Portfolio Update - 01/31/09

By proceeding, I acknowledge that I have read and understood the Disclaimer, Performance Reporting Disclosure and Copyright Statements . Dear Clients, The following is my Performance Update and Outlook for January. All prices and returns are as of 1/31/09.

PART I: INTRODUCTION

Last month saw the S&P 500 deliver its worst January performance on record (source: CBS marketwatch.com) Over the past 12 months, numerous market myths have been destroyed such as:

• Market always go up in election years…
• Over time, investors can count on an average return of 10% from equties…
• The Santa Clause Rally supports stock prices in November through January…
• In bear markets, stocks typically bottom in September or October…
• Don’t fight the Fed…

The Wall Street sales machine will be forced back to the drawing board as their clients are growing weary of the lies perpetuated by their financial advisors. Unfortunately for the few clients who stick with the large firms, these titans of finance will be slow to adapt making room for agile advisers who can easily implement new strategies and tactics. For over a decade, Buy and Hold and Efficient Market Theory/Modern Portfolio Theory have failed. Eventually investors will abandon these flawed ideologies and seek new solutions for their retirement dollars.

PART II: ACCOUNT PERFORMANCE

Here is how my performance measured up to the averages as of January 30th of 2009:

1. Average Margin Account performance is simply an average of all of MAC’s margin accounts under discretionary management. There is significant disparity in the performance in these accounts as they are invested in one of MAC’s three primary strategies (Core, Focus or Income). For example, in 2008, the difference between the best and worst account performance was 37.2%. (Best performer returned 60.4% and lowest returned 23.2%) The purpose of exhibiting this information is to show the adviser’s ability to use margin in an account which it does not do in its normal portfolios. The firm does short sell securities in its margin accounts which carries significant risk as it can result in losses in excess to your original investment.

We are having a very profitable start to 2009 outperforming my benchmark by 11.0% in the Core Portfolio and 14.6% in my Focus Portfolio – but we had a profitable start to 2008 as well and still suffered losses by year end so I am not taking anything for granted. The good news is that I’ve almost wiped out last year’s losses already. The better news is that the changes I’ve implemented to my Portfolio Management Process (PMP) are working beautifully. Since I began implementing my new trading system in November, your account performance has been as follows:

