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Yesterday, in order to reduce volatility and protect our principal, we took some defensive steps with commodity stock positions in many accounts with larger allocations to this class. Based on yesterday's closing prices, more steps will likely be taken in the coming days to reduce volatility and protect capital. As shown in the chart below, the long-term trendline from 2002 in commodity stocks has been breached. Even if we see a rally from here, we will use it as an opportunity to reduce our exposure. The closing price of PSPFX has now breached levels which move the current declines beyond a "normal correction" for this investment. While we are not calling a top, the evidence we have warrants some action.
We also took some defensive action yesterday in accounts with heavier weightings to gold mining stocks. If levels are breached which possibly call into question the long-term trend, we will not hesitate to take additional action.
The great bull market in stocks began in 1982 after years of lackluster inflation adjusted returns. The chart below shows the trendline from 1982 has now been broken. With the exception of HSGFX, which is hedged, our exposure to U.S. stocks has been very limited (good news).
While financial stocks have hit a violent intermediate bottom and could rally for a while longer the odds favor lower lows in the months ahead as housing prices continue to decline. The chart below illustrates the structural nature of the problems facing the housing and financial industry. There are fundamental reasons financial stocks have been hit so hard, reasons which go way beyond short selling. Additional bank failures in the coming months would not come as a surprise, which is supported by the rapid deterioration of the sector. Since our economy has become so dependent on the availability and use of credit, these problems will continue to impact U.S. and global growth.
A recent Bloomberg article illustrates the vast difference between supply and demand in housing. The banks and GSEs (Fannie & Freddie) are overloaded with foreclosures. Vandals often step in making homes near impossible to sell.
July 23 (Bloomberg) -- Fannie Mae, the largest U.S. mortgage finance company, couldn't find a buyer who would pay $6,900 for the three-bedroom house at 1916 Prospect St. in Flint, Michigan. So broker Raymond Megie, who is handling the foreclosure sale, advised cutting the price to $5,000. Megie still couldn't sell it. "There's oversupply," he said. The home sold in 2005 for $110,000. Banks around the globe, especially in Europe, are facing similar problems with mortgage losses.
Stocks Could Rally For A TimeIf you have really done your homework from a statistical perspective, you know methods which trigger signals to enter markets are not the holy grail of investing (said another way, none of them work all that well including the ones we use). In the long run, where you can add value is by improving your tactics for exiting positions. In the simplest form, you let your winners ride and you keep losses to levels which, within the context of the entire portfolio, you can recover from. You can enter the right market and do all the right things and still have negative outcomes. You know this going in. This is a long way of saying, even if we believe in some holdings and our entry point was sound, we cannot let them go against us for too long. Discipline in the short-run may harm your ego by taking a loss, but in the long-run it protects your confidence by protecting capital. Investing is not about trying to be right all the time or about defending predictions, but about protecting and growing capital within the context of an uncertain future.
Things Will Settle DownWhile the volatility has reached near unacceptable and gut-wrenching levels, our approach to money management allows for some losses and volatility in an effort to stay with long-term trends. As a result, it is not surprising that things are presently a little unnerving. You can find past writings where I clearly state how we handle major trend reversals, including that some discomfort is to be expected.Major trend changes, which we are seeing around the globe, are never pleasant to navigate through. While we expect the financial markets to remain volatile, our volatility should come back to more acceptable levels after we adjust to the changing environment. It is not difficult to spot clear trends in the charts above. One of our objectives is to remain in line with prevailing trends. We have a well-defined and disciplined approach to deal with the current environment. It will take some time to execute our plan as conditions unfold. We appreciate your patience as we continue to take steps over time to reduce the current volatility and move toward more pleasant short-term outcomes. Due to ongoing volatility, we may park some cash in some conservative higher-yielding money markets for a while.
Chris Ciovacco
All material presented herein is believed to be reliable but we cannot attest to its accuracy. The information contained herein (including historical prices or values) has been obtained from sources that Ciovacco Capital Management (CCM) considers to be reliable; however, CCM makes any representation as to, or accepts any responsibility or liability for, the accuracy or completeness of the information contained herein or any decision made or action taken by you or any third party in reliance upon the data. Some results are derived using historical estimations from available data. Investment recommendations may change and readers are urged to check with tax advisors before making any investment decisions. Opinions expressed in these reports may change without prior notice. This memorandum is based on information available to the public. No representation is made that it is accurate or complete. This memorandum is not an offer to buy or sell or a solicitation of an offer to buy or sell the securities mentioned. The investments discussed or recommended in this report may be unsuitable for investors depending on their specific investment objectives and financial position. Past performance is not necessarily a guide to future performance. The price or value of the investments to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. All prices and yields contained in this report are subject to change without notice. This information is based on hypothetical assumptions and is intended for illustrative purposes only. PAST PERFORMANCE DOES NOT GUARANTEE FUTURE RESULTS.
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