinion, the causes housing bubble cause are many and not really one thing. People will be writing PHD thesis’s on this for years to come. I will spend a few moments to come up with more or less what “I” think caused the bubble. Global increase in wealthI believe a major cause was actually the sudden increase world wealth triggered by globalization. Wealth worldwide was increasing and “new capital” was being created by the billions each day. I believe to some degree this wealth was being generated faster than it could be deployed. In other words it takes years to build a factory, road, or power plant, it takes a just a few minutes to invest in a stock market, bonds or make a deposit in a bank. It’s always faster and easier to buy something that exists vs. building or creating something new. Globalization is one of the reasons the Chinese ended up owning $500 Billion in Freddie and Fannie Debt (and 4 times that in US debt). The were creating so much wealth that even while funding a 10%/year GDP growth they still had money left over to lend money to us. Without the wealth created by China there would have been at least $2.5 Trillion being invested into the US. That’s a lot of money that needed to be deployed. Thankfully (sarcasm) we had a spendthrift President (Bush) and with a little help from Congress they were able to do something useful with all that unneeded money floating around (more sarcasm). Then if we add the ever diligent American public who “needed” bigger houses that in the end they could not afford and filling those houses with unnecessary crap using their credit cards… Collateral Debt Obligations (CDO’s)The widespread creation of this new way to back mortgages also contributed to this bubble. CDO starting taking off in 2001 and by 2004 this market was $150B/year but by 2006 it had risen to over $520B/year. The old way to make a loan was to one house would go to a bank and they would hold that individual mortgage until it was paid off. With CDO’s mortgages were aggregated and then diced and sliced into tranches (much the same way institutional/commercial loans are done). The first tier would get a lower interest rate but was highly unlikely to lose money, the second tier would get a higher interest rate but bear more risk while the third tier was the riskiest but received the highest rate of return(in theory).




Let’s say we had a $100k house mortgage, we may aggregate that loan with 1,000 other similar loans into a 100 million dollar mortgage pool. Now instead of slicing the risk vertically, each individual house, we slice the loan up horizontally. In this (simple) simple example we will create 3 CDO’s, one for the bottom 80%, one from 80% to 95% and one from 95% to 100%. This is to say that one house loan is now held by three different debt obligations, one for the first 80% of the value of the loan, the second for the next 15% of the loan and the last for the final amount. So in essence you would owe three loans for $80k, $15k, and $5k. In the case of a foreclosure the first tier would get paid off first with and left over money going to the second tier first and if by any chance that there was any money left the third tier would get paid the remaining amounts. Let’s assume that these loans are borrowed at 5% by the homeowner but compensate the lender for various level of risk each tranche would receive a different interest rate. In my example the first tier may get a 4% return, the second tier would get a 7.5% return and the final tier would get 13.5% return (assuming every pays their mortgage). And logically if all these houses in the pool went into foreclosure the 3rd tier would likely not get any of their money back while the first tier would likely get most if not all their money back. The motivation for the last tranche in my example is that as long as <9% of the people completely defaults this still would yield a higher rate of return than the first tranche. These instruments also provided liquidity since it was hard to buy and sell an individual mortgage but a financial instrument that could be traded and an investor no longer needed to make a 30 year commitment before making money in the mortgage market. These instruments added to liquidity in the mortgage market and diversified risk while simultaneously increasing the velocity of money. In other words it attracted a lot of capital to this market, in fact it attracted so much money to this market it was hard to deploy all the capital that was flooding this market (see point 1 global wealth) and hence lenders we tripping over themselves to find people to loan money to fill the demand by people wanted to own these instruments. I, unlike most other people, believe these types of instruments an excellent way to fund houses. This is a great way to diversity risk and open up this market to new classes of investors while better reflecting a sliding scale of risk imbedded in a mortgage (it is a very rare case that a mortgage goes to $0). Many politicians and pundits may point to and then disparage these instruments but I make it more analogist to the Dot.com bubble. Did we get ahead of ourselves with the internet in 1999? Yes, but that doesn’t mean the internet was an evil or atrocious creation, we pulled back and let excess inventory work its way down and today there are far more internet companies and more bandwidth than there was in 1999 but this time it is being utilized rationally. CDO will create wealth (doing more with less) now and far into the future just like the internet these instruments are a cornerstone of our way of life. I predict (assuming no government intervention) that 10 years from now we will create more CDO’s than we created during the peak of the housing market.


