And the winnah is…

We christen our upgraded site with commentary on a look at the winning investment strategy for the past decade: Market timing.

According to LeCompte’s analysis, the strategy bested buy-and-hold, rebalancing and one momentum strategy.

Click here for a concise overview of the different strategies’ returns and variation.

Fortunately, timing was near and dear to our efforts.   Yet while market timers everywhere congratulate each other, we behold a troubling bit of data.  And while it is true that the market performed with the same variation & records positive returns over half the time throughout the past six decades, the mean return for investors vanished in the past decade.  Some call this the market’s “lost decade” as investors have lost money since the turn of the century (-0.12% per mean monthly return) (ibid)

Our focus for the past six months and the foreseeable future is to concoct an approach for our client’s that will take advantage of our research.  Our goal is simply to post analysis at the dusk of the next market cycle claiming we fingered the winner of the next decade.

Gone Fishing

In 1951, Louis Armstrong joined Bing Crosby on television’s popular “The Chesterfield Show” to sing a duet. Of all the chart topping songs each singer made, the song they chose to sing was a tune called “Gone Fishing”. We thought about that song fifty five years later as we perused volumes of new market data and graphs and realized Louis and Bing were singing about an investment strategy custom made for the summer. We began to shop for ‘fishing pole’ stocks – stocks whose trajectory resembled the silhouette of a fishing pole with its line immersed in water.

An investment shift to the “fishing pole” sector?

Sensing opportunity after the market pullback of May 2006, we began tenaciously reviewing pricing patterns and recent financial reports for clues of the “next best thing.” We expected a “next best thing” candidate to emerge from our work as in the past – for example “Japanese stocks”, “oil stocks”, “consumer cyclicals.” Instead what we found (with the lyrical assistance of Mssrs. Armstrong and Crosby) was “fishing pole stocks.” Stocks of all sectors and sizes were being subject to what we will term the “fishing pole” effect. That is to say, the severe drop in the growth of the economy in the second quarter had resulted in a growing number of stocks falling rapidly in one day so that the appearance of the stock’s price chart loosely resembles the silhouette of a fishing pole with its line immersed in water. (Find attached a number of examples below for your visual inspection. A picture IS worth a thousand words in understanding this phenomenon).


Stock prices whose trajectory somewhat resemble the silhouette of a fishing pole with its line immersed in water…

Our point? Some stocks that have already fallen in such a “fishing pole” manner have shown notable relative resilience to a new downturn when one is presented. If this stable behavior continues, we would consider looking into new positions from stocks that showed ‘fishing pole’ behavior.

We made two observations [observations not research findings] on the “fishing pole” effect:

a. The severe one day drop of the stock prices of so many well-known, profitable companies’ stock prices may represent speculators or hedge funds getting flushed out of a position in those stocks. Consider, is UPS really worth $10 billion less in market capitalization on Tuesday simply because its earnings fell on the lower half of its previously stated earnings guidance on Monday? Speculators may be folding as we write.

b. Admit it or not, if an increasing number of stocks are subject to a 10, 15 or 20% one-day price drop, would THAT not be considered “the crash”? That is, if, say, each of the 30 stocks in the Dow Jones Industrial Index fall 15 or 20% in one-day BUT those falls are scattered over 30 to 60 days, the index should be “down 15 to 20%” in total. We are not suggesting that the Dow will fall by such a magnitude necessarily.

What we are suggesting is a 20% crash could occur on one fateful day and garner the moniker of “Black Tuesday” or the fall could occur more slowly over a longer period of time. We submit we may be witnessing the latter. Either way a stronger case for a firmer market bottom can be made once double digit drops are in place.

As we proceed through 2006, we look with great interest on the possibility of catching a ride on the bottom of the line descending from the fishing pole on many a stock.

Let the Data Do the Talking

Are Hedge Funds Making the Healthcare Investment Sector Unstable?

Proposition #1: The first-world’s population is aging and requires incremental increases in healthcare spending to address ailments which afflict the aging.

Proposition #2: The first-world enjoys unprecedented prosperity, wealth and standard of living.

…Proposition #3: If a population is wealthy, they will spend their wealth on something. If that population is elderly, they may be obliged to spend their wealth on products and services to improve their health and extend their lives.

The propositional logic contained above is compelling and arguably has become conventional wisdom among investors. Yet the healthcare investment sector has displayed similar volatility as other investment sectors (see third quarter 2005 and second quarter 2006). Why? If one searches for clues as to why this volatility appears in a sector believed to be demographic dependant and not financially dependent, the counter intuitive aspect of this phenomenon emerges. That is to say, the unexpected volatility of the sector might have less to do with the demographics or the financial viability of companies selling in the healthcare sector as it has to do with who is invested in the sector: hedge funds. Topol and Blumenthal considered hedge funds and their influence on healthcare investments:

“There are more than 7000 hedge funds operating in the United States, with assets approximating $1 trillion.   More than 425 hedge funds were started in 2004. The numbers are imprecise because these funds are not currently required to register with the Securities and
Exchange Commission, but this will change in 2006 [still uncertain at press time].

Since 1990, the assets in worldwide hedge funds have increased 100-fold, from less than $10 billion in 1990 to nearly $1 trillion in 2004.   Hedge funds have a long history beginning in 1949 and typically use higher-risk strategies for investing, such as betting on a stock to fall or borrowing capital to make investments. Nonetheless, pension funds invest as much as 20% of their assets in these funds, and universities and charitable foundations, more than 10% of their endowments. For example, Harvard University invested $500 million, or 2.5% of its $22 billion endowment, in a single hedge fund. In 2004, individuals invested more in hedge funds than all institutional investors combined.

A typical hedge fund charges a 2% fee plus 20% of any gains, which is a considerably higher investment fee than that charged by most alternative investment vehicles.

Approximately one third of hedge fund investments relate to life sciences, particularly publicly traded stocks and derivatives of pharmaceutical, medical device, medical diagnostic, and biotechnology companies”.

Conclusion: We will watch attentively if hedge fund exposure to the healthcare investment sector (~ 33% exposure to healthcare) begins to regress to a percentage found in a broader market index. For example, healthcare companies compile only ~12% of the S&P 500 Index.

Source: JAMA “Physicians and the Investment Industry,” Eric J. Topol, MD and David Blumenthal MD MPP,
JAMA. 2005;293:2654-2657.

The Jeweler’s Eye

Whatever one’s political persuasion it would be difficult to dispute the observation that after living through the 1990s with an administration that could not stop daily adjustments of its core policies to suit the latest polls; since 2000, the American voter has lived with an administration that seemingly does not acknowledge the latest polls.

Our political sources estimate the popularity poll ratings of the sitting president to rival those of Richard Nixon during the Watergate hearings. But the problems do not stop in the Oval Office.

– Over 22% of U.S. respondents to the latest ACNielsen Online Consumer Confidence Study said they are short on cash after they cover their basic living expenses, per marketwatch.

– Outflows of cash from [U.S.] stock funds in July and inflow into foreign funds are big and the Commitment of Traders (CoT) report shows small speculators have given up on US stock ownership, per Salamone September 1, 2006

If the President is under pressure, the US consumer shows signs of being strapped for cash, investors are selling US stocks to buy foreign stocks and the small speculator is betting against US stocks, what’s an investor to do?

May we suggest one consider U.S. stocks?

The decision to ‘go American’ is a vexing one. To begin with, the domestic economy is either in a recession or one shade this side of a recession – we will find out in next month’s data release. Additionally, the US Consumer represents approximately 70% percent of GDP and does not show signs of strengthening (per Nielsen above). Thus we break our present mindset into two parts: (a) the other side of the economy and (b) happy days will come again.

‘The other side of the economy’ has to do with the 30% of the GDP not represented by the US consumer – e.g. industry, infrastructure, et al. Some companies which are in decent financial shape may gather steam whilst the consumer struggles to boost spending.

‘Happy days will come again’ deals directly with how fast the Federal Reserve will come to the rescue of the Indebted US Consumer in the way of reduced interest rates. The housing woes facing the over-leveraged are well covered in the press and do not require re-hashing here. However, the Fed can boost rates to save the dollar or cut them to save the consumer. You can make your bet on which one will play out. But before you do, recall mid-term elections are just around the corner; something that might sway our guess.

Deep Blue & You

Deep Blue was the first computer system to win a chess game against a reigning world champion (Garry Kasparov) under regular time controls. The computer prevailed in the 1997 six-game match – 3 ½ games to 2 ½ games. Alas, Kasparov’s 1997 task of man versus machine is akin to the task facing the individual investor in a market driven by computer generated trading. Let’s examine this notion and consider outwitting a computer-dependent adversary.

