Dental Dollars

The myth of a prosperous retirement for everyone

- Flint Stephens November 13th, 2008

So far this year the S&P 500 is down more than 41%. The Dow Jones Industrial Average has lost about 37% and the Nasdaq is off more than 43%. One result of this serious correction is that a huge group of Americans between 45 and 65 are wondering what their retirement is going to look like. I happen to fall into that group, as do most of my colleagues.

Over the past three decades, retirees have enjoyed the benefits of an economic boom unrivaled in any recent period. Many retirees have more disposable income than at any period in their lives. Instead of downsizing homes and lifestyles at retirement, many I am aware of do exactly the opposite. While these folks worked undoubtedly worked hard and are deserving of their reward, they are also beneficiaries of good timing.

According to the U.S. Census Bureau, more than 80 million baby boomers were born between 1946 and 1964. The first of this group began collecting Social Security benefits in late 2007 (coincidently, about the same time the market started its downward spiral). With problems in the housing markets and the overall downturn in the economy, discussion about the inevitable shortfall in Social Security has been pushed aside. Yet shortfalls in Social Security and Medicare have the potential to create an even greater disruption in the future economy.

According to numbers from the Old-Age, Survivors, and Disability Insurance (OASDI)– more commonly known as Social Security–the program is the largest government program in the world and the single greatest expenditure in the federal budget. It currently constitutes 37% of government spending. Medicare accounts for an additional 20%+.

The problems in the sub-prime mortgage market supposedly caught everyone off guard. In contrast, every president since Gerald Ford has warned about the developing crisis in Social Security and Medicare.

Baby boomers have been warned that they should not count on Social Security benefits to completely fund their retirement needs. As a result many have invested in the stock market in the hope that growth in U.S. equities will provide a safety net to secure their financial future. Unfortunately, in the past eight years the markets have experienced two major corrections and investors who adhere to a buy-and-hold philosophy may be no better off today than they were in 2000.

The chart below helps to illustrate the problem. The black line is the Dow, going back to 1890. The red line is also the Dow, shown on a logarithmic scale so the up and down moves can be viewed proportionally. I added the green lines to show extended periods (up to 30 years) where the Dow failed to achieve new highs. The purple lines I added to highlight two periods of extended bull markets.

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By viewing this chart, one can see that periods of long-term sideways movement like we are now experiencing have occurred several times. The powerful bull market that existed through most of the 1980s and 1990s is the exception rather than the rule. Those whose retirement corresponds with such a run are fortunate indeed. But what about those of us whose retirement comes during a period of market consolidation?

Fortunately, you can see by looking at the chart that even during the sideways periods the market makes substantial up and down moves. Our belief is that by actively managing assets in accordance with those internal trends, an investor is not subject to unmanaged market risk. That is why we moved most of our managed assets to a cash position in May. It is a philosophy in direct opposition to many advisors who advocate that the best course of action is merely to ride the market waves because eventually they will rise.

For my grandparents and great-grandparents the concept of a retirement where one did not work but still had plenty of money did not exist. Instead, they were compelled by their financial circumstances to work as long as they were physically able. Once work was no longer possible, one moved into the home of a younger family member. There is a high likelihood that the current economic situation could force many older people back into that model.

It is my firm belief that the best option for meeting one’s financial and retirement goals is by following an active investment approach that attempts manage overall market risk.
F.S.

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Still no signs of a turnaround in U.S. equity markets

- Flint Stephens November 6th, 2008

A lot of investors were hoping that once the presidential election was over, the stock market would instantly start to show signs of recovery. We saw evidence of those optimists the day prior to the elections when major indices posted hefty gains. Since then, it appears everyone has realized that a change of presidents does nothing to change market fundamentals.

Although there undoubtedly remain some optimists who believe the market bottomed in October, it appears to be mostly wishful thinking because there is no technical nor fundamental support for such an opinion. Below is a chart of the daily price movement of the S&P 500 over the past two years.

