Friday, November 13, 2009

529 Plans and Risk Management

The last few years, 529 Plans became a preferred method for financing college. They offered the ability to have money growing in a tax-advantaged fashion for children and grand children. I never bought one for my kids and I never sold one to a client. Never.

Mark Boucher’s story in his book “The Hedge Fund Edge” always stuck in the front of my brain -

“Recounting a personal experience may be the best way to explain why risk should be of paramount importance to investors. In the early 1970’s, when I was nine years old, my father died of cancer. He had struggled to try and leave me a trust fund with enough money to finance my future college education. Since I had at least a decade to go until reaching college age when my father set up the trust, he put it into stock funds managed by a bank.

From the end of World War II to the late 1960’s, stocks had been in a wonderfully profitable bull market. The public was participating in stocks to the highest degree since 1929, and the prevailing wisdom was that if one just hung onto stocks over the long run, they showed a better return than nearly any other type of asset. (This type of environment should sound familiar to investors of the late 1990’s (and again in the late 2000’s)).

Things did not go according to plan beginning in 1972. From 1972 to 1975, the value of that trust fund declined by over 70 percent along with the decline in U.S. and global stock prices of a commensurate amount (the S&P and Dow dropped by around 50% during the period, but the broader market dropped by much more than that). By the time I started college in the early 1980’s, even the blue chip indexes had lost more than 70 percent of their 1972 value in after-inflation terms.

While my trust had recovered somewhat from 1975 to the early 1980’s, it was nowhere near the level it had been before my father died. In the early 1970’s, he believed he had provided enough funds for me to go to an Ivy League school – but a decade later, the diminished trust led me to opt for UC Berkeley instead. In no way could the trust have covered the cost of an elite private school.”

My concern with 529 Plans is that if you are using them to finance the education of young kids, then the plans will be extremely aggressively invested. They will own lots of Small Stocks and International Stocks. These are extremely volatile asset classes. So if you have young children and you fund this plan, and the markets tank, you have no method for managing the risk in the account. They buy risky stocks and you are along for the ride.

As the child ages, these plans sell stocks and buy bonds. So if your child is near age 18, then you can’t buy stocks if you want, because the plan will force you into bonds. Then you can’t play offense if you want to.

So the worst case scenario would be that you have a young kid and the markets tank and sit around for a few years. Then the markets rally, but by then your accounts are in bonds and you do not participate…

Now the media is picking up on the topic –

“Families whose 529 college savings plans took a beating last year are now looking into safer ways to save for higher education. As a result, banks and financial advisers are beginning to offer more conservative college savings options.”

There is a method top my madness. I sold my house in 2005 (I am trying to buy it back right now at a 49% discount to my sale price – holy cow). I stayed up nights in 2007 reading Money Market Fund Prospectuses to make sure that the funds clients owned had no holdings in Lehman or Bear Stearns. I avoided Corporate Bonds and sold my stocks in early 2008. I avoided 529 Plans because of lack of control. I started buying Gold, long before you were hearing about it on CNBC.

I am humble in the face of the market. If prices fall, I am wrong and I try to get out quickly. If prices go up, then I try to add to what is working. Markets lead. I follow.

I’m a top down kind of guy – is the market going up? Then I am interesting.
Which Sectors have the most strength? Which Industry Groups are getting the focus of buying from the big boys?
Which stocks have the characteristics of the great leading stocks of the past?
Is there a point on the chart where I can buy then, know I have a good chance at success and still have an exit strategy if prices start falling?

The rules set up by the likes of William O’Neil work. Is it a matter having the discipline to follow them and the expertise to customize portfolios to potential risk.

My goal is to manage risk. I define risk as falling prices and falling purchasing power via Inflation and a falling US Dollar. I will make money when the gettin’ is good and then hide when the stuff hits the fan.

I think others are making promises of returns that are not possible or are being achieved at undisclosed risks. I think that selling products like 529 Plans, illiquid Limited Partnerships or Bond Funds that are loaded up on Mortgages and Bank Bonds is unconscionable. The stuff will hit the fan again and you had better have the ability to play defense – because the next unwind will make 2008 look like a picnic.
People ask me if others agree with my opinions. Here is an interview from Dr. Jeffrey Sachs of Columbia University’s Earth Institute –

“Both sides are missing the key fact – the US economy needs structural change that requires a new set of economic tools.”

“What bothers me is that we seem to have two policies. One is we put the pedal to the floor on Monetary Policy, which boosts up asset prices… they’re going up again. That’s what created The Bubble. Then we get a crash. Then we adjust to it. And what have we learned? We’re doing exactly the same thing now as we did between 2002 and 2007 - exactly the same thing.”

