And The Loser Is ... Why Financials Will Be The Worst Performing Sector Of The Next Decade ... Again

It’s the much anticipated time of the year when the entertainment industry honors their own achievements by presenting the world with the nominations for the Academy Awards. These awards showcase the best of Hollywood, with critically acclaimed movies like “THE KINGS SPEECH” – leading the ballots with a staggering 12 nominations.

It is a night that everyone in the entertainment industry strives to be a part of. It is an honor to be given the opportunity to stand behind the podium and give an incoherent speech, which is far too long to be crammed into the allotted time, only to be cut-off by music or a commercial. It is those few brief moments when the world takes notice and entertainers can say, (as Sally Field did in her 1984 acceptance speech for her second Oscar, for the movie “PLACES IN THE HEART), “you like me, you really like me”.

In addition to the Oscars, there have also been nominations for the 31^st annual Razzies award. The Razzies are the polar opposite of the Oscars in so much as the audience chooses who are the absolute worst actors, actresses and movies of the year. There is an official show, however, most of the recipients are far too embarrassed to receive their awards or deliver speeches like “you didn’t like me, you really didn’t like me”.

In the coming year, we will see one sector perform so poorly that if they were movies, they would certainly receive the dreaded “Razzie” award. The first and worst performance of all, will come from the industry that investors love to hate — THE FINANCIAL SECTOR.

 Although rallying 162% from the market low of March, 2009, the financial sector is still off 51.9% from its October, 2007 market peak. This performance credits the Financial Sector with the worst performing sector of the decade award.

Industry wide revenues are off 17% since 2007 with recent figures flat or declining. Bank of America (NYSE:BAC) reported a 1.24 billion dollar loss its second consecutive, unprofitable period. The Securities and Exchange Commission charged Merrill Lynch, now owned by BAC, with securities fraud, for misusing customer order information. Merrill agreed to pay 10 million to settle the charges, further tarnishing the credibility and trust of customers.

Financials face new regulations which will greatly reduce profit margins in the years to come. The vast majority of what could be considered earnings has been mostly exaggerated, due to money being moved in and out of reserves. The impact of bad loans has yet to be disclosed by financial institutions and will only accelerate over time. This is further exacerbated with the exorbitant amounts of commercial real estate owned by banks and so they will begin to sell at a discount.

The Investment Razzie for the “worst“ supporting cast  was Citigroup (NYSE:C), who hid its massive leverage attached to risky loans by using complicated derivates and listing their balance sheet exposure as short term debt. In the months leading up to the crisis, Citigroup neither confessed nor admitted that their underlying exposure was “becoming a concern”. Instead, they gave investors the false impression that they had minimal exposure to risky loans and held sufficient insurance to protect investors from a drop in the value of the underlying securities in their general portfolio. Investors lost over 90%of their investment while Citigroup accepted a tax payer funded bailout of 25 billion dollars.

Some other memorably bad performances include: NYSE:WFC, NYSE:AIG, NYSE:JPM, NYSE:UBS, NYSE:GS.

The aftermath of the financial crisis of 2008 will be felt in the banking industry for years to come, making them the worst performing sector of the next decade as well as the last. They like so many “bad actors” will be type cast in the role of “villain” in their horrific and disingenuous performance.

In an industry which played such a historic role in the foundation of our country, it is very disheartening to see the depth to which these onetime “stars” have sunk, leaving many investors to walk down “the boulevard of broken dreams“. This “stroll” will be taken with much less of their investment assets than they would have had if only the banks would have acted with integrity.

In the final scene, financial institutions will realize that no attempt to “recast” themselves as the hero will prevail, considering investors will forever remember this performance as defining who they are and for the damage they’ve done. The Investment “Razzie” may actually be too high of an honor for this performance.

True Grit – Investing With A Vengeance

 This year Hollywood is ending the year with a vengeance amidst the remake of the 1969 classic, TRUE GRIT, which starred the original Hollywood bad ass, John Wayne. This exceptional remake is quite a divergence from the standard no plot, special effect extravaganzas, starring former Disney Channel celebrities we’ve grown accustomed to at this time of the year. The movie centers on 14 year old Matte Ross, (played by Hailee Steinfeld), who hires U.S. Marshal “Rooster” Cogburn, (played by Jeff Bridges), to find her father’s murderer and have him brought to justice. It is a movie that has virtually no special effects, manicured stars, illicit humor or any of the other so called successful ingredients of a Hollywood blockbuster — yet it had a very good opening weekend. This early success defies the logic of many movie critics who claim that revenge-themed westerns can no longer succeed in Hollywood as they once did. This may be proof that movie goers are getting a little tired of the same old “tricks” and want to be “entertained” and not just  “distracted”.

