Chief Capital Management, Inc.

“The last few years have been the most volatile for all of recorded history.”
-Professor Andrew Lo
M.I.T. Sloan School of Management

“We don’t think that it’s a smart way to manage to be taking the temperature
every day because you’ll be trading your portfolio till the cows come home.”
–Alex Young
Standard and Poor’s Equity Research

     You hate uncertainty and you’ve got uncertainty in spades in the last few years. You don’t have confidence in the government to deal effectively with economic issues like unemployment, deficit-reduction, and tax policy. You don’t trust Wall Street because much of the blame for the economic and market meltdown that began in 2008 comes from speculation and manipulation perpetrated by professionals who knew better either morally, ethically, and/or legally. You don’t have much confidence that the Euro nations can prevail on their less solvent members to adopt austerity measures to qualify for additional bail out funds. All in all it’s a bleak picture and markets are demonstrating that gloom. At the market close today, U.S. stocks fell more than 2% sending the Standard & Poor’s 500 Index to its biggest quarterly drop since 2008 largely on reports from China and Germany pointing to a global economy that is slowing.

     So, what can you do? First, understand that daily buying and selling goes on because different types of investors are seeking to accomplish different types of returns. Day traders–both individuals and institutions–want to literally make a quick buck by sudden buys and rapid sells. You, by contrast, are looking for a long term investment that will grow on an after-tax basis faster than inflation. Ideally, you’d like to see your retirement account balances go up each and every month steadily. Second, accept the fact that market activity reflects a lot of “noise” (pundits’ opinions, rumors, speculative musings) and sometimes the “signal” (earnings per share, firm productivity, financial statement strength) gets ignored. Third, realize that in the long run a balanced portfolio of high quality, low cost mutual funds with attractive, consistent, risk-adjusted returns serves the best interests of diligent and serious investors.

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“We shall not cease from exploration, and the end of all our exploring
 will be to arrive where we started and know the place for the first time.”
-T. S. Eliot

“The tragic events of September 11 have affected us all and in ways we may not yet fully appreciate. The greatness of our country and our citizenry are frequently forgotten during the routine course of our daily lives. Business, personal, educational, and social activities demand more and more of our time and attention leaving little opportunity for quiet reflection and appreciation. It’s odd that in a time of the greatest personal and national suffering we see our true selves comforting strangers, being neighborly to those we’ve never met, and directly feeling the affection of other nations and peoples who mourn for us and our shocking loss. I hope that you have found a way to reconcile this national and personal suffering with your own sensibilities and can look forward with optimism to a future of promise.”

 When I sent you these words 10 years ago, my intention was to offer some comfort and encouragement. In many ways you might still feel the need for more of the same given the decade that we’ve been through. Many of the retrospective editorials and commemorative discussions have ranged widely over the significance of 9/11 and the world we now live in. Many focus on our national security, international relations, our wars, the economy and, inevitably, politics. For you and most Americans it’s the life you live day by day that holds the greatest personal importance. So much of what’s covered in the media, while important and relevant, is simply beyond your control.

 As you reflect on 9/11 and this past decade, think of how you have accommodated yourself to our horrific tragedy and the vast changes it has led to in all parts of your life. Take stock of your efforts, successes, setbacks, and your continuing pursuits looking ahead. Understand what traits of yours have brought you the greatest satisfaction and happiness. Appreciate the good results that you’ve been able to bring about and be encouraged to accept that not every good effort is rewarded. Take the counsel of your own experience and draw lessons to follow in the future. Treasure your lifelong values that serve you well and create new ones that might better help you and your loved ones. Be aware of the fact that you are faced with risk and uncertainty every day and recognize that the first can be managed and the second can’t. Finally, if you are grieving a loved one this September 11, remember all his or her wonderful qualities and apply your grief positively by carrying on as he or she would have wanted.

 America is the greatest country on earth and its greatness comes from you and all Americans living happy, productive, and generous lives. Think about this day and ready yourself for brighter days ahead.

