JR Snell Capital Management, LLC

In my last couple of posts about what I believe to be a profitable opportunity in Treasury bonds (while everyone else has been declaring the death of the Treasury bond market), I’ve come off as a bit of a “contrarian”.

It isn’t my typical “modus operandi” to be a contrarian just for the sake of being contrary as an investment strategy. I really am a believer that the specter of inflation isn’t as certain as “experts” would have us believe. I explain a couple of my thoughts behind my thoughts here and here.

It makes it all the more exciting that a viewpoint that I feel strongly about happens to run counter to “conventional wisdom” (which is an oxymoron) AND I can see a trade-able opportunity develop AND it is so easily demonstrable to my readers.

So, here it is… the Treasury market is up pretty big today and it was up pretty good yesterday as well. OK, so what’s the news? The news is that the manager (Bill Gross) of the biggest bond fund in the WORLD (PIMCO) announced that he had DUMPED every single Treasury bond in the portfolio last month and he urges investors (in general) to do likewise. Buried in his statement is this little gem also…

Gross mentioned that Pimco may be a buyer of Treasuries if yields rise to attractive levels.

Why the rally then? Here is where you get to exercise your yin-yang muscle:

• THE biggest US holder of US Treasuries is no longer a seller.
• He also cannot be a seller in the near future (remember, he now owns none)
• The biggest bond fund in the world has now further stated that they would likely be buyers of Treasuries in the future if prices deteriorated further. This supports prices against further declines… removing much of the risk from the trade.
• Therefore, the supply-demand equation moves favorably to one of more potential demand than supply.

Not to mention the fact that Bill Gross is not going to do “telegraph” his strategy before the fact. If you’re thinking of selling your Treasury bonds now, forgetaboutit… you missed it.

deflation, interest rates, investing strategies, Market Comments, timing, treasuries, treasury

It seems that, the more attention the media gives to the inflation issue, my silence on the subject become more conspicuous as the increasing number of inquiries from worried clients and colleagues would indicate. Since it has been over six months since I broached the subject, I will offer my latest inflation musings here.

Admittedly, the world has changed dramatically in the last six months, but in my estimation, there has been nothing of consequence to change the trajectory of inflation here in the U.S. True, oil prices are spiking and you are probably paying more for a loaf of bread today than you were last July.

We also are seeing a massive amount of fiscal and monetary intervention by the Fed which have, historically, increased inflationary pressures and led to bouts of increasing interest rates to curb its growth.  Food riots are breaking out across the globe, and governments are under siege as an indirect result of rapidly increasing commodity prices (which has the effect of lowering the standard of living), all of which is uncomfortable to watch.

While all of this is hard to ignore, and it doesn’t bode well for the world’s economies, the fact is that all of the same reasons why we here in the U.S. have experienced a long period of low inflation, and even some deflation, still exist today.

In my July 2010 newsletter, I made a reference to the “leaky bucket” scenario in which all of the money that the U.S. and other governments are pouring into their economies, which, ordinarily, should have a stimulative effect, is actually leaking out, drawn to the reduction of debt by consumers, companies and governments alike. As a result, the stimulus and easing is not holding And, until the necessary time for this deleveraging to take effect has passed, we aren’t likely to experience any sustained inflationary pressure.

All of this brings me back to my previous column, (On the Contrary, Again, for Long Bonds. Feb 2010), in which I built the case for a possible move back into U.S. Treasuries which will thrive in a low-inflation economy.

I’d like to get your thoughts on this, so keep your emails coming.

Our friends over at the Daily Capitalist have put together a concise article that explains what I believe will be a fundamentally lingering problem for years to come and is the centerpiece for my argument about why, we as investors should reset our expectations of investment returns going forward.