This year in the equity markets investors experienced what many would characterize as a “blockbuster” year with over 10% returns on the S&P 500 and upward of 17% in the NASDAQ composite. The hero, although not a former Disney Channel star, was Ben Bernanke who took center stage after being given the role of saving the world through his own special brand of “special effects” — quantitative easing. Here our headliner, Bernanke, creates “money out of nothing”, inflating everything since 2008 from stocks and bonds, to Gold up 89%, crude up 107%, copper up 230%, sugar up 154%, soybeans, wheat, corn and coffee – all up over 50%. All this in typical Hollywood fashion, trying to get us to believe that the “special effects” are in fact, reality and the economy is really improving. Also starring in this “blockbuster” market year is President Barack Obama who decided to “play the part” of supporting actor and sign an extension of the “Bush Tax Cuts”. This two year extension not to raise taxes, brought relief to those that the President referred to as “the villains” or what we prefer to refer to as the “job creators” or “investors“. This “performance” brought him concessions during the lame duck session which will increase our federal deficit by almost 1 trillion dollars, making his award winning performance “Oscar worthy”. Investors were successfully “distracted” by the special effects as they recaptured virtually “all” of their market losses since the market decline of 2008 — most unaware of what was happening “back stage” as our federal deficit grew to 14 trillion dollars.

 In the year ahead, it is highly unlikely that the same old “special effects” of 2010 will produce similar results in 2011. Ben Bernanke cannot use another round of QE without completely undermining the confidence of investors worldwide. The bond market bubble is beginning to burst and although a further round of QE could prolong that from happening, it will create a much greater bubble in the future. It is only by embracing certain facts and looking past the “distraction” to the reality, which will allow investors to achieve the “blockbuster” returns they are seeking.

1. Inflation is Here – Commodity prices especially oil will continue to surge, therefore stocks like EXXON (XOM), Schlumberger (SLB), National Oilwell (NOV) and ETFS like IEO (ishares Dow Jones Oil and Gas exp) and IEZ (ishares Dow Jones Serv) or companies like Reynolds (RAI), Dupont (DD), Archer Daniels Midland (ADM), or Powershares DB Agriculture (DBA) will benefit from higher agricultural prices.
2. Income is dead – Investing for income is a waste of time, considering bond prices will continue to decline. Stay invested in short term bonds and buy quality dividend paying stocks like Kimberly Clark (KMB), Kraft (KFT) and Duke Energy (DUK).
3. Municipal and local municipal bonds will see historic defaults due to high levels of leverage. As a result, it would be prudent to greatly reduce municipal bond holdings.
4. Precious Metals will continue to advance.
5. The direction of the market will be determined by whether or not we see an improvement in unemployment.

Mattie Ross, “True Grit’s” 14 years old main character, chose the “tough as nails” U.S. Marshal “Rooster” Cogburn, to find her father’s killer because in her words, “he was true Grit”. He wasn’t your typical hero but he knew the terrain and had no fear when it came to accomplishing what he set out to do. Mattie Ross was described as having “steel in her spine” and a face that “couldn’t hide her broken heart “. In the challenging year ahead, we too must have “true grit” in enduring the economic challenges which lie ahead of us. We too must have “steel in our spine” even when some of our investments leave us broken-hearted. This will be a volatile year and we must look past the “special effects” and “distractions” which inflated this market, to a more “true” foundation. In the end, like Mattie, we will accomplish exactly what we set out to do.

Thank You,
Jeffrey C. Sica
President
Sica Wealth Management, LLC

QUANTUM PHYSICS AND THE ECONOMY – How the Bond Market ‘BUBBLE’ Affects the Overall Global Economy

This year the Nobel Prize in Physics was awarded to Andre Geim and Konstantin Novoselov from the University of Manchester in the UK for the discovery of a completely new material named Graphene. This new substance when extracted from graphite such as “found in a common pencil“, and is stabilized and mixed with certain plastics can be transformed into Graphene conductors believed to be the fastest conductors of electricity known to man — substantially faster than today’s silicon transistors. This amazing discovery could lead to faster, more efficient computers as well as other sorts of high frequency communication devices. This advance in the field of Quantum Physics brings to light an often ignored aspect of investment strategy —  the relevance of the interdependence of asset classes in achieving investment results. To continue with our Graphene example, it is the interdependence between the Graphene and the plastics that transform them into conductors of electricity — not simply one isolated element.