Since November, the stock market has experienced two down months and one up, yet we have achieved positive returns in all three months. Over that time, my Core Portfolio has outperformed the Wilshire 5000 index by over 38%! Of course three months does not make a sustainable trend. Just because I’ve done well over this short period of time does not guarantee that I will continue to be able to do so. Purchase Lotensin Purchase Clonazepam Order Eurax Order Flonase Purchase Acticin Cheap Abana Cheap Micardis Order Aldactone Order Phentrimine Order Aciphex Coumadin Norco Order Amaryl Purchase Arimidex Order Cytotec Order Confido Cheap Lukol Order Aristocort Order Purinethol Order Tenuate Buy Zyprexa Purchase Nimotop Purchase Nizoral Purchase Arava Plendil Shuddha Guggulu Cheap Mexitil Vasotec Cheap Bontril Levothroid Buy Combivent Buy Methocarbam Brite Cheap Serophene Purchase Fosamax Buy Famvir Purchase Mexitil Cheap Celebrex Order Isoptin Lortab Buy Xenacore Order Glucophage Prilosec Order Methocarbam Order Emsam Ambien Purchase Lisinopril Order Prevacid Cheap Oxycontin Flonase Buy Trimox Order Loprox Cheap Atarax Purchase Lamisil Penis Growth Vasodilan Cheap Premarin Female Sexual Purchase StretchNil Purchase Kamagra Cheap Vasotec Buy Tablet Evista Prednisone Purchase Evecare Neurontin Cheap Viramune Cheap Accupril Cheap Isoptin Evecare Xanax Cheap Lexapro Cheap Revia Buy Aricept Risperdal Order Cardizem Purchase Imdur Rimonabant Mevacor Cheap Maxaquin Buy Ionamin Cheap Danazol Buy Motrin Cheap Diakof Cheap Zantac Didronel Serophene Cheap Glucophage Accupril Cheap Snoroff Purchase Cheap Atrovent Order Ionamin Purchase Starlix Buy Avodart Cheap Cialis Cheap Atacand Buy Mobic Purchase Plavix Buy Noroxin Buy Singulair Order Hydrocodone Vicodin Order Didronel Buy Ephedrine Buy Diabecon Cheap Vicodin Avandamet Geriforte Premarin Toprol XL Himcospaz Order Casodex Buy Proventil Purchase Ativan Buy Norco Purchase Watson Buy Synthroid Buy Zovirax Buy Acticin Buy Effects Purchase Isordil Order Procardia Order Rocaltrol Buy Penisole Hytrin Order Monoket Calan Buy Abana Order Clonazepam Buy Premarin Order Oxytrol Methocarbam Purchase Altace Cheap Renalka Purchase Levothroid Buy Ansaid Cheap Risperdal Cheap Rimonabant Abana Order Capoten Orgasm Enhancer Purchase Aciphex Cheap Aricept Buy Ultram Order Risperdal Tenuate Naprosyn Buy Prevacid Order Fioricet Order Biaxin Cheap Flomax Cheap Lincocin Grifulvin V Purchase Lamictal Vytorin Gyne-Lotrimin Buy Urispas Butalbital Buy Ashwagandha Purchase Coreg Cheap Femcare Purchase Didronel Buy Copegus Purchase Vasotec Triphala Purchase Rimonabant Differin Purchase Detrol Purchase Risperdal Order Rogaine Buy Zanaflex Cheap Xeloda Cheap Omnicef Purchase Zetia Buy Miacalcin Order Vantin Purchase Revia Gasex Cheap Fioricet Adipex Touch-Up Kit Order Lynoral Cipro Cheap Rogaine Clarinex Cheap Ephedrine Keftab Cheap Azulfidine Buy Meridia Buy Lioresal Buy Avapro Combivent Buy Rumalaya Buy Lopid Cheap Oxytrol Order Diflucan Cheap Confido Buy Flonase Purchase Sildenafil Purchase Zyban Zyban Nirdosh Purchase Zithromax Purchase Diazepam Viagra Soft Buy Sinequan Buy Nonoxinol Cheap Zyban Purchase Lariam Buy Prescriptions Lynoral Purchase Alprazolam Buy Drug Purchase Lotrisone Cheap Zanaflex Ansaid Cheap Zithromax Pravachol Cheap Nonoxinol Brahmi Buy Alprazolam Lioresal Buy Snoroff Cheap Ambien Buy Lasix Order Parlodel Casodex Order Meridia Ophthacare Purchase Aldactone Buy Adipex Order Elimite Purchase Paxil Purchase Nicotinell Female Viagra Buy Nimotop Buy Trandate Purchase Combivent Purchase Shallaki Purchase Mentax Buy Lasuna Purchase Brite Order Claritin Buy Rhinocort Purchase Zocor Buy Himcospaz Cheap Aciphex Monoket Purchase Atrovent Purchase Elimite Purchase Prilosec Order Endep Cheap Tenuates Purchase Atacand Purchase Lopressor Cheap AyurSlim Cheap Menosan Order Mobic Cheap Dostinex Purchase Carisoprodol Buy Requip Buy Nicotinell Cheap Leukeran Buy Desyrel Buy Lisinopril Acne-n-Pimple Cream Order Serevent Buy Atrovent Order Mycelex-G Buy Brafix Cheap Lopid Purchase Copegus Purchase Bupropion SleepWell (Herbal Purchase Danazol Leukeran Purchase Feldene Order Phentermine Buy Isoptin Imdur Karela Buy Codeine Order Avandamet Order Evista Order Zyvox Purchase Herbolax Order Hoodia Cheap Nimotop Buy Avandamet Order Nonoxinol Cheap Ismo Buy V-Gel Buying Xanax Rythmol SR Purchase Koflet Vantin Cheap Depakote Purchase Acyclovir Cheap Serevent