“We’re back to the same policies. We spent two or three years bemoaning the fact that Greenspan had kept Interest Rates at essentially zero and allowed such a misallocation of Capital, that we ended up with a crash. Now we’re doing it exactly the same way. AND THE REASON IS THAT OUR ECONOMY IS JUST NOT PRODUCTIVE THE WAY THAT IT IS STRUCTURED RIGHT NOW.

We’re not creating truly productive jobs. Just giving tax cuts or the ‘Cash For Clunkers’, which in my view has to be the worst idea imaginable – we’re going to smash up cars, so that we can buy new cars. Is this really the best we can come up with?”

“All they are thinking about is how do we get back to where we were, not where do we need to go. And I think that’s the problem, actually… Congress isn’t going to figure it out. You know, they are completely in the hands of the interests that want to go back to where we were before.”

“We are in sloganeering and we are bouncing back and forth between outmoded ideas and we need, I think, something new.”

“We can’t pay for the absolute minimum core of Government right now and we’ve got a lot of other stuff to do. We have science and technology and roads and power. But right now, our tax dollars barely cover just the Interest on the Debt, the Military spending, the Health Care, Veterans’ benefits, Social Security . ALL THE REST OF GOVERNMENT IS ON BORROWING RIGHT NOW.”

“If you are going to spend $800 billion, you need to think about it (the “Stimulus Plan”) and not just make it a grab bag - which it absolutely was this time… It did not have a structure. It did not really have a plan, a philosophy and so forth. But we’re still in that situation. I think this kind of Government by back room Congressional negotiation doesn’t work, when you really need to make change. That, I think, is what it comes down to.

There are a lot of Interests around. They are very powerful. Finance – look at what the Banking Sector is doing in gutting Regulatory change. Look at what the Health Care Industry is doing in preventing any really substantive change in how Health Care is being delivered. Look at what’s happening with the Energy Sector pocketing whatever they can out of this Climate Change that is working its way through. Hundreds of Billions of Dollars of subsidies given to Utilities in a back room. People aren’t even aware of it.”

Do you wonder why I am buying Gold? Gold is working its way towards parity with the Dow –

But these strong Interest Groups also are leveraging Washington to pump up asset prices. That is why I hold my nose and buy Stocks and economically sensitive Commodities. My job is to protect Real Purchasing Power against Inflation and a falling Dollar. The printing of money is an enormous risk to Real Purchasing Power.

No Goldman is now writing notes that Stimulus 2.0 is a near certainty…

If you want to see the definition of “a misallocation of Capital”, then look no further. China has built a city for 1 million people, and nobody lives in it – “gleaming buildings built with government money stand empty”… Well done.

Wednesday, November 11, 2009

Lou Dobbs Resigned Today

Lou Dobbs resigned from CNN tonight. I don’t care about his politics or your politics. This is a big deal because of what he said. It shows where this country is heading –

“Over the past six months, it's become increasingly clear that strong winds of change have begun buffeting this country and affecting all of us. And some leaders in media, politics and business have been urging me to go beyond the role here at CNN and to engage in constructive problem-solving, as well as to contribute positively to a better understanding of the great issues of our day.”

“I truly believe that the major issues of our time include the growth of our middle class, the creation of more jobs, health care, immigration policy, the environment, climate change, and our military involvement, of course, in Afghanistan and Iraq.

But each of those issues is in my opinion informed by our capacity to demonstrate strong resilience of our now weakened capitalist economy and demonstrate the political will to overcome the lack of true representation in Washington, D.C.”

“Unfortunately, these issues are now defined in the public arena by partisanship and ideology rather than by rigorous empirical thought and forthright analysis and discussion.”

We have entered the time in history where society destroys the old institutions that are no longer trusted, and creates new ones. It is a long, painful process. It’s our fourth as a country – the previous three being The Revolutionary War, The Civil War and World War II.

Neil Howe calls the period “The Fourth Turning”. He wrote a book about it and we are now living through it. He has a recent interview that touches on all of the stuff that Dobbs is talking about –

“We occasionally have to clear away institutions, not only to make room for new ones, but also to create an atmosphere of new trust. That is what we no longer have today.

You were making that point earlier about how there is no social or political consensus. There is such complete dysfunction in the system now that we can’t make even modest incremental progress on any of the issues we face. In the Fourth Turning, we will solve those problems.”

“A Fourth Turning is an era when institutions are suddenly proven ineffectual or are torn down to build something entirely new. It is a time of enormous rebuilding of public, social, political, and economic life – usually in response to an urgent crisis or series of crises that seem to threaten our society’s very survival.”