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“Patience serves as a protection against wrongs as clothes do against cold.
For if you put on more clothes as the cold increases, it will have no power to hurt you.
 So in like manner you must grow in patience when you meet with great wrongs,
 and they will then be powerless to vex your mind.”
-Leonardo da Vinci

 Believe it or not, the Dow Jones Industrial Average is actually up for the year through the end of August. Even though a positive gain of .3% isn’t much to write home about, it is good news in light of all the market volatility we’ve been through lately. The index has regained nearly half of the more than 2,000 points (16%) that it lost in value from July 21 to August 10. The Dow Jones Industrial Average remains off by 10% from its three-year high set on April 29. Since mid-July stocks have dropped sharply due in part to worries over the possibility of the US government defaulting on its debt obligations and over the actions of Standard and Poor’s in downgrading the country’s credit rating.

 The Morningstar website shows all stock Categories down for the last month, the last three months, and the last eight months. The fact that one-year returns are positive and generally in double digits indicates the strong market performance we realized in the last half of 2010. On the other hand, bond Category Averages are generally positive for the last month, the last three months, and the last eight months. Most of those returns are in single digits, however.

 All in all the month of August itself is notable for its extremes. If you needed reassurance that the US government’s 10 year treasury note was still in demand, you got it on August 18. At market close the yield on the treasury note dropped to 1.98%–the first time it ever finished lower than 2%. The yield drops as the demand and the prices paid on the open market for the 10 year treasury note increase.

 The average rate of a 30 year fixed mortgage dropped to 4.15% in the week of August 18. This is the lowest rate in over 50 years. The weighted earnings per share for the Standard and Poor’s 500 companies reached $22.27. This figure beats the previous record set in the second quarter of 2007. These reporting firms have excellent and increasing revenues which makes them more and more attractive to investors.

 Unfortunately all the bad news in the US and from Europe make investors nervous. More than $30 billion was pulled out of stock mutual funds in the week ended August 10. This is the single largest withdrawal on the part of investors since October 2008. In plain terms, the true market fundamentals indicate that several publicly traded firms are very attractive buys even though individual and institutional investors are so worried about the economy that they can’t commit to stock purchases that would otherwise be smart moves in more nearly normal times.

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“I think we ought always to entertain our opinions with some measure of doubt.
I shouldn’t wish people dogmatically to believe any philosophy, not even mine.”
-Bertrand Russell
 
“I’m not sure I want popular opinion on my side.
I’ve noticed those with the most opinions often have the fewest facts.”
-Bethania McKenstry

 Party pundits rant and accuse and promise glibly. They throw around figures, percentages, quotes of saints and sinners, and taglines they want repeated by those they’re preaching to. Given all the political rancor and vitriol we’ve seen and heard over the last three years, you probably welcome any comments that seek to illuminate and explain rather than simply damn or praise. Warren Buffett’s recent comments in The New York Times and on Charlie Rose do just that. His points have enough appeal that they’re worth attention and study regardless of your own politics. You may or may not be a fan of this uber-capitalist but his ideas are specific and worth a listen.

 Basically, Buffet is arguing that the mega-rich (his term) have been spared when political leaders ask the American public for “shared sacrifice” usually referring to higher taxes. “Some are investment managers who earn billions but are allowed to classify [their] income as ‘carried interest,’ and thereby [pay only at a] 15 percent tax rate. Others own stock index futures for 10 minutes and have 60 percent of their gain taxed at 15 percent, as if they’d been long-term investors.”

 “Last year my federal tax bill [income and payroll taxes] was $6,938,744. That sounds like a lot of money. But I paid only 17.4 percent of my taxable income. That’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent.”

 The Wall Street Journal ran an editorial that saw Buffett’s article as a promotion of the administration’s tax plan that asks for higher tax rates on individuals making more than $200,000. Despite the back and forth proposals and the even more fierce debates that will come once the Joint Select Committee on Deficit Reduction meets, the important thing for you as an American taxpayer to focus on is what’s good both for you and for your country. I hate paying taxes. Nevertheless, I love America and I want it to continue to be a land of opportunity. “Americans are rapidly losing faith in the ability of Congress to deal with our country’s fiscal problems. Only action that is immediate, real and very substantial will prevent that doubt from morphing into hopelessness. That feeling can create its own reality.” Let’s hope Congress can heed this call and come up with a rational tax plan everyone can hate.