Tax codeThere are very rational reasons to buy a house (as a taxpayer) but these tax policies skew the housing market toward ownership. I personally, without the tax breaks, would not have just bought a house. The politicians do this to “give” something to the tax payers but this distorts demand also tends to push the prices of houses up. Factor in that this tax break even applies to a second home is even more problematic since typically second homes are bought by “the rich” and they are typically in a higher tax bracket therefore the perverse incentives for the “deduction” is even higher. The tax code creates an artificial demand for houses while driving up prices and this also contributed to the bubble. Many people bought homes or second homes because the tax “break” was sufficient to incentivize them into ownership. I now own a home primarily due to the tax code. Freddie and FannieThese guys also had their share to play in this also. They opened up their lending standards and also encouraged lending to subprime mostly due to political pressures. They enjoyed a competitive advantage because of their implied (now implicit) government guarantee giving them cheap money. One of the bigger and most overlooked features of this entity was that CDO’s had to compete with Freddie and Fannie (F&F). To some degree both F&F and the CDO’s competed for new business essentially diving both parties to the abyss. The biggest contribution by F&F to the crisis was their mere existence; the free market had to compete against an irrational institution and the quasi government agency that decided to dam the torpedoes and took on the free market head to head. F&F aggregated risk and pooled that risk inside these quasi government backed corporations. You could either buy bonds with low risk or buy various types of stock, options, or preferred shares. If you think about it, Freddie and Fannie were the original CDO’s and I find it humorous (sickening) that the when the free market crates a better version of the wheel (Freddie and Fannie) the populist point out the evils of these exotic instruments. These same Congressmen today don’t attempt to put pay caps on the multi-million dollar pay of those executives at Freddie or Fannie (or GM) or want F&F to contribute to the putative TARP tax that is being proposed to raise taxes on Wall Street banks for being too greedy. Why is F&F left out of this demagoguery? Freddie and Fannie should be abolished because the financial engineers has come up with a much better mousetrap and market forces will all be a better judge of risks than government mandates. Just as the regulated phone companies are being replaced by cell phones and magic jack, Freddie and Fannie should be eliminated and the market should decide. No one in the political class is making a big deal about the $5 Trillion of Freddie and Fannie debt that the US now owns in off balance sheet accounting that was a major contributor to this mess. Our political accounts have thing or two to show the armatures at ENRON about off balance sheet accounting and Special Purpose Vehicles. Low interest rates/ Yield curve/ARMsAnother factor was the low interest rates. After 9/11 the Federal Reserve lowered interest rates but at the same time the government was borrowing (due to excessive spending) that make short terms rates far more attractive than long term fixed rates (at least in the short run). If memory serves me right a few years ago 30 year interest rates were 6.5% while an adjustable rate mortgage (ARM) was around 4%. This translated to a $632 monthly


payment for $100k loan vs. $333 monthly payment for an interest only ARM. Since most people don’t look at how much something cost and only look at monthly payments, If you could afford a $650/mortgage this use to translate into a $100k loan but with an ARM you could “afford” (at least for a couple of years) something closer to $200k. Now since about 70% of all people can’t seem to control spending instead of “saving” that difference each for a “risky” loan what most people did was they bought twice as much house. Arm loans increased demand for loans artificially making houses more affordable (or until interest rates go up) driving up demand and the lower rates brought people into the market that couldn’t afford a house before.

9/11Hard to believe but the 9/11 attacks set into motion a series of events that led to lowering of interests rates by the Federal Reserve to simulate the economy, the Bush tax cuts to help stimulate the economy, and the Iraq war that also stimulated the US economy all contributing to the excess liquidity in the world banking system looking for a place to go. Without this event, it is very unlikely that all three of these events would have been in place to excessively stimulate the economy post 9/11 and it is possible that the housing bubble may have not formed or may have been much milder.

Failed Primary Education SystemUnfortunately, most of the citizens of the US don’t have sufficient math skills to understand a fixed rate mortgage vs. ARM and do not have sufficient time horizons to understand what drives interest rates changes. When one side is lending to lend and the other is borrowing to borrow is the surest way to disaster.

Any nitwit can come up with a list of reasons of why they need to borrow money and they also can concoct an equally crazy scheme of how they will pay it back. It is the role of the banker to decide if those reasons are valid and if you can indeed pay the money back. Bankers get paid well because they have the responsibility of properly allocating resources within the economy and theoretically prevent us form doing dumb things with other people’s money. They have failed us recently. Illegal immigrationThis had a smaller but not insignificant part of the problem also; two factors bring this category into play. Ten million illegal’s obviously increase demand for housing, at first primarily in the rental markets driving existing renters in to home ownership. And later as the market needed to deploy more capital it reached desperate levels and loans were offered to these people via the No-Doc(umentation) loans fueling even more demand for home ownership and fueling some speculation.

Human behaviorI would say one of the biggest contributors to the rise of the housing market was just human herd mentality. 80% of the population will always be sheep and will just follow the pack. These types of bubbles have existed and been repeated in human history in almost everything from silver, Dot.com stocks, and Tulips bulbs. Here is a link to one of the more amusing bubbles. http://en.wikipedia.org/wiki/Tulip_mania.


http://en.wikipedia.org/wiki/Tulip_mania

http://Dot.com/

We had investors pouring in money because they had money to put to work and they would ask themselves “how could I loose on real estate?” On the other side, we had people asking the lender “what do I need to do to get the biggest house I can possible get”. The problem is that there should always be at least one adult at the bargaining table willing to say you can’t afford that and historically it has been the lender.

Again, this is the role of the banker in our society is to be the parent and say “no, you can have that”. The combination of situations created enthusiastic borrowers and enthusiastic lenders. Unfortunately this situation didn’t bring at least one adult to the table.

Paul KrugmanOk, he probably didn’t have anything do with the housing bubble directly but he is still a complete idiot.

