A Truly Ghastly Environment

November 25, 2009
This is a truly ghastly environment for yield-conscious investors. Three-month T-bills yield 0.03%, two-year T-notes 0.73%, five-year T-notes 2.09%, and ten-year T-notes a whopping 3.3%. Who is locking up money for ten years at a 3.3% yield? The Fed’s balance sheet is bloated with reserves, and the federal government is running massive budget deficits. Isn’t this inflationary? You betcha. But the combination of an extremely steep yield curve and the Federal Reserve’s promise to leave the fed funds rate near zero for an extended period of time has created a massive carry trade in the treasury market. Long rates are being kept artificially low because the yield curve is so steep. They likely won’t move much higher with short rates near zero. Why? It’s too profitable for investors to borrow short and lend long without taking credit risk. A commercial bank can borrow near zero and lend to the U.S. government for five years at a 2.09% yield. Levered ten to one, this trade results in a 21% return on equity. If long rates aren’t likely to move higher until short rates rise, should you extend the maturity of your bond portfolio to pick up yield? Of course not, you would be speculating on interest rates. Savvy investors have learned to do exactly the opposite of what commercial banks are doing. Stay short.

Investment Success

November 20, 2009
In 1981, the Dow Jones Industrial Average ended at 875, 10% lower than its year-end value in 1965. During this wretched 16-year period, blue-chip stocks went nowhere. This was the ice age for stock prices. High and rising inflation and interest rates and big government were to blame. This sounds eerily similar to America’s prospects today.

Savvy investors have successfully navigated long dry spells in the stock market for decades. What is their secret? Buy the high yielders. My chart compares the hypothetical growth of a $10,000 investment in the Dow Jones Industrial Average, ex dividends, to the growth of a $10,000 investment in the highest-yielding U.S. stocks. The highest yielders are defined as the top-yielding quintile of U.S. exchange-traded stocks. The portfolio of high yielders compounded at 6.4% annually over this 16-year period, compared to a loss on the Dow. For conservative investors and those approaching or in retirement, investing for yield is a must. At my family-run investment company and in my monthly strategy report, we focus exclusively on dividend-paying stocks. Please join us.

A Canary in the Coal Mine?

The Citigroup Economic Surprise Index (CESI) accurately forecasted a 60%-plus rally in the stock market in early 2009. The CESI is an indicator designed to measure whether economic data is coming in better or worse than the average analyst’s expectations. A rising index indicates that economic data is coming in better than expected, whereas a falling index indicates that economic data is coming in worse than expected. The theory is that the consensus expectations for economic data are priced into the market. So then, when new economic data turns out to be better than the market’s expectations, the market should rise to reflect a better-than-expected economic environment.


My chart shows that the CESI led a recovery in the S&P 500 by approximately three months. In October, CESI started breaking down, but the S&P 500 has continued to climb. A continuation of the decline in the CESI may indicate that stocks are poised for a correction. This indicator should be watched closely over coming weeks and months. We follow it daily at Young Research. In Young Research’s Global Investment Strategy, we show subscribers how to use indicators such as the CESI to profit and protect capital. Please join us if you are not now with us. Click here to sign up.

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Jeremy Jones, CFA, is the Editor of Young Research’s Global Investment Strategy and the Chief Investment Officer at Richard C. Young & Co., Ltd., Investment Advisors.

The Irrational Mr. Mishkin

November 13, 2009
In the November 9 Financial Times, Frederic Mishkin, a former Federal Reserve governor, proved that the Fed has learned absolutely nothing from its Greenspan-era forays into dangerously low interest rates. Mr. Mishkin claims in the title of his editorial that “Not all bubbles present a risk to the economy.” I’m not sure which word Mr. Mishkin is misunderstanding: “bubbles,” “risk,” or “economy.” Mishkin goes on to make a lame distinction between what he calls “credit boom bubbles,” like the one that led to the current worldwide recession, and a more benign variety that he calls “pure irrational exuberance bubbles.” Mishkin says that the tech bubble was of the benign irrational exuberance variety. That’s nonsense. Asset bubbles are always dangerous and distorting. Resources are misallocated, irresponsible financial actors are rewarded unjustly, and bursting bubbles destroy the retirement savings of millions of investors. The tech bubble was not benign, and the damage to the economy was only contained because the Fed was inflating a much bigger bubble in the housing market-a bubble that Mr. Mishkin himself claimed didn’t threaten economic instability. Nice foresight. Unfortunately, I am afraid, Bernanke is sympathetic to Mr. Mishkin’s view on asset bubbles. I’m not. The Fed should either clamp down on bubbles sooner, or get out of the monetary policy business. Truthfully, I favor the latter.