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“The politicians were talking themselves red, white and blue in the face.”
-Clare Boothe Luce

“Politics is the gentle art of getting votes from the poor and campaign funds from the rich,
by promising to protect each from the other.”
-Oscar Ameringer

 Americans receiving government services don’t want them cut and Americans paying taxes don’t want them increased. In your own home, you can make adjustments to cut your household expenses and, to a certain degree, increase your income to balance those expenses and your revenue. Doing it at the level of the federal government, however, seems impossible. It’s like belonging to the “homeowners association from Hell” and being dissatisfied with the services you get and the dues and assessments you must pay.

 How’s the U.S. government doing in restoring the confidence of Americans in the economy and the financial markets? Well let’s just look and some developments this week that seem to measure that public confidence.

 First, the Pew Research Center for the People & the Press and The Washington Post  conducted a poll July 28-31 among 1,001 adults and asked them to “use one single word to describe your impression of the budget negotiations in Washington.” Nationwide, 72% described the recent negotiations in negative terms such as ridiculous, disgusting, stupid, terrible, disappointing, childish, joke and frustrating. Only a very few offered a positive (2%) or even neutral (11%) assessment of the acts of Congress.  So much for the verbal expressions of public opinion.

 Second, the U.S. stock market this week dropped more than 512 points (4.3%) yesterday and today only staged a tepid improvement of 61 points (.5%) after trading within a 460-point range during the day. Clearly, investors are discouraged because of the continuing weakness in the economy and downward revisions of the GDP for both the first and second quarters of the year.

 What should an investor do? Be patient. Since the early 1930s, we’ve had at least one major decline of about 15% or more in the S&P 500. Those declines were often followed by strong recoveries. The average annual total return for the five-year periods after each decline was positive 100% of the time and a hypothetical $10,000 investment in the S&P 500 would have at least doubled 12 out of 16 times in those periods. There’s no guarantee that our future will look so rosy. Nevertheless, holding tight through bad markets might be a better approach than turning mere paper losses into actual dollar losses.  Stay tuned.

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“My recipe for dealing with anger and frustration:
 set the kitchen timer for twenty minutes, cry, rant, and rave,
and at the sound of the bell, simmer down and go about business as usual.”
 -Phyllis Diller

 
A friend called the other day totally exasperated with the state of the country. Republicans and Democrats in office don’t care about America or its people but only their own narrow financial interests, he said. Once out of office, they enjoy their retirement and their freedom from any ongoing liability for their decisions which continue to negatively affect so many. He went on at length to list the pet projects of these folks and to explain how they serve only the few. Finally, he relaxed a bit and, somewhat relieved–you know how a little venting can do that–he acknowledged that there really wasn’t anything to be done. I felt helpless to offer anything other than a string of “I know how you feel” responses and a timid suggestion that he think about writing his representatives in Congress. What’s so daunting about our current economic and financial mess is that good people like my friend are suffering through no fault of their own. If you, too, are frustrated, know that many responsible Americans like you are also waiting for the day when their positive participation in the American society and economy are rewarded. It will come.

 The Morningstar database reports the following mutual fund Category returns for broad groupings Year to Date (January 1 through July 22) as of the close of business today:
U.S. Categories          6.43%  (Large Value)              to 8.86% (Mid-Cap Growth)
Foreign Categories    4.25%  (Small-Mid Growth)  to 4.98% (Large Value)
Bond Categories        3.00%  (Intermediate Govt)  to 6.51% (Inflation Protected)

Keep in mind that more concentrated Categories within these three groups fell above and below the ranges here. The U.S. Category of Health returned 16.32% and Financials -1.19%, for example. 

 More broadly, stock funds continue to perform more strongly than bond funds and U.S. stock funds are performing better than foreign stock funds. This pattern has been consistent over the last year and well-diversified portfolios are arrayed across these asset classes based on the individual risk tolerance of the investor. Watching these Category returns doesn’t offer many predictive insights. Nevertheless, they do confirm, from the top down, that both the bond and stock markets are, as leading indicators, pointing to continued economic improvement but at a slower rate than most would like.