What laws should have been in place to prevent the housing bubble?None - As long as we live in a free or semi free society people will always have the right to make bad and/or irresponsible choices. This downturn is the result of people being free to lend and others free to borrow. This is one of the prices of freedom and in my opinion it is worth it, after all the people of North Korea aren’t too worried about the housing bubble since they are too busy worrying about their next meal. Entertaining videoOk, that was long and boring so a Trader Wasteland introduced me to this very entertaining video to summarize the century old debate on what causes booms and busts.

http://www.youtube.com/watch?v=d0nERTFo-Sk

More on these two influential economistshttp://en.wikipedia.org/wiki/John_Maynard_Keynes http://en.wikipedia.org/wiki/Friedrich_Hayek


http://en.wikipedia.org/wiki/Friedrich_Hayek

http://en.wikipedia.org/wiki/John_Maynard_Keynes

http://www.youtube.com/watch?v=d0nERTFo-Sk

Chapter 2Market Dynamics

Economic Projections

It is time to review world events applying my “opinion” based on absolutely nothing other than my limited understanding of how the world works.

The purpose of this section is to highlight current risks in the market. I will attempt to quickly try to explain my thought process behind each rating.

US Economic Indicators (my view) US Gross National Product (GDP) Growth > +2.0 % for 2010

I believe a major economic collapse has been averted. Investments with overseas exposure should be considered due to higher expected growth rates. It seems like we are on track to get some growth this year.

The economy seems to be stabilizing and likely to expand this year

Unemployment of falls to < 8.5% by the end of 2010

I am not sure what I was thinking when I made this prediction… I would be surprised if it fell below 9.0% this year but I am stuck with my prediction until the end of the year no matter how bad it sucked. No more drinking Champaign and making predictions…


I believe unemployment has peaked and we will start to reduce unemployment in the future but for now this indicator is a big negative at 9.7% and almost everyone (including me) believes it will be years before we get back to “normal” unemployment rates. It does look like unemployment may have peaked.

Unemployment is very high

Federal Reserve holds rates steady or raises interest rates 2010

This wasn’t even a tough one to get right. You can’t lower interest rates lower than zero. I expect that we will keep rates low through 2010 although if I was the Fed chairman I would raise them to 0.5% immediately and consider 1% by the end of the year.

Current low short term rates are very inflationary and I feel that it was a necessary evil at last year. Longer term I expect these low rates will cause inflation, which is bad for the value of the US dollar. Hopefully the Fed will start being concerned about inflation the Fed will raise rates in late 2010. I find it odd that we created a crisis by having rates too low (near 1%) for too long and we are going to solve our problem by having rates at 0%.

On an interesting side note, China has been raising rates and reserve requirements. They are busy trying to slow down their economy.


Low rates are good for the market…

Inflation > 3.0% in 2010

The current inflation rate is around +2.1%. I believe the main reason that we haven’t seen massive deflation is due to the vast amount of money the Federal Reserve has printed. Below is a chart of the total money supply. This is how the Fed is fighting deflation, over the past 18 months FTTM has jumped from $4 trillion to $9 trillion. The only bright side is the growth of the money supply (green line, left scale) has slowed and seems to be stable. I will be happier (and so will the Chinese) when money supply starts to shrink (purple line goes below 0%, right scale).


Currently we are not experiencing inflation or deflation and the vast increase money supply seems to have stabilized.

Return of spending by US consumer in 2010

Foreclosures will be higher than historical for the next 2-3 years; consumer spending will take years to recover since much of the spending was financed via fictitious housing values.

This indicator remains weak but stable

S&P profits grow by 20% in 2010

Corporations were financially stronger going into this down turn (except financial institutions) compared to other downturns but this one will be much deeper. Analyst’s expectations are near 30%, but they tend to be a bit over optimistic.

I expect S&P 500 earnings growth to be up 20% from 2009

Stable (- 5%) Real Estate prices in 2010


The 30 year mortgage rate is now to 5.19% near where it was in the last report but off the low near 5.0%. The current administration’s propensity to spend should put pressure on long term interest rates and inflation expectations. The Fed stopped buying mortgage securities in March and rates should rise toward to 6% or higher thereby slowing demand and pushing prices down for houses. This more than anything may undermine the recovery and recreate the disaster that was averted.

30 Year Mortgage Rates

Housing prices are stabilizing; interest rates are low

>$1,000,000,000,000.00 ($1 trillion Dollars) budget deficit for FY 2010

I have already been proven so incredibly wrong on this estimate. I am not sure what I was thinking in January but clearly I was too optimistic (drunk?). The administration is now projecting a $1.56 Trillion deficit on top of $2.3 trillion of revenue they expect to receive. Now who are the ones too drunk (optimistic)?

How much money is the deficit? The government is planning to deficit spend over $5,150 per person ( about $20,600 for a family of four) on top of the $7,500 per person ($30,000 for a family of four) that it actually collects. Wow, this year’s budget actually spends more ($50,600 for a family of four) than the median US household income ($50,000). Does this bother anyone?

How much of my fair share of the $13,000 that will be spent on my behalf do I expect to receive this year? None, I will be mailing a check in the other direction well in excess of $13,000. I am what you would call in Washington deficit neutral or in the land of fairy tales, the golden goose.

On an interesting side note, rents now in the Washington DC are approaching New York City. It’s unconscionable to see our most important place to live is now becoming the political center instead of the economic center.

