Sunday Nov 14 2010
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Canaries were literally once used in coalmines to warn of a lack of oxygen, if the canary stopped singing, get out of the mine. Likewise on the high seas, a canon shot across the bow of another ship is the warning to stop and be boarded. These are a metaphor for the above charts and this market.
We have written extensively about the New Civil War, the Southern Response looms. New York and Californian have partied like the grasshopper while other states acted more like the ants preparing for the winter. No doubt California and New York, both re elected Democrats as Governor, expect the Federal Government to backstop their indiscretions. The republicans swept the southern states . See the battle ahead? Already both NY and CA are selling Build American Bonds, with 35% interest guaranteed by the Federal Government. This past week major, note major, not some small town dinky industrial revenue bond, bond funds run by Nuveen, New York, and Pimco, CA, suffered 5% and 12.5% losses. This wipes out one or two years of interest payments. This is why chasing high yield is so dangerous. Retirees are necessarily a huge segment of the investing public; young people have not saved any money. But retirees are always chasing the maximum yields to provide more cash income, so much for the fixed income theory. Bernanke’s zero interest rate policy has in fact set the stage for the next crisis. Retirees have crowded into high yield municipals and junk bonds. The result is as usual pictured below; everyone is heading for the exits at the same time as they realize both principal and income are in danger. And it is not just New York and CA that are starting to melt
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The first two, NNP and PCK, were one-year weekly charts, for emphasis this is a six-month daily chart. Note the volume bars in the bottom clip at far right; this is a major league sell signal. Note the chart broke both moving averages of 50 and 200 days in just three trading days! These charts are screaming, get out, go to cash, and take that extended cruise. I put this letter together over the weekend. I woke up this morning deciding to add the longer-term view of this same municipal bond fund. This is added to emphasize what an early warning indicator this can be.
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This is a weekly chart of the same Van Kampen fund, VKL. Note it tested the 200-week MA in January 2008 but took until late summer to collapse. A few observations that prick the conventional wisdom balloon of investing.
- It does not matter which big company, Nuveen, Van Kampen, Franklin ‘manages’ the bond fund. Most are required by law to stay invested in the specific underlying securities.
- Diversification is a myth; the market moves as one, the fact that one owns hundreds of bonds across dozens of states does not prevent the value of all of them falling together, which as one can see is exactly what happened.
- Once the 200 week MA was broken the price really collapsed, why? At this point it became obvious to fund holders that the price was collapsing, so they called the mutual fund company and sold out. The fund manager was selling into a collapsing market with few to no bids whatsoever. And so the price fell very, very fast.
- No doubt the buy and hold crowd would say, not to worry, it all came back, so what. Well glad you asked, three comments.
- First, let’s suppose you sold $100,000 of VKL at $11 in January of 2008. You did not have to sweat the collapse of that fall. This saved a lot of worry.
- Second, not many were clever enough to catch the bottom but one could certainly have started adding back at $8.50 once the 50 week moving average was broken to the upside. Now how much does one own, well 100,000/8.50 = 11,764 shares. The sale netted 100,000/11= 9090 shares. So our retiree now has another 2674 shares collecting interest. This would result in a considerable income increase.
- Third, after the junk bond collapses of the early 1990s, the funds did not come back to full value nor did they resume paying what they had been paying, There is every reason to think this will happen to municipals this time around. Google public employee union protests and read some of the 408,000 results. In 1976 it was one city, New York City. Now we have entire states and cities in a similar situation. But the public employee unions are not showing the slightest bit of realism on this issue, even in the face of the GM and Chrysler bankruptcies and final concessions. This will not end in a pleasant fashion. We do not want readers to be worrying about their life savings amid future headlines such as CA Default Looms, LA City Council in Crisis Mode, Chicago Begs Dubai Investors for Relief, believe me those are coming.
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For those of you that think I am perhaps intense about markets now, you should have known me in the 1980s. After trading bonds for years, I simply could not believe stocks were ignoring the bear market in bonds. Each day at 2 PM CST once the bond market closed, stocks would dutifully rally. Even Bill Griffin was amazed on CNBC, FNN back then.
Bonds were the early signal for the collapse of 1987 as well as the collapse of 2008. It is happening again, now.
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Market Perspectives to Date
We began circulating this letter last spring. We caught the move down in stocks last April as well as the bottom and move up in July. We admit that we should have been more adamant about going long in July, amidst e-mails wondering why we were not short. We recommended buying TLT and caught a nice ten point move up. Our call on buying UUP, the Dollar was way early, and UUP fell 1.50 after our recommendation.
Our defense for all of this is simply that the worst of the bear market still lies ahead. The graphs of the municipal bond funds above show that once the fall begins, it is hard to get out of the market fast enough, look at 1987. Now, 1987 was a fourth wave in an overall stock bull market, which began in 1932. As we all know it recovered by Christmas. But we are not in an overall bull market now.
The US is a net debtor to the world, read this weekend WSJ for a take on how the US policy of trashing the Dollar policy was received at the G 20.
The 2008 collapse started just this way, high commodity prices, stocks falling, and the dollar bottoming, just three years ago.
Most participants believe another collapse this soon is not possible. Yet we have shown that this occurred during prior 18-year periods of stagnation, indeed four collapses during those periods were the norm. We have had two so far, 2000-2002,and 2007-2008; we have two more to go.
Act now to preserve your life savings. Exit any and all municipal or junk funds. Conservative investors should lighten up on all stocks. Traders can stay for what will not doubt be an exciting conclusion to the rally from March 2009. We expect the end of that rally in the first six months of 2011. As Art Cashin advises, stay nimble.
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