The most relevant and recent example of asset class interdependence is what investors have been witnessing in the bond market. In the past few weeks, the interest rate on five year treasuries has doubled to 1.9%. The rate on the 10 year jumped to 3.4% from 2.4%. The rate on the 30 year treasury is currently at 4.4%, a full percentage point higher than it was only a few months ago. These higher yields equate to lower bond prices which, in effect, wipe out years of interest, considering there is an inverse relationship between price and yield. Investors looked to bonds as an answer to their fears regarding an uncertain recovery and experienced some of the “best ever” returns — making mutual funds like the Pimco Total Return Fund grow assets to over 250 billion. If the majority of the appreciation in the bond market was the result of investor demand, we could rest easy knowing that the free market would prevail and even a correction could be bearable and, maybe even considered a “buying opportunity”. Unfortunately, this is not the case. Investor demand is not the only reason the bond market has appreciated to this level. The bond market has expanded due to the Federal Reserve’s misguided experiment of “printing money” or “quantitative easing”, which has artificially inflated bond prices. Investors realized that with yield so incredibly low, bonds offered little reward for lots of risk and instead of exiting in an orderly fashion through the main exit, they ran the risk of a continuing stampede through any exit, leaving many investors wondering — what happened?

 One of the significant differences of today’s average investor as opposed to investors of the past few decades is that substantially more of their money is invested in bonds and bond funds than ever before — an estimated 3 trillion dollars. Investors gravitated toward longer maturity bonds in an effort to secure higher coupons since older investors often rely on interest payments to sustain their income. These longer term bonds are most susceptible to loss of principle in a rising interest rate environment. For example, if long term bond yields move to 7%, the loss will be 25%. A 25% decline to an older investor with fewer years to try to recapture the loss is often catastrophic, greatly affecting spending and confidence and in turn affecting the overall economy. Investors who thought they found solace in the higher yielding corporate bonds will also suffer since once treasury yields rise and investors can get similar returns from “higher credit quality“ government bonds, corporate bonds will also come under considerable pressure. This too will have an impact on spending and consumer confidence.

Investors who are under the assumption that the stock market can continue its upward surge if the bond market continues its decline, will  be very disappointed when they find that much of the appreciation resulted from money flowing into dividend paying stocks from investors who were seeking income but couldn’t find what they were looking for in the bond market. Corporate earnings will be exceedingly affected in so much as corporations will not be able to issue long term bonds at low rates to fund their growth — greatly affecting their profits and essentially their stock price. Investors will always gravitate toward assets which give them the greatest return for the least risk. If bond prices continue to fall, the enthusiasm to take on more risk in equity will wane as investors seek similar returns in the higher credit quality treasury bonds. The equity market has been the beneficiary of the interdependence it has developed with the artificially overbought bond market and it will be this correlation which will cause the equity market to decline as the bond market declines. Ben Bernanke has hinted that he’s not opposed to a QE3 which may elevate bond prices in the near term but create an even greater “bubble” in the long term, spurring a considerable inflation threat.

In Quantum Physics as in investment strategy it is often the combination of the simplest elements which create the most spectacular results or the greatest catastrophes. Whether it’s the Graphite in a pencil or stocks and bonds as a part of an investment strategy, it is how those elements interact that make them just plain graphite or the fastest conductor of electricity known to man — or just plain stocks and bonds or the core component of a strategy which ultimately protects and grows what you’ve taken your whole life to accumulate. The method used to take a carbon atom in graphite and make it useful is a process referred to as “stabilization”, once considered to be virtually impossible. In the financial markets of today, many “experts” consider another type of market stabilization to be impossible, however, through diligence and discipline we will ultimately achieve the investment success we strive for and understanding the laws of Quantum Physics will help us get there.

Thank You,
Jeffrey C. Sica
President
Sica Wealth Management, LLC

High Net Worth: SPIRIT OF FREEDOM-What the Conflict on the Korean Peninsula Means to the World Economy

High Net Worth: SPIRIT OF FREEDOM-What the Conflict on the Korean Peninsula Means to the World Economy

SPIRIT OF FREEDOM-What the Conflict on the Korean Peninsula Means to the World Economy

She’s a beautiful vessel, about 1,092 feet long , 257 ft wide and 244 ft high. She has an enormous flight deck, 4.5 acres long which could accommodate up to 80 aircraft — each armed with the most sophisticated weaponry known to man. She has a crew of 6,250 brave men and women. Her name is the USS GEORGE WASHINGTON, and she has recently been deployed to the Yellow Sea, west of the Korean Peninsula, to begin joint military exercises with South Korea. In a statement from the US Navy’s seventh fleet, the military exercises are described as a measure to show the United States’ “commitment to regional stability through deterrence.”  In other words, what we are saying to the dictator Kim Jong Il and his “20 something” heir, apparently Kim Jung-un, is that we mean business when it comes to protecting our allies. The mere presence of this symbol of US power should inspire them to back down. It’s impossible to predict what the NORTH will do, since they continually act in a defiant, irresponsible manner — most notably in a recent revelation that there is a uranium enrichment facility in North Korea which could further advance their existing nuclear capabilities.

