U.S. Market Leading The Way

We’ve noticed a dramatic shift in the markets since the details of the second Quantitative Easing move by the Federal Reserve was announced in early November. Prior to the election and QE2 announcement, the U.S. market was lagging most of our alternative asset classes. Then suddenly, markets reversed course so that now all of the alternatives lag the U.S. broad index.

The first table is as of October 31, 2010.  The sectors and asset classes owned in the mutual fund portfolio model are marked in green, if they are doing better than the benchmark, or red, if they are lagging.

Notice that the majority of alternative asset classes were going up while the U.S. stock market was slightly down during that period. From our selfish standpoint, at that point our model was doing better than the market, and the vast majority of our holdings were doing better than the benchmark.

Then everything changed. The U.S. market started doing better than the alternatives.

Only global commodity stocks were beating the U.S. market, which was in rally mode. We have been struggling, not because we didn’t own better performing alternatives, but because it has been such a narrow market that it is difficult to be very diversified and not have some laggards dragging down portfolio performance.  The second chart is as of March 31, 2011.

In our case, some of our U.S. stock positions, and our gold and precious metals position, were dragging down performance. We recently sold the position in “All that Glitters,” and since quarter-end our utility and pharmaceutical positions have perked up. The insurance holding remains “under water,” though we haven’t owned it for long and since we purchased it, it has generally kept pace with the market.

Thus far, 2011 has been a bit of a Good News/Bad News sort of market. While we are struggling to keep up with our primary benchmark, the S&P 500 Index, the good news is that the broad U.S. stock market is, for now at least, the best game in town.
 
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

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Biking Grand Junction? Start online

For a growing number of Grand Valley residents, spring means the start of biking season.

If you’re a cyclist – especially an aspiring cyclist – you could just hop on two wheels and try to find your way to the best trails to suit your ability. Take that approach, and you’d get a good workout looking for trailheads and suitable rides.

A better approach would be to start on the computer with two excellent websites that contain detailed maps of mountain bike trails and road bike routes in the area.

The first site, Western Colorado Mountain Biking, is found at http://www.gjmountainbiking.com/. Joel Schaefer and Randy Gehl have assembled the site, which includes photos, trail descriptions, and high-resolution maps of the trails plotted on topographical maps. Schaefer and Gehl have ridden each trail listed on the site and have plotted key locations with distances, elevations, and GPS coordinates.

Gehl points out that you don’t have to be an expert mountain biker to ride in western Colorado. For easier trails, he suggests some of the trails in the Lunch Loops area, whose main trailhead is located just up the No Thoroughfare/Monument Road on the Redlands (on the way to the east entrance of Colorado National Monument). Some easier trails also can be found in the Kokopelli’s Trail area (Rustler’s Loop, http://www.gjmountainbiking.com/koko/rustler.html) and in the 18 Road area near Fruita (specifically, the Vegetarian Loop trail). Gehl says Highline Lake also has a nice three-mile loop.

If road biking is more your style (skinny tires instead of fat tires), the Tomorrow Hill Farm website at http://www.tomorrowhillfarm.com/JohnHodgebicycleMaps.html#Top contains a series of useful maps and trail descriptions focusing mainly on paved routes. The maps and descriptions were compiled by local resident John Hodge, an avid cyclist who writes on the website that “a good map brings confidence and an easier, safer, more fun bicycle ride.”

The maps on these websites are worth a thorough review before you start a ride. You’ll gain an idea of what to expect on the trail, and you can be better prepared for the relative difficulty or each ride. Check them out before you ride.

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Mutual funds and ETFs: What’s the difference?

Since 2007, May-Investments has pursued an investment strategy that is primarily focused on mutual funds. However, as markets become more volatile, the firm expects to reintroduce exchange-traded funds (ETFs) to the portfolio.

Doug May, owner and managing member of May-Investments, says ETFs were once part of the portfolio but were phased out about four years ago. Today, ETFs represent a way for the firm to gain an investment foothold in certain niche industries.

“As we contemplate future market volatility, I would think that ETFs would find their way back into the portfolio,” May says.

