The Tasgall Group

This is a good article by John Hussman about portfolio rebalancing and matching your timeframe to your portfolio’s duration. If your primary tool for investment tweaking is asset allocation, it is very good to give you an extra dimension from what you probably already know well.

With the recent surge in Treasury bond prices, the effective duration of a 30-year Treasury bond has climbed from just over 16 years to nearly 20 years. Meanwhile, the plunge in the stock market has collapsed the duration of the S&P 500 from nearly 60 years to just about 30 today.

For investors who rebalance their portfolios annually, this is essential information. Given the probable long-term returns that stocks and Treasury bonds are priced to deliver, an investor seeking a 7% long-term total return would currently require an allocation of about 60% in stocks and 17% in bonds, for an overall portfolio duration of about 21 years ? only a third of the duration that an investor seeking that same long-term return would have had to accept just 15 months ago! Given the poor long-term returns that Treasury bonds are priced to deliver, an investor with any view at all about market direction would likely forego the 17% allocation to long-term bonds, opting for shorter-duration (and only slightly lower yielding) securities until the Treasury market normalizes.

The tired old measure of bull and bear markets are a 20% move in one direction… a purely arbitrary measure of bull/bearishness, but something that a lot of people tend to latch on to.

With that definition, we are currently in a bull market. Even before Friday’s surge, the S&P 500 has gone from a low of 741 at the end of November to a high of 918 around mid-December. That’s a 24% gain in a month, making it a bull market by the “20%” definition.

Does it feel like a bull market to you?

With everyone a-buzz over lower mortgage rates and the large number of people applying for refinancing their mortgages, it might be time to check in on the unintended consequences.

Mr. Mortgage has a good piece titled Low Mortgage Rates to Spur New Wave of Defaults. His argument is that many of those looking to refinance will be rejected, bringing the housing crisis to full front-row impact to all the prime borrowers out there. Here’s a quote:

[Today] the first thing done after the loan application is taken is to call the appraiser for a comparable sale check to see if the value at which the home owner states the house is worth is on target.

Therein lays the rub.

From early reports since rates fell sharply in early December, 80% of the loan applications are not getting out of the starting gate easily. Loan officers are all saying the same thing ? that appraisals are not coming at value due because ?all of the foreclosures and REO sales have taken the value down?. In the majority of these cases, this kills the loan.

The loan officer then notifies the borrower of the news and they are in disbelief. All home owners think that their home is worth the most on the block and I have been told that this is a tough pill to swallow. This brings the crisis home instantly.

Everyone trying to refinance into lower rates at once should hasten the national reality that the largest portion of the home owner?s net worth has evaporated in the past year. One loan officer I spoke with equated this call to a Doctor notifying a patient that they had a terminal illness.

The other three top reasons that loans are not making it out of the application phaseare because of credit scores coming in too low, interest rates not really being what the borrowers are hearing hyped and Jumbo money is near all-time highs.

It may or may not cause the defaults Mr. Mortgage predicts, but there are usually some unintended consequences that wreak more havoc than anticipated… and this would fit the bill for an unanticipated result of lower mortgage rates.

I keep quoting John Hussman because he adds a fresh perspective to the headlines and news articles from other sources…

This is not to minimize the prospects for a further economic downturn, but to say that this is ?the worst economy since the Great Depression? is like blowing up a crate of dynamite on the Nevada Proving Grounds and saying it is the worst explosion since the detonation of the atomic bomb there. Even if the statement is accurate, the comparison is absurd.

Source

Nice graphic from WSJ on the central banking rate cuts:

Good quote:

Somewhere there should be a rule that those who did not anticipate the disaster should be prevented from vain attempts, with taxpayers’ money, to end a financial disaster. This would be particularly applicable to those who claimed that with their skills a disaster was impossible.

As the old saying goes: “Capitalism without failure is like Christianity without hell”. We used this decades ago and Warren Buffet used it last May.

– Bob Hoye

A lot of people are claiming the bottom is in, specifically because the stock market bottoms 6 months before the end of a recession. Since the recession is likely going to be over in 6 months (by whatever logic such prognosticators believe), now is the time to buy. I know I’ve heard this argument at least a dozen times.

John Hussman has a different opinion:

All of us know that the stock market bottoms 6 months before the end of a recession.

The problem is that this ?fact? isn’t really true. The actual facts are that substantial losses typically occur between the market’s peak and the point that a recession is universally recognized, and major gains reliably begin only about three months prior to the end of a recession, and continue into the recovery.

Read more here. Another good quote:

[Don’t think I believe] stocks have ?hit bottom? or that a new ?bull market? is at hand. That sort of thinking isn’t really helpful to investors, who should always be grounded in observable evidence (rather than trying to infer things like bottoms and turning points, which can only be identified in hindsight). Frankly, the idea of identifying those things in real time is wishful thinking.

… Staying with the present moment ? with what can be observed ? doesn’t mean one ignores the past or fails to consider the future.

… Presently, observable evidence suggests that stocks are no longer strenuously overvalued, as they have been for over a decade (with the consequence that stocks have lagged Treasury bills over that period). Observable evidence also suggests that the washout last month was spectacular enough (and the breadth reversal substantial enough) to allow for ? not ensure ? a sustained advance.

I find Hussman provides a tempered stance, and a good focus on the long-term investing landscape. While I don’t always agree with his analysis, I certainly find it thought provoking.

The NY Times put together a little graphical representation of the government commitments over the last year or so…

As many point out, this government profligacy will have a drag on the economy going forward…

Via BigPicture.

Just a quick comment on something I’m observing… the TIP/TLT ratio is falling rather quickly, which implies that market expectations of inflation are dropping. In fact, this indicator argues for a big deflation scare that is coming down the pipeline.

Yes, the bailout, Fed actions, and Treasury spending all are hugely inflationary, but I am pretty sure you’ll be hearing more about deflation soon.

Wonder why the US Dollar is so strong against the Euro lately? The European banks were apparently using AIG to get past capital reserve requirements… and with AIG being knocked out of the game, a lot of problems start piling up quickly…

The K-10 annex of AIG?s last annual report reveals that AIG had written coverage for over US$ 300 billion of credit insurance for European banks. The comment by AIG itself on these positions is: ??. for the purpose of providing them with regulatory capital relief rather than risk mitigation in exchange for a minimum guaranteed fee?. AIG thus helped to organise regulatory arbitrage on a gigantic scale. A formal default of AIG would have had a devastating impact on banks in Europe. This explains why AIG?s problems had sent shock waves through the share prices of European banks. For the time being the US Treasury has saved, inter alia, the European banking system, but given that AIG is to be liquidated European banks now have to scramble to find other ways of obtaining the ?regulatory capital relief? they appear to need urgently.

Get all that? It’s less well known than it should be, but Europeans banks have long been gaming their regulators, having far less than the actual capital reserves that they needed given their balance sheets. AIG filled the hole, selling credit defaults swaps to European banks via which they could tell regulators that they were adequately covered — at triple-A, no less — while carrying less cash than required.

From Kedrosky.