ProfitScore IQ

Details On The Fed’s New Trading System

2010-10-21T20:38:00Z

Details On The Fed’s New
Trading System
November 1, 2010
By John M. McClure
www.profitscore.com

A Brief Performance Update
Is the Fed Helping Fund the Treasury's Pawn Shop?
Did the Germans Just Invade Poland?
Why Should You Care?
Quantitative Easing 2 - Will It Save Stocks?
Is Gold Too Expensive?
Dollar Demoralization
Real versus Nominal Returns - Vive le Différence
‘Foreclosure - Gate' - Implications for Housing and the Economy
Chasing Chuckars with My Buddy Jack

On March 18, 2009 the Federal Reserve announced that they were going to purchase 300 billion dollars in treasuries in the Fed's Permanent Open Market Operations (POMO). The days which the Fed does these purchases are now famously known as POMO days. Over that time, the Fed purchased an average of 50 billion dollars in treasuries per month over six months. All POMO months in 2009 were positive for U.S. equity markets. As a matter of fact, U.S. equity markets climbed faster and higher during the treasury's buying binge than any other time since the 1930's.

Fast forward to present. In the month of September 2010, the Fed started up POMO operations again in earnest with 10 POMO days and even more purchases planned for October and the first part of November. Should you care that the Fed is manipulating the markets and causing risk assets to rocket higher? The price of gold is sure saying you should care.

In this ProfitScore IQ, we dig into the details behind POMO days, and their intended and unintended consequences. The next round of Fed intervention is being called QE 2.0 and it is expected that the Fed will announce in November that they will be purchasing an additional 500 billion dollars in treasuries over the next several months. I have read reports where the market has already priced in one trillion in purchases, so Mr. Market is expecting a really big boost from the Fed. If the Fed surprises to the low side of this expectation, there could be painful consequences.

Before we get started, I wanted to mention that I will be speaking in New York at the Global Equities Trading Summit on the topic of Risk Management Strategies through the Lens of Technology Solutions during October 25th and 26th. If you are interested in attending or you would like to meet, please send me an email.

Something You Should Read
I have been a big fan of John Mauldin's for many years. His most recent report exposing the true foreclosure mess is a must read. What John discusses in this report will make 2008 look like a walk in the park. Do yourself a favor and give his report a careful read. Here is the link to a PDF of John's latest letter:

http://www.frontlinethoughts.com/pdf/mwo101510.pdf

Please be advised to remove sharp objects from your vicinity before reading this letter.

A Brief Performance Update

Below are some quick performance stats. For more detailed performance analysis, click on the blue highlighted portfolio names listed in the table below.

	Jan 08 to	YTD	Sept	Sharpe
Name	Present	2010	2010	Ratio
Income Builder (IB)	13.96%	5.35%	0.02%	1.33
The Guardian (GRD)	4.56%	0.25%	-1.09%	1.51
Harmony Plus (HMY)	3.28%	-3.52%	-1.75%	1.29
The Expedition (EXP)	0.87%	-7.00%	-2.23%	1.03
S&P 500 (SP500)	-22.28%	2.34%	8.76%	0.54
Important Performance Disclosure

Is the Fed Helping Fund the Treasury's Pawn Shop?

Around the middle of September, I was driving in my truck and listening to the ever entertaining Kai Ryssdal on NPR's Marketplace show focused on the day's stock market action. Kai had a guest on the show that was somehow tied to the Obama administration, but I can't remember her name. This guest was answering questions about the Treasury's plan to sell the stock it owns in AIG in order to speed up the repayment process of the 86 billion dollars AIG owes the American tax payer.

The treasury currently owns 80% of AIG's stock. The normal loan repayment plan was going to take many years and the Obama administration wanted to be repaid sooner. Having AIG owe the treasury 86 billion dollars will not be considered a positive campaign influence in the upcoming presidential election campaign.

In the interview, the guest was asked what would cause this plan not to work. She mentioned three challenges to this plan but all were tied back to the economy and a falling stock market. Basically, if the market goes through another bear market, then shares of AIG could not be sold by the treasury. I thought to myself at the time of the interview, what a huge conflict of interest.

Did the Germans Just Invade Poland?

September of 2010 was the largest September in the U.S. stock market since the Germans invaded Poland in 1939. How could that be?

Over the U.S. equity market's history, September has been the worst month to be invested in stocks. The average annual return of September is actually negative over the markets entire history with some of the worst disasters being recorded in this difficult month. When August is down, the chances of having a nasty September actually increases. Since August was down over 5%, and 19 out of 20 government economic reports were negative in September, wouldn't you expect September to have another historical bad month? How could the exact opposite happen? If you said Fed POMO days, you were 84% correct.