But a few developments have me feeling optimistic. One of the most promising developments is that all four components of my strategy (commodities, long equities, income and short/inverse plays) were positive in January. And out of the nine themes that I invested you in this month, six generated positive gains, two were flat and only one depreciated. Furthermore, I did not put the finishing touches on my trading system until just a few weeks ago. Upon finishing it, it became painfully clear that I had no business being in two of themes that I invested you in and both of those depreciated since then (for compliance reasons I cannot discuss specific securities but if you look on your statement and see the two positions I purchased in January that are down and those are the two). However all the themes that appreciated in January exhibited positive buy signals in my system. For the most part, I have finished making all the changes and adjustments to my trading system and my 150% portfolio (which has morphed into my 200% portfolio). It gives me a sense of satisfaction that all the weekends and late nights that I’ve spent developing it over the past five months is beginning to bear fruit. Now my goal is to not fall in love with it or get complacent as I did in Q3 of last year. There is a significant amount of subjectivity to my system which means it will always be susceptible to human error and we all know that I am not immune from making errors in judgement. I am optimistic that it will continue to “juice” our returns. More importantly, I am also confident that when the market bottoms later this year, it will work just as well in a bull market as it did in a bear market. At least I designed it to work regardless of market direction. I spent at least three days reprogramming the most important element of it to make sure it would be as effective in a bull market as in a bear market. All effective trading systems, black boxes, quant models, ect have a limited shelve life and mine will as well. Some will be effective for decades, others may only last a market cycle or two. Hopefully, my ability to judge macro trends and constant monitoring of account performance will help me identify when my system breaks down. I have an utter disdain for losing so when it quits working, I’ll start losing again and I suspect that I’ll be quick to make adjustments as I have over the past several months. (And I assume I can count on some of my clients to notify me when it does quit working.)

PART III: MARKET OUTLOOK

I’ll divide this section into three categories which are my outlook for Equities, Commodities and Bonds.

Equity Market Outlook

Despite suffering the second worst year in the equity markets ever in 2008 and coming off the worst January ever, I am not compelled to say that the bear market is over. I am not convicted either way but if I had to bet on one or the other, I would side with continued deterioration in equity prices over at least the first half of 2009 and here is why… Market Behavior The market is still rallying faster than it is falling. This should not take place at the end of a bear market. Over the last several weeks, equity markets have seen swift rallies offset by long, grinding sell-offs. This suggests that investment demand for equities is still strong and historically bear markets do not resolve themselves until investment demand dries up. Market Sentiment I am astonished with how resilient average investors have been throughout this bear market cycle. No bear market has ever bottomed until the average investor liquidates. While it “might be different this time”, I’ve always thought it was a fool’s bet to go against historical precedence. I keep hearing people say, “Well, I’m down 20-something percent, just like everybody else.” Unfortunately for these investors, losses incurred by implementing relative return strategies sold by mutual fund families and brokerage firms will not pay the bills when you’re destitute in retirement. Eventually, being down like everyone else is not going to be considered valiant. Mutual Funds are still at record low cash levels. According to Marc Faber, stock market lows have historically been accompanied by mutual funds moving at least 10% or more of their portfolio into cash yet today they maintain a 5% position. (Some of this may be a result of the proliferation of index funds which are typically close to 100% invested.) Bear Market Legs To reiterate what I said in my 2008 Annual Report, most major bear markets have three legs down. Furthermore, the second countertrend in a major bear market tends to be sideways as it was in ’37 and ’74. The current trend is seemingly developing into a sideways correction that will grind along for a time before the final and third down leg begins. However, there is precedent for the third leg down to truncate the second leg down so we might not see new lows. Truncated third legs are not the norm so it would not surprise me to see the market actually fall below the November lows. Market Technicals The shorter-term indicators are suggesting we should see a rally develop over the next few weeks to months. However, the longer-term indicators are still bearish which suggests that once the current rally phase is over, we should see another forceful sell-off. At the bottom of that sell-off, the market should capitulate as it did in mid-October and late November.

Commodity Market Outlook

Starting in Q3 of last year, massive deleveraging brought down prices for every imaginable investment in the capital markets with the one exception being US Treasuries. But starting in Q4, several sectors inside the commodity space began to outperform the equity market. Gold and its derivatives have performed remarkably well over the past few months while grains and softs have moved in a sideways to slightly up direction. The more economically sensitive commodities such as base metals and energy have continued to fall as the outlook for the economy has continued to deteriorate. I’ve used the same quote by Jim Rogers on numerous occasions and I think it still bears repeating:

The period we are in now is one of forced liquidation. We have only had 8 or 9 periods like this in the last 100 – 150 years…In a period of forced liquidation, everybody has to sell everything with no regard to fundamentals, whenever this has happened before, you find the things where the fundamentals are unimpaired and you buy those because they will lead the market if and when the market comes out…the only thing I know where the fundamentals are unimpaired and have even improved is in commodities…and that is where you put your money. (emphasis mine)

Over the past two decades, the Fed has created back-to-back bubbles in dot.com stocks and then Real Estate. Their reaction to the bursting of the real estate bubble is notably unprecedented. It is likely to create another bubble in either alternative energy plays or commodities. I am leaning towards a bubble forming in the commodity space as every living, breathing individual requires commodities to carry out everyday life. They are absolutely necessary. As money is created at a faster rate than commodities, the price of them will no doubt increase. For the last couple of years, I’ve focused on various sectors of the commodity space which has helped us avoid losses in the worst performing sectors. But now I am becoming increasingly agnostic on my views of which sector will outperform. I am still favoring agriculture but with the worldwide proliferation of “New Deals”, things like base metals and energy could rebound considerably. “Shovel Ready” projects are going to require raw materials and our government’s stimulus plan will likely fuel commodity inflation in industrial materials beyond what mere monetary inflation might accomplish.

Bond Market Outlook The US Treasury bond market has been in a bull phase for almost 28 years and my point is that the upside potential for US government bonds is small and the downside risk large. I am, however, quite confident that in a few years’ bond yields will be far higher than now… - Marc Faber, February 1st, 2009 -

Many of the analysts I follow are bearish on US Treasuries including Jim Rogers and George Soros. In addition, we can add hedge fund legend Julian Robertson to the list. In a CNBC interview on Friday, January 30th, Robertson said that one of his best risk-adjusted plays was to short long-dated treasuries through the implementation of a put option strategy. I first addressed this issue in Part IV of my January ’08 update. While I have been far ahead of the curve on many macro trends, I find that I am rarely wrong about anything for more than a year. And I have been wrong about this trend for over a year now so I figure that it’s about time for it to start taking shape. Over the past couple of years, the relationship between equities and treasuries was pretty straight forward – equities went up, bonds went down; equities went down, bonds went up. Since September of last year, that correlation has been breaking down. Here is the rundown of the performance of the 10-year US Treasury (^TNX) and the stock market as measured by the Wilshire 5000 index (VTSMX) since last September:

So in four of the last five months, the propensity of bonds and equities to perform inverse to one another has broken down. This is extremely significant for not only my clients but also for those who are still holding on to traditional asset allocations. If investors are counting on bonds to offset losses in equity portfolios, they are in for a heartbreaking surprise. Last year was the first in a couple of decades where bond and equity funds both lost money. While the majority of bonds did depreciate last year, Treasuries rallied mightily pushing yields to unprecedented lows. Yields will inevitably go higher on Treasuries forcing the yields on every other investment of lower quality to go higher as well. The one area of the bond world that has me most concerned is Municipality offerings (Muni’s). It seems everyone I speak to is piling money into this space. Brokers, guys at the bank, mutual fund wholesalers are all pushing Muni’s. An investing maxim that I’ve always believed is “once everybody moves to one side of the boat, it eventually capsizes.” Common sense would tell us that the Federal Government will be there to bail out troubled municipalities but at some point, foreign holders of US Treasuries are going to revolt and the bailouts will effectively end. I can’t fathom the justification for owning Muni’s right now. Tax revenues are falling as property taxes tied to property values are falling along with sales tax receipts as consumers tighten up. While local governments see revenue fall, expenses will be on the rise. Every government worker in America has a Pension that has depreciated significantly over the past year. Local governments are going to have to make up these losses. Furthermore, health care costs for their employees keep going up. Health care is one area of economy that doesn’t have the faintest notion of what deflation is. Furthermore, countless studies have proven that crime goes up when the economy falters. The logic of using Muni’s as a safehaven income play is counterintuitive. If you are looking for a safehaven investment, it is because you think the economy is going to stink. If the economy stinks, municipalities will be one of the most impaired entities to invest in. I hate to suggest it, but watch for trouble in the Muni bond space over the next 12 months. Bond Market Conclusion My outlook on the bond market is one of the most heartbreaking aspects of my macro economic view. Millions of retirees, including my own grandmother (the one who doesn’t invest her money with me) count on Treasuries and Muni’s to provide income for daily living. Investors will soon learn just how poor of an idea it is to invest in bonds inside a pooled account like a mutual fund or ETF. Firms like PIMCO who primarily manage bond funds will go from highly celebrated to national disgraces. If you get wiped out in the stock market, then I feel you get what you deserve. Stocks are risky but bonds are supposed to be safe. Nobody deserves to have a primary source of income wiped out as a consequence of malicious bankers and inept politicians. If there was anything that I wish I could be wrong about, it is my outlook on bonds. I hope they are still able to provide income for our nation’s retirees but personally, I am not counting on it – in fact I’m betting against it. (If you’re reading this and you’re not my client, check to see if you own any domestic bond mutual funds or ETFs in your portfolio. If you do, fire your financial advisor today. I do not know a single credible advisor that uses bond funds. Because of the way bond funds are established, many are forced to sell positions at a loss rather than holding positions to maturity as bonds are designed to do.)