Since the individual investor (read: mutual fund investor) had his proverbial head handed him in the 2002 stock market, many an individual investor has thrown in the towel on the investment markets. Consequently, institutional investors have wrested control of the markets. Circa early 2006, institutional investing is largely a game of giants using computer based program trading. America’s 100 largest money managers now own 58% of all stocks.

Institutional investors show a predilection for employing computers to trade for them. This is corroborated by the fact that computerized program trading now compromises 57% of all volume on the New York Stock Exchange. One can show non-program trading decreasing each year since 2002 when non-program trading totaled just shy of 1 billion shares per day to 2005 when non-programs trading barely exceeded 600 million shares per day.

So by equating the computing power of Deep Blue with that of the computing power of the Program Trades executed daily on the New York Stock Exchange, for one brief moment the mind of Kasparov and the mind of your editor contemplate a similar dilemma: how does one beat the system – the ‘computer system’ that is. In our opinion, poor Kasparov faces a taller task here. Even his powerful mind – a mind by the way that must at a minimum “SEE 10 STEPS IN THE FUTURE” by “envisioning” 5 moves into the future that his opponent will make in addition to the 5 countermoves he will respond with – is bested by a computer that can “see 12 steps in the future.” Wow! Kind of does the Roper poll one better, Huh?  Our “mind” is not necessarily weighed down by the burden of looking 10 steps into the future.

Instead we observe one data set and quickly adjudge that the fuel that keeps those giant money managers going – for the most part large U.S. based companies – is a fuel that has proved less potent than the fuel used by smaller and more diversified money managers – that is small companies and international companies. The data set observed is: since the Wilshire 5000 market peak in March 2000, small companies and mid-sized companies have posted double-digit annual gains through January 6, 2006 while large cap value and large cap growth companies posted approximately 5 % and negative 7% returns, respectively, over an equivalent timeframe1. In addition, excessive relative spending on the part of the U.S. Federal Government is sometimes blamed for the out performance of international investments vis-à-vis their domestic counterparts.

The Largest Money Managers’ computers were ready with lots of money … but looked out onto pools of relatively poor performing investments.

In Hindsight, smaller and international markets have bested some large domestic markets.

The important point is not whether or not this trend continues. The important point IS a nimble strategy of outmaneuvering program trading may lead to excess returns vis-à-vis returns brought about by program trading.

In Foresight, the markets are as prone to erratic and significant instant swings as at any time in the past. By appreciating the repercussions brought on in the wake of massive program trading activity, one may work to seek excess returns. The success or lack thereof of this outmaneuvering may determine who out performs in the investment markets – deep blue or you.

1 “Warning: spin doctors at work”,, January 11, 2006

Let the Data Do the Talking

“Sell in May and Go Away” – a 2005 autopsy

In the hope we have not scared away all but avid chess players and super-computer nerds, one does not need to necessarily understand advanced computer coding to profit in the markets.

Sometimes old-fashioned common sense works too.

In the spring of 2005, the blather that echoed from the media outlets down the corridors of Arlington Hall was: “Sell in May and Go Away”…”Sell in May and Go Away”. This catchy rhyme is put forth by some pundits who lean on data that shows market returns are most favorable from the beginning of the year through April and do not show favor again until later in the autumn. Subsequently, sell your stocks in May as the prevailing market conditions stand athwart your success until autumn winds blow.

Who is Right? Who is Wrong? Who cares! The important point was: as the increasing number of pundits nodded approvingly at the catchy rhyme (perhaps in their haste to summer in The Hamptons), many an investor diligently sold in April as indicated by the market registering a low in early April. What curiously happened next is the markets began to climb after this springtime drop propelling higher for the ensuing three months.

The record (above chart) shows a significant upside awaited investors who avoided the siren call of the catchy slogan: “Sell in May and Go Away”. Only time will tell if the pundits will lean to an unprofitable extend on another one of Wall Street’s age-old aphorisms in 2006.

The Jeweler’s Eye

Quiz: Which organization has a higher credit rating?

In order to prevent Churchill, Stalin, Hitler, Roosevelt, and Charlie Wilson from turning in their graves, we will not provide an outright answer to the aforementioned question. But we will say that the demise of U.S. automobile manufacturers is an on-going glacial slide with potential outcomes that only an egomaniac or a fool would predict consequences of. It is the pink elephant few seem to acknowledge. It combines aspects of the American economy that few other businesses encompass – rising health care costs, antiquated guarantees afforded pensioners, playing to a global consumer market, management versus union match-ups.

We do not know of nor would we predict the date that cancer will be cured.  However, we can gander to say that if and when cancer is cured that it would tend to extend the lifespan of populations the entire world over and perhaps shed light on cures to other related life-threatening diseases.

In a similar vein, we do not know the date that General Motors will cease to exist or merge with an Asian competitor. However, we can say that if and when that would occur:

A bankruptcy effect could be many times that of an airline bankruptcy

US Airways group’s current market capitalization is ~ $2 billion; Delta’s is $124 million (equity only). General Motors’ current market capitalization is ~$12 billion. Ford’s is $16 billion (data: January 11, 2006)

It will be expensive

Someone is going to have to pay for the benefits promised retirees.

The U.S. Taxpayer is a likely end-payor of pensioner’s benefits

If Congress and the Executive’s frivolity shown with the Highway Spending Bill’s passage is any harbinger, is there a politician who would stand in the way of, say, the 2007 American Retirement Act. After all, their playbook has already been written over seventy years ago with the Roosevelt administration’s 1934 Railroad Retirement Act which federalized railroad pensions2.

U.S. Automobile makers will continue divestures away from domestic manufacturing

As the U.S. economy increasing becomes bereft of native science and engineering talent, automakers must either (a) divest operations away from manufacturing or (b) relocate all manufacturing to international locations where science and engineering training thrives.
2 “The Great Train Robbery; how the railroad retirement system swindles taxpayers, robs young workers and derails Amtrak”, Washington Monthly, December 1987

How Low Can You Go

Image Courtesy of:

Parkway Record’s “Limbo” and “Twist” LP records set off a national dance craze forty years ago. Its signature lyrics were: “How low can you go?” Just as the dancer who bends the lowest in limbo party wins, we wonder if today’s stocks are winning by gyrating to a dance akin to the “Limbo Party.”

The present “How Low Can You Go?” craze sweeping the nation pertains to the ubiquity of creative (and complex) credit products and services that pervade corporate and particularly consumer spending. 

The signature of this craze in the financial markets becomes:

“How low can an upfront collateral commitment go for a lendee to secure capital from a lendor?

On the consumer side, Bonner cites ‘interest-only’ mortgages in 50%  of new Jumbo mortgages and nearly 90% being ARMs (adjustable rate mortgages). [1]  On the corporate side, investors have implemented a negative real interest rate investment strategy for the better part of two years. The easy credit phenomenon could very well be international in nature as we recently adjusted our expectations for possible volatility in China due to unorthodox financing schemes in use there. Our April 2005 news bulletin highlighting China was pulled from the press after our eyes beheld new reports providing forensic analysis of the financing that fuels China’s red-hot economic growth.

It was Johnson who said the defining characteristic of a society is the self-descriptive observation that a society never got around to saying about itself. If one were to ask the person “on the street” what exactly is it that the United States will be known for 100 years hence, one supposes the answers would come flying at you…

…Computer Technology: how technology made people’s lives easier
…Bio-Medical Advances: how people lived longer with life saving technology
…Democracy: how the world avoided a major World War…etc.

All are viable candidates. But let us direct your attention to our candidate of choice:

…Easy Finance: how people increasingly enjoyed lower collateral requirements to acquire consumer and corporate niceties.

Lo, it is not our intent to denounce or mock this self-descriptive trend. Au contraire!  At present, most would prefer today’s easy credit environment to the 1930’s style of mass unemployment and economic malaise that befell the US. It IS our intent to finger the stealthy nature of this easy credit craze and investment opportunities which may come with it.

Without any quantitative support to submit for inspection, we might proffer to say that the easy credit trend may last longer than most would expect. After the Federal Reserve began raising rates, our work led us to calculate that if historical trends held, rate hikes would end at the March 22, 2005 Fed meeting.  Of course at this point, further rate hikes (at least in to June 2005 meeting) appear likely although Federal Reserve meeting minutes indicate members have recently discussed hike termination.  To be sure, easy credit financing’s lifespan is finite; yet the first law of motion tells us that an object [trend] in motion tends to remain in motion unless an external force is applied to it. [2]

Now before we draw the ire of those patiently listening to our suppositions who can instantly bury us with an avalanche of warnings throughout economic history (complete with the ensuing disasters) made by those who abandoned a policy of thrift and solvency, there’s the twist [no Chubby Checker pun intended] to our presumption. That is to say, our work tends to support the notion that those that will benefit from the easy credit craze are those who can maintain high credit standing throughout.  A glance at current research indicates a preference towards a moderate weight to a host of sectors; including natural resources, fixed income, health care, defense, international, et al.