 All in all these numbers tell a tale of investor sentiment and expectation that is positive for these markets. In time, this good news should only improve once consumer spending, corporate expansion, and residential construction improve. Along with those developments, unemployment should decline and then all of us will start to feel that our recession is truly behind us.

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“Never Mind.”
-Gilda Radner as Roseanne Roseannadanna
Saturday Night Live

 Does current market activity remind you a bit of last year’s? In mid-2010 economists and other commentators wrote about an impending double dip recession. For the most part May and June seemed to be indicating the same lackluster progress and you might have worried about the country sliding backwards. Today, at the end of the second quarter, it looks like that soft patch is behind us.
 
 Many economists and analysts lowered their estimates for economic growth in May once faced with negative reports on manufacturing, consumer spending, and a low level of hiring by nongovernment entities.  Other negative news focused on a low supply of computer chips and auto parts from Japan, an increase in gas prices, and terrible weather in the South. Stocks had lost most of their gains for the year by mid-June. U.S. manufacturing has been stronger than expected in June, however, and the Dow Jones industrial average was up 168 points today. For the week, the Dow ended up 648 points, or almost 5.5% percent–the best single week for the index in two years.

 On Thursday, Greece voted on domestically unpopular measures that smoothed the way for it to receive its next round of loans to avoid default on its debt. Greece is in a real mess and that country, in time, will have to come to grips with excessive borrowing and literally living beyond its means. That news in the form of higher unemployment and cuts in wages and benefits have led to street riots that highlight our evening news.  

 Federal Reserve Chairman Ben Bernanke and a number of prominent economists have argued that the economy will pick up again once the effects of the Japan disaster have passed and high gas prices have declined. Keep in mind that the stock market is seen as a leading indicator of future economic growth. Despite all our problems around the world, cooler heads believe that solutions are workable even if painful.
 
 Robert Johnson, CFA at Morningstar summarizes the situation optimistically. “But as bad as the numbers will look over the next month or two, there are some hopeful signs just down the road. Longer term, I am convinced that decent productivity growth, favorable demographics, and a sustained real estate recovery beginning in 2012 could drive the economy forward for some time. That is, if the politicians don’t mess it up.”
 

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“We cannot alter facts, but we can alter our ways of looking at them.”
-Phyllis Bottome
“Blessed is the person who is too busy to worry in the daytime,
 and too sleepy to worry at night.”
-Leo Aikman

May wasn’t a good month for the markets and so far June is filled with more bad news. Six weeks ago the stock market was at its highest peak since the Great Recession began. Since then it’s been a rough patch and return figures in various sectors and industries are negative certainly for the latest month, and in some cases, or two. The difficulty in tracking financial activity and economic data is that you don’t really know how to answer the questions you’re inevitably asking yourself: “So what? What does this all mean? What should I do now?”

 A market correction is defined as a decline of 10% or more from a previous market high.
Standard and Poor’s reports that the S&P 500 index is down over 7% since its close at the end of April. Since 1946 there have been 18 corrections during 12 bull markets (more vaguely defined as “a period where investment prices rise faster than their historical average”). These corrections have lasted about 4 months and, on average, stock prices have dropped 14%. You might remember the correction we had in 2010 between late April and the end of August when the S&P 500 index did drop 14%. What made 2010 a relatively good year overall was that the correction was followed by an eight-month climb. 

 Sometimes the best approach to take toward less than stellar market news is to ignore it. Market declines don’t necessarily signal the beginning of a long stretch of losses. During the 1980s and 1990s many investors, in fact, became accustomed to corrections and simply added to their portfolios by “buying on the dips.” They bought when the market dropped because they had confidence in their stock holdings and saw “the dips” as “sales events” where they could gather up more shares at a discount. 

 You know that the Republicans and the Democrats are fighting over the details of a new budget that each promises will get America back on track as a more nearly solvent debtor to the nations of the world who hold our U.S. government bonds. Some could look at this state of affairs and conclude that the U.S. might be downgraded as being a riskier client to be lending to. One commentator recent explained that the credit worthiness of Greece and other European nations make America look like a “prime” borrower compared to the alternatives. Take all this data as you will and embrace the longer view even though, at times, that might test your patience.