So what’s the difference between a mutual fund and an ETF?

Both are legally pooled funds that own investment assets for their shareholders, May says. Mutual funds are designed so that at the end of the trading day, assets in the fund are valued, and the fund trades at net asset value. Basically, you know at the end of the day what the fund’s price is.

In contrast, ETFs are investment pools whose shares trade over the course of the day, rather than at the close of the trading day. As a result, a significant difference can exist between the ETF’s net asset value and the price at which its stock trades. That difference, whether it is a premium or a discount, can create uncertainty that causes investors to shy away from ETF investments.

ETF are designed to track certain indexes, and when they don’t hit their target, investors can become nervous about ETFs.

ETFs exist in specialized industries – for example, utilities – which makes them attractive vehicles for investors looking to move into certain industries.

“We want to control our portfolio, so we’re more interested in the niche ETFs than in broad-market ETFs,” May says.

Many mutual funds are actively managed by professional managers who buy the best stocks of the class in which the fund specializes. In contrast, ETFs tend to buy the biggest stocks in the class without much regard for quality factors. Such a strategy can result in more volatility than typically happens in a mutual fund, May says.

By combining mutual funds and ETFs in a portfolio, investors can gain the advantage of actively managed mutual funds with the potential gains of ETFs that specialize in niche industries, May says. The combination also means that the relative stability of mutual funds can help temper the potential volatility of ETFs.

When ETFs join the portfolio, what will May-Investments clients notice that’s different? Because of the way ETFs operate, clients could see trading costs and commissions in their portfolios for the first time, May says. However, May says the benefits of combining ETFs and mutual funds in the portfolio can be worth the cost.

“I think clients are looking to us to make the right choice between the two,” May says. “Our clients trust us to make the right decision.”

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Local organizations work on Japan relief

It’s a frustrating feeling to watch the unspeakable horror and suffering of the Japanese people in the wake of the earthquake and tsunami, yet not be able to help.

But some organizations are working to support relief efforts to assist survivors of the disaster.

Several Grand Junction-area churches have raised funds to bolster assistance efforts in Japan. One such example is the First Presbyterian Church, where outreach director Debe Colby says members planned to take a special offering called One Great Hour of Sharing at the Palm Sunday service and distribute 33 percent of the collection to Presbyterian Disaster Relief. That organization works with partner groups at disaster sites throughout the world to provide help where it is needed most. Last year, Colby says, the focus was on earthquake-devastated Haiti.

The temptation can be strong, when people are confronted with television pictures of people who need clothing, shelter, and other basic supplies, to try to donate those items to relief efforts. However, Colby says that when disaster happen in faraway locations such as Japan, monetary donations are more effective than donating goods. Donations of goods require shipping and might not meet the precise needs of affected people. In contrast, monetary donations can be used by relief agencies to efficiently purchase the most-needed services and supplies for disaster relief.

The Grand Junction Vineyard church already had an existing relationship with Convoy of Hope, as well as with the Japan-based Christian relief program CRASH.  Vineyard's lead pastor, Kirk Yamaguchi, was in Japan when the disaster hit and quickly put his contacts at the two organizations in touch with one another.  By giving through Convoy of Hope, the church can leverage its cash donation 4-to-1 because in-kind donations can be shipped to places in need.  Since 1994, Convoy of Hope has helped more than 42 million people in over 100 countries, including people in the neighborhood of the Sendai based Morigo Christian Center, where more than twenty CRASH teams have delivered over thirty tons of relief supplies.  Click here to make your donation.

Rotary, of course, is always ready to help where they can.  Rotary International, best known for its efforts to eradicate polio across the globe, also set up a special relief site.  (Click here.)  The Rotary Japan 2011 Disaster Recovery fund was established on March 15.  Donations to the fund count toward Rotary club and district total contribution goals.  However, they are not eligible for Paul Harris recognition and do not count toward club and district Annual Programs Fund goals. 

