JR Snell Capital Management, LLC

Looking back over the last couple of months worth of posts, I’m thinking that it might appear that I’m a little opaque as to what areas of what markets you should be focusing on.

I’m not, so I’ll clear things up before I go AWOL for the week. First, understand that anything can happen over the short-term. What we always work on here in our laboratory is more macro-type thoughts for overall “big picture” positioning for ourselves and our clients. That’s what this is about.

[Sidebar... I think I might have mentioned that we are all about the "return of thought" when managing investments... That is, come up with a prospective course that we believe things will take and position for it. A little more active than reactive, and certainly not passive.]

If there’s no magic bullet or secret formula to this investing thing, the elephant in the room says that those investors who wish to survive (and thrive) in tomorrow’s markets might have to think for themselves (gasp)… or (at the very least) think for themselves enough to know they should hire those people who think for themselves.  – From “How We’re Fixing It”

First, the average inflation rate for the last 100 years or so is about 3.0%. The TIPS market (Treasury Inflation-Protected Securities) is showing the breakeven inflation rate at 1.9%… significantly lower than the 3.0% average. Translation: The market says that economic stimulus and other Fed stimulators (very low interest rates) will not work as planned… Translation: Extended period of very slow or non-growth. Translation: Buy TIPS because the treasury structured them to provide downside protection against deflation (which, of course the Feds assumed would never happen)… and this is really one of the very, very few investments that I can think of that offers this.

We’ve been buying the individual bonds for clients and mixing it up between 7 and 14 year maturities. If you can’t buy the individual things, you can consider the ETF (TIP)… This ETF makes sense for smaller accounts, but they have some additional internal management fees which is why we shy away from them in larger accounts

Following this premise, it wouldn’t hurt to accumulate some longer treasuries… like in the 20 year (give or take 5) range. I hear people whining about only getting 4.20% on a 20 year treasury… but I think if a person accepts what might be the ”new normal”… 4.20% might not look that bad, in hindsight.

We’re not married to holding on to the things for 20 years though. If we were presented with some outsized gains on our treasuries over the next year or two, we wouldn’t be afraid to take the profits and find a new home for the proceeds.

Dividend-spewing, old-line, consumer staples stocks look tasty for a couple of long-term reasons. First, we can get between 3 and 4% on many of these stocks (i.e. HNZ) and their business model isn’t so sensitive to the economic cycle.

Don’t get me wrong… anything and everything will go in the tank if the economy falls off a cliff again (people will even go without ketchup if things get bad). But generally, if our extended-malaise scenario becomes fact, then these consumer staples companies will still be chugging along same as always.

Just be sure to do your homework and feel comfortable that the stocks you’re choosing have low debt and decent enough margins to keep coughing up the dividend if things stay marginal for a long time. Email us if you need some help in this area.

Technically, in the stock market we’re acting a little short-term “toppy”… meaning it’s not a good time to be going after your favorite growth stock. Long-term? At the moment, none of the classic, fundamental, long-term stock market indicators are suggesting that now is a good spot to become a new “buy-and-hold” type of investor. Sorry. Be patient.

The upside to the “new normal” is that we can afford to be patient in the stock market. These days, nothing is going to run away from us for very long. No matter what the economy does, we still believe in volatility. Since volatility is how we’ve always made our money in the stock market, we still believe that there is money to be made in stocks.

As far as the thoughts of chasing stocks for fear of being left behind? We’re content to let everyone else risk heartburn while we just pick at the turkey.

Utility Stocks (as a group) have forsaken me this year by advancing only about one-fifth of the amount of the S&P 500… which can act as a real short-term boat anchor in your portfolio if you own any quantity at all. Yet, my passion for the sometimes stodgy “dividend machines” still burns hot.

Why?  First, there’s the cash flow.  My favorite utilities ETF, the Utilities Select Portfolio (XLU) is spinning off a 4.31% dividend yield in an environment where a half a percent is doin’ good on your money market. That’s worth taking a little bit of market risk.

Then there’s long term performance. The Dow Jones Utility Index has outperformed the S&P 500 by 4.4% PER YEAR over the last 10 years. This puts the DJUI in positive territory for the last 10 years, whereas the S&P 500 is down almost 20% for the same period. And we are supposed to be long term investors, right?

Then… What’s the problem? Why the dismal performance?

To answer the questions, I think we have to look at it in context of what utility stock underperformance might be saying about the economy in general. The last time we emerged from a recession, the utility averages advanced about 25% in the first year of the recovery (2003). This time, they have only advanced about 4%. My opinion is that there’s nothing wrong with utility stocks per se, but they might be telling us that there is still something wrong with the economy.

Mix this in with the failing dollar, gold hitting all-time price highs, and oil’s recent jump back to the $78 per barrel neighborhood and there’s plenty of evidence afoot to suggest that all is not “right” in the realm.

There are so many variables out there that even Helicopter Ben doesn’t have a real clue. Bernanke (at the moment) must be contented to just dump cash on the U.S. economy and hope for the best… while walking the tightrope.

We have the early indicators of inflation that gold, oil and utility stocks might be showing us on the one hand while we have the deflationary pressures that come with collapsing employment, a housing value slam with a possible double-dip and consumer spending that has all but evaporated.

So, I think utility stocks really ain’t misbehavin’… I think they’re trying to tell us something about the economy. And if I’m hearing them correctly, I think I’d rather lie with my lovable dogs (of late), than to be all loaded up on or still chasing after “recovery” stocks.