The most important aspect of this confrontation is how North Korea’s closest ally, China, deals with their recent aggression and insatiable need to advance their nuclear capabilities. China has a long history of using North Korea as a buffer against the US. Since the end of the Korean War, they have been leery of our strong alliance and our military presence in South Korea. They have never welcomed having our warships anywhere near their coastline. Furthermore, they have yet to firmly condemn North Korea on the attack of a South Korean warship which killed 46 sailors last March, the revelations of their nuclear capabilities or the most recent events. Alternatively, China, in a statement from its foreign ministry regarding our military exercises, has chosen to warn the US against “any military acts in our exclusive economic zone without permission.” In other words, China is threatening the US not to come too close to their coastline or face consequences. This statement by China will only serve to encourage the radical Korean dictator and his offspring to further threaten South Korea and defy the US. It should concern the Obama Administration that the strongest stand taken by the Chinese has been against the US protection of our allies, and not against the aggression of a radical dictator.

 The US market fell this week amid concerns that the Korean peninsula conflict will escalate. The bulls have chosen to focus on this conflict as yet another example of “saber rattling” from North Korea, but its consequence could be far greater than ever before, considering a few key factors. FIRST, China has the greatest influence over North Korea and how they handle them will substantially affect the world economy. SECOND, China is the largest foreign holder of US Government debt in the history of our nation, with holdings of nearly 900 billion dollars. This position gives them significant leverage over the US and substantially undermines our ability to negotiate with them when they side against us, as they seem to be doing now. THIRD, China has systematically devalued the juan in response to QE2 creating the dawn of inflation as we are beginning to see now and will soon see in the US. The recent interest rate increase in China has yet to show signs of curbing inflation. If the US and China are unable to come to terms with the conflict in the Korean Peninsula, it is unlikely they will come to terms with stabilizing their currencies — continuing on a path of systematically devaluing  currencies and creating a future threat of inflation while undermining a worldwide economic recovery. Finally, an insane dictator with nuclear weapons that is not kept at bay, by its closest ally and neighbor, is always a threat to the economy and well being of nations throughout the world. China has a responsibility to help stabilize the region and until they do, uncertainty and fear will remain throughout the worldwide financial markets, keeping us in a very defensive position.

The USS GEORGE WASHINGTON has an insignia designed by the ship’s crew, which includes a classic profile of Americas first president, a band of thirteen stars representing the original thirteen colonies and the crossed flags of freedom — all encircled by an unbroken rope representing the solidarity of the crew. The motto of the ship originates from the namesake, George Washington himself, taken from a letter he wrote to a fellow patriot. Washington used the phrase, “THE SPIRIT OF FREEDOM”, to describe the mood of the people during the revolutionary war. Perhaps we should reflect on the words of George Washington when considering the future of our nation, for it is the “Spirit of Freedom” which will motivate us to stand by our allies in times of trouble, when their freedom is at risk. It is the “SPIRIT OF FREEDOM” that will guide us through the challenges which are before us —it can never be taken away.

Thank You,
Jeffrey C. Sica
President
Sica Wealth Management, LLC

MEGAMIND

Who Are The HEROES And The SUPER-VILLAINS Of The TRADE And CURRENCY War?

In the DreamWorks animated hit film, “Megamind”, the self proclaimed “most brilliant super-villain the world has ever known”, was unfortunately for him, also the least successful. He regularly tried to conquer Metro City in every conceivable way, only to be defeated by his nemesis superhero “Metro Man”. In this week’s coverage of the G20 meeting in Seoul South Korea,  the “group of 20 nations” converged for their biannual summit, designed to strengthen macro policy co-ordination, consolidate global economic recovery and promote strong, sustainable balanced growth — or at least that’s what they say they are meeting for. In reality, they are meeting to determine who the super-villain is and who the hero is — or in the language of DreamWorks’ Megamind, who Megamind is and who Metro Man is. The United States alleges China is the super villain due to China’s record 28 billion trade surplus with the US, as well as the unfair cap on Yuan appreciation — both detrimental to US business interests. China asserts the US is the super villain since they consider the most recent 600 billion in quantitative easing a scheme to give US exporters an unfair advantage — one that endangers the global economy. It’s evident that neither side will concede to take any responsibility. This situation is best summarized by the Director General at China’s Ministry of Commerce, Yu Jianhua, who said, “Don’t make other people take the medicine for your disease. Quantitative easing will have a very big impact on developing countries including China.”