One more potential irony is: volatility may be part and parcel of a strategy incorporating high credit quality company investment.  Note the first six months of this year has presented investors with some of the most violent, albeit contained, market swings in recent memory. Attention to capital preservation should not be overlooked.

In the end, Market Bulls hope that the easy credit’s party extends longer than that of the Limbo Party’s.  Callahan notes that the Limbo Party record label was losing money two years after the record’s release and the label company was de-listed by the New York Stock Exchange five years after the release of Limbo Party. [3]  We can hope the NYSE listed stocks in today’s finance sector do not meet the same short fate.


1.  Per Bonner, ‘Attention! Deficit Disorder’, Daily Reckoning, May 17, 2005
2. Per Serway, Physics, Saunders Golden Sunburst Series, 1983, p. 68
3. Per Callahan, Edwards and Eyries, “The Cameo-Parkway Story,” August 6, 2003

Inflation: The Stealth Tax

How will deficits which abound from the U.S. Federal Government’s coffers down to those of the smallest municipality be reconciled?  One can quickly surmise the glimmer in a politician’s eye when the short-term benefits of inflation’s sultry siren falls on his or her ears amidst budgets plagued by rampant Federal spending and tax cuts.  People in power know deficit spending is important business.  For instance, Thomas found that Alan Greenspan’s visits to the White House under Bush have quadrupled since Bush replaced Clinton (deficit spending has characterized the Bush administration). [1]  As with most economic data, inflation figures can be sliced and diced to appear to support just about whatever one’s particular agenda entails.

“Inflation is a stealth tax and has a very efficient built-in collection scheme… everyone holding Dollars is affected and everyone’s purchasing power is diminished, therefore the collection of this ‘tax’ is 100%efficient. And to make it even better, there is no paperwork to fill out, no check to send in, no harassing telephone calls from the tax collector, and the government can continue to print all of the dollars it wants so it can continue a free spending policy.”   –  Stephen Williams in “Cycle Pros”

What’s an investor to do?  “Occasionally successful investing requires inactivity,” Buffett imparted to his devoted flock. [2]   Further, Hanson observes ‘man is hard-wired to appreciate perceived success and feel comfortable with consensus’. [3]   So although inflation may offer modest short-term appeal to politicians, it is easily explained why investors would shrink from investing new dollars given inflation’s less appealing longer-term effect; namely a demonstrable ability to destroy an economy.    But…ah…Grasshopper, attend us when we say that which is bad for the U.S. economy may cloud potential good for U.S. companies.  In the event you happened to take up residence on another planet for the past five years or so, let us acquaint you with the trend of outsourcing as one example of corporations’ productivity.  Outsourcing is a company’s use of resources in a location outside of its native country; usually as a means of increasing profit through a more cost competitive climate.
With that said, investors should naturally focus on sectors which have demonstrated profit potential in the face of inflation.  “When it comes to money,” Kilgore advises, “it’s always better to bet on results than potential.” [4]  If history is any guide to the present and if inflation accelerates, the energy sector might reward investors.  Can you say $3 per gallon of gasoline?
At the same time, investors should not overlook that if Japan can continue to produce improvements in its economy, U.S. companies may take their outsourced, competitively priced wares abroad.  Don’t forget healthcare.  Recall, many believe the Japanese and European economies pulled the U.S. out of the recessions of 1981-82 and 1990-91 respectively.  So do not discount the possibility of surprises befalling the investment community in the coming quarters even though the specter of inflation may startle one as would a B-2 stealth bomber parked outside one’s window.

Let the Data Do the Talking

An unanticipated and unwelcome development which makes investment analysis more difficult AND less meaningful has emerged: recent changes in economic data released by and compiled by the U.S. government make those reports released after 2003 less meaningful.  Data from early 2004 to present is now littered with statistical adjustments.  For instance, earlier this year, employment and unemployment reporting calculations were altered so future reports now have little relevance to any similar report released prior to January 2, 2004.  Furthermore, in the first week of June the Federal Reserve revised all of its money supply data back to 1998.  Money supply analysis for the past six years was made irrelevant in one release of a report.
Does this mean economic reports are any less useful than in the past?  Heavens no.  But it does mean perception, not reality, will bear the weight of meaningful economic analysis for the foreseeable future.  After all it’s not as though economic reporting was an exact science to begin with.  Recently, Lussier ridiculed so-called economic “experts” and their opinions.  He measured Wall Street experts’ forecasts.  The results from data from 1982 to 2003: [5]
Their One year nominal GDP forecasts were off by 102%.
Their Two-year nominal GDP forecasts were off by 109%.
Their One-year inflation targets were off by 29%.
Their Two-year inflation targets were off by 41%.
Therefore it comes as no surprise that researchers find that consensus is typically useless for handicapping future market pricing and it is the contrarian who may have the best approach to making money in the markets.  We were moved to lessen our dependence on the options markets for future price modeling as the option market’s contribution to price discovery has been found to be as low as 17% on average. [6]   The need to refine one’s forecasting techniques cannot be understated as research finds that macroeconomic factors are unable to explain momentum profits after simple methodological adjustments to take account of microstructure concerns. [7]
Forecasting changes as the world changes.  “China has 4,813 cement plants, more than the rest of the world combined, and they still don’t have enough” Wiggin writes.  “Projects like the Three Gorges Dam and Beijing Olympics forced China to gobble up 55% of the world’s supply of cement, 40% of its steel, and 25% of its aluminum.” [8]  We see on this side of the Pacific that GMAC [GM’s financing arm] now “contributes 2 out of every 3 dollars of GM’s profits…with more than half of the financing profits completely unrelated to the auto business” Bonner reports. [9]  Naisbitt wrote of the U.S. morphing from a manufacturing economy to an information economy in his 1970s best-seller Megatrends.  Today, that book would assuredly address the financial economy.  Kasriel calculated “between 1960 and 1984…banks, brokerage firms, finance companies and the like accounted for 12% to 22.5% of total corporate profits”. In 2002, the financial sector contribution reached 44.75%…”[10]

The Jeweler’s Eye

In the next 60 days, America will be covered with reports from the Democratic and the Republican National Conventions, with one sometimes feeling the biggest question might not be how each team of nominees will perform during the revelry.  Instead, the question lurks: will terrorists strike the convention?  If not at the conventions, where will they strike next?
We have arrived at a conclusion which will someday be deemed correct or incorrect that terrorism has been institutionalized.  Concern is everywhere and dwells in every bosom across the country.  No one is safe.
From an investment perspective, we have taken an initiative over the past quarter to calibrate our applications to analyze securities as though 9-11 did not occur.  For example, we attempted to derive estimates of how much Coca-Cola might have been sold sans disruptions post 9-11.  How many Seniors postponed elective surgeries?  How many vacationers postponed trips to foreign countries due to fear of the terror bogeyman?  We do so not in denial of that God forsaken tragedy that affected thousands of our countrymen.  It must also be stated that we recognize our techniques are rudimentary if not outright inaccurate.  Nevertheless, should another major terror attack be undertaken on U.S. soil, God forbid, we believe the average American (and for our focus: the average American investor) would proceed through the SARA healing process (Shock, Anger, Rejection, Acceptance) more quickly than any of us did after the collapse of the World Trade Center.  In a recent interview with Berkowitz, Buckley stated there is no way the threat posed by extremist and non-consolidated Muslim terrorists compares with that of, say, the threat posed for over forty years by the Soviet Union and their 3,500 nuclear warheads bristling from launching pads aimed at targets in the U.S.11   It is for these reasons that we believe investors may be surprised as growth continues in certain areas of the economy.
Of course, fortunes may be made or lost in determining which sectors may experience growth.  We offer one for your consideration: caring for the health of an aging population.
Hopefully it comes as little surprise that Health care now constitutes almost 15 percent of the United States’ gross domestic product – or double what it was 30 years ago, according to the Washington Post.  In a report released in April, NACS reported “The per-person cost of health care in the United States has risen to $5,440. That amount is double what is spent in European countries.”[12]
It may come as a surprise the extent which health care is a global business.  The New England Journal of Medicine (NEJM) detailed the composition of the International Medical Graduate list with Indian-born graduates constituting over 20% of the whole.[13]
Though conventional wisdom may view cardiovascular disease as being assimilated with Americans, the NEJM report illustrated the growth in the incidence of cardiovascular disease in non-Western cultures in the next 15 years. [14] 
The same report depicted Cholesterol levels to have increased over 20% during the past 20 years in a study conducted in Beijing. [15]
And do not forget diabetes.  “An estimated 170 million people worldwide suffer from diabetes, which is a leading risk factor for cardiovascular disease” Mendoza wrote. “The majority of people with diabetes – roughly 65% — will suffer a heart attack or stroke, a rate that is up to four times higher than in adults without diabetes.” [16]
The world’s getting older.  All people will require more care to their health.  Some people will have the money to pay for that care.  Other people will rely on alternate means  to pay for their care.


