Posted on Thursday, June 11, 2009 - by Henry Walter
June 2009 Round-up

PERFORMANCE
After a spectacular performance in March and April, the market rose modestly in May. Year-to-date the Dow is still negative, down 3.1%, but the broader S&P 500 is +1.8%, the Russell 2000 (small stocks) +0.4%, and NASDAQ +12.5%. Overseas, Europe is +5.7%, Asia-Pacific +11.7%, with China +44.6%, India +51.6% and Taiwan +50.1%. Latin America was strong with Brazil +41.7%. Looks like the BRIC countries was the place to be.

Treasury yields surged to their highest level since November, not what Ben Bernanke had in mind. For example, the 10-year Treasury’s yield, which had dropped to 2.04% last December, closed the week at 3.5% after rising as high as 3.7% during the week. In May we also saw oil make the biggest monthly gain in 10 years and silver the biggest monthly gain in 22 years. And during the month of May alone, the price of gold rose from $890/oz to $979, a 10% increase. So far this year, 36 banks have failed, 305 are on the list of “problem” banks, and, according to the FDIC, one-fifth of all U.S. banks are in trouble. And it looks like General Motors will file for bankruptcy with the end result that the U.S. government and UAW will own most of the company, and it will become a government ward. Naturally, the biggest losers in the GM fiasco are the U.S. taxpayers.


OUTLOOK
Who should we listen to? Certainly not the large investment banks that have their own agenda to sell you products and services with high fees and commissions attached. If you turn to “independent” advisors they are all over the map from “opportunity of a lifetime” to “the worst is yet to come”. The truth is no one can predict the future, but that doesn’t stop them trying. Perhaps we should listen to ourselves and consider different approaches rather than trying to find an “expert” who can tell us what to do. What Chris Davis said at the 2009 Morningstar Investment Conference (see “Bear Markets” below) makes a lot of sense to us. We also think most investors would be better off over the long-term in index funds and so-called lazy portfolios. Also, investors should be prepared to take some chips off the table when there is euphoria in the air (not now), and add some chips when there is fear and despair in the air (possibly now or soon).

Regardless, here is what Martin Feldstein thinks about the current outlook, courtesy The Bruce Blog. He is an economics professor at Harvard, former chairman of the Council of Economic Advisors and president of the US National Bureau for Economic Research. “The positive effect of the stimulus package is simply not large enough to offset the negative impact of dramatically lower household wealth, declines in residential construction, a dysfunctional banking system that does not increase credit creation, and the downward spiral of house prices. The Obama administration has developed policies to counter these negative effects, but, in my judgment, they are not adequate to turn the economy around and produce a sustained recovery. Having said that, these policies are still works in progress. If they are strengthened in the months ahead – to increase demand, fix the banking system, and stop the fall in house prices – we can hope to see a sustained recovery start in 2010. If not, we will just have to keep waiting and hoping.”


IS THE U.S. INSOLVENT?
You be the judge. This is from the transcript of an interview Steve Scully of C-SPAN had with Pres. Barack Obama. It was taped on May 22 and aired on May 23. Scully: “You know the numbers, $1.7 trillion debt, a national deficit of $11 trillion. At what point do we run out of money?” Pres. Obama: “Well, we are out of money now. We are operating in deep deficits, not caused by any decisions we’ve made on health care so far.”


MORE ON INTEREST RATES
As noted above, interest rates on Treasury notes and bonds spiked last week, although they fell back a little on Friday. And as rates go up, bond prices go down. Investment grade corporates were spared since they were not bid up during the flight to safety late last year. So, is the Treasury bubble about to burst? We don’t know, but we still retain our hedge (TBT, Proshares Ultra Short 20+ Treasury ETF) just in case. One interesting development last week was the news that China was now buying Treasury bills and short-term notes in place of bonds, and diversifying into gold, that barbaric relic! And China is not the only country trying to protect itself from the financial and economic mismanagement in the U.S. Already countries and investors are wary that the UK will lose its triple-A rating, and the influential bond fund manager, Bill Gross of PIMCO, said in a recent interview on Bloomberg Television that the U.S. might eventually lose its triple-A credit score.


