JR Snell Capital Management, LLC

For months and months (or maybe even a year) I’ve been banging on the table about how I expect that a decent portion of account returns for 2010 might just come from long-term (20+ years) government bonds.

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.

If you’ve “subscribed” to get web site updates to keep one eye on the market while you do other things… this post is for you.

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.

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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.

The latest market meltdown has gotten folks asking me about our performance as compared to the stock market (again). But I’ve always thought a little differently about comparing our management of client accounts against various indices. (The industry calls this “benchmarking”.)

I find it interesting that investors would want to compare whole portfolio returns to the stock market. It’s funny how consumers of financial products maintain this decision bias by wanting to compare all returns “against the market” to decide if they’re getting good advice or not.

I don’t think investors are necessarily to blame for this bias… I think our industry might have brainwashed people to think this way. After being subjected to the stream of advertisements on TV and in magazines comparing “this fund” and “that fund” against the market, what can we expect investors to do when looking for intelligent ways to discern between copius financial choices?

To get market returns… or a reasonable comparison between what you’re doing versus what the market has done, you have to accept “market risk”. Yet, what I know from innumerable conversations with real people who have real concerns, investors do not want to accept “market risk” for the entirety of their investments.

I think a better “benchmark” to judge portfolio performance would be to compare your performance to what you set out to do. I call this “Personal Benchmarking”. Once you’ve released your portfolio from the chains of relative performance and embraced the concept of absolute performance (Personal Benchmarking) all investment decisions become significantly easier to make and to manage.

If you’ve planned that you’ll need a certain average annual rate of return to make your retirement work, what relevance is the stock market to you personally? It’s one of the hardest concepts to get your head around… but it’s worth it when you do… kind of Zen-like if you will.

So, we try to use the stock market as simply a tool to help us to reach your objectives. To do this, we have to first define your objectives, then we have to have the courage to “walk away” from the market when necessary and to exploit it when possible. (Hint: Get this report.)

If you REALLY think about doing things this way, you are naturally going to under perform when the market is “hot” and “risky”… and you’re going to outperform (sometimes significantly) when the market craters. But then again, who cares? The goal isn’t to “beat the market”, the goal is to continue on a track to meet your personal objectives?

Remember when I wrote the “Market Timing for Dummies” thing? It was in December of 2008 and my little chart that I showed in the post indicated that, at that point we’d been out of the market for a year and we might be out of it a while longer too.

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We’ll, we’ve been out of the market another 8-plus months since then. Guess what? While you weren’t paying attention, we slipped into a bull market! What? Yes, it’s true… here’s the chart from almost a year ago brought up to today’s date.

Before you defrost those little wieners-on-a-toothpick that you’ve been saving for this party, here’s what it means and what I’m doing about it and what I think you should do…

Ready? Here’s the answer: “ATTITUDE SHIFT”. Since 75% of all stock price movements are in the direction of the overall market, we can begin to think that price situations will begin to resolve in our favor now, instead of assuming that everything’s going to immediately go into the crapper the instant we buy it like the last almost two years. That’s an attitude shift.

Before buying anything, make sure the financials are right and good… and that the chart looks favorable… and that you’re only putting an appropriate amount of your dough in each situation… and that you protect yourself against too much loss. (I like 10%).

As the rally continues to mature and goes through a couple of “tests” and subsequently continues to keep the wheels on, you can add to successful positions, start adding additional positions, etc. etc…. all the while limiting your risks.

So, it’s an attitude shift to where you would begin the process of investing in stocks when they look right. Moving all at once to a fully invested position could end up being a mistake if things take a sudden turn for the worse.

I remind all that you cannot predict the future.

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.

Should we have an opinion about the stock market, or even about the direction of the economy? Is it important to set a firm course of action based upon our expectations of what we think will occur in the coming months?

Most readers when asked, would think these questions a bit silly. They’re a bit silly because everyone “knows” you must have an opinion to be a successful investor. Or do you?

Of course, being who I am, I would tend to think just the opposite. Did you ever think that the investors who have a firm opinion about what they believe will occur in the future are taking a risk with their flexibility? They’re messing with an essential investing skill that is the ability to change and adapt to a very fluid and dynamic situation?

Take, for example the annual Barron’s survey from a year ago about what 12 prominent strategists thought would be the course of the economy and the market for 2008. First, not a single one of them predicted a recession even though we were already in a recession at the time of the survey (December 2007). Second, their ending estimates for the S&P 500 were between 1525 and 1750. The S&P 500 closed 2008 at 903.25. That’s an embarrassingly huge miss!

Rather than throw these collective strategists into the “idiot-pile” for their lousy foresight,  I’m more inclined to think them fools for even attempting it. And so publicly too! Oops.

Of course, it would be a bigger shame if they managed or advised others based upon an unflinching adherence to their predictions. That’s a portfolio-wrecking miscalculation and strategy. And this isn’t just one “strategist”… it’s all of them.

