...we're always in pursuit of the investments, sectors and regions that are on the move...

August 16, 2010

Dear Clients and Others:

I wanted to make you aware of two things:

First, I will be away from the office from Tuesday 8/17 through the end of the day Wednesday 8/25. I will be in the office first thing on Thursday 8/26. While away I will be checking email and periodically listening to voicemail.

Second, I am implementing the new program that I alluded to in my last email. After much, much investigation and study, I’ve invested in technology that I believe can make money in both down and up markets. I’m very excited about all of this and would like to share with you what I mean by all the above. I offer you the opportunity to view and discuss evert aspect of it, including how to participate. I am capable of conducting a webinar from my computer to yours, as well.

Please let me know.

Darrell Kay

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June 30, 2010

Based on evidence that has always and only been observed during or immediately prior to U.S. recessions, the U.S. economy appears headed into a second leg of an unusually challenging downturn - John Hussman, Hussman Funds, www.hussmanfunds.com, June 28, 2010.

Much has been written recently about whether we may move into a double dip recession in 2011 and whether the bull market will last. My first reaction to all the goings on is that we are in uncharted waters. Normally, coming out of a recession, we witness robust economic growth and a healthy bull market. Further, it is often said that every bull market climbs a wall of worry.
However, there are elements of this recovery that make things seem different, that call into question the usual assumptions about impending events.

It is undeniable that low interest rates, easy money and government spending SHOULD create a favorable environment for the economy and for the stock market. Easy money usually leads to business growth. This favorable environment is the single most cited reason defending the durability of the bull market. Additionally, corporations are considered to be in relatively strong shape financially (although smaller businesses are having difficulty borrowing). It is the non-corporate entities, i.e. people and governments, that are having difficulty.

The other side of the argument cites the following factors as ominous tipping points:

• The recession that just ended last year was not the common "overheated economy" recession. It was driven by so-called asset bubbles. Asset bubbles unwind in different ways and can require more time. Cheap, easy, printed money was a key ingredient in creating these asset bubbles and the U.S. government is currently attempting to employ the same strategy as a cure.
• Government debt is exploding, creating fears of "Greece" like scenarios. Along similar lines, several states are looking at possible bankruptcy  scenarios. This only compounds the problem. See graphics below (courtesy Hedgeye Risk Management).
• Debt liquidation is contracting the economy. Specifically, when people and businesses pay down (or default) on debt, they are not buying goods and services. Private debt is being replaced with government debt. Unfortunately, exploding government sectors cannot effectively replace contracting private sectors.
• The oil spill can eventually create damage in the hundreds of billions of dollars. It has the potential by itself, depending on severity, to provide a tipping point.
• Tax increases are set to take place at the end of the year. Some parties are speculating that increased tax receipts in 2010 are not signs of growth but signs that people and businesses are just accelerating gains from 2011 into 2010.
• Many countries (not the U.S.) are implementing fiscal austerity measures. This is contractive. Economic illness can be catchy.
• Consumer confidence, a key ingredient to economic growth, is tumbling (Wall St Journal, 6/29/2010, "Consumer Confidence Tumbles"). Consumer spending was a huge ingredient in the last recovery - especially in real estate.
• Home prices are not recovering nationally yet.

From everything that I can see and everything I have been able to read, I feel that the chances of a double dip recession in 2011 are likely about 50-50. This may sound wishy-washy but it may also depend on factors that have yet to play out. In other words, the possibility is very real but just not knowable yet. Recessions are generally unkind to the stock market. Also, the markets typically move in advance of economic events.

Finally, even if the recessionary scenarios do not materialize, the stock market upside may be limited. Solid, substantial gains in the market eventually require solid, substantial economic growth. It has to be more than companies making themselves more cost efficient.

Changes in the Works
I have been working hard in pursuit of a strategy/strategies that I feel may be able to make money in both up and down markets. I recently licensed technology that will enable me to pursue such strategies and portfolios. If you are interested in discussing and exploring this program, which is quite different from "buy and hold", please contact me.

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April 20, 2010

The current reality is that a strong rebound in corporate profits (the greatest and truest stimulus of all), ultra-easy money from the Fed, and some small stimuli from government spending are working to generate a stronger-than-expected recovery in a basically free-market economy that is a lot more resilient than ... critics think. Larry Kudlow, A V-Shaped Boom Is Coming", CNBC, Kudlow Report, 4/9/2010

Let's try to sum it up. We have a Muddle Through Economy this year (not much more than 2% overall growth for the year), with a slowing economy next year. Unemployment stays high. If we get our deficits under control, we lock in a slow-growth economy for 5-6 years, but after that we could get back on track. A recession puts that brighter outlook out a little farther. Unemployment would go north of 12%. I might note that the stock market drops an average of 40% during a recession. John Mauldin, "Is This A Recovery?", Frontline Weekly Newsletter, 4/3/2010.