The unfortunate fact remains that credit for most of America is still tight, banks are still trying to repair their balance sheets, and the overlying problem is real estate, the detritus of the Fed’s reckless monetary policy. Credit expansion fueled by the Fed’s easy money policy of the early 2000′s drove private debt to fuel housing over-production, and drove commercial debt to fuel commercial real estate (CRE) over-production. It was the greatest such expansion of money and credit the world has ever seen and it went primarily into real estate. We are now facing the consequences of that expansion and boom: the bust.

You can read the article in its entirety here.

credit crisis, deflation, fed, real estate, treasury

While most eyes have been gazing skyward for a view of stock market tops, mine have been scouring what looks more and more like the lows of an oversold bond market.  The stock market appears as if it will continue to steam along with some brief sell-offs, and it will likely climb through another cycle before it spins off any major indications.  The more interesting story is the long bond market which has all but been left for dead by the rest of the street, and that makes me all the more interested.

If you’ve been following along with me for the last year, you know that I still see some upside for the long bond, this in the face of a mass exodus of bonds and bond funds by institutions and small investors alike.  Of course, that is what being a contrarian is all about.

A brief history:

November 2009 – I primed the pump, suggesting that it may be time to begin accumulating long bonds (Picking at Your Turkey, Nov 2009)

Spring 2010 – Bill Gross of PIMCO issues warning on long bond suggesting its run is over

Spring 2010 – We initiated aggressive buying campaign in long bonds

August 2010 – After a 5 month, 15 point rally in the long bond, we liquidated our positions

December 2010 – Following a 4 month, 12 point decline in the long bond, I intimated that things were looking interesting again for bonds (Outlook for the Long Bond, Dec 2010)

December 2010 – January 2011 – Massive outflows from bonds and bond funds as investors run for the hills. Good sign.

February 2011 – As the chart below indicates, we may be right where we were back in the spring. I’m feeling an itch.

So, here we are two months later and the signals are gaining strength again, the strongest of which is that small investors have almost completely abandoned bond funds, the key sign that all contrarians like to see.  Additionally, we’re hearing more and more talk about the return of inflation which is supposed to scare us away from bond investments.

Technically speaking, the case can be made that the long bond is approaching an oversold position and is due for a bounce.  Fundamentally, the long bond can be expected to bounce along with a feeble economic recovery which is not likely to produce any marked change in the inflation trajectory, allowing the Feds to maintain downward pressure on interest rates.  In the meantime, Treasuries are still the haven of choice for domestic and foreign institutions when things start to go south.

With all of that said, it’s the extended weakness in bonds which has everyone running in one direction that has me wanting to run in the opposite direction.  Stay tuned.

This just in: The SEC, through a study mandated by the Dodd-Frank financial reform law, is now recommending a common fiduciary standard for brokers and registered investment adviser who provide personalize investment advice. Let’s see, this comes just 70 years after the enactment of the Investment Adviser Act of 1940. Well, it is progress, I guess.

While the debate over fiduciary standards has been waging for a long time,  the SEC has, essentially, turned its head while registered reps (brokers) have been holding themselves out as ”financial advisors”  even though they are not required to act in the best interest of their clients as their self-proclaimed title would suggest. All the while, we, as Registered Investment Advisors (RIAs) have always been held to the strictest fiduciary standards.

It’s no wonder that 76% of investors already believe that such a standard already exists for all “financial advisors”, and that there is no distinction between the advice offered by a registered investment advisor, who is required to act in a strict fiduciary capacity and a stockbroker who simply must establish suitability when recommending a product.*

The SEC study, and that’s all it is, a study, puts forth a recommendation that additional rules and guidelines be developed to align the fiduciary standards of brokers with those of registered investment advisors who are regulated under the Investment Advisers Act of 1940. The study cites the need to protect investors who have a reasonable expectation to receive advice that is in their best interest.

In response, broker-dealers are putting on a happy face, reaffirming their support for such standardization. Anything less, would cast an uncomfortable light on the stark differences in standards between brokers and RIAs who actually are acting in their clients’ best interest. In the meantime, they are quietly grumbling about the incompatibility of these fiduciary standards with their business model.  Their concern is that, acting in a fiduciary capacity, that is, in the best interest of their clients, may preclude them from selling proprietary products off their shelf.