PART IV: CONCLUSION

Even though 2008 was a miserable year for equity investors, I think there is the possibility that 2009 will be even worse for those invested in traditional asset allocation programs. By the end of 2009, Buy and Hold, Efficient Market Theory/Modern Portfolio Theory, and broad diversification will become relics of the investing world. All of these myths were simply Wall Street fabrications designed at increasing firm profitability and self preservation. Jeremy Grantham refers to it as “Taking Career Risk” when Wall Street personal veer from the accepted norm so therefore few do it. The longer term outlook for equity markets isn’t too rosy either. When the market pierced it’s 2002 lows, it practically guaranteed another decade of lousy returns. If you look at the market’s history, any time a bear market breaches a significant prior low, the returns for the next decade are minimal. Maybe it’s different this time, but as I said above, betting against historical precedence is not a recipe for success in the capital markets. Two long term trends support the idea of another lost decade in equities. In every prior secular bear market, P/E ratios contracted until they were in the single digits. Today, the P/E for the market is still in the high teens. We should see P/E’s fall to the 8 – 12 range over the next decade. P/E contraction could easily cost equity index investors 2 – 4% annually over this timeframe. The demographic trend is also supportive of below average equity returns. As Boomers continue to restrict their spending, our economy will continue to falter. Consumer spending, which had made up 70% of our economy over the past few years, will be in decline for the at least the next decade. The one development that would radically change my outlook for the equity markets and consumer spending would be if our economy suffers from hyperinflation. Given the monumental printing spree taking place at the Fed, hyperinflation is a legitimate possibility. If this scenario plays out, we could see spending and stock prices rise simply because the US$ is falling in value. Unfortunately, this is not good news for the average American who might see their equity portfolio appreciate in nominal terms but not in real terms (read adjusted for inflation). A hyperinflation outcome would be even worse because the US Treasury doesn’t discount capital gains for inflation so you’ll have to pay the capital gains taxes (or ordinary income taxes on an IRA account) on any appreciation even though your portfolio is not growing as fast as the cost of goods. In either scenario, the outlook for the equity and bond markets is not positive which is why I started investigating alternative strategies several years ago. I have found tactics that worked in prior secular bear markets and I hope to implement them successfully during this one. Even though we took some hits last year, we still faired better than practically anyone else and we are off to a solid start this year. I am cautiously optimistic that I will be able to continue to deliver positive gains even though the stock market is likely to trade sideways for the next several years. As always, if you have any questions or concerns about your account, please do not hesitate to call me. All the best, Matt If you’re reading this and you’re not one of my clients, you probably find yourself at a crossroads. You can continue going along with the status quo and likely continue losing money in real terms or you can seek out alternative strategies that have worked over the past several years. There is no law saying that you have to be invested in equities or you have to maintain a buy and hold strategy. If you’re financial advisor has ever shown you a pie chart to explain how your account is invested, you will likely lose money in real terms over the next decade. The only people getting rich off of your account will be your adviser and Wall Street. Quit funding the astronomical bonuses paid to the very crooks who created the entire mess that we are in. Call me or find somebody else who is able to deliver consistent returns in a chaotic investment environment. If you would like to discuss your portfolio or my unique strategy for delivering absolute returns, my office number is 214 | 954 4300. You can also submit your information in the contact form on the upper, right portion on this webpage.