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Outputs
Successful investing is 'avoiding' emotion (you can't control emotion) while waiting for instability which indicates a change in trend:
· ‘late’ instability example, VIX Rate Of Change from –ve to +ve (selling in 2007, falling side of bathtub) · ‘early’ opposite instability ex. VIX ROC from +ve to –ve (buying in 2003, rising side of bathtub) · stability indicates 'wait' - no change in trend (bottom of bathtub) · noise can be filtered out by taking in a longer period, 45 weeks, and a large market for example, S&P 500.
As an investor, there are 3 traps to avoid:
· turkey when assets are overvalued (during late instability) · loss aversion and framing effect (ignoring painful losses) · value (during stability...chart is flat)
Government should avoid these traps…
· Liquidity trap when credit fails (delinquency high) If default rates get high enough, banks will simply be unwilling to lend which will severely limit money and credit creation….Paul Kasriel · Mild deflation trap when high government debt traps the government with high debt service. Any small inflation will cause the debt service to rise to an unsustainable level. Inflation can’t be risked. The hope here is that private debt can be written off gradually. Private economy recovers eventually and government debt is paid down for example, US 1950s-1970.
At the end of a trend, consider: “You are a contrarian or you are a victim”...Rick Rule June 2009
See latest charts…with high volatility, increase the moving average as it reduces ‘noise.’
Make VIX invisible so as to avoid ‘noise’. Mark 45 wkma and ROC.
VIX now declining but corporate profits, fundamentals such as deflation, and continued job losses are not bullish.
Market tremors indicate there is more to come...I anticipate a continued period of instability for 2-3 years followed by a longer period of stability. A ‘bathtub’ consisting of falling prices followed by a period of stability and then rising prices.
Short-Term (all 7 must turn)
Yr/Yr Change SP500 Operating Earnings ↓ Yr/Yr Change in Delinquency Rates ↑ Yr/Yr Change in12mo tax revenues ↓
Longer-Term Total Credit Decelerating Credit Standards Tightening Spreads Volatile Total money velocity Declining now 16% Mean Market P/E volatile
Co-incident Indicators...Updated Jul'09 federal program taking state claimants Yr/Yr Change in Aggregate Weekly Hours (AWHI) ↓ PPI, CPI must rise above 0% ↓ CPI nsa May’09 -1.3 % PPI sa May’09 -4.7% Yr/Yr Change Capacity Utilization ↓ (falling, must start rising before recovery) Price Changes (45 week) ↓ [Social Mood: Negative on Real Estate, Economy, & Stocks] ↓ Payroll Growth (12mo) and Wage Inflation ↓ $USB :GLD bonds bearish, below 45 wkma Bonds to Gold
$USB:$SPX bonds bullish, above ROC Bonds to Stocks
$SPX below 45 wkma, and ROC negative S&P 500 ROC
Inflation Indicators…Updated Jul’09 Yr/Yr Average Treasury Int Rate Change -33% ↓ Average Treasury Int Rate 2.7% ↓ Debt Service Ratio 13.5% well below 35-40% CPI ↓ PPI ↓ MZM (cash available to treasuries) 9609 billion and rising
Total adjusted monetary base...essentially money printed by Fed without issuing bonds:
What is bought?
Currency Indicator…Updated Nov’08 IRD favors USD PPP favors USD
Portfolio Bias The inflation charts show forces of inflation falling fast. Delinquency rates are now running at 7%. A decelerating credit market favors government bonds and "flight to quality" investments. Although you will see large price swings in various markets. Bias: Deflationary
Buy Value At Recovery Turn and Use Portfolio Bias....VCU (Value, Credit, Up-trend) 1) Value or under the mean 2) Credit Accelerating. Bias Inflationary. 3) Up-trend...beginning of market positive percent change ( Ideally Long Term Dependence as well)
At this time, the ultimate chart showing long term dependence and VCU is the US treasury bonds 30 year. Value- Reversion to the Mean: Yes as they haven't participated in recent market advances (below the mean - negatively correlated asset). Credit: 'Flight to Safety' Long Term Dependence: Yes, chart shows long term up-trend.
The cold statistics have hardly been encouraging for the traditional [buy and hold] view. On a total return basis, the Ibbotson data show that the S&P 500 has underperformed long-term Treasury bonds for the last five-year, 10-year, and 25-year periods, and by substantial amounts. - Peter Bernstein Feb, 2009
Up-trend: Yes since 1982.
As for stocks, there's no compelling value. I say wait for a crash/opportunity.
Portfolio: US Gov't Long Bonds or TLT
As for stocks...don’t buy Buy Value...Industry Watch….Nothing at this time
If after recession, there is no private credit growth, candidates are: infrastructure, and food. If there is private credit growth, value strategies can be employed such as Graham investing and ‘Robot’,
As stocks sell off some industries will become bargains. The chart should show a significant sell off with a down period. I watch for the major bargain industry and buy its dogs when the chart shows a turn. The longer the down market the better the upside. The gold and oil stocks showed a long term dependence ... down for 20 years, 1982-2002. So they were primed for a good rally in 2002-2007.