How worried are the broker-dealers? Probably not much. You see, it will take several more studies, several Congressional hearings, and much more debate among the SEC Commissioners before any guidelines are developed. Then, there is the central issue of who will provide oversight of the brokers which won’t be easily resolved.

Even then, broker-dealers may not be overly concerned, thanks to their lobbying efforts that resulted in the insertion of a provision in the Dodd-Frank bill stating that “brokers providing personalized advice have no ongoing responsibility for their recommendations.” Huh? Isn’t this where we are now?

While I’ve been a strong, vocal advocate of fiduciary rule standardization, I’m still not holding my breath over the possibility that things will change anytime soon. And when it does come down, I fear that the rules and the oversight may be watered down which will make it all nothing more than window dressing.  .

Eventually brokers may be allowed to wear two hats, which can only lead to greater confusion. I proudly wear the same, single hat I have been wearing for several years. I get paid by my clients to render sound, highly personalized advice and receive no compensation from broker-dealers How else can my clients be assured that their interests are paramount?.

If you might be confused about the roles and responsibilities of your broker or advisor, drop me a line and I’ll explain how our fiduciary practices protect the interests of our clients.

*According to a study released in September, 2010 by North American Securities Administrators Association

It’s been the law since 1933 that anyone that wants to encourage a private investor to make an investment in just about anything (i.e. real estate partnerships, loans to an individual or business, an investment in an idea or a business) must be licensed to sell those securities, the investment must be registered in the state where the investor lives, AND the actual investor needs to be what the SEC tags as an “Accredited Investor”.

Up until recently, the SEC definition of an accredited investor was someone who had a net worth in excess of $1 million dollars, or annual income of $200,000 ($300,000 if married) in each of the last two years and expects to earn at least this much in the current year.

One could consider the value of his or her home (as well as investment real estate) as a part of the net worth requirement, so people who needed money for their projects had a fairly large pool of MOPs (Millionaires On Paper) to hit up for money.

Fortunately, to save ourselves from ourselves, the “heroes” of Dodd-Frank came along and changed the definition for our own protection (tongue firmly in cheek) to read: “a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of their primary residence “ (emphasis mine).

Now, they’ve gone one step further and limited the pool further by requiring that if you’re underwater on your mortgage (of your primary residence or even investment real estate), you must further subtract the amount you’re underwater from your net worth.

So, if you’re the government and you want to work your way out of a liquidity crisis and encourage people to buy homes and invest in business… don’t you agree that making it more difficult to find investors to invest in homes and business is the way to go? (Tongue still firmly in cheek!)

That is why MOPs are now out of the game.

In my previous post, The Problem with Investment Models: Not Keeping it Real, I wrote of the well-known investment guru, Nassim Taleb, to validate my position on the use of investment probability models such as Modern Portfolio Theory (MPT). Allow me to expand somewhat on our reasons behind our difficulties with MPT.

In his best-selling 2007 book, Black Swan: The Impact of the Highly Improbable,” Taleb argues that these models are essentially useless because they ignore the stark reality of cataclysmic-sized risks that have rocked the financial markets time after time. He contends that probability models are based on a dilution of major, market shifting events (black swans) that, while rare, have the effect of rendering the models nearly ineffective.

Models that only assume the existence of white swans rely upon scenarios that exclude the real possibility of events such as the Lehman Brothers collapse, the near failure of AIG, or the collapse of the housing market, and the potential financial collapse of several European countries. With such events occurring more frequently, it seems that we’re surrounded by more and more cliffs.

This leaves investors who ascribe to MPT or other probability models in a perilous position where probable risk has been severely underestimated, and without a way to react except after the damage has been done. While MPT may be an appropriate tool to analyze historical returns, its danger as an investment tool is that it can provide a gilded view of future performance. Those investors utilizing MPT may, in fact, be walking backwards towards the cliff with their eyes on past investment results and little concern for impending disasters.

