CaduCap

After clearing the technical hurdle on September 20, the action in stocks has been mostly positive. There have been some down days, but there has not been a breakout to the downside and the markets seem to rally from there on a consistent basis. In addition, money flows are moving away from US Equities. In our opinion this is a recipe for a continued rally. We will be watching data closely because economic data, including consumer confidence, continues to be poor. Time will tell if data like the consumer confidence index is being driven by effective election attack ads on incumbents handling of the economy. We are looking for some leadership in the market and right now it seems to be technology. Industrials are not far behind. These sectors usually rebound during a recovery and indicate strong business spending, no doubt fueled by the cheapest debt capital anyone has seen. Another important point to keep in mind is that the leaders in the market today are truly international companies. While things may not be great in the US economy, a lot of the world is doing pretty good. Take a look at Thailand’s market this year for a case of optimism. As always, it is important to stay diversified.

Yesterday’s climb in the S+P 500 broke the index out of the trading range it had been in since May. We aren’t sounding the all clear yet. Last time the market broke down it was just after a Federal Reserve policy meeting. Guess what is going on today? The Fed should release a statement around 2:15 pm. At that time the market will digest what they say and decide what to do between this afternoon and tomorrow morning. Stability would be good here for the bulls.

Great article this morning from Bill Fleckenstein citing Dennis Gartman. These are two of the better macro-picture guys out there. Both are also strong Gold advocates. We also agree that gold/precious metals/commodities have a place in most diversified portfolios. The amount and type of investment depends on an individual client’s goals and objectives. In addition to gold, many businesses (i.e. equities) are inflation hedged investments. Many businesses can raise prices and therefore revenue when in an inflationary environment. That gives them the ability to increase their dividends. We think it is better to own an equity with a strong balance sheet, defensible business with pricing power, revenues in multiple currencies, and a 4% yield than a US TIPS bond with a 1.5% yield in the current environment.

*Not investment advice. Please contact one of our advisors to talk about your specific situation before investing.

A rather disturbing story about fraud and questionable motives was put out today regarding UN pollution credits. It is a good read to demonstrate why artificial markets don’t work. I call all carbon trading markets artificial because they were created to trade something that is irrelevant to an underlying product. You don’t need a carbon credit to burn coal or light your fireplace. Any country or company who realizes that buying a carbon credit or creating one has no bearing on their actual operation can game the system to the detriment of all. I am not advocating free-for-all pollution, but allowing someone to create something out of nothing (i.e. a carbon credit) is a recipe for manipulation and ultimate disaster. From an investor standpoint, better to stay away from companies that participate in these artificial markets.

It does not take a leap of faith to extend this logic to the Federal Reserve Note. The dollar used to be backed by gold, silver, and other metals, now it is backed by a promise from the Federal Reserve that it is worth something. As we have learned since its existence, and greatly amplified since 2008, the Federal Reserve can create these notes out of nothing and place them in the market. While the market is much larger and virtually every entity on the planet has bought into its validity, it is still an artificial market that we don’t want 100% exposure to. Unfortunately, most other currencies are operating in exactly the same way. That leaves investors with the option to invest in precious metals directly, as many are now doing. We are currently advocating a position in precious metals and precious metals companies for our clients. Please contact us if you want to talk about your specific goals and objectives.

Since May 2010 the S&P 500 has been stuck in a trading range. We are looking at 113 on SPY for the top and 104.5 as the bottom. So when SPY is around 110-113 we are looking to sell and at 104.5-106 we are looking to buy. These ranges have held since the flash crash of May 6. The flash crash is the common name for the event, whose origin still remains a mystery, is when stock markets went down about 10% across the board and then quickly rebounded. Investors have been skittish since and economic data suggests growth is slowing or stopping in the US. These factors create fear in the market. On the other hand, companies continue to make a lot of money and yields in the Treasury and corporate bond market are relatively low. These factors make equities look attractive. So far neither of these camps have been able to gain the upper hand so a trading range is the result. At this point we are inclined to hold equities, but keeping a larger than normal allocation in cash.

We are not actively buying bonds (Treasury or corporate), except for those with variable coupons or shorter maturity <2014. With the 30 year at 3.8% there isn’t much upside left unless we enter a Japan style deflationary spiral but there is a lot of downside if interest rates and/or inflation rise.

Companies with pristine balance sheets (i.e. making money and more cash than debt) are issuing debt at very low yields and the difference between stock and bond yields is at a cyclical low. For yield we are looking at traditional and convertible preferred stocks as well as MLPs, royalty trusts, and other equities who are able to easily cover their yields with cash flow. When credit spreads increase and long-term yields rise we will start buying again. We are always on the lookout for closed-end discounts to allow us to implement our strategies. Obviously, if market inefficiencies allow us to buy longer-term debt at significant discounts and at attractive yields for risk we will be buying, but as of this post, that is not the case.

Corporations are also holding record amounts of cash on their balance sheets. If interest rates continue to provide virtually no yield on that cash, we expect the merger market to heat up. Baskets of mid-cap and small-cap stocks are ways to play this because companies almost always overpay for acquisitions with smaller companies usually benefiting.