Inflation or deflation? A V-shaped recovery or something indistinguishable from recession? Enough new hiring to reduce unemployment or another jobless recovery? Predicting the future is always a crap shoot, no matter how hard economic modelers try to convince you otherwise. Getting a grasp on the here and now is generally easier. Not this time. Rarely have so many observers looked at the U.S. economy and come to such diametrically opposed conclusions. We’re either entering the Promised Land or staring into an abyss. Carolyn Baum, "How Can We Explain The Bipolar Economy?", Bloomberg.com, 4/20/2010.

In my last newsletter I talked about the current bull market. All bull markets climb a wall of worry and this one is definitely no exception. The above quotes illustrate the differences of opinion that always exist. It is a matter of fact that all the dissenters EVENTUALLY are correct. It is a mistake, as I see it, to dwell on what might or might not happen. The best way to answer the question of whether the market is headed up or down is not to answer it. The correct question is "what is moving today?".

As concerns today's opportunities, small and mid size companies are rallying the most. This is fairly common in new bull markets. Many of you who are long time clients remember that we made good money in small cap funds at the start of the last bull market. For a while we have held good size positions in two excellent such funds:  the William Blair Small Cap and the Fidelity Midcap Value. We are also holding Fidelity OTC which combines technology with small companies. Beyond these, we hold positions in certain strong industry sector funds: Select Industrial Equipment, Select Biotech, Select Medical Delivery and more recently Select Transportation. We may sell Medical Delivery soon since the fund is not sure it still likes the new health bill. We are not using foreign specific funds right now because they are lagging the above. If you are using the moderate or conservative model, you hold a major position in the Loomis Sayles Strategic Bond fund, which has been an all star. Those of you in Fidelity-funds-only accounts are using Total Bond and Small Cap Stock instead of William Blair and Loomis Sayles.

Looking back on the last 24 months, we greatly outperformed the averages and other advisors during the first year, but left money on the table with our one year staged re-entry culminating in March 2010. Overall, the numbers show that we have outperformed for the 24 months; nevertheless, I have changed some of our systems to enable a faster return to 100% invested in the future. In any case, we are unequivocally fully invested today and actively participating in what we believe are superior sectors, funds and market segments.

Please contact me with any questions regarding your allocations or risk profile.

Darrell Kay

[If you would like to print out the newsletter, click on the PDF link on the left sidebar]

February 13, 2010

“…Thus far, [all factors] continue to support the likelihood of further advances in the primary uptrend, albeit possibly after a [likely] near term corrective move.” – Lowry’s Institutional 12/4/09.

Probabilities are not certainties, and allowance for exceptions to the probabilities is always necessary.  But, it is important to keep in mind that...the issue is whether the short term correction may not be quite over yet, or whether it is already over.  In either case, there is little or no evidence at this point, based on our longer term measurements of Supply and Demand, that the market has been rolling over into a bear market. On that basis, clients should still be viewing periods of short term corrections as an opportunity to buy stocks...Lowry's Institutional  2/13/2010

Sharp corrections happen and I hate them. However, all I really care about is whether this bull market is rolling over into a bear market. So far, the evidence doesn't support that. Until there is evidence to the contrary, we will want to remain invested.

There are pessimistic viewpoints, of course. Many of these point to the anemic economic recovery and ominous backdrop of government debt, personal debt and insolvency. There is much in the news that is negative and some of it seems to portend impending doom. I won't argue what the future holds, but will attempt to focus on what the investment world is doing at present. I have many times pointed out that the stock market is tied long term to economic strength and growth while the shorter term is always unpredictable.

I am often asked about inflation. As stated in these newsletters previously, inflation is not occurring presently but it likely exists in our future. Inflation is a two sided coin. One is the supply and abundance of money (think trillions of dollars of fresh money being printed as I write) and the other is demand for goods and services. With the recessionary overhang in the U.S. and globally, the demand for goods is low (think real estate glut, unemployed people and high inventories of goods). Once the global recession ends and demand for goods increases, we will likely see the inflationary effects that so many people are anticipating. We will want to prepare for that in our investment portfolios.