In our previous writings we have been fairly clear on our stance that MPT doesn’t work because it is largely based on risk calculations that implies knowledge of future uncertainties, which is impossible.  It also assumes that people, as a whole, do act rationally, which has been disproven time after time.

We have also politely suggested that, absent a crystal ball, investors who formulate their own thoughts and opinions, or who are thoughtful enough to seek the advice of those who follow their own thinking, are better positioned to survive, and even thrive in uncertain times.

Taleb reinforces this principle in a list of his own ten principles for protecting your portfolio against “black swans” that were quoted a couple of years ago in the Financial Times.  His ninth principle states, “Citizens should not depend on financial assets or fallible “expert” advice for their retirement. Economic life should be definancialised. We should learn not to use markets as storehouses of value: they do not harbor the certainties that normal citizens require.

We believe that, if you “definancialise” your investment approach and, instead, focus on what it is that is most important for you to achieve, you’ll not only avoid the cliffs, you will gain a firmer grasp of your financial future.

The approach is simple, easy to understand, and it centers on you.  Please feel free to contact me for a brief overview.

bailout, buy and hope, credit crisis, investing strategies, investments, strategy

To my chagrin, I am often reminded, by well-meaning clients, that our investment philosophy seems to run counter to the mainstream thought which relies heavily on popular investment theories and hypothetical models such as Asset Allocation and Modern Portfolio Theory.  Not one to take up the whiteboard and start lecturing, I simply point them to our appraisal of these academic theories and their near ruinous application in the real world of investing (How Investing Got Broken).

By no means is this a source of frustration for me.  I know how difficult it is to run against the herd.  It’s natural to feel isolated and vulnerable when you see the masses moving off into a different direction leaving you to your own doubts about the validity of your direction.  Would you feel any different if you knew they were heading towards a cliff in the dark of night?  While that is not necessarily a certainty, our contention is that an overreliance on lab-generated portfolios can lull investors into a blinding complacency that will impede their ability to change direction before they reach the edge.

Rather, my frustration is channeled into the army of well-meaning, but misguided advisors out there that continue to promulgate investment myths based on flawed models that have yet to prove their validity, and, in fact, have led many institutions and millions of individual investors over a cliff.

Nassim Nicholas Taleb, one of my favorite investment philosophers, has been on a mission to expose risk models, such as MPT, as pure academic folly, and his latest rant actually is an indictment of the Swedish Central Bank (the issuer of the Nobel Prize in economics) for legitimatizing a theory that has led to market crashes and huge government bailouts. (‘Black Swan’ Author Says Investors Should Sue Nobel for Crisis. Bloomberg. Oct 2010).  Taleb holds no malice for the theorizers. He wants to hold Nobel accountable for rewarding a destructive fallacy.

While that may seem like a drastic, and perhaps, improbable step, Taleb has cast a light of controversy on the underlying problem of probability models that have undeservedly earned academic respect and legitimacy for which there is no valid basis.

Stay tuned for my next post wherein I dissect the controversy of probability models as they apply in your investment decision-making.

If you have questions or comments regarding the use of investment models, I would appreciate hearing from you.

bailout, buy and hope, investing, investing strategies, safety, stock market, strategy

Mutual funds have had it bad enough over the last decade, and I’m not one for piling on, however, some things bear repeating in the hopes that history doesn’t repeat for my investor friends who are intent on finding the next big winner.

I previously posted a rant about the fallacies of past performance as a gauge for selecting mutual funds (Finish this Sentence: “Past Performance is….” June 21, 2010), in which I concluded that better investment results could be achieved by simply throwing darts.  The facts that I gleaned from  Standard and Poor’s research, demonstrating a startling low repeat rate for top performers, speak for themselves. When more than 95% of all equity funds fail to sustain a top half ranking over a consecutive five year time  frame, one would be hard pressed to arrive at a different conclusion.