This massive taxing, borrowing, and spending will eventually have a catastrophic impact


on interest rates, inflation, value of the dollar, and standards of living for everyone. In 1944, Friedrich Von Hayek wrote a book call “Road to Serfdom” eventually he received the Nobel Prize in economics in 1974. Everyone should read this book.

I believe thoughtless government overspending is harmful in the long run

International value of the US dollar declining >35% in next 5 years

In the long run the dollar has no direction to go but down. The combination of poor education, poor fiscal discipline (public and private), and mass retirement only leads me to believe over the next 20 years it would be better to place a significant portion of your investments overseas to obtain better growth and to take advantage of the eventual currency devaluation and fall in local purchasing power.

The value of the Dollar has increased almost 10% since the recent low in November. The question is did the dollar rise in value or were all the other currencies just falling faster?

Long term bad for US investing; Good for Foreign investments and commodities


http://upload.wikimedia.org/wikipedia/en/c/c6/Debt_to_GDP_Forecast_Chart.png

Improved Liquidity in 2010

Liquidity became almost nonexistent for a few days in 2008 and the lack of liquidity could have caused a worldwide credit collapse… Thankfully I can report that this indicator has returned to an almost normal range and lets all hope that it stays there.

The below chart shows the TED (Treasury Euro-Dollar) spread. This shows the premium that banks must pay over Treasuries to get money. This is kind of like a fear index for the credit market.

This indicator has improved significantly and near normal!

Technical Indicators

Technical analysis is the attempt to forecast the future direction of prices through the study of past market data. I tend to use Barchart ( http://www.barchart.com/ ) to come up with a final “objective” opinion of an investment. I say objective since it a purely mathematical method to project a direction of an investment. Its primary ability (flaw) is that it tries to predict the future by interpolating from the past performance. One phrase does come to mind, “Past performance is not an indication of future results”.

Model Portfolio and other technical indicators (+100% = strong buy; -100% = strong sell)

US Stock 7/1/09 1/3/09 3/31/09 Link SPY +64% +64% +80% http://quotes.barchart.com/texpert.asp?sym=SPY&what=opinion

QQQQ +72% +96% +80% http://quotes.barchart.com/texpert.asp?sym=qqqq&what=opinion

IWM +48% +88% +80% http://quotes.barchart.com/texpert.asp?sym=IWM&what=opinion

Foreign 7/1/09 1/3/09 3/31/09 Link


http://quotes.barchart.com/texpert.asp?sym=IWM&what=opinion

http://quotes.barchart.com/texpert.asp?sym=qqqq&what=opinion

http://quotes.barchart.com/texpert.asp?sym=SPY&what=opinion

http://www.barchart.com/

EFA +32% +56% +64% http://quotes.barchart.com/texpert.asp?sym=EFA&what=opinion

EEM +48% +80% +72% http://quotes.barchart.com/texpert.asp?sym=EEM&what=opinion

BondsTLT -16% -88% -72% http://quotes.barchart.com/texpert.asp?sym=tlt&what=opinion

SHY +67% -88% -16% http://quotes.barchart.com/texpert.asp?sym=SHY&what=opinion

Gold/Euro/Yen/US Dollar/OilGLD +32% -8% +8% http://quote.barchart.com/texpert.asp?sym=gld&code=BSTK

FXE +80% -56% -72% http://quote.barchart.com/texpert.asp?sym=FXE&code=BSTK

FXY +32% -64% -100% http://quote.barchart.com/texpert.asp?sym=FXy&code=BSTK

UUP -80% +72% +64% http://quote.barchart.com/texpert.asp?sym=uup&code=BSTK

USO N/A +48% +72% http://quote.barchart.com/texpert.asp?sym=uso&code=BSTK

VolatilityVIX -96% -32% -24% http://quote.barchart.com/texpert.asp?sym=$vix&code=BSTK

These indicators seem to gravitate toward any stocks. Overall the indicators still prefer stocks over bonds and again I couldn’t agree with the results more. Bonds are also VERY weak and this once again validates my thesis of never owning bonds for more than a two year time horizon.

The CBOE Volatility Index (VIX) (Fear index)

The Volatility index (VIX) can be thought of as the US stock market fear indicator and the lower it is the lower the fear in the market. This indicator is one of the more valuable tools to evaluate what implied risk is in the market at any given point in time. As the VIX goes lower the lower the supposed fear is in the stock market. This indicator is positive sign for stocks. If this index got above 25 again I would consider shorting stocks again.

These technical indicators have are positive for all stocks, and for owning the US dollar. Foreign currencies are weak and all bonds are extremely negative.


http://quote.barchart.com/texpert.asp?sym=$vix&code=BSTK

http://quote.barchart.com/texpert.asp?sym=uso&code=BSTK

http://quote.barchart.com/texpert.asp?sym=uup&code=BSTK

http://quote.barchart.com/texpert.asp?sym=FXy&code=BSTK

http://quote.barchart.com/texpert.asp?sym=FXE&code=BSTK

http://quote.barchart.com/texpert.asp?sym=gld&code=BSTK

http://quotes.barchart.com/texpert.asp?sym=SHY&what=opinion

http://quotes.barchart.com/texpert.asp?sym=tlt&what=opinion

http://quotes.barchart.com/texpert.asp?sym=EEM&what=opinion

http://quotes.barchart.com/texpert.asp?sym=EFA&what=opinion

Chapter 3The Plan

Every trader reserves the right to make a more intelligent decision today than he made yesterday. - Sheldon Natenberg

Where do we go from here?