Sell Over-valued and Use Portfolio Bias....VCU
1) Over-valued way above mean 2) Credit is decelerating. Bias deflationary. 3) Chart is 'choppy' high % change moves. Sell 'hype'.
No stocks to sell at this time.
Hedged Position There is always a chance that I am being fooled by randomness. I believe the portfolio should still have a bias such as deflationary or inflationary. Right now it's deflationary. As such, the portfolio should always have a hedge in the opposite direction, possibly leveraged, in case an earthquake comes out of nowhere.
If your hedge is to be leveraged, it should be thought of as insurance. The investment for the most part is a throw away. I have a small position in gold at this time.
Hedge: 5% GLD
Background
"Be fooled in small matters, not in the large." p. 203 The Black Swan Liquidity tends to flow to "dry" areas. When liquidity is withdrawn, markets drop except "flight to quality" investments. With liquidity, returns will be best in areas that have been dry. The flow here will raise these boats faster than any others.
You use the deflationary/inflationary bias to select the type of investments. But you keep in mind that in a credit driven system, the catastrophic event will be deflationary followed by a possible currency devaluation or hyperinflation. As the economy gets closer to this threshold, it will oscillate between the deflationary and inflationary biases.
The Fed knows this problem and so over-reacts when the threat of deflation is apparent and makes credit available very cheaply. On the other hand, they live with the legacy of the 1970s and want to also fight inflation. When the CPI and core CPI meet their thresholds (ie. 3%), they raise rates and attempt to limit credit availability. They are in a delicate balancing act which is a losing game in the end as you can't grow your debt faster than your spending or income forever.
Unfortunately, there is a delay from the time the Fed starts to raise rates and a credit deceleration. In fact, as the Fed starts to raise rates, credit will actually accelerate as people are afraid of being locked out of the market. At some point, the rates will rise high enough for the credit fever to break. The credit fever can break abruptly or slowly.
If I believe the economy has a deflationary bias, I put 80-90% into treasury bonds. Once credit starts to flow again, I look for an investment class or classes that have been beaten down during the credit deceleration phase. I focus on the less ‘noisy’ charts (usually indexes) and ignore the ‘wildly’ random ones. Within this group, I then select the industry charts that show long term dependence (ideally) and an obvious breakout recovery (up-trend). You find these sectors by analyzing the stocks first then working back to their industry charts. For example, sort for stocks that have been dropping for a few years showing a breakout of 40% in the last year. I briefly check the stock charts of this industry for the obvious up-trends. By watching for some kind of up-trend, you avoid the 'value trap' which occurs when buying a low-priced stock only to have it remain low priced, either because the stock deserves the low price or because the market never catches on to the mispricing.
With 50% in VCU, I keep the other 50% in treasury bonds of the currency with best PPP. Some of this bond portfolio may be invested in GLD if the major currencies EUR and USD fall to negative real rates. Up-trend means the chart shows some sign of life. Strip the chart to its bare minimum and look at it over the past 3-5 years. Ideally you want a 3-6 month breakout. At the beginning of a bull market, charts are more reliable in showing an up-trend. %change is also a good indicator. They aren't very useful at the end of the bull market as price swings are large/wild. I use the 45 wkma and the 45wk ROC. Alternate Strategy … Real Rates Portfolio As volatility increases, it becomes more and more difficult to interpret ups and downs. As such, the investor retreats to the least volatile, 3 mo T-bills. However, during Weimar the T-bill discount rates were 5% per month and inflation 20%. Hence, the real rates were –15% per month. In this case, gold was clearly the investment of choice. In 2009, real rates are 3mo Tbill rate — rate of inflation, 0 - -3 = + 3% per year.
Buy/sell rules that worked in volatile Russia, Argentina and Weimar are: 1) Buy 3 mo T bills with positive real rates OR a savings account 2) More gold with mild negative real rates and all gold with significantly negative real rates
Alternate Strategy … Permanent Portfolio
As investors, we have to admit that quite often the simplest approach works best. It's hard to realize sometimes that all the effort put into analysis can go for naught.
Taking a simple method, why not construct a permanent portfolio consisting of the best investments in the two environments of debt deflation and hyperinflation? If a black swan occurs in either direction, you are covered.
The proportion is according to your risk tolerance. GLD is more volatile than bonds about 3:1. 75% US Bonds 30 year or TLT / EDV if you don't want to purchase bonds (Best Investment in a Deflation) 25% GLD (Best Investment in a Hyperinflation)
Why US Bonds? In a deflation, Americans will consume less and shrink their trade deficit. They will also favour local producers again shrinking their deficit. These events will be bullish to the USD.
GLD is a stock proxy for gold. You can always buy the real stuff instead. If the stock market were to shut down as it did in 1914 for 6 months, the pure stuff would obviously do much better.
OR
This strategy pays interest on both deflation and inflation protected components. 50% TLT (gov't long bond ) 50% TIP (gov't inflation protected)
________________________________________________________________________________________________________________ I am not responsible for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. As I do not charge for my web site, it provides information "as is" for informational purposes only, not intended for trading purposes or advice.
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VIX |
ROC VIX |
Stock Market |
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Falling |
Large - |
Bull transition |