Wildfires in Colorado

I wanted to take this opportunity to let our friends and clients in Colorado know that you are in our thoughts and prayers as you go through the tragedy of the wildfires in Colorado and especially in the Colorado Springs area.
Ed Mallon

Position Clarification

Many of us are feeling ”overloaded” by what we read and see about the U.S. economy, as well as what is happening in Europe and many third world nations. To put it as succinctly as possible: I am bearish on where the world stands currently. Accordingly, I will be taking a more reserved position. I have begun to underweight--by a substantial amount--the equity positions in each of our four fundamental categories (Conservative, Moderate, Growth and Income, and Aggressive). To give you an example, the allocation for a Growth and Income portfolio would normally be about 60% equities and 40% fixed. With the changes we are currently making, that portfolio will only be about 20% equities, about one-third of what I would normally allocate. You might wonder why I wouldn’t just get rid of all the equities. The answer is, I could be wrong! In addition, I am moving away from indexing, such as the S&P 500, and small stocks, and am going with managed portfolios of large- and medium-sized companies. I believe that, in times like these, the actual management of large stocks will offer better performance. I also like dividend-paying stocks. In the portfolios for which I have discretion, I have allocated few or no international equity positions because I believe they are too risky. In the long run, I am very bullish on the U.S. as I believe that the U.S. has four major attributes that no other country can equal: a stable government, the highest productivity in the world, the best overall quality of goods produced in the world, and inexpensive and plentiful energy supplies (especially natural gas). My perspective is that, once we are past the upcoming U.S. elections, Europe quiets down, and a decision is made on federal taxes and spending, it will be time to re-enter the stock market in full force. I expect these issues will all be resolved by the early part of next year. In the meantime, I remain cautious. Ed Mallon

Facebook and the Stock Market

For the past several weeks Facebook has been dominant in the financial press. What would be the initial price ($38), how many shares would be sold (422 M) and how high would it go the first day ($45)? Facebook was the talk of everyone who used it and therefore thought it would be a great stock to own! Often when an IPO is issued it goes up dramatically, not everyone gets to participate (meaning the small investor is left out) and it makes the early investors wealthy. So far none of these is the case with Facebook. The stock at this writing, late in the day on Friday, is back to where it started after having risen briefly in early trading. Just about everyone who wanted stock got it, including the small investor. The early birds in the IPO did not get wealthy the first day! This is also the first time in years that I had clients calling us up wanting to buy this stock. Why wouldn’t you want to own Facebook (or why would you want to own Facebook)? The dominant reason to own Facebook is that you like the product and you want to be a part of it! This is not a logical way to buy stocks; but it is not all that unusual either. When Facebook is analyzed on a fundamental basis it does not hold up. It has virtually no earnings relative to price. It was acknowledged during the filing of the IPO that the most prevalent use of Facebook is on smart phones and they have not figured out how to place advertising on this medium that will result in significant revenues. In the case of the basic system their biggest advertiser, General Motors, announced earlier this week they would no longer advertise on Facebook because it was resulting in no additional sales. The CFO of Facebook also indicated earlier in the week that a significant portion of the funds raised would go to attempting to find a way to get ad revenue on smart phones and there was no certainty of success. For now the syndicates that offered the IPO are doing their best (as they should) to support the price of the stock at its initial public offering price of $38. What will happen after the support period ends is anyone’s guess. My guess is that many individuals who wanted the stock bought it because it was a product they liked and they will keep the stock. Institutions that acquired shares did so in many cases because after the cooling off period of 60 days, Facebook will become part of the NASDAQ index. If you do any indexing you will need to own Facebook. The institutions, too, are unlikely to sell Facebook. It will be interesting to watch how Facebook does even as the S&P 500, which started the year at 1277, reached a high on April 2nd of 1419, and has now receded to 1293, or a drop of 9%, having lost almost all of the gains since the beginning of the year. We may be headed into Bear Market territory (loss of 20% from the high). Facebook has made it interesting during this past month. Anticipation can really be fun!
Ed

Trading Range Blahs!