The economy and budget deficits

The economy is weak but stable and is likely to remain weak and stable through 2013. It is important to note that at the end of this year the Bush tax cuts expire increasing the top rate by 4.6% and more than doubling taxes for dividend income (from 15% to a max of 39.6%). Then in 2012 the Health Care tax goes into effect on the same individuals for another 3.8% tax on all investment income.

These tax increases will come at a time when our economy should just be turning around and more importantly these taxes are targeting investment income that is likely to have grave consequences for investment and the prospects of creating new jobs. I don’t think we will have clear direction of where to put money until next year once all the tax policies effects are known and the market digests all the new tax policies.

High dividend stocks have been a staple of my investment strategies for the past few years but with the new tax rate going into effect these stocks are likely to take a pounding from of the “rich” people selling these stocks to avoid paying the higher taxes. We are back to the days where you should buy and hold low dividend stocks and only sell them when necessary to raise cash for needed expenses (such as your tax bill). This effect will significantly reduce the expected income received by the government and at the same time weaken the economy. In other words they won’t reduce the deficit as much as expected so interest rates will rise and investments will tend to be stagnant to avoid taxes.

The cruel fact about all this taxing is if you assume revenues go up 13% (taxes going from 35% to 39.6%) and also assume those making over $250k pay most of the taxes. Since income taxes “only” raise about $1.0 Trillion in revenue the most the government can hope to gain from raising taxes is $130 billion ($0.13 Trillion) so… if your deficient is expected to be around $1.5 Trillion “soaking” the rich this idea really doesn’t get you shit…

Now the other revenue streams are around $1 Trillion in Social Security taxes and another $400 billion in corporate and other taxes… I suspect that raising taxes will gain a modest revenue increase of roughly $0.05 Trillion but that may be lost in reduced growth in the other sources of revenue such corporate taxes and Social Security tax due to lower investment and lower employment rates. All in all I do expect revenues to rise next year to roughly 3% due to a stronger economy not because of higher tax rates (in my opinion).


So what does this huge as tangent have to do with investing? Well, my point is that raising taxes at this point of the game is sort of meaningless (unless your true objective to reduce the wealth gap). The only way to reduce the deficient is to cut spending and our current administration has too many “good” ideas that require funding. Therefore spending is going to continue up but there are no new substantial sources of revenue. It will take until at least 2013 for the economy to recover enough to bring in the previous $2.7 Trillion in revenue compared to our current $2.4 Trillion including all the tax hikes while spending is likely to increase substantially (health care).

The US government is in a real jamb and it is unable to get itself out of it. It is clearly spending way too much money. Get this, next years spending will be twice as much as total government spending in year 2000 and believe it or not revenues actually rose under Bush by about 50%.

I hear from the left that tax rates are “only” going back up to the rate they were at under Clinton. I am fine with that under two conditions all those tax rates should go into effect (that means that some of 50% of the population that pays no income tax would start paying income taxes again) and spending returned to what it was under Clinton ( a cut in the size of the federal budget by 50%)

So here is the point. The US government is on a collision course with financial disaster. I know of no way to stopping it. I will never hold long term Bonds denominated in US Dollars nor have net investments that are tied to the US dollar. What is given is that interest rates MUST GO UP, the government is going to crowd out capital to fund its spending. Eventually the most likely “band aid” will involve devaluating (either directly or indirectly) the US dollar. This is as sure as the laws of physics. We got ourselves into this current mess by individuals borrowing money they could not repay therefore our logical solution to this problem is for us to collectively borrow too much money that we can not repay? I warned my readers of the impeding housing bubble in 2006 and now am warning you of the impending US debt spiral.

The Dollar and US Bonds (the next bubble to burst)

I can’t emphasize this enough… I will not buy nor shall I ever hold US Treasuries Bonds (except for TIPS). If anything I will short US Bonds (via TBT). Yields are far too low for the risk being taken, the flight to “quality” has artificially driven rates low (bond prices high) and they will fall when the recovery begins. The Federal Reserve will need to eventually raise rates and this will also cause bonds to fall. I fully expect that interest rates to go up (bonds fall when rates rise) this year. Add to this the vast debt that we are incurring and I can only come up with one conclusion; Government Bonds are likely to fall by 30-50% in value over the next 5 years.


Muni bonds

Taxes are going to go up and people are going to want to shelter income, tax free bonds are going to go up. I am thinking about buying some Muni bonds now and selling them when 2011 arrives. If you need tax free income this is one of your few options and it’s a nice place to keep short term funds in lieu of cash in the bank.

Long term these bonds will get hit with rising interest rates so the trick to Muni bonds is twofold. First, find bonds that aren’t likely to default. Second, I would not invest in any bonds that have a maturity longer than 2 years. Muni bonds will have exposure to inflation risk and dollar risk.

Corporate Bonds

Corporate bonds are likely to get beat up later this year due to taxes increases next year. I plan to avoid them until 2011 and then buy some in my IRA. Another factor to consider is if inflation starts to appear bonds do horribly during inflationary time and I suspect inflation will appear in the next couple of years.

