It’s difficult to check your hunches at the door, but I still manage to stay disciplined and only act on what the actual facts are saying. It also serves to remind me of the title of one of my favorite author’s books, “Dig Your Well Before You’re Thirsty.”  (Harvey Mackay, if you’re interested).

Although sales related, the basic tenet of Harvey’s book is that you need to build your network and to prepare your groundwork BEFORE they are needed. If you wait until you find yourself unemployed or looking for some other professional assistance, it is far too late to attempt to build a plan.

Now, while things are good, is the most important time to prepare a plan of action for market malfeasance. Paradoxically, this one best time also happens to be the least motivational time to do it. And it is this very recent market history with its unbroken chain of recent successes that makes me an even more vocal voice in the woods… and the same reason it gets so danged hard to get people to listen right now.

If you haven’t already done it, it is time to build in a backstop of courses of action to keep you and your investment portfolio on course to your personal goals regardless of what might lurk around the boom-bust corner that the markets have become in the past few years. My clients and I already have. See how we accomplish this here.

Why? Because things couldn’t be better.

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.

We didn’t really broadcast our spring Treasury buying spree (we have to keep some things “client only”), but our clients saw it in their accounts… and this has been the last time (March – April 2010) that we did any serious accumulation of Treasury bonds in client accounts.

In my late August post, we suggested that if you are “following along” you might want to consider moving out of the longer-term treasuries.  We didn’t really offer up the mechanics of why we were suggesting this, we just offered up that we were liquidating Treasury positions in client accounts.

Although we’re not purposely contrarian in our investment style, our way of thinking typically puts us at odds with the mainstream. Apparently, many in the media are seeing an end to a multi-year bond run as of the past few weeks.

Bonds have been a major magnet for new money over the past two years – until last month. According to the Investment Company Institute (ICI), the weekly net new cash flow to the bond market eclipsed stocks for two years, until the two weeks ending November 23.

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Paradoxically, to us it’s beginning to look interesting again!

I don’t know what the rest of the financial press has been looking at (maybe nothing?), but the chart to the left is what we’ve been watching for the past couple of years.

Just so you know where we’re coming from.

It’s a tough read for a couple of reasons… it’s very thick (over 700 pages) and it’s written in the style that folks used back in 1841. For me, it takes a lot of concentration to read and comprehend just because the style is so foreign to our contemporary way.

Nonetheless, it’s an important book and details a number of historical speculative bubbles. By recommending and discussing the book for clients, I am leaving a couple of messages… First, it’s human nature and second, it’s nothing new.

The NY Times has now recently published an article that demonstrates that there is a chemical reaction that occurs in our brains that makes us “feel good” when prices are running up speculatively.

But according to the article, while dopamine is flowing freely and generously for most of the run-up, the dopamine STOPS firing as we hit the more “bubble” phase of the run-up (the last phase).

The chemical changes might be that “little voice” or a general feeling of uneasiness about overall conditions. But, because of what’s called the “Country Club Effect”, nearly everyone ignores “the little voice” much to their later chagrin.

Many times successful investing seems to be having the ability to heed the warnings of that “little voice” instead of allowing your rational mind to convince you otherwise.

Now it seems that there’s a rational explanation for why the smart decision sometimes appears to be the irrational decision. Hmmm, interesting.

I anticipate that US Treasury securities will continue to be our baseline method providing the ability to persevere for the next who-knows-how-long.

and…

I would expect that between positioning in and out of Treasuries as appropriate and positioning in and out of equities as appropriate, our clients will continue to persevere… and quite possibly prosper.

You can read these quotes in context here. You can also review some of my other musings about the long US Treasury Bond “opportunity” here and here.

This is how we felt about long-term treasuries last year at Thanksgiving, from our post called, “Picking at Your Turkey”:

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.

We are in line with mainstream thought in that we believe that bonds as an asset class (and specifically long-term government bonds) might be a good thing to have in your portfolio at most times. However, we depart from the mainstream because we do not statically allocate a portion of a clients’ portfolio to bonds and then hang on for hell or high water. Radically, we believe that there might be times when it is not a good time to make new purchases of the “long bond”.

And in a further logical departure from current financial dogma, we believe that there are even a few times where it’s in our best interest to actually sell them out of our accounts completely.

NOW WOULD BE ONE OF THOSE TIMES.