INFLATION
Many observers believe that spending is out of control and as a result inflation will become a serious problem in a year or two, if not before. In fact, recent speeches of Fed officials would lead one to conclude that they want inflation to help reduce the burden of debt at every level in the economy. Trial balloons are starting to pop up. Recently, Gregory Mankiw, former White House adviser, and Kenneth Rogoff, who was chief economist at the International Monetary Fund, suggested what the U.S. economy may need is a dose of good old-fashioned inflation. “I’m advocating 6 percent inflation for at least a couple of years”, said Rogoff, who is now a professor at Harvard. “It would ameliorate the debt bomb and help us work through the deleveraging process.”

But in a recent Op-Ed article in the New York Times (May 29, 2009), Nobel Laureate and Princeton economics professor Paul Krugman, argues inflation is not a problem and that the only thing we have to fear is inflation fear itself. To read the full article Google “The Big Inflation Scare”. Just in case Professor Krugman is wrong, we favor hard assets in our portfolios.


HOUSING
We found a recent New York Times article, describing the growing wave of foreclosures, of great interest. The first wave of foreclosures was mainly from the “flip-this-house” crowd who basically walked away from speculative real estate purchases as the market tanked. The second wave centered on sub-prime borrowers whose low “teaser rates” adjusted sharply higher in 2007 and 2008 – making their monthly mortgages suddenly unaffordable. Now we are in the middle of a possibly much larger wave, brought about by the dismal economy. This wave is still “intensifying” according to some economists. In fact, up to 60% of all home mortgage defaults this year will be due mainly to job losses, up from 29% a year ago. The main source of swelling foreclosures hasn’t been toxic sub-prime loans recently, but standard prime mortgage loans. Credit Suisse has a nice chart summarizing the whole situation. Google “New Mortgage Loan Reset Chart”, click on the first entry and then click on chart to enlarge.


BEAR MARKETS
Chris Davis, who runs Select American, Davis New York Venture and the Clipper mutual funds, was the opening day keynote speaker at the 2009 Morningstar Investment Conference held last week. Throughout his career Davis said he often envied his grandfather and father, legendary investors Shelby Cullom Davis and Shelby M.C. Davis, for having lived and worked through severe bear markets that allowed them to buy great companies at bargain prices and set themselves up for years of strong returns. As Shelby Davis told his grandson, “You make most of your money in a bear market, you just don’t realize it at the time.”

“Now I finally got my chance and it feels like hell,” referring to the fact that the funds he runs suffered steep losses in the bear market that began in October 2007.

Over the last few months he has been buying globally dominant, self-financing companies like Johnson & Johnson (JNJ), well-managed companies with the capital and mind-set to exploit the market dislocations like Berkshire Hathaway (BRK.A) and Lowes (L), selected financials, and energy, commodity and agriculture related companies because of the growth of the middle class in emerging markets is inexorable and will continue to increase demand for resources.


BEST PERFORMING STOCKS OF THE LAST DECADE
In a recent issue, Business Week listed the 20 best-performing stocks of the decade. Business Week restricted the list to S&P 500 members with betas less than 1. Here is the list with percentage gains:



What is significant is the predominance of resource stocks. Ten of the twenty are energy companies of one kind or another. Many of the rest are involved in healthcare. How did EK do during the decade? Not well, down over 90%.


END NOTE
Since we are running out of our allotted space, we’ll have to end it here. But we have some interesting material on alternative energy, and some notes on pension funds, insurance carriers and target-date funds which we will try to pick up in July.

For questions or additional information on this blog entry, please contact us.

Posted on Wednesday, May 27, 2009 - by Henry Walter
New Info On EK Fixed Income Fund
Posted on Tuesday, May 27, 2009 - by Henry Walter

Fixed Income Fund, New Information

In item #11 of the May, 2009, Roundup we noted that the key to assessing the health of a stable-value fund is the market-to-book-value ratio, and that we had asked Kodak for a reading. We now have a response that at the end of February, 2009, the ratio was 94%. We assume that the ratio applies to the synthetic GIC portion of the Fixed Income Fund, which is most of it.

