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.

Oh yeah, and she’s damn good at it. Seriously… like professional-grade damn good.

Yes, she has rules too. One of her rules is that if something’s coming into the house, another item must go out. We’re way past the “accumulation” stage of our lives and we’re now in the “upgrade” stage.

(My rather crude translation of this is, “You can’t put ten pounds of sh** in a five pound bag”, but now that I’ve actually written it down, it doesn’t sound very bright.)

Another rule is that it has to be actually worth something. You would be surprised at the amount of good stuff that some people will practically give away. I can’t figure out why people do this, but they do. Too tired? Too lazy? Just way too sick of looking at their own junk? I have no idea.

But because these people are out there, my wife never goes anywhere without a jeweler’s loupe and a diamond tester. These are admittedly odd things to keep in your purse… but the payoff can be handsome for the trouble. That and she’s addicted to the hunt.

And all along the way of the Never-Ending-Great-Treasure-Hunt that her travels are, along with the gold and platinum and various diamonds, rubies and what-not gems and doo-dads and unwanted heirlooms come the oddball bits and pieces of the equivalent of the precious metal family’s loser child: Silver.

Her silver hoard was mostly represented by orphan spoons, charms, bracelets, candlesticks, and the like that have kind of come along for the ride like barnacles on the Cutty Sark. But every now and again, even the great sailing ship comes in to dry dock to scrape off the barnacles. And such it was recently for the accumulation of silver whatsits and doodads that she decided the time was ripe to be unceremoniously “scraped off”.

And in the “scraping off” process, she matter-of-factly inquired of me about the price of silver. Out of curiosity I suspect because she’d heard a blip about it on the news. Even though I don’t personally trade commodities, I still keep a sideways eye on them because they can occasionally affect the stock and bond markets and at the moment they seem to be on everyone’s mind. But I only peek out of curiosity, or if someone asks me about something commodities-related and I need to sound smart.

I was thinking it had been somewhere in the $20’s, but I was wrong… very wrong: Silver had gone vertical. After about thirty years of languishing between $5 and “who cares”, the loser child had suddenly gotten a PhD! It was almost 50 bucks an ounce. Of course, I had to check a couple of times… but, yep it was closing in on $50.

So she hustled “the hoard” down to a friend who owns a jewelry store that buys such things for a percentage of the melt value. She had a quicker step to get down there this time, I suspect because the price of the stuff seemed a bit out of line with reality. But, other than that it was all rather routine and typical. She’s a frequent customer.

The deal was done, a check was pocketed and it was back to business as usual for the Never-Ending-Great-Treasure-Hunt that her travels are.

And during the next two weeks (right up to today even) the price of silver has collapsed. It’s lost about a third of its value: It was around $48-plus an ounce and now it’s in the low $30’s. It’s been an historic selloff… dramatic and speedy.

I know my wife doesn’t care. She accumulated a large position at cheap prices over a long period of time. She then sold her entire position, without emotion when the market appeared to have lost its senses. And then she moved on to “business as usual” without another thought.

She just executed the perfect trade.

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.

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.

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?

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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.

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.

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.