Dear Client,

To say that the last three months have been dramatic is to REALLY say something because it comes on the heels of a heart-stopping stock market selloff followed by a mind-bending reaction rally… the likes of which haven’t been seen since Herbert Hoover was in office.

And who could forget that that it has been only about a decade since the stock market last showed us it’s “teeth”? It’s certainly been an era to feel like one could easily get “bitten” as an investor.

Of course recently, just at the point that it feels like we deserve to have some stock and bond market stability, we are again subjected to the kind of volatility extremes that have been cropping up more and more often the last few years. Have we been shown that we’re only living in the “eye of the financial storm” at the moment?

The first quarter of 2010 seemed to come and go quietly as we moved toward ever higher highs. I jotted a web site update in mid-May as I noted that I was feeling a certain level of complacency creeping back in to investor’s attitudes about the markets. Since then I’ve also been reminded by a client of a web site update from February of 2009 in which I wrote the following…

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.

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.

Could it be just that simple? Could it be that many investors have dismissed their earlier correct assumptions because it is all taking so long? Is this “thing” so massive and lumbering that it can only unfold in “slow motion”?

During the second quarter, the buzz suddenly became about sovereign debt, which we’ve known for a while was going to become a problem one day soon. It appears that “one day soon” might be nearer than we thought and the market has been asking the question, “If the rescuers need rescuing, who is left to bail out whom?”

The tacit assumption has long been that China will provide some base level of support for the balance of the world via overwhelming demand for everything in the face of an otherwise global economic slowdown. However, there’s been recent chatter about a growing housing bubble in China and speculation that this might just be “the other shoe” to drop on an otherwise fragile global economy, bringing Round Two of the Global Financial Crisis with it.

But it hasn’t been just the stock and the bond markets that have been particularly quarrelsome the past few years. It’s been downright difficult, if not treacherous being an investor in any arena. For instance, real estate did something that it has never done before: It decreased in value. Conventional wisdom had it that despite the leverage routinely used by real estate investors, it was still considered a “safe” investment because real estate prices have never, ever gone down… not even during the Great Depression. The only safe bet now is that investors will never look at real estate investments the same way again.

Other types of investments have all experienced similar difficulties: Private loans, small business loans, real estate loans and partnerships, even previously assumed long time successes such as Bernie Madoff and a host of other Ponzi-schemers that have all been discovered to be “swimming naked” the moment the money tide went out.

So, while the financial turmoil of the past couple of years wipes out or changes much of the world’s conventional wisdom, it also performs a “cleansing” that presents new opportunities with new players in a new financial landscape.

All of the turmoil of the past few years will one day pass and the opportunities will be there for those of us who refuse to focus on the past. We need to keep our focus on keeping our minds open to the new and different opportunities that most certainly will present themselves in the future… while persevering through the “creative destruction” that we find ourselves in the midst of today.

Our Current Outlook

Bill Gross of PIMCO (Pacific Investment Management Co) speaks of an economic era that we are entering that he is calling the “new normal”. In recent papers he has been going into great detail as to the justification behind his theory, but basically “new normal” means an extended period of sub-par growth throughout world economies.

A favorite theory being embraced by what I believe might be the majority of investors is this theory that some day in the not too distant future we will be wrestling with some significant inflation pressures… possibly even a stagflation situation (stagnant economy, rising prices).

Over the past year or so, I’ve been inclined to side with those that anticipate inflation, but now I am beginning to modify my view of our future world. I’m beginning to consider the possibility that our current Keynesian monetary policy of flooding the economy with money MAY NOT lead to inflationary pressures. After watching unemployment not respond to unprecedented government spending, and housing not respond to historically low interest rates, I’m starting to see the US economy and perhaps the world economy as a “leaky bucket”: We continue to pour more and more into the bucket, but it is leaking out just as quickly (or even more quickly).

What is the “leak” in the bucket? I believe the “leak” is the process of deleveraging… up and down the line… from the smallest of consumers struggling to pay off their JC Penney charge card all the way up to the nation of Greece struggling to pay down their country’s debt.

Until the world deleverages, nations can pour as much money as they want into their respective economies and still not see net economic gains. They can throw it toward bailing out the banks, or homeowners, or other countries. At the end of the day it is just moving it from one side of someone’s balance sheet to the other side of someone else’s balance sheet.