The gold line is a 50-day simple moving average. I have included it because it is one of the simplest and basic tools of technical analysis. When an investment is trending strongly above its 50-day MA, that is a good indication that risk is fairly low. In general, most investors should never consider purchasing an investment that is trending below its 50-day MA. On this chart we see that the S&P was trending above that mark until October 2007, which we now know was the peak for this index. Since then, the only time the index has stayed above its 50-day MA is during a two-week period highlighted by the pink oval. Currently, the S&P 500 is moving away from its 50-day MA after a sharp climb last week.

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The middle portion of the chart is a moving average convergence divergence (MACD). During periods of market strength, the MACD will trend above the zero level. Like the 50-day MA, the only time that occurred in the past year was a brief span in April and May. Recently the MACD began rising, but now it is curling over and appears to be poised to head down again. Half cycles where the MACD turns back down before approaching the zero line are viewed by many technical analysts as very negative for the market.

The bottom portion of the chart is a volatility indicator. Going back to 1970, it has never been at this level before. In the October 1987 crash, it reached slightly above the 0.03 level. In the fall of 2002 near the end of the last bear market, it peaked at slightly above 0.02. As I have indicated in the past, volatility can be misunderstood. We like volatility when the bias is upward, but that is certainly not the situation now. In a steep downward trend, volatility is a good indicator of market risk. So this indicator is currently showing that risk is probably significantly higher than at any period in the past four decades.

There is a chance that those who believe the market has bottomed are correct, but based in the weakness of economic fundamentals and a wide range of technical indicators, I think there is a good chance that the real bottom is probably still ahead and perhaps significantly lower.

F.S.

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In spite of erroneous reports, U.S. dollar showing strength

- Flint Stephens October 30th, 2008

Last week I wrote about the recent weakness in gold. So this week I was a little surprised to see an advertisement advising people to buy gold because it is up 30% for the year and should continue to go up because of a weak U.S. dollar. Gold is actually down about 11% since the beginning of the year and about 25% from its peak in March.

The information about weakness in the dollar was equally wrong. Over the past few weeks, the dollar is actually showing quite a bit of strength. Below is a chart that shows how the U.S. dollar (black line) has fared over the past six months compared to some other currencies. As you can see, over the past three months, the dollar has gained 15%.

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Compare that to the Mexican peso (maroon line), the British pound (blue line) or the Euro (gold line). Over the same time span, these currency funds have declined from 18% to 42%. In recent weeks the only currency other than the dollar with a positive return is the Japanese yen. It is up 5%, but has weakened considerably in the past couple of weeks.

The middle section of the chart is a moving average convergence divergence (MACD) of the dollar. It remains positive, although it is indicating that the dollar might see more consolidation over the near term. The bottom portion of the chart is a relative strength index (RSI). It is trending solidly above the 50 level that indicates positive strength and momentum.

As long as this global economic crises continues, the U.S. dollar is likely to remain the top performing currency, because it will be in high demand. In spite of Europe’s attempt to make the euro the worldwide currency of choice, the dollar retains that position. During tough economic times, people worldwide try to hoard as many dollars as possible, because they know the U.S. will do whatever it can to maintain the dollar’s value.

In 1990, I was in the Soviet Union negotiating a contract to lease a cruise ship for a season. The communist government was still in control of pretty much everything, including the shipping company. We reached an agreement on price, the only catch was that money for the ship had to be paid in hard currency U.S. dollars. The irony of the situation was that at the time, it was illegal for someone to pay for any goods or services in the Soviet Union with anything other than rubles.

But communist officials knew their days were numbered. The best chance for their economic survival as individuals and as a country was to get hold of as much American cash as possible. For several years after, as the value of the Russian ruble collapsed, the unofficial currency of Eastern Europe was the U.S. dollar. I visited Russian banks that had no rubles to distribute, but had a back room with tables covered in stacks of U.S. currency.

Most of the world’s developed economies are dependent on spending by American consumers. Now with Americans cutting back on their worldwide purchases, there won’t be as many dollars floating around and the demand for them will increase. As a result, the dollar should remain strong as long as this situation remains critical.
F.S.