From mid-April 2011 through October 2011, we saw the S&P 500 index decline by more than 19%. It then rebounded to reach a peak of 1419 on April 2nd, 2012. Since that time, we have seen a steady erosion of prices, demand and follow through in the market. As I am writing this, the S&P 500 stands at 1397, which is a 1.6% loss for April. The market’s day-to-day volatility makes this statistic meaningless. It’s the fundamental and technical factors gripping the market now that are more concerning. The economy is still moving forward, but at a considerably slower rate than anticipated. The rate of growth for the first quarter was expected to show a gain of 3.5% but came in at 2.2%. This is well under the fourth quarter rate in 2011. Corporate earnings have been mixed, with some big winners but many companies failing to meet earnings expectations. The good news is that consumer spending is up. The markets have been looking for help from the Federal Reserve to further stimulate the economy. It seems increasingly unlikely that the Federal Reserve will step up with any stimulus because the economy is growing, although at a slower pace. Europe’s economy is stalled, with England now in a double dip recession and Spain back in recession. On a technical basis, short term demand has expanded but long term demand is falling off. This means that a question exists about the intermediate and longer term outlook of the market’s uptrend. The increasing number of stocks selling below their 30 day moving average indicates that investor demand is now focused on fewer companies. The NYSE’s Operating Companies’ advance/decline line failed to confirm the April 2nd highs. That failure was the first divergence since March of 2009. With all of this information, it seems likely that the stock market is headed downward in the future. Although May traditionally produces the peak of the stock market, last year it happened in April. A lack of supply appears to be holding this market together. Bad news could change that in a hurry. As I stated in a previous blog, an average bull market lasts 39 months. This market will be 39 months old in June.

Looking at the Bull

Trying to determine the status of the stock market at any point in time is difficult at best. When the market continues to rise for a sustained period, we call it a “Bull” market, and when it declines for a period of time, it is considered a “Bear” market. The determining factors in most cases are the interval and rate of movement. On average most “Bull” markets last about 39 months. During a bull market, a correction of more than 10% usually occurs once. The question is whether we are still in a bull market or if it has ended, and are we now entering a new one. This is rather important because it can give us a much better idea of what to expect. The bull market that began in March of 2009 has had two corrections of more than 10% (16% and 19%). This has not happened since 1940. Two indications that the bull market had ended were noticeably absent. The April high should have been preceded by a falling advance-decline line of the NYSE Composite. It wasn’t. At that point there should also have been a persistent rise in selling pressure. Again, there wasn’t. A bear market is one defined as a drop of 20% or more from the high of the bull market. The drop from April to October of 2011 was 19.3% (close but not enough). In light of other considerations, it appears that we are 36 months into the same bull market which began in March of 2009. Because it has aged this long, events in the bull market are beginning to indicate that we are coming to the end. Two major examples are a greater selectivity of stocks being purchased, and larger stocks dominating the increase in values while small and medium stocks tend to see a deterioration in value. We are seeing both of these happening now. Looking at all of the above, it appears to me that we are coming to the end of this bull market. Ed Mallon

Inflation on the Rise?

A report released today indicated that inflation is "rising." The report seems to say that the cost of gasoline, in particular, is causing the problem. On closer examination, I wonder about the reality of the rate of inflation. At the end of last year, the annual rate of inflation was 3% for the 12 months ending in December. For the 12 months ending in January, it was 2.9%. To me, it appears that, while inflation is a potential concern, especially to the bond market, it is not out of control and will likely result in no changes to Federal Reserve policies. Still, it bears watching. Ed Mallon

FRB Action

For the past two days, the Federal Reserve Board has generated a great deal of anticipation over its next action. The Chairman of the FRB, Ben Bernanke, has indicated a willingness to be more open with the thoughts shared by the members and will give a longer-term idea of where short term interest rates will be headed. Yesterday, he gave a clear message that the FRB is planning on keeping interest rates low into 2014, and that it does not see inflation as being the problem it was in 2011. This information is important for planning on how to position fixed income investments for the future. A shift from very short term to higher paying intermediate term fixed investments is now likely, as there will be less fear of an upward shift in interest rates that would reduce the value of bonds. The result will also be likely to mean that corporations will be better able to plan capital expenditures that require financing. Both of these should benefit the economy over time. The stock market is responding favorably to this information, which will be good for corporations, business expansion and profits. Ed Mallon