The system is broken and everybody knows it. Big change is coming. I read this article today about a Columbia University professor who bunched a woman in the face over an argument about the merits of “white privilege”. Are you kidding me?

Howe has this to say on the topic –

“(W)e see (Baby) Boomers as they grow older continue to rip into each other on these subjects more than anyone else. This is the generation of culture wars, and I’m convinced they will still be shouting at each other on radio talk shows into their 80s.”

It is indicative of the tone of conversation within the country right now. The leadership has lost its purpose. Everything is a war of rhetoric. They are there to serve us, yet nothing is getting fixed – and Rome is burning to the ground, while the bankers loot all the gold.

Every 20 years you get a generational shift, where a new generation takes over the culture as they reach adulthood – the Leave-It-To-Beaver (Silent) generation did as they were told and built the new great society mandated by the GI generation, The Baby Boom came of age during the Consciousness Revolution and rediscovered the individual and Generation X embraced Ronald Reagan and took risk and innovation to new heights.

Here are the timelines for those periods where each generation controlled the culture –

Silent 1946 -1966
Baby Boom 1966 – 1982
Generation X 1982 – 2000

Why is this important? Look at how these dates align with the Stock Market!

Rally followed by consolidation, as generations pass the mantel of leadership. As an investor, you need to think cyclically. Seasonally. Every 20 years, the clock turns. The seasons change and you have to change with them.

We have entered the period of societal deconstruction.

The youth define the era. The “Millennial Generation” is now in charge. According to Howe, “(w)e have found that, throughout American history, the generation entering young adulthood has always shaped our impression of where the country was headed.”

You need to understand who the Millennials are –

“Yes, the Fourth Turning will be an era in which government is increasingly important, but it will not be the kind of big government your readers associate with Boomer-driven liberal ideology.”

“These young people want to take charge, they trust big institutions and want big challenges to be solved with political and governmental activity.”
That is what struck me about Dobbs today. The country is begging for leadership that will set aside the political rhetoric and fix the problems we all know we have.

“Two-thirds of this generation voted for Barack Obama.” They want change. Obama isn’t following through, so his poll numbers are falling.

They want to build strong families and communities –

“When surveyed about what they want to do with their lives, Millennials say they want to be good neighbors, they want to be good citizens, they want to have balanced careers. A record number, according to the UCLA Freshman Survey, said they want to get married and have children.”

“Although they are going to use government aggressively and use community aggressively, they are going to do it for purposes that will seem surprisingly bland and conventional to older people.”

Sounds to me like innovation and risk taking are gone. Maybe that is what stocks have been pricing in for the last nine years…

They are the chosen ones –

“Millennials will emerge as the special generation. Everyone will want to sacrifice for their needs. And if Millennials face a real emergency and if their future is at risk -- particularly if they are actually getting shot at or are in harm’s way – there’s no way Boomers will be able to preserve their benefits. Not if preserving those benefits is seen as endangering the future of this special Millennial Generation of young adults.

Consequently, I think that in this Fourth Turning, we’ll see a re-tilting of the budget and our entire political policy away from the old and back to the young. This always happens during a Fourth Turning. Our policy biases move back towards the family, towards investing in the future, and towards institutional arrangements that are good for young people.”

The entire Social Contract is going to be re-written. All the pensions and healthcare plans that the Baby Boom has promised itself will be gone or extremely altered. You will need to have the capacity to self-finance everything. That means working longer and saving more. This is about survival. If you aren’t thinking this way yet, you are nuts.

“In the economy, we think there is going to be a period of very rapid structural change. Certain sectors are going to grow. We are going to see much more investment in security, in infrastructure, and in education, to the extent that we can afford it. And a lot of those things are going to be pushed by government.

But in the private sector we will see a push towards middle class – middle-class consumption, middle-class needs, and middle-class values. The rich and the poor will not fare as well. The rich obviously will be a target, given that, particularly for the populous minded, they represent a threat to the community. The poor will also no longer be catered to as much. But rebuilding the middle class will be an incredibly important part of the Millennial Generation’s political agenda.”

Protectionism will increase. The Dollar will fall to make it economically possible to rebuild the manufacturing Middle Class.

“Older generations, both conservative and liberal, tend to define Millennials based on their own established set of values and ideologies. They don’t stop to see that this generation is coming with a whole new agenda that cuts across these categories.

It might help to think of the Millennials as capitalists, but they want capitalism with a public purpose. Through regulation, incentives, and social engineering, they want the markets to be orchestrated toward some end that we all want. But they do not want to stop markets with pointless regulations. That is not where this generation is coming from.”