An all-inclusive, equal opportunity bear market

- Flint Stephens October 23rd, 2008

During the early part of my career as a financial writer, I worked for Howard Ruff, who had written a best-selling book called How to Prosper During the Coming Bad Years. The bad years he was referring to were the late 1980s and one thing he advised was for investors to hedge their market exposure and hedge against inflation by buying gold and silver.

His advice proved to be accurate. Precious metals prices soared and investors who listened to Ruff made a lot of money. He parlayed that successful call into the highest circulation investment newsletter of its era–The Ruff Times– with more than 250,000 subscribers.

Of course Ruff is not the only analyst who has advised that gold tends to be a solid investment during uncertain economic times. The yellow metal has long had ardent proponents who talk about how it holds its value unlike virtually any other investment. A gold buff once explained his passion for gold by noting that at the turn of the 20th century, a man with a one-ounce gold coin could buy himself a pretty nice suit. One hundred years later, that same ounce of gold could still purchase a quality suit.

While his reasoning was sound, I did not point out that if the same man had invested that amount of money into GE or AT&T stocks, he could have used the proceeds to buy dozens of suits through the years.

So given the fact that investors tend to flee to gold during times of economic turmoil, one might expect to see the price of gold soaring in recent weeks. In fact, gold is struggling along with every other sector of the markets.

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The chart above shows the price of gold (black line) over the past year. The gold line is the S&P 500 and is included just for comparison. While gold has done quite a bit better than the S&P, an investor who bought gold a year ago has still lost money. And in the past few weeks, the decline in gold has been much steeper than in stocks. In March 2008 gold topped $1,000 an ounce, an all time peak. Gold is now trading at just over $700 an ounce. That is about the same rate of decline as the S&P 500 over the same period.

There is something called the Dow/Gold ratio that can explain part of the reason about why gold is declining along with stocks right now. But all you really need to understand is that contrary to many previous periods of market weakness when investors moved assets to gold, in this downturn, gold is also in a steep decline.

As we have indicated for many weeks, this correction is very unusual because every market sector is declining. For anyone looking for a safe haven for their investments, right now the only viable options appears to be money market funds.
F.S.

- Flint Stephens October 16th, 2008

As professional money managers, we are also in the business of client recruitment. For the past couple of years, we have been particularly adept at making certain our clients were properly allocated. Our strategies were weighted toward international funds in the early part of 2007. During late summer in 2007 we switched assets to bonds, avoiding the October market downturn and capturing some nice gains in the early part of 2008. In May 2008, we moved virtually all assets to cash, sidestepping this severe downturn.

With that kind of recent performance, we have attracted the interest of many potential new clients. But some are hesitant to make the switch, because their current brokers or managers are telling them that this is the market bottom and they would be unwise to move now and miss the inevitable new bull market.

The problem with such reasoning is that while no one can predict exactly what the markets will do, most technical and fundamental indicators are still showing a market dominated by weakness. The current situation is unprecedented in many ways. Traditional Wall Street managers want investors to hang on because that is what is best for them, but not necessarily what is best for investors. These managers might want to keep in mind one of Wall Street’s oldest axioms: “don’t fight the trend.” And right now, the trend remains decidedly negative.

Below is a chart of the S&P 500 going back to the beginning of 1994. Notice that the current descent is much steeper than any experienced during the 2000-2002 bear market. The red line marks the lowest point of that decline, which happens to be the next level of technical support at about 780. That is about 13% below the current level. If the index were to drop below that level (and there is no technical or fundamental evidence that it can’t or won’t), then it is anyone’s guess about where the next support level would be. It could be near the 600 level marked by the blue line. That would be about a 33% drop from today’s level. If you think it can’t drop that much, think again. The Nasdaq lost even more during the 2000-2002 bear market.
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On the bottom of this chart I have included two technical indicators. I could have included a dozen and they would all show essentially the same thing. Every technical indicator that I am aware of is currently negative. The middle portion of the chart with the squiggly blue and brown lines is a moving average convergence divergence (MACD). I added the horizontal green line to show that it is currently well below its lowest levels in 2001 or 2002. The MACD is a useful tool to help identify market extremes, but it cannot pinpoint exact tops or bottoms and I do not know of any tool that can.