According to the Hueler Companies (www.hueler.com), which tracks such things, the average stable-value fund at the end of 2007 had a ratio of 99%, and at the end of 2008, 95%. The lower the market-to-book-value ratio, the more dependent investors are on the financial strength of the wrap providers. We don’t pretend to be an expert on stable-value funds, but we assume that a low ratio would put pressure on the crediting rate. The crediting rate is the actual yield an investor receives.

If you have specific questions about the Fixed Income Fund you can contact SIP through T. Rowe Price or call Kodak Benefits. Depending on your question, they may not have an immediate answer, but they should be able to research the question and get back to you.

For questions or additional information on this blog entry, please contact us.

Posted on Monday, May 18, 2009 - by Henry Walter
May 2009 Roundup
1. The new title reflects the fact that starting this month we will be posting only one article each month. If there are important developments in the financial arena, particularly if they affect SIP, we will cover them in special postings as required. The views and opinions expressed in this article are those of the writer and do not necessarily reflect the views and opinions of High Falls Advisors, LLC.

2. Hopefully you are feeling a little better about your SIP or retirement portfolio after the explosive rise in the stock market since March 9. On March 9, you may recall, the market was off about 25% year-to-date and more than 50% since the high in 2007. As we write (May 10), the market is up for the year with the exception of the Dow at -2.3%. Elsewhere, the S&P 500 is +2.9%, NASDAQ +10.3%, Russell 2000 +2.5%, the World (EAFE) +2.3%, DJ Americas (which includes Latin America) +6.7%, Europe (DJ Stoxx 600) +6.4%, and DJ Asia-Pacific +7.5%, with China up 44.2%. The problem we all have is deciding whether this is a suckers’ rally, or the start of a new bull market. So far the current rally is smaller in duration and magnitude than the average rally during the bear market from 1929-1932. It is also worth noting that the resurgence in the S&P 500 has been driven so far by three sectors, consumer discretionary, materials and technology, with a fourth, financials, kicking in recently. Also, the lowest quality and most speculative stocks are rising the most.

3. When it comes to forecasting the economy and stock market, you have plenty of choices, as always. Fed chairman Bernanke is telling Congress that recovery is ahead and housing near a bottom. Ever optimistic Abby Joseph Cohen of Goldman Sachs sees the S&P 500 gaining at least 20% in 2009, and Bill Miller of Legg Mason is similarly bullish. On the other hand, Nassim Nicholas Taleb, author of the “Black Swan”, told a recent conference in Singapore, “This is the most difficult period of humanity that we’re going through today because governments have no control”, according to Bloomberg. And New York University professor Nouriel Roubini, who predicted the crisis, told Bloomberg News that analysts expecting the U.S. economy to rebound in the third and fourth quarter were “too optimistic. Certainly the rate of economic contraction is slowing down from the freefall of the last two quarters (but) we are going to have negative growth to the end of the year, and next year the recovery is going to be weak.” Finally, Jim Stack, proprietor of InvesTech Research headquartered in beautiful Whitefish, Montana, just raise his equity allocation from 60% to 80%. P.S. He’s usually right.

4. The financial news last week was dominated by results from the Fed’s bank stress test. It appears that the Fed caved. As an example, on Monday of last week, Citigroup’s shortfall was set at $35 billion. By Thursday the final number was $5.5 billion, raising questions about the credibility of the whole process, according to the Wall Street Journal. Initially investors liked the results driving the KBW Bank ETF (KBE) up 35% for the week. A better way to judge the health of the banking industry, according to Alan Abelson in Barron’s (May 11, 2009), is to look at the data gathered by Institutional Risk Analytics, which is free of government spin. On a regular basis they run their own stress tests on 7,600 small, medium, and large banks, and compile an index. The benchmark equals 1 set in 1995. At the end of 2008, the index stood at 1.8, and at the end of the first quarter, 2009, at 5.57. Their latest report goes on to comment that it’s “pretty clear that the condition of the U.S. banking industry is continuing to deteriorate, and we are still several quarters away from the peak in realized losses for most banks.” Don’t worry, however, the government is here to save us.