1 K. Thomas, University of Pennsylvania Wharton School, Christian Science Monitor, May 2004
2 E. Fry, Daily Reckoning, April 20, 2004
3 V. Hanson, National Review Online, “Our Reptilian Brains,” May 28, 2004
4 T. Kilgore, CBS Marketwatch, May 24, 2004 
5   per Pierre Lussier, Investment Information Provider
6 per Chakravarty, Gueln and Mayhew, “Informed Trading in Stock and Option Markets,”  Journal of Finance, June 2004, p. 1235
7 per Cooper, Gutierrez Jr. and Hameed, “Market States and Momentum,”  Journal of Finance, June 2004, p. 1345
8 per A. Wiggin, Daily Reckoning, June 2, 2004
9 per B. Bonner, Daily Reckoning, June 2, 2004
10 per P. Kasriel, May 6, 2004
11 per W. Buckley Jr. in interview with Jeff Berkowitz
12 per NACS, April 12, 2004
13 per New England Journal of Medicine, June 10, 2004
14  ibid.
15  ibid.
16 per Dr. R. Mendoza, Biotech Report, June 14, 2004

I Joined the Wrong Mob

Around the time of his deportation to Italy, mobster Lucky Luciano granted an interview in which he described a visit to the floor of the New York Stock Exchange. After he visited the floor of the NYSE someone explained to him the role of the floor specialist, he commented, “A terrible thing happened. I realized I’d joined the wrong mob.”

Three years ago, Federal agents commenced a campaign to root out the wrongdoing on Wall Street that Luciano eluded to decades earlier. After the Ebbers, the Sullivans, the Fastows, Quattrones, the Koslowskis and Stewarts now made their way to court, the question is asked: where does Wall Street go from here?

It was not all that long ago when media outlets routinely headlined charges brought against company directors, insiders and some outsiders.  Today, news comes on a somewhat irregular basis that one defendant or another has agreed to pay penalties or serve a prison sentence. Naturally, the aftermath of prison sentences does not have the news sizzle of a real-time guilty plea handed down by the justice system.  However, the consequences may be just important as the verdict itself.  Without having a great deal of quantitative news data due to the exact reason mentioned in the previous sentence (viz. less media attention).  We will gander to say that many more corporate financial reports would pass the “white glove” test today vis-à-vis the number that would have passed, say, in the year 2000. Long remarked that a typical board of directors meeting today finds not only directors in attendance but also the director’s attorney in-tow. [1]

Interestingly enough, investors’ memories proved quite short in terms of scandals unearthed at mutual funds.  “In Dalbar’s scandals study, 75 percent of mutual fund investors could not even name one of the dozens of firms involved  in the scandals. Not one!” [2] 

Of several notions that come from (a) a move to a police state-type environment and (b) investors’ reluctance to concern themselves with wrongdoing, one cannot shake at least one of these notions.

Several years have prompted securities salespeople to promote the notion of – “safe-ness” – in their practices.  Safe is being sold with the caveat that big is better. Case in point, of all the analysts covering the largest U.S. companies

(according to Zack’s), 67% advise a STRONG BUY/BUY, 30% advise a HOLD and 4% a SELL.  It is notable that those professing a belief in the superiority of cash-laden mega companies vis-à-vis alternatives represent such a large portion. Compliments of Mssrs. Ebbers, Fastow, Sullivan et al., the herd has moved to perceived safety.  That, in our opinion, opens up vast territory of “un-promoted” investment amidst improving economic numbers.  “The market rarely accommodates the majority.”

Several years have prompted securities salespeople to promote the notion of – “safe-ness” – in their practices.  Safe is being sold with the caveat that big is better. Case in point, of all the analysts covering the largest U.S. companies (according to Zack’s), 67% advise a STRONG BUY/BUY, 30% advise a HOLD and 4% a SELL.  It is notable that those professing a belief in the superiority of cash-laden mega companies vis-à-vis alternatives represent such a large portion. Compliments of Mssrs. Ebbers, Fastow, Sullivan et al., the herd has moved to perceived safety.  That, in our opinion, opens up vast territory of “un-promoted” investment amidst improving economic numbers.  “The market rarely accommodates the majority.” [3]

Let the Data Do the Talking

Question #1: With oil prices holding the world ‘over a barrel’, why haven’t alternative energy forms taken hold?

It’s not (yet) cost effective. “Using coal, the most common source of electricity in the US today, consumes around four times more energy as the resulting hydrogen can produce.” [5]

Question #2: Does Europe still have anything to offer?  Germany’s unemployment checks in ~ 10% with percentages four times that figure in Eastern Europe.

Consider: Europe’s Research & Development [R&D] (read: the future) shows remarkable strength. Although General Electric’s market capitalization is over five times the size of, say, Siemens, Siemens spending on R&D last year was over three times that of GE’s. In defense and aerospace, the UK’s BAE Systems is roughly one-fifth the size of, say, United Technologies.  Yet BAE’s R&D spending is approximately 3 times that of United Technologies spending on R&D.

Question #3: Are the health care expense and pension woes a real threat to U.S. companies’ balance sheets?

Consider:  These costs can have a profound impact; particularly at larger U.S. companies.  For instance, at Honda Motors “each car costs the company $107 in pension and health care costs. But at GM, the cost is $1,360. You can imagine

what the cost is for Chinese manufacturers.”

In 1964, Republicans were reduced to a minority of 140 as against 295 Democrats.  “There was nowhere to go but up” the Hoover Institute wrote. In 2004, Democrats were reduced to a minority of 203 as against 232 Republicans

To carry recollection a step forward, only four years later Strom Thurmond changes affiliation and moves from the Democratic to the Republican party. In 2004, leading Republicans led by Specter have already begun the move towards the Democratic ideology.

Ten years after reigning as House Minority leader, Gerald Ford found himself in the White House following Watergate.  The important point to drive home is: we ARE NOT necessarily inferring that the Pelosi administration will occupy in the White House in 2014.  What we ARE inferring is: when levels fall to statistically remarkable levels a re-balancing may be in the cards.

We will watch for any significant movement among politicians to fill the vacuum of this majority gap and more importantly the type of platform purported by such potential move.  Washington IS power and if and when power begins to change, we believe, opportunity for investors will present itself.


Our point for spouting off such seemingly unrelated data is: It is not outlandish should most Arlington Hall Research readers find they were unaware of this data – this makes sense as there has been little media attention on these data points.  Due to this lack of media attention, those readers who DID know one or more of the points mentioned above probably found this information through unconventional sources (trade journals, inside communication, etc.). In our opinion, if pertinent information such as that found above is unknown to most investors, surprises may be likely.  If surprises are likely, it is important for investors to resist the temptation to PREDICT outcomes and instead try to PREDICT THE PROBABILITIES. Even geniuses understand this approach.  For when referring to Heisenberg’s Uncertainty Principle, Einstein’s biographer suggested “all that physicists could hope to predict are probabilities that it will behave in certain ways.” [7]

Question #3: Are the health care expense and pension woes a real threat to U.S. companies’ balance sheets?

Consider:  These costs can have a profound impact; particularly at larger U.S. companies.  For instance, at Honda Motors “each car costs the company $107 in pension and health care costs. But at GM, the cost is $1,360. You can imagine what the cost is for Chinese manufacturers.” [7] The per-person cost of health care in the United States has risen to $5,440, which is double the amount spent in European countries.