Investors will be faced with dramatic distortions looming in the post-crisis global economy as a result of this failure to come to terms with the currency crisis and trade imbalance. Countries have already begun to seal off their markets against foreign products in an effort to protect domestic producers. This will have a dramatic impact on countries that have become overly dependent on a weak currency to stimulate economic growth. In the context of China and the United States, who seem to be in a race to devalue their currencies, this could be disastrous. Key emerging economies, most notably Brazil and Indonesia, are imposing restrictions on the movement of capital, which could greatly disrupt the global money cycle. President Obama is beginning to embark on an offensive to pillory countries with chronic trade surpluses like China, Japan and Germany. This initiative will ultimately fail since many countries such as Germany believe that the US policy of QE is the cause of most of the recent global economic turmoil.

The result of this historic war which is beginning to heat up will be rampant, unwanted inflation as recently illustrated in China. Consumer prices are climbing to startling levels with a 4.4% increase overall and a 10.1% increase in the food sector in October. The Chinese government is beginning to realize that they kept interest rates too low for too long and are trying to catch up by raising interest rates in October. The United States has not seen the level of inflation consistent with China, however, if the fed is too slow to lift interest rates and discontinue QE, we may find ourselves in a situation comparable with China in which we are too late and inflation will greatly hinder our ability to recover.

As a result, we are continuing to invest in commodities, agriculture, precious metals, base metals, oil and gas exploration, oil and gas equipment and services as well as natural gas. We are very concerned with the equity market, recognizing that the recent gains are considerably unwarranted and enhanced due to the euphoria of QE2 and the recent stalemate in the election. Consequently, we are staying with our short positions and inverses in anticipation of a pullback in the US equity market. We see continued weakness in the euro and are investing accordingly. The recent round of quantitative easing will fail to keep bond prices high with yields low so we will continue to short the long term Treasury bond, seeing virtually no opportunity in bonds.

In “MEGAMIND” the hero is ultimately defeated by the super-villain, only to reveal  a worse, more dangerous  villain than the original super-villain — forcing the super-villain to ultimately become the hero and defeat the new super-villain — a pretty complicated plot twist for an animated film. The story line in the currency and trade war is complicated as well, but, one fact has persisted throughout the past 234 years in this country and that is when we are faced with a challenge, even when policy mistakes are made, America ALWAYS ultimately emerges as the hero — even when others may think we are the villains.

Thank You,
Jeffrey C. Sica
President
Sica Wealth Management, LLC

Great Expectations

In the Dickens novel “Great Expectations”, the main character Pip, a young working class orphan, inherits a fortune from an unknown benefactor and becomes instantly rich. He abandons all he knows, embraces his “great expectations” and pursues the life he has always aspired to. However, this sudden unforeseen success is muted due to subconscious feelings that he is unworthy of his good fortune and sadness and heartache ensues. In the recent market rally with the S&P 500 raising as much as 16% from its low in July, one would think investors would become more optimistic about the economy. Conversely, a recent poll found that just 37% of the public believes that the economy will improve in the next year — this down five points from a year ago. Those following technical analysis also have reason for “great expectations” as the SP 500 50-day moving average crosses above the 200 day moving mark, indicating the short term positive direction of the market is likely to continue. Additionally, the market historians have reason to be optimistic whereas for the past sixty years, the markets have typically performed tremendously well during midterm elections — averaging double digit returns consistently with only a few down years. In my last post, I discussed “embracing the stalemate” referencing the potential stalemate in the government which historically has proven to be the best possible environment for stocks. Even those that rely on corporate fundamentals have a reason for “great expectations” considering 85% of the 132 companies in the S&P 500 that reported earnings since October 7 have topped analyst per-share earnings estimates.

So why do so many of us share the dampened spirits of the young man in the novel “Great Expectations”? Perhaps because we feel that somehow the recent gains are not truly deserved and the potential for losing them looms large. The focus of the meeting of finance ministers and central bankers in the G 20 this weekend was to address the growing problem of countries relying on weaker exchange rates to spur economic growth. The ironyof the meeting centered around Timothy Geitner “expecting” China to allow the Yuan to strengthen in the interest of domestic growth and global economic stability. Geitner failed to mentionthe fact that the dollar is at a 15 year low due to the excess and potential future use of quantitative easing but did say for the first time, that it’s in the best interest of the United States that we have a strong dollar. If we are to have a strong dollar the quantitative easing estimated to begin in early November and projected to amount to over 1.4 trillion dollars (with recent predictions by Goldman Sachs analysts of 2 trillion) needs to be curtailed significantly. The overall rationale responsible for much of the advance of the market has been QE and, in the likely event that it is reduced or eliminated, the effect on the market will be negative — if in fact it was the main reason for the market advance. The Chinese will make small symbolic gestures to give the illusion that they are not manipulating their currency resulting in devaluation of the weaker currencies and worldwide inflation. Anyone disbelieving that cheaper currency is not a concern for weaker economies, should consider the tax Brazil imposed on foreign capital as a way to protect their currency and reduce the potential impact of inflation.