Morningstar Advisor’s Director of Fund Research, Russell Kinnel, did pile on with a revealing analysis that exposed more of the naked truth about past fund performance. In his article, The 12 Shocking Mutual Fund Statistics (Sep. 2010) he builds an even broader case for general skepticism when evaluating mutual funds.

The most illuminating item on his list: The worst 15-year return (minus 8.17% annualized) by a fund that, during that timeframe, had a one-time, chart topping return of 165% – a stark,  and hopefully unnecessary, reminder that you shouldn’t gauge a fund based on a single year’s performance.

What’s in a Name?

He had a couple of ‘funny if it weren’t true’ statistics that highlight the problem with selecting funds based on their names.  Funds with the word, “Growth” in their names could surely be expected to grow over time, but 650 of these so-named funds actually shrunk over the last decade.

The Past Performance Cover-up

In my post I also pointed to the fact that poor performance records are often swept under the carpet when fund companies discontinue them.  Kinnel zeros in on the so-called “balanced funds” of which 75% with a 1 star rating were “wiped off the face of the earth” in the last five years.  While this may be an appropriate business strategy, it has the somewhat insidious effect of propping up the overall performance record of the fund group with investors being none the wiser.

Okay, that’s my half-yearly rant on mutual funds and the flawed reliance on past performance, but it is a timely word of caution in light of their recent emergence from a decade long slumber.  My clients will continue to benefit from the more thoughtful approach that we use to generate returns based on their specific needs, not on the irrelevant past.

If you would like to learn how an individualized investment strategy can put you in control of your financial future, drop me a line. I’d be pleased to speak with you.

I’m usually hesitant to employ sports analogies in my musings as they can sometimes be tiring and clichéd. But, the tempered exuberance springing from the recent stock market run-up has me thinking of a slumping homerun hitter who suddenly redeems himself and his team with a bases-clearing dinger, and the fans, who had been ruthlessly cursing him, once again cling to the fleeting moment as proof (or, more accurately, hope) that all is well again.  Is this a baseball moment for investors?

When the stock market surges, as it finally did in the 4^th quarter, one can imaginatively correlate it to the scene of a cheering crowd springing to its feet as it watches the home run ball sail over the fence. That is, if there was even a crowd there to see it.  It’s likely that most of the fans, disheartened by the poor performance of their team over the season, just stayed home, which was largely the case when the stock market began its run up in September.  Most investors didn’t get into the game until the rally was well underway.

Cut to the player who, day in and day out, manages to find a way to get on base, drawing walks, spraying singles to all fields, and occasionally powering one to the outfield.  If he gets on base four or five times out of ten, he creates more opportunities to score runs than the long ball hitter who can’t find the ball 75% of the time.  This is not to diminish the importance of the long ball; we all need one occasionally to help us win a game.  But, if you’re not getting on base enough, you’re not creating enough opportunities to score.

History has shown that hitters or teams that rely upon a long ball strategy have a much more difficult time in overcoming slumps. They must continue to use the high-risk tactic of swinging for the fences in order to catch up in a game or in the standings.  Interestingly, no team since the year 2000 has ever led the league in homeruns and won the World Series.

We employ an “on base” strategy in our portfolio management that seeks to get runners on base and then find a way to score runs.  It involves waiting patiently at the plate for the right pitch that we can convert to singles with disciplined, high percentage swings.  While we do hit one out of the park occasionally, it’s our on base strategy that has kept us in the game in good and bad markets, scoring runs for our clients, and winning more than we lose.

I’ve beaten this baseball analogy to death, and promise no more, at least for awhile. The baseline point to be made here is that it’s much easier to control the game and score runs with a multi-dimensional strategy than simply swinging for the fences.

If you want to contact me to discuss your on base investment strategy, I promise not to bring up baseball.