Our point for spouting off such seemingly unrelated data is: It is not outlandish should most Arlington Hall Research readers find they were unaware of this data – this makes sense as there has been little media attention on these data points.  Due to this lack of media attention, those readers who DID know one or more of the points mentioned above probably found this information through unconventional sources (trade journals, inside communication, etc.). In our opinion, if pertinent information such as that found above is unknown to most investors, surprises may be likely.  If surprises are likely, it is important for investors to resist the temptation to PREDICT outcomes and instead try to PREDICT THE PROBABILITIES. Even geniuses understand this approach.  For when referring to Heisenberg’s Uncertainty Principle, Einstein’s biographer suggested “all that physicists could hope to predict are probabilities that it will behave in certain ways.”  [8]


 The Jeweler’s Eye

Recent economic-related topics that you WILL find covered in-depth at media outlets include: the U.S. budget deficit, Social Security reform, the trade deficit with Asia, U.S. dollar strength, etc.  One item that has appeared to escape attention is a seed that was planted the morning after George Bush declared electoral victory and ushered in his second Presidential administration.  We acknowledge that its consequences are longer-range and not fit for consumption of a media aimed at an audience which revolves on an instant gratification axis. Nevertheless, the situation is remarkable and a severe dichotomy exists in the world’s most powerful city – Washington D.C.  Let’s turn back the clock forty years.


2004 Democratic House Minority Leader = 1964 Republican House Minority Leader

In 1964, Republicans were reduced to a minority of 140 as against 295 Democrats.  “There was nowhere to go but up” the Hoover Institute wrote. In 2004, Democrats were reduced to a minority of 203 as against 232 Republicans


To carry recollection a step forward, only four years later Strom Thurmond changes affiliation and moves from the Democratic to the Republican party. In 2004, leading Republicans led by Specter have already begun the move towards the Democratic ideology.

Ten years after reigning as House Minority leader, Gerald Ford found himself in the White House following Watergate.  The important point to drive home is: we ARE NOT necessarily inferring that the Pelosi administration will occupy in the White House in 2014.  What we ARE inferring is: when levels fall to statistically remarkable levels a re-balancing may be in the cards.

We will watch for any significant movement among politicians to fill the vacuum of this majority gap and more importantly the type of platform purported by such potential move. Washington IS power and if and when power begins to change, we believe, opportunity for investors will present itself.



1. R. Long interview with R. Arnold
2. P. Farrell,, “Zombies”, Sept. 10, 2004
3.  Analyst Recommendations for: GE XOM MSFT PFE C WMT AIG BAC JNJ IBM, Zack’s Investment Research Inc., Jan. 11, 2005, 1:00PM EST
4. M. Hulbert,, “The dog that did not bark”, Nov. 11, 2004 
5. P. Norton, “Breakthrough in Hydrogen Production for Fuel Cells”, Nov. 29, 2004
6. MIT Technology review; R&D Scorecard 2004, Dec. 2004
7.  B. Bonner, Daily Reckoning, Sept. 23, 2004
8. .B. Bonner, March 1967 in Einstein: the man and his achievements edited by G.J. Whitrow 


I Made All My Money Selling Too Soon

120-second Summary:

J.P. Morgan’s observation remains as insightful at the beginning of Anno Domini 2004, as the day he uttered that sentence.  Rewards have been heaped upon speculators in the last quarter of 2003. Stocks tripped through sell limit levels with regularity not seen since 1999. Some believe a phase of market consolidation will materialize where a trading strategy will best a buy and hold strategy. Our work tends to support this approach, ceteris paribus.

The attention given to market sentiment indicators has grown to levels unlike any we can recall. Wall Street soothsayers read tea leaves on no less than three different dimensions of market action; a bet on a bet on a bet, as it was. This work refers to one analysis made at the price level (e.g. the S&P 500), one at the option level (e.g. the Chicago Board of Exchange) and one at the sentiment level (e.g. the OEX sentiment level). What one finds is that “analysis of an analysis of an analysis” creates a “new math” that makes less relevant comparison to past analysis of market performance. A phenomenon was explored in 1927 when physicist Heisenberg turned the science community on his head when he proposed his uncertainty principle. He contended that “the more precise the measurement of one position, the more imprecise the measurement of another, and vice versa” (The American Institute of Physics, 2004). In terms of investment management, this concept translates to ‘the more precise the measurement of a stock price’s independent variable, the more imprecise the measurement of the stock price (dependent variable).’

Applying this notion to the stock market can lead one to build a case for potential investment returns possibly residing in more risky stocks which have already experienced significant price appreciation. “While the market may be overvalued from a fundamental standpoint, sentiment indicators as a whole are not showing that the market is overvalued” Schaeffer opines. “Short interest on Nasdaq stocks growing by 3.3 percent in December is not indicative of an overvalued market.”

Let the Data Do the Talking

Biderman fingered three sources of fuel for rising stocks prices in 2003.

Hedge funds funneled “about $200 billion into equities.”

Pension funds funneled “roughly $100 billion into stocks since the end of March.”

Individuals poured “about $130 billion into U.S. equity funds since the end of March.”

The first two are spent and the individual investor is the left to support funding of equities, according to Biderman.

Tax law plays a role. Capital equipment purchases, for instance, spurred by a complete write off of the first $100,000 may have pulled 2005 spending into 2004, according to Contrary Investor. This tax legislation will sunset in December of this year.

Liabilities continue to mount:
Existing Home Price: Avg. Family Income (last record 305% early 1980s)
Annual growth rate of Pension Liabilities at S&P 500 cos. (per Newman)
Total Debt per man, woman and rug rat in America ($34 trillion total)
Price fluctuation could be driven by shifts, perhaps significant, in investor sentiment.

One would expect sentiment to shift as various market imbalances slow or reverse course. Contrary Investor suggests these imbalances include foreigners’ purchases of dollar denominated assets, excess global liquidity and dollar devaluation.

Do not forget increased program trading has led to increased volatility in the past and program trading is increasing at roughly 35% per year. Program trading “will overtake all other trading by March 2005,” according to Newman’s calculations.

Who’s going to Tell You to Get Out?

Though less probable than the scenarios noted above, the biggest surprise which could occur in the first half of 2004 would be for the market to move lower in the first half of the year, according to Katz. Indeed, this possible scenario existed in early 2003 as well. When an imbalance of this sort occurred in the past, we enjoyed wide positive out-performance of the indices. To be sure, trillions of dollars of investor assets vanished under the tutelage of Wall Street strategists.

Newman reports that Bearish strategist advice outnumbered Bullish strategist advice only 9 weeks out of the 190 weeks since the Bear market began in December 2000.

The Jeweler’s Eye

Inflation: A Debtor’s Best Friend

Wiggins reminds us that debtors do indeed have friends. As the indebtedness of the United States escalates, one can surmise the question is not “If inflation will rear its head?” but “When will it rear its head?” One could base this comment based of a self-serving need.

Over the past three years in these pages, we have drawn out possible paths for stocks and bonds in the event of a collapse of economic growth in the United States. As a supporting corollary to that work, we propose that in the event the Federal Reserve’s loose rate policy is able to continue to fan the embers of economic growth inflation may become an obstacle to stock price appreciation.

In order to “size up” the current level of indebtedness in hopes of making a case for inflation’s value to the United States’ policy, we turn to Hazlitt’s work in the area.  Hazlitt stated that “It is true, no doubt, that an artificial reduction in the interest rate encourages increased borrowing.” Bonner illustrates current debt trends

In the 1960s, Americans borrowed $1 for every $3 of extra income they earned.
In the 1980s, they were up to borrowing $1.50 for every $3 in new income.
In the 1990s, they borrowed $4 for every $3 in new income.
By October 2003, they borrowed $9 for every $3 in new income,
Richebächer notes.

Historical stock price performance demonstrates that inflation is no friend of bull markets. As such, one should carefully monitor price reports over the coming year in order to discern the extent to which inflation may be used to offset the country’s debt burden.

The Maestro

“I am not the world’s greatest conductor…I am just the only good one.”

Toscanini is supposed to have said.  He was an energetic master of the baton, always in command and an absolute perfectionist.  Slonimsky wrote Toscanini’s ability to communicate with his players and singers was extraordinary and he was affectionately known to them as: “The Maestro.”

It is in the spirit of Toscanini that investors will profit in the coming year. It has taken a Maestro’s verve to excel in order to win in a world of investments where losing money means making money, where one is rewarded for consuming and penalized for saving. Toscanini’s energy is required to profit in a market where risky investments are safe and safe investments are risky. This environment is not necessarily a good or bad one but it does mean profitable investing will be made more treacherous as a result. As an example, Caterpillar recently traded to a 52-week high in spite of the fact that the company’s latest report indicated it has more debt, less profit, less return on equity, less sales as a percent of stock price and the highest price-to-earnings ratio as at any time in the past eleven years.