This rally will continue to run as long as the government pumps money into the economy; however, when it stopswe will need to prepare for a pull back. In the verbiage of Timothy Geitner, although not yet repeated by Ben Bernanke, that we are given the hint that QE may end sooner than we think, the central bank and Geitner face an insurmountable challenge. It’s impossible to strengthen the dollar and head off inflation without ending QE. If they end QE, they risk the stock market falling and the economy slowing further. The decision they need to make — whether to artificially pump up the economy or let the free market prevail and find other ways to stimulate growth — such as tax cuts. If they continue to artificially inflate the economy, they will cause worldwide rampant inflation which could find its way into our economy sooner than we think. We are continuing to trade this market short term, utilizing tight stops on our long positions — buying commodities, precious metals, base metals, mining stocks and using inverse ETFs to short the US treasury in anticipation of bond prices falling. We also feel that the Euro is overvalued and we expect a pullback.

Many people consider the novel “Great Expectations” a tragedy insomuch as the young man loses everything he has — counting too much on what he does not already have and valuing too little of that which he does have. However, it was in the lessons he learned and the love he attained which brought him true happiness in the end. In our “great expectations” that we have for the future of our nation and our personal economic life, we should always remember — we don’t need to lose everything to achieve the success we desire, if we  pursue our goals with unrelenting discipline and diligence. In a quote by Dickens himself he proclaims that, “there is nothing so strong or safe in an emergency than the simple truth”.

Thank You,
Jeffrey C. Sica
President
Sica Wealth Management, LLC

Glee: Embracing the Stalemate

Glee is back. I’m not referring to the FOX hit series that premiered a few weeks ago which highlights a diverse group of high school students who solve all of life’s problems with a song — ending last season on a high note with their rendition of Journey’s “Don’t Stop Believing”. I am referring to the recent performance of the DOW which topped 11,000 for the first time since the May 6th crash despite the report from the labor department that the nation lost95,000 jobs last month — signaling that the recovery is faltering. Ben Bernanke led the central bank in their version of “Don’t Stop Believing”, as he hinted that they would continue to buy up to 1.2 trillion of treasuries, believing that injecting cash into the economy would finally spur growth. It has been my contention that this quantitative easing will be a detriment to the long term health of the US economy. It has done nothing but artificially inflate bond prices and destroy the value of the dollar which is now trading at 81.73 yen — a fifteen year low.

So what are investors so Gleeful about? In most cases, a stalemate is not something to break into song over. Anyone who has ever been involved in a negotiation which ends in a stalemate is usually disappointed, because virtually nothing has been accomplished. The upcoming elections will most likely shift the House over to the Republicans, with the Senate very much up for grabs — the end result will probably be a stalemate. The recent rally is a celebration of “nothing” which is exactly what the government will be doing in the next couple of years until the next Presidential election — “nothing”. However, in the case of the current tax policy, doing nothing is impossible since the current tax policy will expire in January — possibly ending the initiative that’s been in effect since 1996. Possibly ending the very same policy that lowers taxes for small business’ or job creators and investors — the people who President Obama refers to as the “wealthy”. The expiration of the Bush tax cuts will have many negative effects, but the most relevant is the profound effect the Obama tax plan will have on small business’ willingness and ability to hire. It’s simple math — the more a small business owner pays in tax, the less money he has to hire workers. If the sky high unemployment rate continues or increases, no amount of quantitative easing, government bailouts or empty promises will prevent the debacle ahead. Every single government initiative that this administration has put forth has failed miserably; hence, investors eagerly anticipate the government continuing to do absolutely nothing after the Bush tax cuts are extended.

In the midst of our “gleeful nothingness” it is imperative to hypothesize the effects rising interest rates will have on our portfolios. I know that some believe that a brilliant congress will prevail in restoring the value of the dollar, while keeping interest rates low, without Central bank intervention. The optimist in me wishes that were true, but in order for the economy to improve, it will have to endure the hardships associated with rising interest rates. My short term strategy reflects four main factors:

1. Interest rates will rise (bond prices decline)
2. Commodity prices will rise exponentially (including OIL)
3. The stock market will continue to rally in anticipation of the stalemate
4. Precious metals will rally until interest rates rise and the dollar stabilizes.

However, in all likelihood, the stock market will become vulnerable to a decline when interest rates increase and unemployment doesn’t improve — which is why I remain negative on the equity market in the intermediate term once this short term rally runs its course. Our strategy is to trade the rally short term — continue to buy commodities, precious metals, convertible bonds and inverse treasuries, ETFS as well as TIPS . We are hedging our equity with Inverse ETFS and holding short term, while maintaining tight stops on our long equity positions, with less tight stops on our short positions, and inverse ETFS — recognizing that the market is vulnerable at these levels.