The bottom portion of the chart is just a simple momentum indicator. Like the MACD, it is also at a level much lower than it reached in 2001 or 2002. But there is certainly nothing to indicate that it cannot go lower still.

The next chart below is the same as the one above, except it is just for a single year. I added the purple trendline just to show that the S&P 500 is definitely in a downtrend and I see nothing on the chart that would convince me that a bottom is near. The gold line is a 50-day moving average of the S&P 500. Notice that the currently price is well below that 50-day MA. Before a real bottom is reached, the gap between the gold line and the black line would have to get much narrower.

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On this chart, the MACD is much clearer. Notice the separation between the blue line and the black line. A bottom will not be formed until those two line converge and the blue line crosses over the brown. Based on the current gap, that is several sessions from occurring. But even when that happens, it is no guarantee that a bottom is in place. All it means is that momentum has changed from negative to positive. That has happened several times in the past year but the bear market is still dominant.

One of the problems with technical tools is that they are virtually all lagging indicators. In other words, they do a poor job of identifying exact turning points in the financial markets. So how do we determine when the market has made a bottom? There is no one who can positively state when the exact bottom has occurred. But it is possible to identify some of the signs one might expect to see when a bottom is near or has formed.

The first indicators are usually economic fundamentals. There will be improvements in things like unemployment rates, retail sales, housing starts, durable goods orders, etc. When any one of these type of reports is better than anticipated, you might see the market react with a significant daily gain. But any subsequent bad news will send it plunging again. It will take several positive reports in a row to stabilize the daily volatility. So far that does not seem to have happened.

When the bias in economic reports turns from negative to positive, technical indicators will start to improve. The MACD will rise and cross above the zero line. Momentum will turn positive. Relative strength will rise above 50 and then stay above that level. On the equity exchanges, advancing issues will outnumber declining issues for several consecutive sessions. Again, so far that has not occurred.

Until we see confirmation from some of these signs, it does not make sense to remain invested in the markets or to jump back in in anticipation of a new bull market. These indicators all currently still show an equity market where risk outweighs the potential for reward.

When a new bull market is born, you do not need to worry about missing out. While it is possible that there will be individual market days with gains of 4%, 5% or even more, bull markets always rise much slower than bear markets fall. Look again at the top chart. It would have been tough to miss the bull market that began in 1995 and continued until 2000, or the one that began in 2003 and continued until 2007. Catching the exact bottom is far less important that missing the major declines like the one that is currently underway. Indexes normally consolidate in a sideways pattern before advancing out of a bottom. The pattern tends to be shaped somewhat like a bowl rather than a spike.

As I explained last week, Wall Street’s premise that the best investment strategy is merely to buy and then hang on until the day of retirement is not in an investor’s best interest. Brokers and advisors who are currently advising clients that they should remain invested and hope for the best could very easily be doing their clients more financial harm. Are you really going to continue to trust someone who has already advised you to sit by and take no action while your account declined 20%, or 30%, 40%, or even more?

Of course as mentioned above, the financial markets are in uncharted waters. Some analysts have compared the current situation to the start of the Great Depression, but many circumstances are completely different than ever before. I claim no special ability to be able to accurately forecast market movement and it is possible that the market could rally several hundred points tomorrow and never look back. But since I don’t profess to know what is going to happen, I will rely on the technical and fundamental tools referred to above, all of which are showing that the worst is not yet over.
F.S.


Important Investor Information: Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that future performance of any specific Strategis strategy will be profitable or reach its performance objective. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be either suitable or profitable for a specific investment portfolio. Certain portions of this update contain a discussion of various positions and beliefs as to current and anticipated market conditions, which are based upon professional judgment. However, there can be no assurance that any such position or belief will prove to be correct. In addition, due to various factors, including changing market conditions, such discussion may no longer be reflective of current position(s) and/or belief(s). Finally, no reader should assume that any such discussion serves as a substitute for personalized advice from Strategis or any other investment professional.