Toscanini’s penchant for perfection however would be tested with broad market strategies; as there is little in the way of logic and reason by which a perfectionist feeds. Consider that insiders are selling shares as fast as at any time since 1987. Biderman paints the bearish liquidity picture by highlighting a ‘lack of corporate buying and a ton of new offerings.’ Financial sector debt now exceeds $10 trillion, Daughty charges. But it was less than $2 trillion in 1987.

Stansberry illustrates the glacial shift from U.S. homeowners to home-renters:

“…before 1997, around $50 billion a quarter was being borrowed against homes.
Today the run rate is near $200 billion per quarter, or four times more.”

With excellent insight, Newman sliced to the core of the question of why jump-starting the U.S. economy has proved so god awful difficult.

“In 1997, the economy was able to generate a dollar of GDP with less than $3 of private borrowing. Today it takes about $5 of borrowing to generate that same dollar in GDP. And tomorrow? As long as rates remain low, perhaps there’s a chance we continue to muddle through…”

Davis remarked we’ve got this $32 trillion debt bubble out there, and it is as risky as can be. And, yet, rates are plunging, so everything looks manageable. It is true that half of all outstanding mortgages were refinanced in the last 18 months. It is also true we’ve had 2.4 million bankruptcies filed since the economy started up in the fourth quarter of 2001. But, with rates down at these levels, we are managing.

Alas, the Great Toscanini surely must have managed to deliver fine performances amidst less than perfect circumstances; we too will continue to forage among the most profitable pockets in a chaotic economy and seek to continue to deliver a fine performance in the spirit of a “The Maestro.”

Let the Data Do the Talking

Our most current research indicates:

Unless the NYSE’s value falls roughly 5.8% from current levels (using the value on September 15, 2003), the probability of a significant market pullback in the near-term is low, ceteris paribus.

While it is true that there is a better than 1-to-1 probability that the Nasdaq Composite may be poised to give up some ground in the near-term (written in late September 2003), the S&P 500 model provides no signal at present.

To be clear, the formation recorded for the Nasdaq Composite doesn’t always occur at tops, but, when it does, it helps build our confidence in the reliability of the signal, to paraphrase Swerlin. More specifically, heavy shorting of stocks listed on the Nasdaq could prevent said sell-off from materializing.

This data is comforting, to be sure. Nevertheless, the “warning flags” mentioned in our July issue remains. As a conspicuous example:

Comments on Recent Portfolio Management:

With some holdings having been on the books for well over 12 months, we were delighted with the timing of our decision to offload massive treasury debt.  In hindsight, we missed the top of the treasury market by only 10 days – selling May 30 with a market peaking June 13!

We continue to monitor the risk in our portfolios vis-à-vis the broad market.  For instance, on a day when the U.S. market was down ~1.35%, seven of the top twelve positions in all portfolios, we hold, were positive for the day. (Data day: June 23, 2003)

The Jeweler’s Eye

“A penny to spend and a dime for the bank”

John D. Rockefeller famously advised youngsters with this savings ratio. Times change and today’s investor must plot a course for profitability amidst a U.S. Consumer, particularly young consumers, employing the near opposite approach of that of Rockefeller’s.

Bonner calls the American Consumer “the world’s mouth.”

A most conspicuous violator of Messer. Rockefeller’s proposed savings ratio is Generation Y. A study conducted by Harris Interactive suggests that today’s Generation Y (consumers aged 8 to 21) credo would read:

‘A penny to save and a nickel to spend’

If the $211 billion that Generation Y will earn in 2003 would be allocated according to Rockefeller’s advice, the proportion could be graphically represented as follows:

Instead, based on the results of a nationwide survey, this group’s spending and savings will be apportioned as:

According to a NACS report of September 5, 2003, “the study results indicate that youth income is down over the past year, but spending is up.”  ‘This shows that this age group has been willing to forgo savings in order to keep their spending levels consistent,’ said John Geraci, vice president of youth research at Harris Interactive. ‘It is a very optimistic generation, and they demonstrate a great deal of confidence that the economic rebound is around the corner and that good times are ahead for them.’

The question then becomes: What companies stand to benefit from this ‘very optimistic generation’? In one of the more surprising data points contained in the report, only 15% of Generation Y consumers buy online. So ‘playing the internet angle’ is perhaps no more profitable as with adult consumers.

Our research indicates Generation Y spending materializes in electronics/games, retail clothing and entertainment; mostly made in Asia.

A curious and indirect link for investors to gauge the fuel supplying Generation Y’s spending power is: their parents’ financial welfare. For the same report shows “A majority (87 percent) of income for children under age 13 years is parent supplied – either through allowances, asking parents for money, or through money earned from special chores or household work. In contrast, 37 percent of teens’ income and 7 percent of young adults’ income is parent-supplied.
Not surprisingly, teens and young adults rely predominantly on paid jobs for their income.” (per NACS, September 5, 2003)

As explained in the opening section of this report, resistance remains on the path to paying off high liabilities. Yet, these parents have managed to muddle though as of the writing of this bulletin.

At this point, we would like to identify the “sweet spot” for the investor as regards this societal urge for high consumption – parents’ desire to continue to fund the high consumption of their children and their own, for that matter.

As parents intend to fund this spending they will increasingly lean on income from asset backed securities and firms selling income generating investments. Closed end debt and preferred stock represents the former while the latter is served by mortgage investment firms which allow parents to tap into the equity of their residences.

If you permit us to step back from our normally quantitative backed commentary, we have a suspicion that more of these creditors stand to be pushed to the limit and will adjust their financial planning in order to avoid falling through the cracks into the realm of bankruptcy. The behavior we speak of is akin to that of Jimmy Stewart’s character in the Christmas classic “It’s A Wonderful Life.” Moviegoers will recall that his character attempts to use cash value of his insurance policy to cover his financial shortcomings.

Today’s behavior includes tapping out home equity and funding high levels of insurance in lieu of disciplined traditional periodic investment plans.

Case in point, a Congressional Research Service analysis of Census Bureau data in 2001 found:

“50%+ of employees aged 25 to 64 don’t own retirement savings accounts of any kind.”

History tells us markets may extricate excessive debt in one of several methods. Whichever method is utilized, the fact remains the debt will be extricated at some point. Drawing comparison to the Savings and Loan debacle, we have constructed a proposed tracking schedule by which investors could follow a plausible exit for the U.S. economy from a debt laden consumer base.

see the dot.Mom bubble, November 10, 2001

Whatever the final outcome, the U.S. economy eagerly awaits the time when those facing crushing debt and possible bankruptcy can enjoy a ‘Wonderful Life’ and fund spending from current assets rather than future liabilities.

Until that time manifests itself, we have added a good number of insurance companies and quasi-insurance firms to our portfolio mix.

The Right Track

120 Second Summary

Will Rogers

“Even if you are on the right track, you’ll get run over if you just sit there.”  – Will Rogers

This advice offered by the always witty Will Rogers reminds us that even if one’s portfolio returns best over 98% of money managers in the world, occasionally, bear markets visit the stark reality of statistical theorems upon you. Accordingly, we have adjusted a few positions in order to set up on what we believe may be the “next” right track.

Let it be said, no investment strategy was ever met with greater investor skepticism than ours to massively deploy funds into treasuries, strips and treasury market funds over the past 18 to 24 months.  Perhaps someday, researchers will derive theorems highlighting how controversial strategies lead to future profit as the potential upside identified by our work was, largely, realized. We were on the “right track.”

Though we still believe this approach will continue to garner fruits of profit, one must pause to remark upon the breathtaking speed at which hostilities concluded in Iraq plus [what appears to be] an upcoming $350 billion federal stimulus to the U.S. economy.  This combined stimulus may represent additional profit potential for investors and we have considered increasing asset backed income securities and selecting diversification abroad though we still avoid a number of U.S. blue chips whose sales continue to descend faster than their stock prices. It will be at another time and place, where the question will be answered: ‘How will the United States Treasury rebound from significant tax cuts sans coincidental spending cuts?’ [1]

Burke offers considerable data to assist in beginning to address this rather complex and unique question (tax cuts sans spending cuts). He submits two possible paths for the market to travel in order for stocks to re-visit attractive valuations relative to fundamental data. His research leans on evidence from the “nowhere” trading range of 1968­1982 and the plummet of 1929-1934. [2]

The biggest dilemma we face is: discovering which of these two paths best matches that which the market will travel in the coming years.  At this time, the data produces statistically insignificant results – viz. you cannot prove returns may outweigh risks. Therefore, we move with caution and construct investment strategies to (1) avoid the perils of EITHER of these two scenarios while (2) striving to outperform market indexes in the process.  In a word, we will determine if we are on the right track.  If we are not, we may find the ‘new’ right track may be our old favorite track. Recall, the trend is your friend until it isn’t.

