July 2010 Market Update

MARKET COMMENTARY

July 2010

 

Stacey and I want to thank each of you for your patience and cooperation during our transfer from Commonwealth to Sorensen Financial Management, Registered Investment Adviser with Charles Schwab & Co, Inc. as custodian.  You should now be receiving statements from Schwab and we are working on preparing your next quarterly report with the historical data on your account.

We are very pleased with this new arrangement for it allows me greater latitude in managing your portfolios and responding to changing market conditions.

I trust that you too will be pleased with the change as time goes on.  Let us know if you have any questions.

 

FINANCIAL REFORM BILL

 

The long awaited and debated financial reform bill finally passed on July 16, 2010.  The primary issues that were addressed in the bill are as follows:

The transparency and independence of the Federal Reserve System.

  1. What to do about financial institutions that, if allowed to fail, could bring down the entire financial system.
  2. The derivative and hedge fund markets that are so large and unstable that they threaten the stability of all markets.
  3. Credit rating agencies that are supposed to be objective in rating securities for investors are in bed with the issuers of securities.

 

General guidelines were established to deal with these matters but the real work begins now as the regulatory agencies develop rules to apply the new law.

 

Will the bill actually accomplish anything?  Not much in my opinion.  Remember these are the same regulators that were charged with enforcing the existing laws to make sure none of this happened in the first place.  The people that commit these abuses are so far ahead of the game that overburdened government agencies will never keep up.

Secondly, the banking industry and Wall Street asserted so much influence on the legislative process that they came away virtually unscathed.

Bill Gross, one of the most successful bond fund managers, expressed it best when he said,

“They should have just made Paul Volker (Former Chairman of the Federal Reserve), Dictator in Chief instead of continuing to let Wall Street own Washington.”

 

Bottom line, you cannot legislate morality.  In this day and age we seem to have an oversupply of very unethical people in high places.

 

 OUR PORTFOLIO STRATEGY

 

Does the reform bill change my assessment of where our monies are best placed?  Absolutely not.  In fact it reinforces my concern that the market is still in the hands of day traders with super computers.  While the bill requires some types of derivatives to trade on exchanges, it does not make them illegal which is the only way those in the know say their deleterious effects can be stopped.

Also, it does not address flash trading or dark pools which now constitute 60 – 70% of the trades on the NYSE and 2/3rds on the NASDAQ.  Dark pools are trades done away from exchanges by hedge funds etc., and are only reported at the end of the trading day.  The exchanges collect fees from this type of activity.  Obviously this trading is not regulated and can cause enormous volatility as we have seen.

I am convinced that the only way to make any returns at all on your investments without risking the loss of your principal continues to be in government and/or very high quality corporate bonds.

In view of this, most of you will see that I have purchased units of a “Corporate Income Trust Series 2” in your accounts.  Just like the first UIT we formed a year ago, I worked with the bond analysts at Van Kampen to choose high quality bonds for the Trust.  We did not rely on credit rating agencies, but instead the analysts combed the balance sheets of each company to be assured of its strength.  This will bring the allocation in most of your portfolios to approximately 65% corporate bonds (through UITs) and 35% in short term Treasuries and cash.  For clients taking income we did not purchase the new UIT as we need to keep your portfolios more liquid.

The interest rate on the Trust is in a range of 4.5% current yield, and 3.4% yield to maturity.  These bonds will mature in approximately 7 years.  By comparison, 10 year treasuries were yielding below 3% when we purchased the new UIT, so we got a higher yield with a shorter maturity than treasuries without giving up a lot on quality.

Remember, this is not a bond fund.  This is a unit Investment Trust.  These bonds will mature inside the trust and if held to maturity, will return your principal unless these companies default.  The units of the trust can be sold at any time if needed, but like any bond you could get more or less or the same as what you paid.  If, as it appears, we are in deflationary times; the value of the interest you receive on the bonds and the principal when it is returned to you will be worth more than it is now.  In deflation, the purchasing power of the dollar increases over time.

I am satisfied that this is the best possible strategy for our life savings at this time.  If conditions change and I want to do something different we are not locked into anything.

 

NEWEST THREAT TO WORLD ECONOMIES

 

On the international front much graver issues are in debate than financial reform.  We are at a very dangerous juncture where the Central Banks of the world must decide whether they will continue to prop up their ailing economies with more stimulus money thereby increasing their national deficits or will they reduce all spending in an attempt to pay down the debt.

The consensus of world leaders is that there is no consensus.  Many believe without continued stimuli their economies will sink back into an ever deeper recession.  Others fear that continuing to borrow money to provide the stimuli will take their national debt to levels that they will never be able to recover from; risking systemic currency collapse.  Critics of that strategy predict that tightening spending will send the world into depression.

Federal Reserve Chairman, Ben Bernanke’s recent statement that the future is “uncertain” marks a definite retreat from his former statements about a recovering economy.

The next few months will be very critical as international leaders walk a very fine line between tightening too much or too little.  What is different for us is that the United States is no longer in the economic driver seat.  By incurring so much public debt we are in a weakened position just as any company or individual loses status when there is a question as to whether they can repay their debts.

Countries like China, whose citizens have saved their money, are in more powerful positions.  Indeed, one of the solutions to this current dilemma is to persuade the Chinese people to start spending their money by buying our exports.  Whichever way you look at it, we are not in control any longer.  This is why I am being very cautious in positioning your investments.

We are having such a beautiful summer this year.  Let me do the worrying about the economy and you enjoy yourselves.

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