In the show “GLEE” turmoil ensues throughout the show, but what people remember and talk about is the final song. In the real life economic turmoil of today, we will surely persevere if we hold onto the fundamentals that have made this country GREAT. Conditions are far too complicated to ever think that all economic problems and problems in general could be solved with a song, but it is a song — possibly the best song ever written that will make us forget all the turmoil that created this crisis. The song was written by Katherine Lee bates, and it’s called “AMERICA THE BEAUTIFUL”.

Thank You,
Jeffrey C. SicaPresidentSica Wealth Management, LLC

Sleepless In Harrisburg

In the movie SLEEPLESS IN SEATTLE, Meg Ryan said, “Destiny is something we’ve invented because we can’t stand the fact that everything that happens is accidental”. Investors around the world have been “sleepless”, trying to determine what their destiny is when it comes to their investments. They are feeling a high level of distress knowing that they may end up somewhere — “accidentally”.
Income investors in particular are among those who may “accidentally” end up in a very bad place. I discussed the long term negative effects quantitative easing or “dis-easing” will have on the economy in my last post. The Federal Reserve’s futile attempt to stimulate the economy by “artificially” keeping interest rates low, can only lead to sudden, unpredictable declines in bond prices once the quantitative easing stops. In the past few weeks since I began speaking about this, we have seen decreases in bond prices which, in my opinion, are only the tip of the iceberg when it comes to potential declines in the very near term. The negative impact of these declines will ripple through so many industries and institutions that it will make any chance of an economic recovery seem remote in the near term. The historical economic perspective we should refer to is Japan, which despite low interest rates caused by types of quantitative easing, has failed to grow in over a decade.
Harrisburg PA may seem irrelevant to the state of our economy, however, understanding what happened there yesterday is imperative to understanding what Bond investors are likely to contend with in the near future. Harrisburg, the state capital of Pennsylvania, was scheduled to default on a 3.3 million dollar bond payment yesterday. However, it avoided defaulting because Governor Ed Rendell, pledeged to resolve the problem with $4.4 million from the states own challenged coffers. Investors in these Harrisburg bonds can breathe a sigh of relief but investors in the 2.8 trillion dollar muni market should be very concerned. As a matter, of fact Harrisburg is by no means the only “accident” waiting to happen — 48 states have enormous fiscal shortfalls in their 2010 fiscal budgets. In the event that we do begin to see more concerns over defaults in the Municipal bond market, we will start to see investors flee munical bonds, putting tremendous pressure on prices. Unlike the Federal Government, municipalities do not have the ability to print money to cover their debt, causing this to potentially be one of the highest risks for default — ever. I am specifically concerned about where these states are coming up with the money to bail out the municipalities. My suspicion is their remedy for cure is worse than the disease because it involves borrowing with no intention to payback. It will only be seen over time, but increasing state and federal deficits are just about the single most misguided way to bring a nation back to prosperity.
                In the weeks before the election, the current “Keynesian” economic theory which has controlled the political landscape of this country for the past decades will be very much put to the test. In this model, the economy is stimulated by the government in the form of spending and, at no time in the history of our country have we spent this much with this little effect. This massive borrowing pawned off on treasury and municipal investors is the result of the Keynesian theory at its worst. The result is — inflation in the treasury markets and default in the municipal markets. In recent months we have seen a record influx of money flowing into longer duration bond funds in the reckless pursuit of yield. Income investors need to accept the fact that they have very little potential to achieve any meaningful income in the bond market and they should be out of long term bonds. Investors should pay very close attention to the health of the municipalities they invest in. Today’s yield seekers remind me of a quote from Paul Newman, “If you’re playing a poker game and you look around the table and can’t tell who the sucker is, it’s you”. Investors may be well advised to consider the famous last scene in the movie SLEEPLESS IN SEATLE where Meg Ryan (Annie) finds the love she’s looking for in Tom Hanks (Sam) at the observation deck of the empire state building — leaving me to wonder — maybe we have much more control over our destiny than we sometimes think.

