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.

OK, it might be just a wee-bit twisted that I sit around and think about IRA accounts… but I do. Anyway, I was thinking about IRAs last night and I wanted to remind everyone about two things with IRA accounts that are coming up.

First…

Our rich Uncle Sam, in his efforts to help soften the blow of the stock and bond mess we’ve all experienced over the last year or so, has waived the Required Minimum Distribution for 2009. I IMPLORE YOU… if you do not absolutely, positively NEED your RMD to keep the lights on, PLEASE do not take the distribution. This is a GIFT… (another) from your Rich Uncle Sam… do not look it in the mouth.

Second…

2010 is the year of the Roth IRA conversion. This can be a tricky one, but the basic difference between a Roth IRA and a regular IRA is that Roth IRAs are the opposite of regular IRAs… their contributions are not tax deductible, but their withdrawals are tax free. The catch is that there are income limits on who can contribute to a Roth IRA… so most of my clients and others who I work with demographically, we have usually not been able to throw Roth IRAs into the mix…. EXCEPT:

THE LOOPHOLE…. during 2010 ONLY, regular IRAs can be converted to Roth IRAs FOR ANY INCOME LEVEL… not just the restricted lower income limits. You will have to pay taxes on the amount converted, but that will be it forever…. No required minimum distributions, no taxes on withdrawals, no affect on your Social Security Income if you have a pretty beefy IRA account.

Given that the taxes on your IRA can also be spread out over three years (2010 ONLY, AGAIN) and the investment markets may have handed you a fairly low valuation point for conversion, this just might be the best news you’ve gotten in a while.

It’s complicated and unique to each individual’s situation, so I will be working with my clients and their accountants over the next few months to help them decide if it is right for each of them. If you are not a client and would like additional information, contact me at 480-575-7688 and I’ll hook you up with the right people.

Even I am a little surprised at this one… Here’s the quote, clipped straight out of a MarketWatch article:

Click to enlarge

Let me paraphrase my favorite part….

“You can look at all the great fundamentals in the world, but if there’s not a demand for the stock, it really doesn’t matter. I learned that point blank in the last few months.”

OK, two points… First, if the only financial thing you’ve ever done is to have a garage sale, then you know that if there’s no demand for something, it ain’t going to sell… no matter how lifelike Elvis looks on velvet.

Second, if you get all the way to chief investment officer before you figure this “no demand” thing out… and only in the last few months?? Well, I don’t even know how to explain how “squishy” that makes me feel.

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.

OK… The world is not coming to an end already…. Yes, we have problems… Yes, they are serious… and yes, they will take years (probably many) to resolve.

We have some massive deleveraging as a country and as individuals to work through. Deleveraging is painful, whether you are a nation or a household. As we pay down debt (individually and collectively), those funds have to come from somewhere… Maybe they come from curtailing our spending, maybe we curtail our investing and saving.

If you can think about what you would do personally if you find yourself having to “de-lever”, then you know exactly what is happening with our economy. You know why spending has evaporated, why no one is buying cars, or houses, or Rolexes right now.

You see, it’s not just that credit has tightened up, it has. But, I think we have to recognize that the demand for credit has evaporated as well. It’s for this reason that I believe that simply making credit more available will not solve our problem… We all have to de-lever… pay off debt, pay down mortgages, get off the credit cards, etc.

It doesn’t matter whether you personally find yourself in the position where you must de-lever. If you don’t, your neighbor probably does and the country definitely does… and this is what matters: There’s A LOT of it that is going on.

The solution? Time. Time for Americans to do what they’ve always done: Get up in the morning, work hard and pay our bills. We will take the kids to school and soccer practice and buy a house or a car if we need it.

And we’ll do this all the while and over and over and over until the problem solves itself. It will solve itself because it will all be done with a new attitude, one of frugality and a new conciousness of the difference between a WANT and a NEED.

Maybe we can learn the lessons that our ancestors learned during the Great Depression without having to plumb the same depths of despair.

Frankly, what we don’t need right now is the excessive hand-wringing and scare-tactic speeches that our President has been making as a ploy to get his package passed. And we don’t need the media hype and horror stories thrown at us every single day. We get it… the economy sucks.

What we do need to do is to stop, take a deep breath, relax and to look around. Most Americans are working, have good jobs and are not in trouble with their mortgages. Most Americans are already doing what needs to be done to get us out of this thing. We’re a lot more resilient and creative than ‘they’ think we are!

A couple of months before I started writing blog entries, I “looked into the abyss” on my own personal trading screens here at the office.  It was mid-September or so, right after the Fed let Lehman fail and before the significance of what just happened was really felt by anyone but a few… yet.

Early the morning of the 15th of September as I look at my screens, I’m thinking that I’m seeing a “blip”… you know, a data error, an internet outage, the ghost in the machine… whatever.

Specifically, what’s confusing is that the couple of trust preferreds that I follow (like bonds, but traded on exchanges in $25 hunks rather than the off-Broadway $1000 chunks that a regular bond trades), traded at around $15.00 or so a minute ago and now many of them are now being “bid” at an odd $.50 or so. For a few minutes, I thought the system totally freaked. After a while the 50 cent bids finally were replaced by 3 to 5 dollar bids… then up to about 7 to 8 bucks… finally settling in at about two-thirds of what was bid the day before.

Of course today, I now know it wasn’t the ghost in the machine… it was the abyss. I had looked “over the edge”. I had seen the financial “white light”.

And apparently Hank had seen it too. He met with Congress, made the talk show rounds (white as a ghost, btw) and said SOMETHING to Congress and they gave him the money. So, what was the SOMETHING that scared him so badly?

OK, so thanks to Representative Kanjorski of Pennsylvania (maybe he was talking out of school??), we’ve got a pretty decent idea what happened that day. He says that…

“On Thursday, September 15, 2008 at roughly 11 a.m., the Federal Reserve noticed a tremendous draw-down of  money market accounts in the USA to the tune of $550 Billion dollars in a matter of an hour or two. Money was being removed electronically.

The treasury tried to help with $150 billion. But could not stem the tide. It was an electronic run on the banks The Treasury intervened, but, had they not closed down the accounts, they estimated that by 2 p.m. that afternoon. Within 3 hours. $5.5 trillion would have been withdrawn and collapsed within 24 hours the world economy.”

Watch the video, his explanation starts at about 2 minutes and 20 seconds into it. I also double-checked some additional congressional testimony tapes where Rep. Kanjorski questions Mr. Paulson about this very thing because I didn’t want to foist some “conspiracy theory” crap off on my loyal readers. In the tapes, Mr. Paulson does not deny what happened.

[[He also mentions that there was only the 'lone gunman' and there was no alien autopsy.... Sorry gang.]]

Now we know.