The American Red Cross is providing relief resources to the Red Cross organization in Japan, and monetary donations are welcome. To donate to Red Cross relief efforts, visit http://www.redcross.org/, click the red “Donate Funds” button, and check “Japan Earthquake and Pacific Tsunami” on the page that appears. According to the Red Cross, gifts to the American Red Cross will support disaster relief efforts to help those affected by the earthquake in Japan and tsunami throughout the Pacific. When donations exceed American Red Cross expenses for a specific crisis, contributions are used to prepare for and service victims of other crises.

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Reverse mortgages are worth a look for retirees with home equity

Retired people who have equity in their homes and need extra income might find that a reverse mortgage gives them more options.

Reverse mortgages are loans against the property that do not have to be paid back as long as the homeowner lives in the home. Many reverse mortgage programs and payment plans exist. The homeowner may choose a monthly payment, a line of credit, a lump-sum cash advance, or a combination of any of these. There are no monthly payments. The loan is paid back in one payment when the home is sold.

“Reverse mortgages are a way for older adults to receive money out of their home and be able to live in their home as long as they choose to,” says Valerie Begalle, a reverse mortgage specialist with MetLife Home Loans. “The FHA requirements to receive a reverse mortgage are that the homeowners be 62 or older and have equity in the home, and live in the home as a primary residence.”

The funds received in a reverse mortgage are considered proceeds of a loan; consequently, the funds are received tax-free. Reverse mortgages have no income qualifications, the borrowers retain title to the property, there are no restrictions on the use of the money received, and because reverse mortgages are federally insured, no debt will be left to the homeowners’ heirs or estate.

The responsibilities of the homeowners are to live in the home as their primary residence, keep the property in good repair, and remain current on real estate taxes and homeowners insurance.

“Many people have been told that a reverse mortgage is too expensive, but there are so many new programs with lower origination fees, no service fees, and even a purchase product, that folks can downsize from a larger home into a smaller more manageable home with no payment,” Begalle says.

Reverse mortgages are not for people whose priority is to leave their property to their children free and clear. The mortgages can affect the inheritance that children get from their parents, particularly if the children planned to inherit their parents’ home. Begalle says that if a reverse mortgage exists on a house, then upon the last parent’s death, the house would be sold, the reverse mortgage would be paid back to the lender, and any extra proceeds from the sale would be distributed to the heirs. The possibility of such a circumstance occurring should be discussed among family members before a decision is made about a reverse mortgage, Begalle says.

“On the flip side of that coin, reverse mortgages are all non-recourse loans – you or your heirs are guaranteed never to owe more than the value of the home,” Begalle says. “They are federally insured loans, which means if when the home is sold the homeowners owe more than what the house is worth, the insurance picks up the difference, and there is never any debt left to the heirs.”

“Also, if the children would like to obtain a mortgage to keep their parents’ home, they can do that,” Begalle says. “They simply get a loan for what is owed on the reverse mortgage and the home is theirs.”

Because some reverse mortgages are more expensive than other sources of financing, borrowers have to clearly understand the expected costs.  However, under the right circumstances, Begalle says, reverse mortgages can be an excellent way for older adults with equity in their home to tap that equity and remain living independently.

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"All That Glitters" Is Sold

The model portfolios recently sold off a significant position in gold and precious metals owned through a no-load mutual fund holding. The sale doesn’t alter our long run belief that gold may be an important hedge against the declining value of the dollar. However, the discipline has been pushing for this sale for a couple of months, and as the portfolio accumulated other “hard asset” investments that have been doing better, recently (such as energy), we felt that it was time to sell the fund and move the money into areas that have been performing better.

Gold stocks moved up strongly last Fall, even doing better than the price of the underlying commodity. The stocks have leveled off since mid-November while the rest of the U.S. market has performed very well. It was almost as if the “normalization” of the U.S. economy, in turn, takes some of the “panic trade” out of the gold stocks. Still, the underlying commodity has been able to continue making new highs. Whether the commodity is just catching up to where the companies were already trading remains to be seen.

My personal belief is that it won’t be too long before the gold stocks go back into the portfolio. However, with roughly 30 percent of the portfolio already in other energy and commodity investments, it was a little disconcerting to watch the portfolio go down full force when commodity investments were selling off, but only have part of those investments participate on the up days.