5. It seems like there are two types of equity investors today, those who want a pullback so they can get in, and those who are already in and want the rally to continue ad infinitum. And then there is a third type, like your writer, who is partially in. What should they wish for? Also, you have the money managers who have to put up good numbers in 2009 after a dismal 2008, to make their bonuses or keep their jobs. There is an old Wall Street adage, which we certainly are not recommending you follow, to the effect that when in doubt, wait it out. At any rate, there are a lot of anxious buyers out there fearful that they have missed the train, but with some bad news they could disappear rapidly.

6. According to Standard & Poor’s Index Services, between 2004 and 2008, the S&P 500 outperformed 71% of actively managed large-cap funds. In addition, the S&P MidCap 400 Index outperformed 76% of mid-cap funds, and the S&P SmallCap 600 Index outperformed 86% of small-cap funds. Critics maintain that there are serious flaws in S&P’s methodology, but we’ll leave that to the statisticians to sort out.

7. Robert Reynolds, president and CEO of Boston-based Putnam Investments, is in Washington to ‘help’ Congress revamp the 401(k) industry after several trillion dollars of retirement assets have been destroyed by the market meltdown. Keep in mind that Mr. Reynolds and the industry will be pushing their own agenda, not your agenda. It is too bad the industry did not do something before the meltdown. Some of you may remember the four Putnam funds that used to be part of SIP and crashed and burned in 2000. Well, they crashed and burned again in 2008. The worst performer, the Putnam OTC Emerging Growth Fund, was finally discontinued at the end of 2008.

8. Gold bugs were delighted to hear that China’s gold reserves now total 1,054 metric tons, up from 600 in 2003, or a 76% increase in five years. Here are the top holders of gold (at least those reporting) with the percent of reserves in parenthesis: USA 8,133 metric tons (78.9%), Germany 3,412 (71.5%), IMF 3,217, France 2,487 (72.6%), Italy 2,452 (66.5%), GLD, a gold ETF, 1,104, China 1,054 (1.6%), Switzerland 1,040 (41.1%), and Japan 765 (2.2%). Those who are bullish on gold point out that China and Japan have a long way to go to bring their reserves up to what seems to be normal. Other countries with low reserves include Russia and India.

9. The Doug Fabian Lemon List of mutual funds for the period ending 3/31/09 was just released. The concept is fairly simple. To make the list, a fund must under perform its peer group average for the last 12 months and for the last three- and five-year periods. The new list includes 2,337 funds. The 10 largest mutual funds on the list are as follows: Dodge & Cox Stock, American Funds Bond Fund, Fidelity Magellan, Davis New York Venture A, Fidelity Equity-Income, Dodge & Cox Balanced, T. Rowe Price Equity-Income, Franklin Income C, Fidelity Freedom 2010 and Fidelity Investment Grade Bond. Note that Fidelity has four on the list of the largest, and that T. Rowe Price Equity Income, a long-time favorite of participants in Kodak’s SIP, is also on the list.

10. The debt clock is ticking faster than ever. According to Money and Markets, the total tally of the government’s bailout operations and commitments is $14.7 trillion. But only $2.5 trillion has actually been spent or lent so far. Sounds inflationary to us. Meanwhile, in 2008 alone, U.S. households lost $12.8 trillion using Fed data to make the calculation.

11. The ‘crediting rate’ of a stable-value fund like SIP’s Fixed Income Fund is the yield an investor receives. When you buy and sell a stable-value fund you do so at the ‘book’ value, rather than ‘market’ value. The key to assessing the health of a stable-value fund is to look at the market-to-book-value ratio. As we understand it, funds must disclose the ratio in their financial reports at least once per year. The ratio was not in the recently issues 2008 SIP Annual Report, so we called Kodak and asked for the ratio, and are waiting for a response. If anyone has a number please let us know. For more on safety, we recommend you read the following article which appeared in the Wall Street Journal on May 4th, “When Safe Places No Longer Feel So Safe”. Just Google the title.

12. An easy-to-use Morningstar mutual fund rating tool is now available. Currently it is free. It’s hidden, so here is how to reach it. Google ‘Morningstar spy home page’. Click on ‘Spy Homepage’. Choose ‘Spy Selector’ tab. Type ticker in box. Hit ‘Get Score’. Before you do anything else, add the page to your favorites so next time you don’t have to go through this rigmarole again.

For questions or additional information on this blog entry, please contact us.