The only solution is time. We need time as individuals and as nations to deleverage ourselves. I’ve expressed my thoughts to many of you that our financial issues are “generational”… meaning that it will take a generation for them to work themselves through. For example, our exit from the housing crisis could come as a result of enough people walking away from their mortgages… but it will only transfer the debt to the bank and then to the government as the bank is again bailed out and then ultimately on to you and me in the form of higher taxes or an extended slow-growth economy. Another way to exit the housing crisis is to wait for enough people to have paid down enough of their mortgages to again be “above water” allowing normalcy to return to the housing market. I’m assuming it is to be a combination of both… but the end result is the same: It will take time. This is my version of Bill Gross’s “new normal”.

While one set of opportunities has been winding down for the last few years, a new set of opportunities has yet to reveal itself. This leaves us in a bit of a “no man’s land” in the investment landscape. But again, to simply persevere and avoid chasing “old” opportunities will insure our ability to take advantage of our as yet unseen future.

Specifically

I anticipate that US Treasury securities will continue to be our baseline method providing the ability to persevere for the next who-knows-how-long. I believe that part of the new normal involves some moderate level of deflation for the foreseeable future, allowing your purchasing power to increase even without any real investment returns.

I expect that we will continue to see extended and significant moves up and down in the stock markets… probably quite similar to what we experienced between the end of 2007, down to the March of 2009 lows and then up to the April of 2010 highs. Our opportunities in the stock market will come by accepting that there is a disconnect between the stock market and the economy and by taking advantage of the volatility that we are sure to experience because of it.

Although the market may show little to no net increase over the next decade or two, I would expect that between positioning in and out of Treasuries as appropriate and positioning in and out of equities as appropriate, our clients will continue to persevere… and quite possibly prosper.

As always, I am honored to be your guide through these historical times. Please feel free to call or email if you have any questions or need any assistance.

Jeff Snell

Managing Member, JR Snell Capital Management, LLC

In my post “Market Timing for Dummies” I describe a methodology that I use to help us decide if we want to be generally in, or generally out of stocks. It’s not necessary to go into detail about the methodology of the indicator we use, as I go into it in detail here.

Click to Enlarge

Also, as a “bribe” for subscribing, you would have received a free report that describes how we use this indicator, how to calculate it and how to get it on your computer desktop for free.

If you’ve subscribed in the past and no longer have the report, please email us and we’ll send a copy. Use the Contact Us form and put in the comments that you are a subscriber to my blog and you’d like to receive a copy of the Market Timing Report.

…and if you haven’t subscribed to receive blog updates, then go here to subscribe and you’ll get a copy of the report for free.

Oh yeah… Why am I mentioning this now? Because as of Friday July 2nd, 2010, we kicked into a Bear Market according to this indicator.

Will the market crash? Will the indicator show a “false negative”? Hard to say, but rules is rules and if you’re following this indicator for some of your long term stock investments… well, it’s time to exit them for right now.

Ahh priorities… Clients always get first whack at my time. I might be on the more  “public” tasks of preparing annual reports, quarterly reports, talking to accountants, compiling year-end numbers, or working on each client’s annual Roadmap planning updates.

Or, I might be on the more “in house” tasks of balancing or rebalancing client accounts, analyzing stock positions, considering stock positions, research, trading into or out of something that I like or don’t like, etc.

These two priorities have kept me pretty busy… end of year and most recently end of quarter stuff… But, I’ve also been busy with my second course of action, which is helping new people to become new clients. Since I really take my time with their stuff and all new clients go through the process of figuring out where they are and where they want to be, this can take a lot of time.

After all of this, comes time for blatant self promotion and article-writing… which includes sitting back (a little… not enough to tip over my chair) and observing the world of the markets with a fresh enough eye to comment on them.

While I have had some difficulties getting far enough down the list to get pen to paper (figuratively, of course), there’s the OTHER reason: Any pearl of wisdom starts with a grain of sand that aggravates enough to impel one to action.

Frankly, every time that I look back to my late November post, I observe that what I recommend is what I’m still doing… this is what I’m still thinking… this is how I’m still positioning client accounts. And you know what? The market is still where it was when I wrote the post in November, about 1100 on the S&P 500.

So what’s changed? What’s the “sand in my mussel”?

Complacency. I can feel it creeping in again. I feel it when I talk to clients and prospects and I even feel it in my casual conversations. It is just these times that the general public seems to get a wake up call. Are you going to answer it?

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.