After dragging my feet for a couple of months, while the discipline said “sell” but my gut said “hold on,” I finally caved in and decided to follow the discipline and sell the holding, at least for now. 

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

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Sharefest: Showing Love in a Practical Way

Spring means many things to many people – vacations, flowers, sunshine, and often projects and cleaning too. Thanks to some local Churches, it just might mean a helping hand from a neighbor to those in need as well. On Saturday, April 30th through Sunday, May 1st, faith based organizations from all over the valley will take on a variety of projects at Grand Junction’s fourth annual ShareFest.

We caught up with Debe Colby, Interim Director of Outreach Ministries for First Presbyterian Church, to learn more about this awesome event. Among other things, Debe has spearheaded the efforts to organize this year’s event. So what exactly is ShareFest? “ShareFest is a weekend where people from different churches and denominations in the Grand Valley come together and serve the community, sharing the love of Jesus tangibly with…neighbors in a variety of ways.” They do this by taking on, or adopting special projects; for example, some groups adopt spring clean-up for entire neighborhoods, while others wash cars, clean windows, pull weeds, rake, or paint a house. The focus is on those in need, particularly the elderly, though one group makes care packages for Mesa State College students during finals weeks, so the scope varies widely. The work provided is completely free of charge with NO strings attached, and is a lifesaver for many - I’m sure!

Doug has been a big fan of Sharefest for years. “Every Spring I get excited when I see the efforts put in to help neighbors on Sharefest weekend,” he told us. “I’ve been meaning to get involved for several years, but each year I seem to be late in getting my list of projects turned in.” (Sometimes it can be really embarrassing to work with Doug.)

According to Debe, as of April 7th, there were still 117 un-adopted projects for the 2011 ShareFest, so if you have some free time on the weekend of the 30th, you may think about getting a group of friends together and pitching in. These projects can be viewed (and even adopted by you or your organization/group) on the official website, http://www.gjsharefest.com/. They also accept monetary donations for those wishing to contribute financially, even from Doug. Just remember to note whether the contribution is made to the broad Sharefest fund, or whether it should stay specifically with the First Presbyterian project funds.

Conversely, if you know someone who needs a helping hand (other than Doug), you can submit your need through their site as well. Submissions are closed for this year’s event, but just as surely as spring rolls around every year, so do the projects that come with it, and the need for helping hands. As long as participation remains strong, ShareFest is likely to return in 2012, so a special THANK YOU goes out to all those willing to roll up their sleeves and chip in!
 
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

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Start Right | Finish Well

A recent New York Times article showed that a little known secret of investing is that historical returns can vary dramatically depending on starting and finishing times for the period of time in question.  Pick the wrong year, or decade, or even twenty year period, and you can fail to keep up with inflation.  But if you start right and finish well, selecting an opportune point of entry and have an optimum exit strategy, the market can be a wonderful place to invest.  The NYT chart shows clearly that the long-term assumption that "stocks earn 10%" is a dangerous presumption.  Investors who buy and hold are often frustrated if they think that "time in the market," alone, is a sufficient buffer against disappointment.

The stock market matrix chart was prepared by Crestmont Research and is a wealth of information, albeit in the form that only a chart geek (like me!) could love.  Take a look for yourself.  It's a work of art, in my opionion.

What investors should take away from viewing the chart is the question of what is a realistic return expectation?  One obvious point is that the chart has a lot of red color, and red represents time periods when stocks fail to keep up with inflation - and deep red probably means they failed to keep "up" at all!  There's a reason why we call it "red money" in our practice.  It requires active management, to coax more green into the mix, and those periods where anybody can make money in the stock market don't happen as often as we would like.

Ed Easterling, a Corvallis, Oregon-based investment advisor, observes in the article that, "market returns are more volatile than most people realize....even over periods as long as twenty years."  This is particularly true for investors who adhere strictly to a buy-and-hold strategy, whether - as we are known to observe - they are passive "by choice" or "due to inattention."