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“The bravest are surely those who have the clearest vision of what is before them,
glory and danger alike, and yet notwithstanding, go out to meet it.”
-Thucydides

“A hero is someone who has given his or her life
 to something bigger than oneself.”
-Joseph Campbell

      Today is Memorial Day. Originally it was a remembrance of fallen Union and Confederate soldiers and it was first observed May 30, 1868. The date was chosen because it was not the anniversary of a battle. After World War I it was extended to honor Americans who died in all wars. Today graves will be visited and cleaned and decorated with flowers, letters, children’s artwork, and other realia meaningful only to the mourners and the mourned. Many Americans will spend the day at leisure–grilling, shopping, playing with the kids and friends–perhaps only thinking about war and veterans when watching televised specials celebrating this day with patriotic songs. 

     As the face of war has changed over centuries so, too, has the face of sacrifice and loss. The dead have given their “last full measure of devotion” as Lincoln put it. Similarly, the living veterans have also given their all and lived to carry on lives born out of that transforming experience. Those who left home to fight return as different souls. Some for the better but many for the worse. 
        
     So what then do we do on Memorial Day? There is so little that we can do and yet a little from many can help ease the pain of loss, can validate the sacrifices made, and can encourage optimism for a new life after military service. Think about making Memorial Day and every other day of the year a time of grateful reflection and appreciation. Visit a gravesite or a memorial and thank the dead for their fidelity and their duty to you and your family and your great life as a free American. Then think about passing along the same message to the living veterans you know and meet. If you have veteran friends, relatives, or acquaintances, thank them. Tell them you’re grateful for their duty. Tell them you admire their service to their nation. Look them in the eye, shake their hand, and speak to them from your heart. It can be brief and direct and whatever your words, it will be perfect. Be ready for any response and listen to those who want to talk and respectfully move on from those who don’t. If all this is too direct and personal for you, consider flying the flag. It really is a beautiful flag that tells others much about you.
 
     Remember what these veterans have given. These acts of thanks suggested here should come from your heart and make sense in your head. If you served, you know what you went through and gained and lost. If you didn’t serve, compare your life experiences to those who did. Think about that and honor veterans today–both the quick and the dead.

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“If the economy were a 19th century clipper, it would be fair to
 say its mainsail–consumer spending–is luffing, the
 nautical term for flapping in the wind.”
-Paul Vigna
The Wall Street Journal

     This afternoon Morningstar analyst Jeremy Glaser offered several comments to summarize the current state of the market. Essentially the U.S. market continues to perform well despite mixed economic data. Consumer spending increased by 0.4% in April, a slowdown from the 0.5% rate measured for March. Incomes rose 0.4% as well, in line with economists’ expectations.  Pending residential real estate sales dropped by 11% in April according to the National Association of Realtors. The index had increased over the last two months, but this unexpectedly large decline shows how fragile the national housing market is.

      Consumer sentiment increased in May according the Reuters/University of Michigan index. The index reading of 74.3 was significantly higher than the 72.4 that economists had anticipated. Inflation expectations fell for both the one year and five year periods. This is good news even though actual increases in consumer spending when scrutinized are more attributable to inflation and specifically to higher gasoline prices. 
 
     The Morningstar database reports the following mutual fund Category returns for broad groupings Year to Date (January 1 through May 27) as of the close of business today:
U.S. Categories           5.62% (Large Growth)           to 9.23% (Small Growth)
Foreign Categories   -1.45%  (Emerging Markets)  to 5.23% (Europe Stock)
Bond Categories         5.29%  (Hi Yield Bonds)          to 1.10% (Short Government)

Keep in mind that more concentrated Categories within these three groups fell above and below the ranges here. The U.S. Category of Health returned 15.52% and Financials -.02%, for example. 

     Overall, stock funds continue to perform more strongly than bond funds and U.S. stock funds are performing better than foreign stock funds even though the spread between these groups narrowed for the month of May. This pattern has been consistent over the last year and well-diversified portfolios are arrayed across these asset classes based on the individual risk tolerance of the investor. Watching these Category returns doesn’t offer many predictive insights. Nevertheless, they do confirm, from the top down, that both the bond and stock markets are, as leading indicators, pointing to continued economic improvement but at a slower rate than most would like.

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