Occassionally, for one reason or another I’m forced to take a moment and tame some of the squirrels that are running on the treadmills of my mind.

My most recent session was prompted by a friend who wrote me an email asking about an article she’d read. The article discusses the French Revolution and how the government ran their printing presses churning out money to the point that it destroyed their economy and precipitated a revolution.

Actually, rampant inflation is just about the one thing that the common folk just can’t take. Not only did revolution in France present the opportunity for Napoleon to jump onto the world stage, a similar situation in Germany after World War I put the German economy in such a rotten place that Hitler’s promises of prosperity at any price resonated with a desperate populace.

So, yes I think by trying to print ourselves out of the current crisis we might be putting ourselves in a precarious position… but I differ a bit from the article because I think we will probably recognize this as our next problem before anyone goes to the guillotine. The next solution becomes to raise interest rates and keep them elevated for an extended period.

I imagine that this will be necessary, but in the process it will dampen our future economic prosperity for a very long time to fight some very stuborn inflation. I feel certain that our leaders will choose this option over revolution.

Anyway, here’s the meat of my reply to her email:

Interesting… Obviously, I’ve been a huge fan of cash the past 16 months or so! It’s funny also because adding TIPS (inflation protected treasuries) is a part of my “Going Forward” plans that I’m presenting to clients next week.

As for gold… Well, I just can’t quite stomach it at $1000 per ounce… I’m feeling it’s a bit like oil at $145 per barrel last summer. Everyone said it was easily going to $200.

I look to implement a lot of the ideas from the article.  But I’m hoping to do it in a manner that doesn’t just kill my client’s prospects forever if we are wrong. Everyone’s uncomfortable right now and maybe even a little bit scared, so I don’t want to do anything too radical, no matter how rational it sounds at this moment. Sometimes these decisions and rationalizations that are made during very turbulent times end up being huge mistakes and we look back and can’t imagine how we thought such thoughts.

So, I’ll march forward incrementally. At present, I’m thinking that we’re probably looking at some serious deflation for a while and then a very muted, long term half recovery that could stretch out to a decade or so.

This leads me to a place where cash is king at the moment for most of our money. But, somewhere in the future there is going to be the opportunity, as interest rates rise, to buy these TIPS and hunker down for the possibility of some real ball-busting inflation.

Fortunately, these things usually unveil in slow motion. So slow in fact that people begin to dismiss their earlier premises and question their previous conclusions even though they are probably still correct.

As an example, I thought the housing market and the stock market were overpriced going back into late 2005. But, after another year-plus of both markets continuing to escalate, it was only reasonable that I doubted my own previous conclusions. I was right, but early. Being too early is the same as being wrong as far as our pocketbooks are concerned and I was on the edge on this one. Honestly, it coulda’ gone either way.

So this is kind of my big-picture picture. What I don’t say in the above letter is that while the economy may stagnate for the better part of a decade or more, I firmly believe that the stock and bond markets will experience continued strong rallies and significant selloffs. It’s not a longshot bet that the stock market will end up right where we are today in another decade or two.

If that’s the case, I wouldn’t want to be a “buy and hold” investor, but if you’re willing to be nimble and cynical, there’s a lot of money to be made during this whole period of economic malaise. If you need an historical precedent, go back and look at a chart of the market during the Great Depression after the initial, monster selloff. What a great time to be an investor with actual cash!

All we have to do is have some cash left at the end of the monster selloff that we find ourselves in today.

Last night’s treasury auction demand was so high that investors bid the rate negative. There’s a solid rundown of the situation here.

According to Bloomberg, If you invested $1 million in three-month bills at today’s negative discount rate of 0.01 percent, for a price of 100.002556, at maturity you would receive the par value for a loss of $25.56. 

Deflation impacts everything

As if it wasn’t easy enough to lose money in the stock market, now you’re guaranteed to lose money in short-term treasuries! I’m not sure that this is what everyone has in mind when they talk about Treasuries being “guaranteed” investments.

For those worried about the possibility of deflation, this should be a little reality check… It’s heeere. The point at which people are willing to PAY money to lend it should be a sign that maybe a huge contingent of very smart folks think that cash will be worth more in the future than today.

Here’s other evidence…

• Stocks? Deflated… down 40% or so, depending on the day.
• Real Estate? Deflated… down 20%-40% depending on where you’re looking.
• Gold? Deflated… It’s an inflation hedge and it’s down 20% plus recently.
• Oil? Deflated… down around 70%
• Garbage? Deflated… Don’t laugh, it’s true. They’re calling it the “Trash Crash”!

The Trash Crash? Yes, mixed paper has dropped to $20 to $25 a ton from $105 in October, tin is down to $5 per ton from $327 a year ago, cardboard that sold for about $135 a ton in September is now going for $35 a ton, plastic bottles have fallen from 25 cents to 2 cents a pound, aluminum cans dropped nearly half to about 40 cents a pound, scrap metal tumbled from $525 a gross ton to about $10.

Ouch… throw in the fact that most larger US cities have recycling programs whose costs are offset by what they get for the recycled material, and you’ve got another municipal owie to deal with.

So, yeah… wake up… deflation’s here, now, already. Rather than fret about it, I’m going to focus my energy with my clients and on this blog putting forth and implementing strategies to deal with it and maybe profit from it. I’m interested in now trying to detect if we’re in for an extended period of deflation or and what signs will I need to see that shows us the trend is reversing?

For now, I’m thinking about selling off about $4 million in 3 month Treasuries that I bought for clients about 2 months ago. They’re selling very near face value a month before maturity. Who’d a thunk it?