Contravisory Blog

Excerpt from this month's ContraSignals

This week we are sharing some insight from our monthly research publication, ContraSignals.  One of the most popular components of ContraSignals is our group focus recommendation report.  Each month, our we provide a buy or sell recommendation for a particular industry group based on our unique relative strength perspective.  This month's group focus recommendation centers on investment banking and brokerage stocks.

For the second time this year we are recommending a strong sell on investment banks and the brokerage industry.  We believe weakness in the relative price trends could be foretelling an end to their historic business models.  A model that was substantially aided by a near 30 year secular decline in interest rates combined with a totally opaque fixed income market.  Now with interest rates near zero, and potential change in customer fiduciary responsibility, the market is saying "beware."  It's highly unlikely these companies will be able to recognize, or adjust to, their changed business conditions any time soon.  Sell investment banks and brokers. 

Click to download the accompanying chart Download GroupFocus0910. 

Enjoy the long weekend everyone. 

 

Interest Rates and Bond Performance

According to The Investment Company Institute, from January 2008 through June 2010, outflows from equity funds totaled $232 billion while bond funds have seen an inflow of $559 billion!  With data like this, we can't help but wonder if the bond market is the next bubble to burst.  It's no surprise how popular bonds are considering their performance since 1982.  Starting in 1982, the Fed began easing interest rates (through the Fed Funds Rate) from its peak of around 19% all the way to our current day rates of practically nothing.  With rates at near 0, we've been wondering what could be in store for bonds if and when the Fed decides that it's time to start raising rates again. 

For a historical perspective, we took a look back to 1955.  In January of 1955 the Fed Funds rate was just over 1%.  From 1955 through 1981, the Federal Funds Rate gradually increased from 1.39% all the way to 19.08%.  Rising interest rates adversely impact bond prices.  As rates rise, the higher, more attractive bonds that come to market cause existing bonds values to decline (bond yields and prices act in an inverse relationship). 

We thought we would take a look at the performance of the bond market during the rising interest rate environment of 1955-1981 to see how bonds performed.  The results were stunning. 

The average annual performance of bonds from 1955-1981 (as measured by Long Bonds) was just +2.0%, much less than the historical long-term average for bonds.  To put that in perspective, if you invested $100 in bonds in 1955, your investment over the next 26 years would be worth just $174.  Also keep in mind that the period of 1955-1981 was one of above average inflation.  If you take inflation into account, the inflation-adjusted value of your $100 investment would be just $50, a 50% decline.

For comparison purposes, over the same period, the average annual return for stocks (as measured by the S&P 500) was +10.1% and a $100 investment would have grown to $997.    Adjusted for inflation, your stock investment would be worth $294. 

The Fed Funds Rate is currently at 0.21% and one thing is for sure, it can't go much lower.  Using history as as our guide, when rates eventually rise, would you rather be invested in stocks or bonds? 

Contravisory Q2 Letter to Investors

This week we are sharing some of our insight and market perspective from our most recent quarterly letter to investors: 

After one of the most impressive post-bear market rallies in history, the over-analyzed “pullback” in stock prices finally stepped forward during the 2^nd quarter.  For the quarter, all major indices experienced the correction. 

While it is disappointing to experience this kind of setback, it is imperative to understand that historically, economic expansions last about four years, as do bull markets.  We are in the early innings of today’s bull market and most bull markets are accompanied by corrections, some of which can exceed 10%.  While this correction has been sharp, it is important to remember that the market is still up over 50% from its lows in March of 2009.  The longer-term trend for stocks is still decisively up and current data continues to point to an expanding U.S. economy. 

 

While our process is technically driven, we are not oblivious to the various economic forces in play and the resulting preponderance of "doubting Thomases".  There is no doubt that investors from Main Street to Wall Street are frightened.  The news is almost uniformly negative, predictions of a “double-dip” recession are rampant, and the fear is palpable.  However, such fear is understandably rooted in the bear market of 2008/2009.  The deep bear market wounds have had a severe impact on investor psychology.  As contrarians, we interpret such bearish investor sentiment as a strong buying opportunity.  It’s time to step forward.  As Warren Buffet likes to say, he is fearful when others are greedy and greedy when others are fearful.  

 

Best wishes for a relaxing and restful summer. 

Bill Noonan

President & CEO

7/1/2010

Sector Performance since the Health Care Reform Bill

It may seem like yesterday, but it's been over four months since Congress approved the hotly debated health care reform bill on Sunday, March 21.  As we all know, Congress and the American public were divided about the bill and its potential impact to the health care sector and beyond.  Granted, it has only been four months since the bill was passed, but we thought it would be interesting to gauge the stock market's reaction so far. 

To that end, we used sector ETFs to calculate the performance of each sector from the close on Friday March 19th through July 29th. 

Utilities +1.8%

Telecom +1.0%

Industrials -2.1%

Consumer Staples -3.1%

Information Technology -3.6%

Materials -4.4%

Energy -5.8%

Financials -6.2%

Health Care -11.8%

S&P 500 -4.9%

It will ultimately take years to determine the success or failure of health care reform.   For now though, these results would indicate that the market is not embracing the concept of health care reform and has concerns about its impact to the health care sector. 

Frank Thoughts: Client or Customer?

In this edition of Frank Thoughts, Frank makes the important distinction between being a brokerage customer and an investment advisory client. 

  In the financial business, the difference between a customer and a client has often been misunderstood … sometimes confused intentionally by the “high end” marketing of brokerage firms.  The term “client” seems, from a marketing viewpoint, more “upper class.” And it is.  Here’s why.  A customer is one who pays for a transaction.  When you come to a toll booth on an interstate highway, and pay a transactional cost to travel the highway, you are a customer.  It’s like going into a supermarket.  You are clearly a customer.

  A client, on the other hand, pays a fee.  It is a subtle but immense difference!  The broker, such as Goldman Sachs, has the job of making money from you; the other has the task of making money for you.  The client and fee based investment manager are both on the same side.  The investment manager’s interest and the client’s are identical; both want the client’s portfolio to increase in value.  That way the client is happy. He has more money and the investment manager has more money to fee … so he’s happy as well.  In the investment business one standard, broker’s suitability, rewards only salesmanship.  The other rewards, or penalizes, performance.  One is a product sold, the other a service earned.  One has an inherent conflict of interest, the other absolutely none! 

FRANCIS PATRICK BOLAND

7-15-10