The 20-year median real return (the return above the level of inflation) is 4.1%.  If inflation increases at a 3% rate, which might be a reasonable long-long-term assumption, then a passively managed stock portfolio might be expected to return 7.1%.  That's not quite the 10% that many planners assume, and well under the presumed 20% rates of return that investors held during the technology bubble, when unrealistic thinking and irrational exuberance were the norm for investors and investment bankers, alike.

I'm not writing this to discourage investors from buying stocks.  Given the negative real rate of return facing bond and money market fund investors, stocks might be one of the best games in town - particularly if the companies in question can maintain pricing power.  However, stock investors need to go in with their eyes wide open.  Financial advisors who spout platitudes about how a long-term time horizon erases the risk, or how "time in the market" turns this risk profile upside down, are doing a disservice to their clients.

The best thing that can be said about stocks, in light of this chart, is that as bad as it looks, the bond chart probably looks worse!

 Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

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Almost Finished

To save about $2 on the software, I converted from TurboTax to H&R Block for my 2010 tax return. Some people go to Las Vegas to gamble. I go shopping. My CPA does the business taxes, but for my personal taxes I use software because I figure they’ll have to throw about 20 million people in jail if it makes a mistake, and there just isn’t enough room in the slammer for all of us.

The I.R.S. has estimated that I can do my taxes in about 3 ½ hours, which is crazy. It took me longer than that just to buy the alcohol I needed to get me through the data entry process. It’s the same as when I used to have my CPA do my personal taxes, except that now there’s no issue when I search through the stack of receipts at midnight, in my underwear, which is something that used to drive my CPA nuts. No wonder he stopped working out of his house. In the movie version of my life, these forms are kept hermetically sealed in neat files, locked for security and ordered chronologically. In real life, I use a garbage sack with a twist tie.

The I.R.S. assigns letters and numbers to different tax forms. I graduated from the 1040EZ many years ago – about the time my braces came off, as I recall. Like many others, I use the schedule A because the government subsidizes the huge mortgage payment we took on when we bought a new house last year. Schedule A is also used to deduct charitable contributions, such as tithing. I find it somewhat humorous that the Administration is trying to reduce the tax break for donating to charity, but lawmakers of all persuasions are digging in to protect the right of Americans to buy more house than they need, which I consider to be more of a privilege and less of a “right.”

My tax return is a four letter form. Schedule D, for realized gains, is next. Isn’t it irritating that the government feels entitled to gain from our investment prowess, but that’s just the cost of living and investing in America. And, to be honest, since some of those gains are merely the result of inflation, and since the rate of inflation is likely to skyrocket as a result of current government policies, I guess maybe they do have a right to claim some of those gains as their own after all.

I’m fortunate that the letters in my return stop at “K.” The K-1 is used to report income, or lack thereof, from my business. Currently, I get to choose whether my lack of income is taken personally, flowing directly onto my personal income tax, or whether it is taxed corporately, in which case it will once again be taxed to me personally, as a dividend, should I ever decide that I need the money more than my corporation does. Thus, I get to choose whether the money is taxed once, or twice. Naturally, I choose the alternative which costs me the least amount of money. This freedom to choose between being taxed once or twice is receiving the scrutiny of Tim Geithner, my public servant who heads up the U.S. Treasury’s efforts to debase the dollar. To Geithner’s way of thinking, I should always have to pay taxes twice, although personally I would much rather just eliminate his salary, once and for all.

Then there is the “kiddie tax.” That will be the real test for my new software. Can it handle calculating taxes on the kids’ accounts? The examples given by the tax guides generally use the example of a single tax return, for a single child. It never occurred to the writers that some of us are slow learners and have more than one deduction.

I don’t know when I reached the stage in life where completing my tax return revolves around whether my K-1’s come in on time. It came on slowly. And each year it seems like I have more of them. It’s like a frog in the frying pan and this was my year to get boiled.