Something one could consider is buy corporate bonds and selling (shorting) Treasuries. This would offer some protection from inflation and likely to yield a decent return under most circumstances but this idea isn’t very viable without a significant amount of cheap leverage.

Financial stocks

Too risky… Although I may be tempted by Goldman Sachs (GS) Gold

Here is what I dislike about gold. I really do find it a funny item; it is extremely hard to find and our society spends a lot of effort finding, digging it out of the ground, and refining it. Then once we have some we tend to either burry it again in a bank vault underground somewhere (so others don’t find and extract it) or its turned into jewelry and fillings then eventually buried 6 ft under ground again. So to me it seems like we dig it out of the ground to eventually put it back into the ground somewhere else?

Holding gold also doesn’t produce any wealth, in fact, usually you have to pay someone to hold it for you (safety deposit box) or at least have some insurance to protect from theft. Most other investments are in some sort of economic activity and produce some sort of revenue, while gold just sits there collecting dust.

What I like about gold is that it is a reasonable store of value during times of inflation. Also most of the easy gold has been already been found already and as it has become more difficult to find and mine each year, in other words the supply is more or less fixed or decreasing. As third world countries become richer they tend to want to buy some of this silly metal also. Demand for this product will continue to increase as more people around the globe are able to afford more luxury items.


The more I look at gold the more I like it. I have only just started collecting gold coins and recently bought more gold and a few platinum coins. I believe that is wise for me to have at least 1% of my net worth in gold but not more than 5% under any circumstance.

The there ways to own gold is either buying gold coins directly or keep in a safe (I use Kitco - https://online.kitco.com/bullion/completelist.html) or to buy the Gold EFT (GLD) via the stock market. The third but harder way is to buy gold on the commodities exchanges. I am also considering buying some gold mining stocks.

One issue to consider is that gold, silver, and platinum fall under the heading of "collectibles" in the eyes of the Internal Revenue Service, making these metals similar to artworks, antiques, vintage wine, and baseball cards. This status means that profits from gold and silver investments do not qualify for the 15% long-term capital gains rates that pertain to stock and mutual fund investments and are instead taxed at 28% if held for more than one year. To the best of my knowledge this doesn’t seem to change next year.

It is my belief that gold over the long run will outstrip inflation due to stable to falling supplies and an increase in demand therefore I will continue to “collect” gold coins whenever I have a few extra unused dollars laying around over the next several years.

Oil/Energy

Oil has been remarkably resilient. The funny part is that investment has fallen in new fields and if the economy ever recovered then oil would increase 50% fairly easily from current prices. Oil was high due to impending demand of the world economy, drilling has fallen and are likely to have severe shortages of oil in the next 2-3 years.

Oil stock may be a good place to put a little money in this year. If the dollar weakens and/or inflation takes hold these stocks will outperform. I own shares of British Petroleum (BP) for its high yield and the Canadian oil company Suncor (SU) that harvests oil from tar sands. To some degree I would shy away from US based oil companies since the “windfall profits tax” will likely be enacted the next time oil hits $150/bbl.

Domestic Stocks

I prefer stocks that have exposure to the emerging markets and don’t depend as much or Europe or the US. International tech companies seem to be a better play.

Chinese and Emerging markets

I am still a believer that these markets will drive the world economy over the next 50 years. I will be investing there based upon these beliefs. I am waiting for a major pullback to buy. This and energy is where most of my money will be invested for the foreseeable future.


https://online.kitco.com/bullion/completelist.html

Summary of Mark(et) Economic Indicators

GDP Growth – The economy seems to be stabilizing and likely to expand this yearUnemployment – Unemployment is very HighFederal Reserve Bias – Low rates are good for the market…Inflation – Currently we are not experiencing inflation or deflationConsumer Spending – This indicator remains weak but stableCorporate profits Growth Rate – I expect S&P 500 earnings growth to be up 20% Real Estate Market – Housing prices are stabilizing; interest rates are low Budget Deficit – DisastrousDollar – Long term bad for US investing; Good for Foreign investments and commoditiesVolatility Index – Down from highs, stabilizingTechnical Indicators – Strong for all stocks and US dollar, weak for bondsLiquidity – This indicator has improved significantly and near normal!

One thing to point out is that it appears that I have some disagreement within my indicators regarding the US dollar. My analysis of the falling dollar is long term while the technical indicators are good for a few months under ideal situations. So, in essence I am predicting a short term rise in the dollar followed by a long painful decline or as like to say a “bear market rally” in the US dollar.

So… What is the Plan?

This year also I plan to invest in low dividend stocks such as tech and growth stocks, oil, commodities, and emerging markets on any major pull back. Add to that a touch of gold and a speculative play on Municipal bonds while short the US bond market (TBT)

I still do not see myself becoming a committed investor this year but I will want wait until 2011 to see how the increase in taxes changes the market. I think late 2010 early 2011 will create investment opportunities.

I believe that were having real troubles keeping up with oil demand when the world economy was good, if the recovery starts up again oil is going to shoot up again. It is already over $80/bbl already without much of a recovery. Don’t get me started on green energy replacing oil, its not going to happen in your lifetime. New energy demand will always outstrip the ability to build sustainable projects. By the 2050 the world (even with all the green initiatives) will be consuming 50% more oil than it does today.

