What Asset Class Correlations Meant Last Year and What They Mean Today

Traditional “diversification theory” is based upon past history, where owning U.S. stocks, foreign stocks, REITs and commodities, etc., allowed for a reduction of downside risk in bear markets. That all fell apart in the autumn of 2008 when everything was collapsing; all asset class correlations essentially went to one. The only asset classes that held up were: Cash, U.S. Government Bonds and Managed Futures.

Since the market bottom in March of 2009, traditional asset class correlations have gone to one again. Since early March, when the rally began, the correlation between equities and high yield bonds, real estate investment trusts, industrial metals and oil are all 0.94 or higher. In other words, all those markets are moving in sync. Even gold has a remarkably high correlation of 0.76 with equities. Basically, an asset allocator could have thrown darts in March and found things that went up.

We do not throw darts. We rigorously evaluate asset classes and individual securities, looking for opportunities to reduce portfolio risk every day. Based upon the massive rally in the majority of asset classes, most investors and professionally managed portfolios are at high risk for another massive stumble, if and when it happens. We have significant allocations to the following, all of which have NOT been highly correlated with the stampede and should hold up well in the event of another turn down into a bear market:

• Cash
• Managed Commodity Futures
• Managed Financial Futures
• Gold
• Merger Arbitrage fund
• A Long/Short fund
• Short Term, High Yield bonds in GMAC and Ford Motor Credit

Extending Unemployment Benefits and New Home Tax Credit: More Signs That This Will Be No Normal Recession

President Barack Obama is set to sign a $24 billion economic stimulus bill Friday, providing tax incentives to prospective homebuyers and extending unemployment benefits to the long-time jobless.

GDP = Gross Deception Picture

The band, Styx, had an album in 1980 called the “Grand Illusion."

Wall Street and the news media went hog wild with euphoria last week when the GDP (Gross Domestic Product) grew at 3.5% annualized rate. This is a grand deception. In reality, the majority of the 3.5% came not from consumer spending or increased factory production but from government spending. If you remove the government stimulus, you end up close to zero or even negative. Thus GDP = Gross Deception Picture.

Making matters worse, millions of dollars of the stimulus have ended up in the hands of fraudulent citizens. An example would be the “first time home buyer credit” of $8,000. The inspector general for the U.S. Treasury recently testified before Congress that 19,000 filers had NOT purchased a home that filed for the credit. Another 74,000 filers were not first-time homebuyers. This totals over $600 million going to fraud. Five hundred people under the age of 18, most notably a four-year-old, have also claimed the credit. To add further insult to injury, 53 employees of the IRS have been found to file illegal claims.

Investing lesson:

Our government is running a Ponzi scheme by artificially propping up the U.S. economy via racking up trillions in debt. When the patient is taken off of stimulus life support, it may get very ugly again. This is why I believe that this will not be a normal recession recovery and that we are likely entering a phase of low economic growth for the next 5-10 years.

Why Invest With A Mutual Fund When The Manager Refuses To Invest With You?

Morningstar: 51% of mutual fund managers have ZERO invested in their fund. Just 9% of managers have more than $1M invested. If you do not eat your own cooking, the stew must not be very good. I have in excess of $1M invested in our mutual fund.

Investing lesson:

NEVER, EVER, invest with a mutual fund, company or financial advisor where they do not believe enough in the investment to invest in it themselves.

Investing And Entertainment Do Not Mix

Investing done right is quite boring for the average consumer. With the human emotions of greed and fear driving much of investor behavior, it should come as no surprise that investors fall victim to Ponzi schemes that they know, in their hearts, sound too good to be true, but go for it anyway. These range from Hedge Funds to Variable Annuities to TV “Pitchmen.”

Of course, that is not how it looks on TV: Jim Cramer yelling and Maria Bartiromo on the floor of the exchange for the closing bell. Why that's exciting stuff! Suze Orman as well.

CNBC + Investing = Action Sport.

Danger Will Robinson, Danger!

At the top of the tech bubble, investing became America's favorite spectator sport. Everywhere you went, CNBC was playing. I still think that there's something odd about sitting in your dentist's office watching CNBC, but back then you couldn't escape it.

It seemed to die down a bit as volatility dropped from 2004 to mid 2007.

Then it was back. Round-the-clock coverage of the "Financial Crisis" and insightful commentary from Jim Cramer. I have never been surprised that people watch Cramer. His show can be entertaining, but I can't believe that people act on what he says. It's like taking knife handling advice from a circus clown.

Investing lesson:

Take the time you used to spend watching “financial entertainment” and do something worthwhile or simply fun. Never, I mean never, ever, confuse “financial entertainment” for professional advice.

Bear Markets Do Wonders for Retirement (If You Are Young!)

“The six-month bear market that wiped out nearly half of Americans' retirement savings threatens to scare away the class of investor who has the most to gain from it: young people”.

“Mutual fund manager T. Rowe Price says in a study that those who began to systematically invest in equities in severe bear markets were "significantly better off 30 years later than investors who began in bull markets".

Click to read the full article from: (TheStreet).

Investing lesson:

The article cited above is very consistent with my “contrarian philosophy." In other words, to succeed as an investor, you need to usually do the opposite of “conventional thinking."

Words of Wisdom From James Stewart and WADEX Portfolio Moves

Most financial journalists are very poor at providing readers with advice that is "wise." One of the few good ones out there is James Stewart, who writes for the Wall Street Journal and Smart Money Magazine. Provided below are some pearls of wisdom from Mr. Stewart's 9/29/09 column.

"So the lesson of this rally seems to be that the strong are likely to get stronger, which is very much the hallmark of a momentum-driven rally. If you think this rally will continue, and want to buy now, this evidence suggests you should look for stocks that have already done well and appear to be overvalued. While it flies in the face of value-driven logic, these stocks could very well be the best performers in the last gasp of a rally."

To me, this is the logic of the hard-core trader and momentum investor. It not only depends on the rally continuing, but assumes investors will know when it’s over, and it’s time to get out. So far as I know, no one has perfected a system that can provide such perfect timing.

As I’ve said before, no rally goes on forever. The tide will turn, and when it does, I suspect the overvalued stocks will be the hardest to fall. That’s why I’ll continue to prune my exposure to the highest-flying stocks when and if we hit another selling threshold. Cash may seem dull today, but remember what it felt like just a year ago?