Let the Data Do the Talking

In April 2003, the S&P 500 posted gains not seen since 1982 and the index posted an impressive increase for the quarter amidst the bear market.  Consequently our relative preference for capital preservation led to our relative quarterly performance slipping vis-à-vis the lofty spread posted in the first quarter. Notwithstanding, we are pleased to report we have maintained relative out-performance in most managed account portfolios over the entire period since we began measuring individual portfolio quarterly performance.

Conservative guidance protected a significant amount of capital vis-à-vis the major market averages for quite some time.  Then, on March 12, 2003, our model registered a signal commensurate with the signal registered on the short-term market bottoms seen in July 2002 and October 2002. We began to redeploy some assets over the quarter.  However, as the signals in July and October 2002 begat rallies which later fizzled coupled with other red flags still waving in the market winds (e.g. over-levered consumers), we opted to measure, not over-allocate, our exposure to market risk as projected market return scenarios remain fraught with significant macroeconomic challenges; some not seen in seventy years (e.g. a geo­synchronous economic downturn).

We are inclined to believe the legal woes permeating the mutual fund industry coupled with the inability of many high net worth investors to diversify, at the best, prevent significant market upside and, at the worst, represent future investor casualties.  A change in these phenomena would be cause for re-evaluation of investment strategies.

More specifically with regard to diversification, an autopsy is performed to address the question: Just how did the median stock market investor lose so much money since 2000?  We think clues were in the data.  Consider:

(a) Individuals hold a disproportionate amount of their retirement plans in the company stock of their employer.[3]

(b) Investors are prone to investing in familiar stocks and ignore portfolio diversification. [4]

The mean U.S. household holds only 4.3 stocks: [valued at $47,334]

The median U.S. household holds only 2.61 stocks: [valued at $16,210]3

[It is commonly accepted that market risk cannot be reduced without at least 10 – 12 stocks.]

Nearly 50% of High-Net Worth Investors cannot diversify into the stock market.  Note, private equity capital was worth more than public equity in the United States as late as 1995 [notice?] and is still of the same order of magnitude today [5]. In addition, “over 45 percent of the net worth of investors with private businesses consists of private equity.  Of this more than 70 percent is concentrated in a single firm.” [6]

Why you may ask is the private business owner important to the public equity markets? Answer: Investors in private businesses hold over 12 percent of the total public equity in the United States.[7]

As fundamental recovery fails to materialize and over $3 trillion in investor assets have been lost while in the custody of mutual funds, the fuel for a new secular bull market remains unidentified. Like an aging magician who cannot perform tricks of old, the Federal Reserve’s 13 attempts at monetary stimulus have come up dry.  Thus, all eyes direct their attention on fiscal stimulus (as noted above).  Maybe $350 Billion can pull the rabbit out of the hat. 

The Jeweler’s Eye

What often occurs is exactly the opposite of what everyone is awaiting or outright expecting. Our work persuades us to believe the battle lines are becoming more pronounced while both “sides” are growing impatient – the bulls grow more bullish and the bears more bearish. For instance, a recent study implies bullishness by correlating bullish days on the market with sunny weather. [9] Using corporate insider activity and sentiment as variables, the editor of Investor’s Intelligence called for a falling market with lows in ‘May or July’ of this year. As most focus on the battle in the U.S. between the bulls and the bears, we scan the horizon for investment opportunities.

We watch the trend of increasing layoffs of high salaried Americans af the first world [10] is the Asianaztion of the first, second and third worlds.

and they are going to the University.

Given the geo-political climate in Asia at the moment, fear rules the day. Nevertheless, the aforementioned charts should open investor’s minds to the potential such trends represent.

A Shortage of Geeks and Nerds on Campus

Engineering graduates are growing scarcer in U.S. Universities. 

and those that are graduating are more likely to be foreign students.

they are increasingly planning to stay in the U.S.

The shift of engineering from the U.S. to foreign countries reinforces the notion of the proliferation of the service economy in the U.S. vis-à-vis that of a manufacturing economy.

and the shift also reinforces topical interests deemed important to U.S. residents.

The Nantucket Sleigh Ride

Executive Summary:
19th century whalers became familiar with the spine-chilling experience of a “Nantucket Sleigh Ride,” a term used to describe a wild ride which harpooned whales would take sailors.  Typically the ‘ride’ would reach speeds of 35 miles per hour and take 4 to 12 hours; The sailors’ survival depended largely on the quick reflexes of the Boatsteerer who continuously poured water over the harpoon’s rope to prevent the wood from burning and stood by with an axe to cut the line if the whale decided to dive into the ocean’s depths.

After a stint in the gyrating investment markets of 2001 and 2002, investors can surely empathize with the ‘spine chilling experience’ of those sailors on their Nantucket Sleigh Rides. A crude parallel exists between the boatsteerers’ skill and the value of lightning reflexes required in a stock market with three times the volatility of any previous market and enough background obstacles to fill an ocean.

A titanic struggle plays out between those who believe the whale will cease its wild excursion (bulls) and those believing the sailors will be pulled into the icy depths (bears). We contend each ‘side’ has enough potential firepower to lead to a ‘ride’ of perhaps extraordinary duration.

Find commentary on our recent views, research and trading in
Winning with a Smörgasbord of Systems.

Commentary on topics in prior issues can be found in:

Update: A Not-So-Demanding Economy
Update: Base Instincts
Update: dot.Mom bubble Under the Microscope
Update: It’s a Long Way to Timere and
Update: Small Wonders: End of a Love Affair?

Other entries include Give Me Liberty or Give Me Breadth!
Keeping the Credit Respirator On Just a Little Longer and
Why IT Failed.

Since last issue, one of the two important ingredient for a market rebound have
turned bullish – buybacks. The other – cash takeovers – has not yet turned. Read:
Buybacks Beginning? and
Return of Takeovers and the LBOs?

We scout the market for clues of a market rebound in:
The Bond Holder Becomes the New Share Holder
To Bottom or Not to Bottom
Dipping Into Treasuries
The Great Search for Cash and
Capitulation are You Out There?

Inflation gets a look in:
Will Inflation Return?
Analysis of falling markets can be found in:
How Long Does a Bear Linger? and
Volatility: Yelling “Fire!” in the Back of a Theater.

The aftermath of corporate criminal prosecution is addressed in:
Hurricane Warning: Corporate Crime Collateral Damage.

The market may feel the effects of Consumer Income, Pension Plan Re-balancing
and/or Real Estate Inflation. They are respectively covered in:
All Eyes on the Right Jolly Old Elf
Will Pension Plans Dive In Again? and
Resting on Real Estate Inflation.

Foreigners’ impact is addressed in:
Will Foreigners Continue to Fund Americans’ Dreams?

Market sector items falls into:
Bill Gates: Bullish on Technology, Bearish on Microsoft
How a Business Takes Out a Loan
Biotech is in Triage and
Yesterday’s Education Leaders Pass the Baton.

It is a natural instinct to shrink from the unknown. So we turn to the great minds of
yesterday with hopes of charting a path for identifying profitable investment
themes in:
Reading the Tea Leaves: A Perspective.

There are a few angles we used to outperform indexes in our clients’ accounts.

Will Airport Security Workers Rescue this Economy?

We look for fresh territory in:
The Rise and Decline of the Buy-and-Hold Investor
Commodities Call
Setting Tripwires for a Market Rebound
Strengthening Our Data Analysis
The Frustrating Business of Domestic Security and
A Glacial Shift: Profit From Opinions Not Just Data.

We find a number of intriguing economic data in:
Greenspan? Watch Out For McDonough
Hey Buddy, Can You Spare a Dime?
Oil Still Matters
Land(s) of the Free and
Questionable Forecasts.

Other market commentary is detailed in:
Profits in the Land of the Rising Sun
Colleges: A Culprit in the dot.Mom bubble Conspiracy?
September to September
To the Victor the Spoils
The Expanding Beltline of State Governments
Flat Chips
Expecting No End of Mideast Violence for the Near Term
We Don’t Care What Coca-Cola is Doing!
Empowering a Commander-in-Chief
Cleaning Up in Japan
Does Conventional Wisdom Matter Anymore?
Indonesia’s Importance
Rating the Movies and
Nursing Home Care 101.

Finally, we update new services and service features in:
Automatic Statement Bundling Launches
White Glove Service
Winning in a Losing Market and
Aiming to Better Serve You Through the Internet.