The Euro is in real trouble due to the deficits of the PIIGS (Portugal, Italy, Ireland, Greece, and Spain). I shall not invest in anything denominated in Euro’s for the foreseeable future.

The US has demonstrated its dependency on credit and if we add in the fact that we have a growing budget/dollar time bomb, it still brings me back to the same theme that I have had since the first issue of this report. With my long term view on global macroeconomics and my view of the US macroeconomics of the US debt markets, I have no choice but to invest outside of the US, minimizing my exposure to the US dollar and especially avoiding dollar denominated government bonds …


Chapter 4Investments Ideas for 2010

Short term cash

Barclays Short-Term Municipal Bond ETF Symbol SHMSector Municipal BondsRisk LowReturn Very LowTime Horizon Short Term 1 -12 monthsTechnical Rating -64%Tax implications Federal Tax FreeAccount(s) Taxable ONLY

I often use SHY as a short term location to earn some interest on my cash. This year I will instead of using SHY will be using Barclay’s Short-Term Muni Bond Fund (SHM). I expect that these types of instruments are going to get very popular once taxes go up. One note is that I expect all interest rates to rise (bonds will fall) due to our current fiscal issues so there is some general market risk associated with these. It currently has a 1.9% Federal tax free yield. I ran the Barchart technicals on this one and it’s indicators are very ugly.

Reversed leveraged US Bond ETFs

UltraShort Lehman 20+ Trsy ProSharesSymbol TBTSector 2x leveraged short US long Bond EFTRisk SpeculativeReturn moderateTime Horizon Medium termTechnical Rating +72%Tax implications Consult tax advisorAccount(s) IRA and Taxed

The investment seeks daily investment results, before fees and expenses, which correspond to twice the inverse of the daily performance of the Lehman Brothers 20+ Year U.S. Treasury index. This is what I will use when I decide that I want to short the long bond. This ETF moves opposite direction and twice as fast as the 20-30 year bonds.

This is one of my preferred investment ideas right now and the technical ratings agree.


Financials

Security Name Goldman Sacks Symbol GSSector Investment BankingRisk Moderate + Return Moderate +Time Horizon Long term (36 months +)Technical Rating 0%Tax implications low dividendsAccount(s) Taxed

Why do I like Goldman Sacs? It survived and paid back the government. I plan to own some when the rating improves.

Technology

NASDAQ 100 ETFSymbol QQQQSector Various tech firms Risk ModerateReturn Moderate +Time Horizon Long Term (36 months – 60 months)Technical Rating +80%Tax implications Low dividendAccount(s) Taxable

Of all the tech names I like Microsoft, Intel, Cisco, Google, and Apple… Most are contained in this one simple ETF. This is the easy way to invest in tech.

Precious Metals

GoldSymbol GLDSector Precious MetalRisk Moderate Return Moderate +Time Horizon Medium term (3 months – 60 months)Technical rating +40%Tax implications Long term capital gain rate of 15% does not apply to this ETF.

Long term capital gains rate for this security is 28%Account(s) IRA; short term taxed

What this ETF does is allows you to buy gold as if were a stock. Each share that you hold is equivalent to owning a 1/10th of an ounce of gold. The gold is stored in a bank vault in Great Britain. Gold has always been a currency of safety and I believe world demand for this metal is only going to go up as the world gets richer. Also as the US


dollar falls gold will tend to go up. I believe that gold will be $1500 per ounce within the next few years.


Chapter 5International ETFs for 2010

2010 Consensuses Economic Growth Forecast by CountryChina 8.6% Chile 3.5% United States 2.7% Japan 1.5%India 6.3% Thailand 3.3% Russia 2.5% Argentina 1.4%Egypt 4.5% South Africa 3.1% Canada 2.4% United Kingdom 1.3%

Indonesia 4.5% Turkey 3.0% Israel 2.4% France 1.3%Malaysia 3.9% Mexico 3.0% Pakistan 2.4% European Union 1.2%

Singapore 3.8% South Korea 2.8% Sweden 1.9% Italy 0.9%Brazil 3.8% Hong Kong 2.7% Poland 1.9% Spain -0.1%

Taiwan 3.5% Australia 2.7% Germany 1.6% Venezuela -3.4%

My strategy is based on one simple idea. Invest in stable countries that have high economic (GDP) growth. Therefore I would invest in China, India, Brazil, South Korea, Australia while avoiding Japan and Europe.

International Investments to watch

Morgan Stanley Capital International Australia Index Symbol EWASector International ETFRisk MediumReturn Medium+Time Horizon Long term Technical Rating +88%Tax implications Consult tax advisor Account(s) Taxed

I own this to invest in China and India indirectly; I believe that Australia is a place to invest because of its raw materials and the proximity to India and China. This ETF is traded in the US that matches the Australian stock market, which is a significant supplier of raw materials to Asia. This stock has also taken hit as commodity prices have fallen but should be strong in the upcoming years.