So I won’t be filing on time. I’ll file my extension, buy another six-pack, and revisit my taxes again in October. When I file, the IRS wants me to e-file. Filing electronically probably saves them data input time, and they don’t have to scan the document before they lose it. I figure that they ought to share some of the pain that I experience each year, so I fill each form out by hand, after the software has determined the correct dollar amounts. Then I crinkle the paper up so it won’t go through a scanner, and mix up the pages so that some agent in Utah has to sort out the 90+ pages that I send them before they can begin entering the data.

They estimated that it will take me 3 ½ hours to complete my return. I’m hoping that it will take them at least that long to sort out and type in my return. Maybe in 2012 they’ll send me a nice letter, asking me not to file at all. 
 
 Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

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Is The "New Normal" Normal?

Someone asked me the other day if I’m still in the “double-dip” (recession) camp, which led to an embarrassing confession that though I once believed that higher rates would choke off the nascent recovery, the current recovery has lasted long enough, and been strong enough, that I think those of us who were double-dippers ought to confess to being wrong. Do I think that the current recovery will eventually turn down? Of course. But if it turns down next year, or even next month, I think it would be disingenuous for the double-dip campers to claim that they accurately forecast this cycle.

In fact, thus far the “new normal” feels pretty normal, when you look at the strength of the current recovery and if you study how the market has responded to these statistics.

Our May-Investments Leading Economic Indicator remains strong, with 8 of 10 indicators showing improving conditions. Even bank lending has turned up, if only barely, indicating that since banks have stopped buying Treasury securities, they now have enough funding available to pay both their exorbitant CEO bonuses and make the odd loan here or there to small businesses who desperately need it. While overly tight bank regulators remain focused on denying capital to just about anyone who might need it to do business, forestalling job growth and pushing former pillars of the community into the hands of better-financed Fortune 500 competitors, at least (statistically speaking) the problem has finally stopped getting worse!

The two current areas of concern are export growth, which seems to be stalling, and a bit of a slowdown in the technology sector, probably related to the economic trauma suffered by Japan which may be impacting the greater Asia region. In any case, with 80% of the indicators improving, it’s hard to see why it makes sense to run for the hills. Economic growth appears to be real, significant, and ongoing.

Fidelity's Market Analysis Research & Education group published an analysis that shows that from the perspective of the stock market, the post-Recession recovery has followed a very normal path. Early in the recovery, financials and consumer cyclical stocks led the way. Now in the mid-cycle of this expansion, energy and industrials are leading the rally. The sector rotation we’ve experienced has thus far behaved exactly as a textbook on the investment cycle would have forecast.

Strictly observing sector performance, the failure of the banking sector to either write-off or in any way digest its bad loans is not apparent. The de-leveraging of the consumer sector, and the degree to which many small business owners and consumers have been cut off from access to credit, doesn’t really show up. Nor has stubbornly high unemployment seemed to matter. As far as the market is concerned, the economy put in a typical V-shaped rally and robust expansion by businesses is leading to a resurgence in inflationary pressures, which would typically result in a modest mid-cycle rally in stocks, especially by the business sector.

I think “the market” is wrong. I think the banks put in a “dead cat bounce” where those banks that didn’t go belly up, beneficiaries of an enormous wealth transfer from savers and taxpayers to incompetent financiers, rallied strongly on a faked recovery in banking sector earnings. It restored consumer confidence, but the systemic cancer remains. I think that corporate America has taken important steps to cut costs, especially in the area of interest expense, but historically high profit margins seems out of step with the economic realities facing the country. Finally, I think that to the degree that the market recovery was stoked by an end to distressed selling, mostly because bonds and cash no longer pay a competitive return (there’s no place else to go), today’s zero interest rate environment seems like an ingenious deception rather than solid long-term rationale for investing in stocks.

But sometimes it’s best to keep the alternative scenarios in mind, especially if you are writing only seven paragraphs after confessing to have blown it with my “double-dip” forecast. The investment business is, if nothing else, a humbling enterprise. I still expect inflationary pressures to get worse, interest rates to move high enough to shut down expansion, and at that point I believe that today’s deferred problems will resurface so that the next cycle down will be severe – hopefully not as severe as 2008, but nonetheless a severe recession, when put in historical context.
 
Let’s hope I’m wrong again.  

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .

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