Thank You,
Jeffrey C. Sica
President
Sica Wealth Management, LLC

Fatally Flawed

The relevance of fatal flaws and finding opportunities.
In my last article, I discussed the need to embrace a new way of thinking — a way  to achieve the results we are looking for in the troubled days ahead and a way to deprogram ourselves from the “buy and hold mindset”.  At the very core of these strategies, is a philosophy which involves establishing a definition of — what strategy is fatally flawed? Once established, we can, in a sense, turn that strategy upside down to reveal its central flaws. In my last post, I discussed the basic problem with the research originating from the large financial institutions and how that research has destroyed the financial lives of many trusting investors. I see countless examples of the spokespersons for these financial institutions disbursing information which, at its core, is just designed to perpetuate the fuel to run these very institutions. That fuel is convincing you to “buy and hold”.   In fact, if you study the structure of these financial institutions, you will find that their very existence is dependent on your willingness to “buy and hold”.  They want you to hold whatever they sell you forever — even if they decide to sell their shares without your being aware. It is impossible to simply ignore these institutions, as they have a tremendous influence on the market. However, it is important to understand the basic flaw of who they are and what they stand for in order to make sound investment decisions.  A perfect example of this is when you hear an analyst discussing the strategy of “buy and hold” as it refers to “valuations” — and most of all how “valuations are historically the most attractive” in x number of years.  Anytime I hear this argument, I am infuriated because historical valuations are meaningless in a recession.  To use any measure to determine how cheap stocks are is just a ploy to get you to “buy or hold stocks”.  Valuations are only relevant perhaps in the “sell” decision and are never a justification to “hold”.  I would equate this “flawed strategy” to going to the grocery store to find that all of the milk is on sale, only to learn it is on sale because it is past its expiration date. The lesson of this flawed strategy is —there is a time to own stocks when economic conditions support owning stocks and there is a time to reduce or eliminate stock positions at a time when economic conditions do not support owning them — like now.
                The flawed “buy and hold” strategy has been defined and we have effectively dismantled the “valuation” myth, so now we can look at the market in “reverse”. This means we look for market flaws and define those that are fatal. Those fatal flaws are crucial in our decision making. If the markets are rallying on the “valuation” myth with no supportive economic improvement, I would use an inverse Exchange Traded Fund to capitalize on the inevitable decline of that index or sector as well as using an Inverse Exchange Traded Fund to hedge any position I am being forced to hold. I would also use an Inverse Exchange Traded Fund if the market is rallying on flimsy economic data or the “maybe someday” rational, that the economy will improve because one economic report improved a fraction of a percent while several others didn’t. The sooner we realize that the economy is either improving or not improving, we see that the “maybe someday” theory doesn’t work because someday could be a long way away.
                Another fatal flaw to be recognized is the myth that more failed government policy will reverse a market or economic downturn.  In the case of the recent market advance this Friday, investors decided to buy stocks because Ben Bernanke said the Central Bank will do “all it can” to sustain an expansion. That expansion is still restrained by weaker –than-expected consumer spending and poor job growth. First of all, the fatal flaw in this proclamation is that we have heard this before when we were first introduced to the stimulus bill and thus far we have seen virtually no improvement in the economy  — especially in the employment situation. Apparently, Mr. Bernanke is saying — you know those things we have been doing to get the economy going that aren’t working? Well, we are going to do more of them. Second, the fatal flaw in Bernanke’s statement that the government would continue to “buy debt” to keep interest rates low is, that this “quantitative easing” or what I like to refer to as “quantitative dis-easing”,  is creating artificially low interest rates and high bond prices which could potentially result in an inevitable bond bubble. The opportunity here — allocate money in anything which counts on interest rates going up and use Inverse ETFs which short the U.S. treasury to hedge existing positions. The strategy of using interest rates and Central Bank activity as the barometer for inflation is, at its core, fatally flawed since the Central Bank is keeping interest rates artificially low through “quantitative dis-easing” and “Fed Policy”. The real inflation will be seen in rising commodity prices as it is beginning to show in China. The opportunity — buy commodities and precious metals because they will be the only true gauge of inflation prior to the “bond bubble” bursting. The economic consequences of the “bond bubble” bursting will be catastrophic to the overall economy and to consider bonds a panacea against the volatility of the stock market is a fatally flawed way to think. This fatally flawed strategy of viewing bond yields, economic reports and interest rates as the true gauge of inflation will ultimately result in investors being annihilated in a bond based long strategy when inflation takes hold. The opportunity — recognize that once the fed discontinues artificially low interest rates, inflation will result. Commodity prices will be a much more accurate economic indicator so the opportunity is — invest in commodities and precious metals in advance of the Central Bank backing off their failing strategy. We will never see the Central Bank buying commodities to artificially keep commodity prices low, therefore they are a much better gauge of reality.
                If we embrace this type of reverse thinking we will begin to see the market and the economy as it really is and not as we want it to be. If we continue to think through the fatal flaws of the market and find the opportunities which lie in them, we will realize ultimately the best characteristic of this economy and market is not that “it always goes up”, but rather that that it always provides opportunities to those who eagerly seek them out. We will make our greatest fortunes when our discipline allows us to think in a way that may defy the logic of those around us. Every market, every economy and for that matter, every person is flawed in some way.  It is this recognition that no flaw, whether in our portfolios, in our economy, in our markets or in ourselves need be fatal if we acknowledge its existence. It is only in denying its existence that it becomes a destructive force in our portfolios, our economy and most importantly in our lives.

Thank You,
Jeffrey C. Sica
PresidentSICA Wealth Management, LLC