Lions and Tigers and Bears – Oh my!

After raising three kids I can say that I have seen the movie “The Wizard of OZ” more times than I care to count. Something I have found interesting is that there are a few differences between the original book and the movie most of us are familiar with.

For starters the Ruby slippers were silver and there were four witches in the book. Also, the story was a political diatribe arguing the big issue of the day – our monetary system moving from the Gold Standard to paper money. The Yellow Brick Road represented gold, while the silver slippers explained the use of that precious metal. Dorothy was walking towards the Emerald City (Washington D.C.) which was pushing for a paper money that was green. The creator of The Wizard of OZ, Frank L. Baum apparently didn’t care for President McKinley because the leader of the Emerald City was portrayed as a charlatan.

The Wizard of Oz is filled with examples of how things can appear one way on the surface and be quite different in reality – a metaphor not only for life but for financial markets as well.

In our last Quiver Quarterly we shared with you the following three year graph of the S&P 500 and noted four reasons why investors should tread lightly.

S&P 500 – March 2007 to March 2010

bigcharts.com

Since our last writing the financial markets have seen increased volatility as reflected from this updated chart of the S&P500 which reflects the worst May in market history according to Bloomberg.

S&P 500 – June 2007 to June 2010

bigcharts.com

Lions and Tigers and Bears

For financial markets the month of May seemed to have its own version of “Lions and Tigers and Bears – Oh my” with flash crashes, global debt issues, proposed financial reform and weaker than expected economic reports. All of which leads to the question of whether the recent market volatility is just a simple correction in a market that will continue higher or the beginnings of something bigger.

The poor price action in financial markets over the past few weeks adds support to our past claims that the spot marked with an X on these charts will be reached at some point this year. This is also where we feel there is a lower risk entry point for investors that are looking to invest into equity markets.

This area was chosen based on the fundamental belief that this represents fair value for most stocks within the S&P 500 index based on their earnings. In addition, this also represents technical support for the markets and will most likely induce some buyers. Whether those buyers will stick around to be long term investors will be dependent upon the economy and whether or not markets can stage a rally off of this ledge of support.

In 2001 and 2002 financial markets declined in the first leg of this Bear Market followed by a robust recovery in 2003. The first eight months of 2004 were marked with volatility as some economic reports showed a road to recovery while others centered on employment continued to be stuck in the mud. This is when the Bush administration was hot and heavy on promoting the economic growth as a “jobless recovery”. At the time the unemployment rate was hovering near 5.5%.

Towards the tail end of ‘04 financial markets started to see a reduction in volatility and re-initiated growth into 2007 as the economy began to show signs of job creation.

OZ Behind the Curtain

This is where things can be a bit like OZ and not be as they appear to the naked eye.

The powers to be in the Emerald City have a funky way in how they calculate job creation. I’ll attempt to explain in a simple way.

Each March the BLS looks back five years at how many old businesses failed and how many new businesses were birthed and model how many new jobs were probably created or lost on a net basis each month.

The major flaw with this model is 2009 and 2010 are so far away from what the economy was doing from 2004 to 2009 that it is insane to conclude the 2010 economy is generating the same amount of new jobs from newly birthed businesses as 2004 to 2009.

This year is even a bit trickier with the addition of Census workers which are temporary jobs that will skew the numbers in a positive way. This sets us up on a slippery slope where expectations will eventually not be met as the unemployment rate continues to climb even though the number of claims for unemployment declines.

The bottom line is that there is little to no job creation at the current time and when you couple that with consumers, corporations and governments that are straddled with trillions of dollars of debt you have some powerful deflationary effects that will work as a head wind against equity markets and create a tail wind in other asset categories. For this reason it will be important for investors to have their assets tactically managed over the next few years as opposed to a passive “diversified” allocation of different types of equities or mutual funds. The way money will be earned over the next few years will be quite different than how it was done in the past.

As Dorothy would say, “We’re not in Kansas anymore”.

Moving Forward

With all that has been said and noted what should investors do now in preparation for the future? It’s always a bit dangerous to give blanket advice not knowing the readers time horizon so the following will be based on the view point that we feel most moderate risk investors with a 5 year time horizon may want to do.

When it comes to equities we feel it would be best to wait to put additional capital to work in equity markets until you see the markets reach the area marked with an X on the previously shown charts. In the event the market cycles should shift and we get the impression the equities markets will move higher as opposed to lower we will address that in future Quiver Quarterlies.

Interest Rates

Interest rates are the hot topic as most people anticipate rates moving higher along with inflation.

In fact in past quarterlies we have backed this thought process for the longer term picture. However, in the shorter term time frame (next few months to year) the likelihood of rising rates seems mute. The reason for this is that all of the current forces within markets are more deflationary than anything else. In addition to market forces The Fed has explicitly stated they will do everything in their power to keep rates low and there is an old adage “don’t fight the fed” which deserves to be respected.

From an investment thesis it is most likely rates will remain range bound moving sideways until there is a change in stance by The Fed. This can be good for short term traders and a bit frustrating for longer term investors or investors needing to create yield in their portfolios.

The Dollar

With the breakdown seen in Europe the Dollar has been the investment to own with gains of more than 15% since November of ’09, something that was discussed in past Quiver Quarterlies.

Moving forward, The Dollar has moved a little too far too fast and is due for a pause. Any decline in The Dollar is a buying opportunity in our eyes as the longer term pattern for The Dollar looks to be up.

Gold

Gold is at a watershed, having respected resistance at $1250 before retracing to test support at the December 2009 high of $1220. The earlier breakout is not yet convincing. Reversal below $1200 is unlikely, but would warn of weakness, while breakout above $1250 would confirm a primary advance to $1380.

Oil

Crude oil recently respected primary support at $70 a barrel, but momentum is declining and failure of support at $70 would signal a primary down-swing with a target of $50 a barrel.

We do find it interesting that with the problems in the Gulf with BP as well as geo-political issues in Korea, Iran and Israel that oil has not seen an increase in momentum. This is typically not a good sign. If a market can’t move higher when the fundamentals indicate that it should then there is an unhealthy disconnect. However, as long as $70 dollars a barrel holds any selling then investors can continue to hold this asset class in their portfolio.

Well it’s time to click our heels and move on to other things so with that we will wrap up this issue and encourage any of you that would like more information on markets or investments to contact us or come visit us at our next open house on June 25th where we will discuss these topics in more depth. You can RSVP by calling our office at 949-492-6900 or emailing us at info@quiverfinancial.com

Until next time stay safe and enjoy the beginnings of summer.

Warmest Regards

Colby McFadden


*The opinions expressed are those of Colby McFadden and Quiver Asset Management as of 6-10-10 and are subject to change due to market and other conditions
** Graphs provided are for illustration purposes only and do not reflect a specific investment recommendation
-There are risks inherent in investing in the stock market. Price value will fluctuate.
-Past performance is not a guarantee of future results
-The S&P 500 Index is a market-value weighted index consisting of 500 widely held U.S. stocks chosen for market size, liquidity, and industry group representation. Performance is compounded, distributions reinvested. An investment cannot be made directly in an index. Past performance does not guarantee future results.