China…


Chapter 6Mark’s Model ETF Portfolio

Asset reallocation

General profile for a several diversified portfoliosRisk Adverse Balanced Growth Aggressive

US Large Cap: 20% 30% 40% 30%US Small Cap: 10% 10% 20% 30%International: 10% 20% 30% 40%Fixed Income: 50% 35% 10% 0%Cash: 10% 5% 0% 0%

US Large Cap: SPDR S&P Depository Receipts (SPY) 33%NASDAQ 100 Trust Shares (QQQQ) 33%Vanguard Value VIPERs (VTV) 33%

US Small Cap:iShares Russell 2000 Index (IWM) 100%

International: iShares MSCI “EAFA” Europe, Australia and Far East Index Fund (EFA) 50%iShares MSCI Emerging Markets Index (EEM) 50%

Fixed Income (Bonds):iShares Lehman 20+ Year Treasury Bond (TLT) 25%iShares Lehman 7-10 Year Treasury Bond (IEF) 25%iShares Lehman Aggregate Bond (AGG) 25%iShares GS $ InvesTop Corp Bond (LQD) 25%

Cash:iShares Lehman 1-3 Year Treasury bond (SHY) 100%


Year to Date Returns

NameSymbol 12/31/09

Price3/31/10 Price

YTD Gain %w/o Div

YTD Gain % w/ Div

SPDR S&P Depository Receipts SPY $111.44 $117.00 4.99% 4.99%NASDAQ 100 Trust Shares QQQQ $45.75 $48.16 5.27% 5.38%DIAMONDS Trust DIA $104.07 $108.61 4.36% 4.62%Vanguard Value VIPERs VTV $47.75 $50.47 5.70% 6.26%iShares Russell 2000 Index IWM $62.44 $67.80 8.58% 8.86%iShares MSCI “EAFA” EFA $55.28 $55.98 1.27% 1.27%iShares MSCI Emerging Markets EEM $41.50 $42.12 1.49% 1.49%iShares Lehman 20+ Year Treasury TLT $89.89 $89.50 -0.43% 0.25%iShares Lehman 7-10 Year Treasury IEF $88.60 $89.50 1.02% 1.63%iShares Lehman Aggregate Bond AGG $103.19 $104.20 0.98% 1.61%iShares GS $ InvesTop Corp LQD $104.15 $105.77 1.56% 2.42%iShares Lehman 1-3 Year Treasury SHY $82.96 $83.37 0.49% 0.69%

Results for the various “autopilot” portfolios

Risk Adverse Balanced Growth Aggressive

Q1 ’10 Return 2.89% 3.31% 4.46% 4.80%’10 Implied Return Rate 11.57% 13.23% 17.83% 19.21%

’09 Return 11.14% 19.65% 31.48% 36.54%’08 Return -8.18% -18.66% -33.90% -39.60%’07 Return 7.82% 9.40% 10.04% 10.45%’06 Return 9.72% 13.63% 19.09% 21.83%’05 Return 5.49% 7.55% 9.73% 11.77%


Chapter 7Final Thoughts

The Good

Interest rates are low and credit has become more available The risk of financial collapse has been greatly reduced China’s economy seems robust and growth is real Credit spreads and volatility indexes (fear indexes) are greatly reduced Economic stabilization has occurred around the world World GDP is projected to be positive in 2010

The Bad

High US unemployment Governments interfering/controlling allocation of resources Congress is full of economic idiots who think they legislate wealth Higher taxes in 2011 on capital/production The government has grown substantially and no end point is in sight Iran’s nuclear program and Israel’s 238 thermonuclear weapons Trade war rhetoric Healthcare (wealthcare) reform Some corporate debt is being issued cheaper than US Debt The current political goal is to divert investments toward consumption

The Ugly

Exploding budget deficit/national debt due to increased wealth redistribution We may be seeing the beginnings of a US Government debt spiral The Social Security time bomb Looming long term collapse of the US dollar Potential for US bonds may be downgraded Risk of PIIGS default that will lead to another round to the credit crunch Misallocation of capital resources The political class doesn’t understand the basic mechanics of economics


Final thoughts:

I reluctantly condoned of the action that the Federal Reserve has taken with monetary policy since these actions has probably saved the credit market from a total collapse, although it has/is gambling with the credit rating of the United States. I do not approve of the new spending plans or the expansion off social programs of the current administration or other economic foolishness of “our” legislators.

I hate all bonds especially US Government Bonds! I will be short bonds by buying the double reverse bond ETF TLT. It was my investment pick of the year.

I like tech stocks because they are a good way to shelter income since most have low to no dividends. When I need money I can sell them and only pay 20% in gains beginning in 2011 if I hold them for more than a year.

When everyone was borrowing I was saving and now that everyone is savings it is time for me borrow. I now own a home in West Virginia with a big fat 30 year mortgage and shall not buy a home in Baltimore.

I like gold and don’t like the US dollar but my technical indicator has warned that this may not be the correct time to buy gold or to move money into foreign currencies. I still think I will be eventually correct but will avoid any more commitment of resources in this area until those indicators are in line with my long term strategy.

I have much more to say but I need to spend the rest of my time determining how big my check to Washington is going to be this year. So many of my musing are going to have to wait for another day, luckily we can always thank the political class for always giving me something to write about.

This is the conclusion of my report, I hope to get the next report out by July 11th 2010 and entertain you with my new thoughts and reflections. Please send any questions, comments or topic ideas for future issues to me via email. GOOD LUCK!!!

Regards,




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