Top 10 Mistakes #1

November 6, 2009
The #1 item on my list of the top 10 mistakes investors make is taking a casual go-it-alone approach to investing. Wall Street is dominated by PhDs, MBAs, CFAs, CPAs, attorneys, and other highly trained professionals who spend the vast majority of their waking hours looking for an edge. You have to recognize that the person on the other side of every trade you place may be more informed or knowledgeable than you. My staff and I spend our entire days reading about and analyzing companies, economies, and the financial markets. Individual investors allocating capital on a part-time, do-it-yourself basis have absolutely no chance of success. These investors are likely to do more damage than good. Savvy, smart, successful investors recognize the need for professional help. I’ve long advised investors to seek out the help of a registered investment advisor who charges less than 1% and has a basic investment philosophy that is similar to yours. At my family-run investment company and in my monthly strategy reports, we take a conservative approach, with a focus on diversification, dividends, and compound interest. If you share our philosophy, and you are not already with us, please join us.

See Top 10 Mistakes: #2

Blowing Asset Bubbles

At the Fed’s last meeting, Bernanke and company decided to keep the monetary throttle pegged. Apparently, the massive real-estate bubble inflated by an ultra-loose monetary policy that almost caused a collapse of the global financial system hasn’t changed the Fed’s view on asset price inflation. The Fed continues to cite subdued inflation and low rates of resource utilization as reasons to maintain its ultra-loose monetary policy. Bernanke and company are, of course, completely ignoring asset prices. Gold is at a new all-time high, oil is up 155% from its low, the S&P 500 is up 57% from its low and now overvalued, and the trade-weighted dollar index is down 12% from its February high. The valuations on some assets are bordering on bubble territory. The Fed is once again guiding the U.S. economy down a treacherous path of asset price inflation. This is a misguided strategy. There is danger lurking for millions of investors who do not recognize that the recovery in financial markets is grounded not in fundamentals, but in easy money. I would advise you to remain skeptical of the stock market rally. Continue to invest defensively.

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Jeremy Jones, CFA, is the Editor of Young Research’s Global Investment Strategy and the Chief Investment Officer at Richard C. Young & Co., Ltd., Investment Advisors.

Class A American Fund Nightmare

My mother is always finding things because she pays attention. And she’s passing that skill along to my kids. After a recent walk, they came back cheering about finding $2. It may as well have been $2,000.

You too may be a person who knows how it pays to pay attention, and if so, you’ve probably taught that lesson to someone you love. Here’s another lesson for you to teach, from a box titled “How the Largest Mutual Funds Did” in The WSJ‘s “Money and Investing” section. The box illustrates how most investors are sold what they own, how little attention they pay to fees, and how a ratings service can be way off base.

The largest stock fund is Growth Fund of America Class A, with $149.3 billion in assets. The fund carries a front-end sales load of 5.75%-which means that your $10,000 becomes $9,425 out of the gate. And a 6.1% return gets you back to square one, or your original $10,000. Not great numbers, especially in a down year. Imagine how new investors felt losing 39.07% in 2008, not including the sales load.

The problem is as clear as day. If a salesman is faced with selling a no-load fund (i.e., one without a commission) versus a loaded fund, which one is he going to choose? Shockingly, Morningstar gives the fund four out of five stars. In fact, 6 of the 10 largest mutual funds are all Class A or front-end-loaded American Funds. What are investors thinking?

Not surprisingly, the other four, offered by Fidelity (custodian for private client accounts at Richard C. Young & Co., Ltd.) and Vanguard, have no front-end sales loads. The seventh-largest stock fund, Vanguard 500 Index Investor Shares, has no front- or back-end loads and has an annual expense ratio of 0.18%. That’s low, and yet Morningstar rates it only three out of five stars. Come on, how does Growth Fund of America get a better rating? Oh, and did I mention that in addition to the 5.75% load, investors in the latter also pay an annual expense ratio?

Through September, investors withdrew $19.3 billion from American Funds while other major firms had inflows. Investors in Growth Fund of America withdrew $334 million in the month of September alone. Obviously, they are catching on. Unfortunately the front-end loads probably are not being returned. This was an expensive lesson for those investors, and one that could have been avoided. And if you’re short on time, working with someone who pays attention for you is always the best place to start.

E.J. Smith is Managing Director of Richard C. Young & Co., Ltd. an investment advisory firm managing portfolios for investors with over $1,000,000 in investable assets