So, it’s pretty obvious that it’s a fool’s errand to try to predict the future for any reason, let alone the stock market. This is why it doesn’t matter what I think about the future. The good news is that when I’m stacked up against some of the greatest economists in the world, I figure I’ve got about the same odds as them as being right. The bad news is that those odds are somewhere between slim and none.

What to do?

I think that it is more important to imagine a number of potential scenarios and their corresponding courses of action. From this brainstorming session, you could put together a number of “if-then” statements, much like a computer program would be written. Then you can develop a written plan for the future of your investments in a sequence of decision statements. Maybe a statement would go something like, “If interest rates decrease to below 2%, I will sell my Treasury bill investments.” [This is not advice, only an example.]

As I advise clients and manage portfolios I’m always playing this little “game” with myself. I never make an investment for myself or others without an “if-then” rundown… and right now I’m playing it with the stock market.

Here’s the playbook from my mind at this moment:

1. IF I see that a short term rally is developing, THEN I will invest about 50% of my clients’ growth stock capital.
2. IF any of these stocks loses 10% of their value, THEN I will liquidate the position.
3. IF any of these stocks gains 30%, THEN I will exit the stock and take my (our) profits.
4. IF I see that the rally is coming to an end, THEN I will sell any of these new positions at the slightest weakness.
5. IF I see that the short term rally has turned into a new Bull market, THEN I will commit the second 50% of my client’s growth stock capital to the market.

For the record, I’m still waiting for #1 to be True. I have some other “if-thens” that I’m playing with Treasuries, Investment Grade Bonds, our Utilities Select Strategy and the Dogs of the Dow Plus Strategy but I don’t want to annoy you with the incessant squeaking from my mental squirrel cage.

For everyone who is anxiously awaiting a new “buy” signal for the stock market, I still have no news. Things, believe it or not, are about the same as my last post about market timing. For the more technically-oriented investors… or those that feel like they need a little more detail about the “whys” of what’s happening at the moment, here is the complete description of exactly where we are.

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The situation at present is that we have broken a minor, valid downtrend line (yellow downtrend line) and then gone on to form a couple of minor, higher lows (green up arrows). Recently, we’ve hit our heads on the 10 week moving average (blue line). The last time that this happened, it spelled trouble for the markets (yellow down arrows).

Today’s million dollar question is how this will resolve. Are we setting up for another leg down or will we hold the line and ultimately move higher? As it is right now, I can say that we are firmly on the fence.

Also, don’t forget that I’m talking about a short to intermediate term possible turnaround here. Everything needs to be considered in the context of an overall bear market as I have been discussing.

I’ll let you know when that changes.

I’m continuallyamazed by the number of advisors and investors that have been “brainwashed” into believing that buy and hold investing is the only way to invest.

I prefer to call it “buy and HOPE” investing, which I feel is a little bit more descriptive of the style. When you buy and hope invest, you are ASSUMING that all will be well, and profitable… just in the nick of time (i.e. the day before you need it).

In my humble opinion, making these kinds of assumptions is REAL RISK. The idea of having things that I cannot (or will not) control shaping my and my client’s destiny… this is far too risky for me and clients don’t want to hear that “odds are” they’ll be OK.

The biggest argument for buy and hope investing that I hear are negative arguments. If you’ve been out poking around in investor-land for any length of time, you may have heard these gems…

1. “No one can time the markets.”
2. “If you would have missed the X biggest up days in the market, your returns would have been [far lower] [non-existent][negative][etc.]“

Here are the translations:

1. “I can’t time the markets, nor do I have the guts to take a stand and tell you when to get out of the markets because I could be wrong and you wouldn’t like me anymore. By following ‘mainstream’ investment thought, I can blame my laziness or my lack of knowledge on the market… Sorry, not my fault.”
2. “As a balance, if you would have missed the X biggest DOWN days in the market, your returns would have been [far better][good][at least positive][etc.]. Not to mention, many times the markets will go through extended [15+ years] periods of flat or negative performance.”

Bottom line… Yes, you can market time. If you’re not afraid of the possibility of being wrong and all you want to do is avoid the BIG HUGE BEAR MARKETS [and that's all a long term investor should ever have to worry about anyway], then yes, you can and should get out of the market when things are setting up to be very bad for your portfolio. I’m still baffled as to why your ‘run of the mill’ advisor wouldn’t suggest this to his clients. Maybe the operative word is ‘run of the mill’, eh?

OK… back on topic. Here’s how it’s done: Pull up any chart of the S&P 500, change the period to weekly, draw a 10 week exponential moving average and a  40 week exponential moving average and get out of the market when the 10 week goes below the 40 week. Simple, effective and long term. Make a point to look at the chart every now and again [maybe monthly, more often if the lines look like they might soon cross over].

Also, I have a chart that I’ve set up on StockCharts.com that I use for this purpose. I’ve saved it off on my desktop as a bookmark and I look at it every now and then to remind myself that, at the moment we are in a bear market… and I will know exactly when we are probably not any more.