I think of Google as the ultimate Millennial company, where the Billionaire founders use their personal fortunes to invent things that make society better. They don’t want to profit from these endeavors. This is great for the average guy who doesn’t want to pay for something, but is kills the margins for the for-profit businesses competing in the same space.

The invention and innovation has taken place. We are now at the stage of picking the winners –

“We pick the winners that can make all of our lives better, the innovations that every family should have, or which we are going to build under every street in America. In Fourth Turnings, society picks winners, and we use those winners to build new infrastructures. That may be another point to keep in mind as investors and businessmen.

The Civil War and its immediate aftermath was the final flourishing of the greatest railroad projects this country ever saw. And out of the American Revolution came the toll roads and the great canals. World War II brought about the roads and the interstate highway system and so forth. We create infrastructure projects in Fourth Turnings, and we organize the institutions that keep those projects going throughout the subsequent First Turning, the Post-Crisis era. And we expect to see this again in the years ahead.

We are beginning to see it already with Obama and his large-scale vision, whatever you think about it, for digitalizing medical records, and installing Internet across America, and building high-speed trains. I think the idea of having public goals and creating big things again resonates very well with Millennials in particular.”

You can’t be investing in the future like you have been the last 20 years. The game is changing. The markets are already picking out the new Dow 30. Google? Apple? Microsoft? Cisco? It sounds like Solar and Fiber Optics are going to rock. We’ll see how it shakes out.

When I saw Dodd speak today, it triggered my thoughts on these subjects. His words were carefully chosen. They were chosen to reflect that he and a group of big players (like the boys at CNN) understand that a new message has to conveyed and a new civil tone has to take over our politics.

I think the real message out of Dodd today is that there are many significant issues that need to be addressed and fixed and if you can’t put away your partisan rhetoric for the betterment of the country, then you are going to get run over.

Massive change is coming. It is going to be ugly. It is normally accompanied by deflation and massive inflation. You will need to stay on your toes and protect your own interests while society tries to use your personal wealth to finance this change.

Tuesday, November 10, 2009

Large Is Taking Over

Large is starting to outperform Small. The theme going forward will be a narrowing market, with fewer leaders and the need to be able to differentiate between what is pulling the market upward and what is hanging on for the ride higher.

OEX is the S&P 100 – the 100 largest US public companies. See how OEX put in a higher low and is now testing the highs of October?
RUT is the Russell 2000 Small Cap Index. See how it put in a lower low and is now below the 50-day (Blue Line)?
Even if they both work their way higher, I expect Large to outperform Small.

As you can see, prices call easily stall out here for a few days, but it seems like the Distribution Days of the last few weeks have been resolved and that prices want to go higher.

Gold has broken out of an 18-month consolidation. That is a very positive development. The market sits around for a long time, then makes sharp moves, then sits around for a long time… Gold’s rally off of the 2006-2007 consolidation lasted for about 7 months and returned about 40%.

The Point and Figure charting method targets at least $1,240 for Gold on this move. I’ve been buying Gold for a long time and posting about it for at least a year.

How high does it go - $2,000, $5,000? I have no clue. I only know that the trend right now is up and looks like it can carry higher. I like the fundamentals and will own it until this move out of the 2008 – 2009 consolidation ends. Then I will evaluate how things look after the 2010-2011 consolidation…

For now, Gold is extended on a daily chart. I will look for a pullback into $1,087 or $1,064 before adding more.

Gold Stocks are breaking out of long consolidations. That tells me that the big boys are ready to start buying them. That confirms my Bullish thoughts on Gold and Commodities.

HL broke out of a 2-month base.

Newmont Mining (NEM) has broken out of a multi-month consolidation.

This may be my favorite chart in all of the markets. Royal Gold (RGLD) has broken out of an 11-month consolidation.

Barrick Gold (ABX) has also broken out of a long consolidation.

Silver (SLV) has been much more volatile than Gold and is now sitting at the top of a 2-month consolidation. I want to own Silver if the big boys show up too break it out of this base. Watch for head fakes.

Crude Oil (USO) is now in a “base on base” formation. The second base normally takes a lot less time to form than the primary base, I am very interested in USO.

Berkshire Hathaway is trying to break out of a 3-month consolidation.

Industrials (XLI) are testing recent highs. If Industrials breakout, then the market probably has another leg up. If Industrials fail here and break down from a failed triple top breakout, then the correction has most likely arrived.

There are many good looking charts here –
Best Buy (BBY), John Deere (DE) and WalMart (WMT) are breaking out.

Mosaic (MOS) is trying yet again to break out.