– The Editors

Since The Last Time We Spoke:

Winning with a Smörgasbord of Systems

We are asked to give reasons why we maintain such conservative investment allocations. The answer is two-fold: (1) it’s working and (2) the pervasive lack of empirical grizzle supporting optimistic projections which we fear more than rattlesnakes and balanced budgets.

If you believe a market sell-off would have adjusted investor’s expectations to a lower level, 14 minutes after the Dow had registered a 390 point fall breaking through its 9/11 floor, the headline hit the wire:

4:14PM, 7/19/02 “Repositioning for a market upswing”–Deborah Adamson
Repositioning for what? Consider actual data from last quarter (SPX=918.84):
Price/ Earnings = Price/Earnings ratio
918.84/24.70 = 37.2

Perry states “You do not make money by being right. You make money by knowing when to run away.” Indeed it was that apologist of the utopian potential of the state, John Maynard Keynes who cautioned “markets can remain irrational longer than you can remain solvent.”

Our recent ability to outpace the market indexes, which incorporated an unprecedented high level of conservative investment allocations, can be attributed to the simultaneous use of a smörgasbord of at least 7 (and up to 12) different screens for securities. Indeed a study from last year concludes that ‘even simple methods of combining [screens] could produce a better overall system than either one alone’ [technology & trading, December 2001].

Schaeffer contends:

“Speaking of a “contrarian’s delight,” I recently reviewed the mid-year forecasts from Barron’s and Business Week. And from the sheer sanguineness of each of these prognostication compendiums, it is safe to report to you that the capitulation phase of the bear market remains well out of reach. Business Week tells us that it “sees stocks ending the year up in the single digits – perhaps around 2%.” Assuming by “stocks” BW means “the S&P,” this would place this index at about 1170 by year-end, or about 18 percent above current levels. And Barron’s reports that “more than a few of our distinguished (Roundtable) crowd now believe the market is setting up for a rally, one that could lift the busted techs and telecoms, maybe the drugs, and certainly the Nasdaq, by more than 30%.”
As for me, I’m sticking with my forecast in last December’s Business Week Market Survey of 925 for the S&P at yearend 2002. But there’s no guarantee at all that this will be the low for the year.”

Update: Small Wonders: End of a Love Affair?

Small caps start to feel the bear market. Bidermann reports:
“[June 17, 2002] Small cap has stopped getting new money. The small cap value funds we track with $12 billion in assets had net redemptions of $83 billion over the past fortnight.”

Update: dot.Mom bubble Under the Microscope


According to Fed Funds Flow:

“During the first quarter of 2002, total credit market debt grew as follows:

Contrary Investor remarks:

“Just a few tidbits before we get to the household and corporate sectors. This is the first time in many a moon that the Federal debt has been in a more than benign expansion mode. Chances are this accelerates possibly significantly ahead. From a purely longer term macro standpoint, periods where government borrowing and spending has been in a significantly expansionary mode have been periods where common equity P/E multiples have not. We’re in the early innings of government deficit spending for this cycle. Our second comment is that domestic financial sector debt has been in a meaningful expansionary mode for more than a decade now. The consistency of financial sector credit expansion has been such that most investors are now numb to the recurring double digit characterization of growth. Much as the mainstream became numb to equity valuation levels just 24 short months ago. The good news for now being that the numbness in terms of equity valuation has worn off. The bad news being that shock has now begun to set in.”

They continue:

“The consumer simply cannot continue to outspend and out borrow GDP growth rates indefinitely. A GDP which owes a good chunk of its prior decade growth not only to consumer spending, but importantly to corporate capital spending. As you may remember, just a few short years ago virtually no one in the mainstream consensus anticipated an implosion in corporate capital spending that was literally right around the corner, despite the fact that anecdotal evidence was in abundance. Does that same experience now hold true for consumer spending?”

Update: It’s A Long Way To Timere

On the morning after the Dow Jones Industrial Average slid 390 points [Saturday July 20, 2002], of the 40 largest news services in North America, only five elected to carry the Dow’s descent to a “4-year low” as a headline.  Based on the reasoning found in these pages over the course of the past year, we tend to be persuaded that more than 12% (5 out of 40) of the news services will need to ‘headline’ an evacuation of the market before a longer term market bottom is in place. [Note: of the 5 headlines ‘headlining’ the Dow’s fall, three headlines reported the fall in a conventional manner, one predicted sunnier days (viz. “Stock sliding but sales aren’t”) and one was a Canadian news service.]

With regard to sentiment among investment advisors:

Per Jeff Cooper of (July 17, 2002),
“In 1994, there were 45 weeks in which bears outnumbered bulls among investment advisors. This year [2002], we have yet to see a single week in which bears outnumber bulls.” In fact, based on the readings of late, a case could be made that advisors are closer to “euphoric” than anything else. In addition to all the talk of a bottom being at hand, this continued optimism pervades nearly all public comments by market pundits.”

Sparks reminds us (July 19, 2002):

“Optimism is most destructive in a market that is already technically weak. A good example of this phenomenon occurs at an auction. If you see something you like at an auction, you can help bid up the price until you don’t have any more cash. When everyone exhausts all their available cash, the price stops rising. The same type of thing happened in 1993 when market strategists allocated an excessively large amount of their portfolios to stocks. According to Merrill Lynch Quantitative Analysis, the average percentage of available funds that strategists were allocating to stocks in September 1993 was 62%. Even though this may seem like a long way from 100%, it is still a high number. With such a large amount of assets allocated to stocks, the potential buying strength was minimal.”

Give Me Liberty or Give Me Breadth!

Lane observes:

“The recent drop in stocks, he said, differs from the panic sell-off last September. In trading immediately after the attacks on the United States, stocks tumbled to three-year lows, but after a week of heavy selling, the breadth improved.

“Institutions on the buy side (like mutual funds) are not showing any confidence or conviction,” Lane said. “Last September, we saw big surges in gainers versus decliners, we saw institutions step back into the market. Now, you are not seeing anyone step up with confidence or conviction.”

Keeping the Credit Respirator On Just a Little Longer

Marketwatch recently reported:

“A federal judge stopped the implementation of a law that would have required the nation’s largest bankers to include credit card “warnings” in monthly customer statements. The ruling, by U.S. District Judge Frank C. Damrell in Sacramento, comes three days before the law was set to go into effect. Damrell said both sides needed time to research whether the law would be too financially burdensome on banks.

The new law would have required the companies to send the warnings only to customers who make just the minimum payment for six months in a row.  Credit card companies that have monthly payments of 10 percent or more of the entire balance are exempt. Howard N. Cayne, an attorney for the Washington D.C.-based firm representing the banks, said that because adding the warnings would be costly, banks would have no other choice than to increase their minimum monthly payments. States are not allowed to pass laws that interfere with monthly payment schedules or interest.

“National bank powers trump the state law,” Douglas Jordan, senior counsel for the U.S. Comptroller of the Currency, told the judge.  He ordered both sides to research the issue and told the bankers to perform a cost-benefit analysis to prove the warnings would be burdensome. Both parties will turn in their reports in October and the case will be reheard on Nov. 8.”

Resting On Real Estate Inflation

Contrary Investor finds (July 15, 2002): “It is our humble observation that consumer behavior over the last half decade at least has been very dependent on having at least one meaningful household asset inflate. Common equity did the trick in the late 1990’s, but it now seems that household confidence rests largely on real estate inflation.”

They prepared a table as follows:

The Rise and Decline of the Buy and Hold Investor
Increasingly, we find our research chock full of data which support a trading strategy vis-à-vis a ‘buy-and-hold’ strategy. It is an understatement to say the investment markets have seen good times and bad as of late and thereby now contain datum expected in both raging bull markets and bear markets.

We contend the buy-and-hold investment strategy has an ‘American appeal.’ That is to say, it possesses those attributes which are, to be sure, American.

Easy to understand
(even) Patriotic

Indeed, the impact of the plentiful fruits bestowed upon ‘buy-and-holders’ in the second half of the 1990’s is so profound that there are investors who, we contend, will not be persuaded to adopted another investment strategy in this life, regardless of the data presented.

Nevertheless, it is incumbent on us, in an advisory role, to demonstrate that data.

The work we cite is that reported by Ruggiero (April 2002):

“During the period, the S&P 500 made 450.25 points in 14.82 years. Our rules [based on COT reports published at the CBOE] were in the market only 35.44% of the time and our results were as follows: number of trades- 18 and win percentage- 88.89%.”

“Being in the market about 35% of the time with this simple system produced 178% of a buy-and-hold return.”

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