The problem with government manipulation for a quantitative manager like ProfitScore is that there is no way to model the data. How could you possibly model the Sunday night chats in 2008 where President Bush, Paulson, and Bernanke would announce the baling out of Bear Stearns, Fannie Mae, Freddie Mac, Money Market Funds, Long-term Interest rates, etc? These events are random events that are impossible to predict.

Fed POMO days are different because the Fed openly announces them on their web site before they happen. Here is a link announcing the next round of purchases http://www.newyorkfed.org/markets/tot_operation_schedule.html. POMO days are also unique in that there is now enough of them to begin to model their effect on U.S. and world markets.

The market has closed higher on the last 14 POMO days. Actually, the 12^th day closed down 5 basis points but for the sake of keeping this example easy to understand, I am going to call it an up day. Since every day has a 50/50 chance of being up or down the chances of having 14 up days tied to POMO days is 1 in 1,400.

I summed up the monthly performance of the S&P 500 from March 2009 to September 2010 and the number comes to a non compounded gain of 46.96%. I then summed only those months where the Fed had 5 or more POMO days in the same month (March, April, May, June, July, August, September 2009 and September 2010) and the non compounded gain was 46.36%. Let me be more clear - 98.72% of all market gains since the bear market rally began in March of 2009 can be attributed to Fed intervention.

The current month of October will be another POMO month and it is already up over 3%!

I could mention that this next round of POMO days is two weeks away from mid-term elections and that there is a POMO day the day before the election, but I will refrain myself from bringing politics into this maddening discussion.

For those of you who would like to jump into the numbers, here is an excellent blog post from Trading The Odds discussing the statistical probability of the market closing higher in and around POMO days. http://www.tradingtheodds.com/2010/09/permanent-open-market-operations-pomo/

Why Should You Care?

Some of you reading this are probably saying - why should I care if the Fed used manipulation to make equity markets go higher in price? Heck my 401k is now worth more than it was in March of 2009. That is a fair point so let me ask you a few questions.

Are you better off today than before the crash?
Is your real estate holdings worth more or less than they were 5 years ago?
How much interest are you earning on your savings and fixed income investments?
What are your job prospects?
Is it harder to get a loan today than it was 10 years ago?
Can your dollar buy more today than it did 10 years ago?
Why is our budget deficit projected to run over a trillion dollars a year for the next several years?
Does mortgaging your children's future make you feel good or bad?

The Fed and the U.S. government are conducting damage control, and they are the ones that caused much of this damage in the first place. Yes, they have made the stock market go artificially higher but they also helped get us into this stinking mess. Dropping interest rates in 2002 to historically low levels and keeping them artificially low is one of the main drivers for catapulting real estate prices into the stratosphere until they finally collapse. In economics, there is always a cause and effect.

Ultimately low interest rates, ridiculous amounts of stimulus spending, and trillion dollar budget deficits will lead to the incestuous printing of money and spiraling inflation. I am not sure if it will be this decade or next, but a loaf of bread will cost many times more than it does today.

The Feds manipulation of the market has negatively affected me and my clients short-term, but traditional investors will pay the price long-term because risk assets are priced to perfection and the next bump in the road is going to once again rip the guts out of the average investor. Investment roller coaster rides are no fun for any type of investor.

If you have been a reader of this letter, you could sense my frustration over the last 16 or so months. I knew something was wrong with the natural flow of the markets, but I couldn't prove what it was. I called it the invisible hand. Markets were not functioning in a normal way, but I didn't know why. I felt that government intervention was probably the culprit, but I didn't have the data to back up my claims.

I'm relieved to finally know what influence caused the greatest bear market rally since the 1930's, because I thought it would be 30 years or more before the real reason was finally disclosed. It is a sad day a sad day indeed when you have to factor Fed intervention into your investment models.

The United States considers itself a free capitalist society but our actions in difficult times don't reflect this belief. Straddling the socialist fence is political in nature and there is going to be hell to pay for our politically motivated bad decisions. Quantitative easing is about to be kicked into hyper gear with QE 2.0, so we haven't seen anything yet. In about 50 years, it will be hard for our grandchildren to believe that a loaf of bread only cost $2.27 in 2010. As my good friend Tim Burke recently wrote, the dollar is going to a sad place.

Let's see what others are saying about QE 2.0?

Quantitative Easing 2 - Will It Save Stocks?

A very interesting paper was published in early October by Erico Matias Tavares, he asked the all-important question in the title: Will Quantitative Easing Save the Equity Markets? No doubt most traders and investors are asking themselves the same question.

Tavares wasted no time getting down to brass tax.

"Notwithstanding persistent headwinds in the global economy, ranging from sovereign debt fears in Europe to double dip risks in the US, equity markets had their best September in over seventy years. This may be largely attributed to the expectation that in order to prop up a flagging recovery the US Federal Reserve will soon embark upon a second quantitative easing (QE) program, as further evidenced by recent US dollar weakness and gold reaching historical highs (in nominal terms)."

"This expectation seems to be getting traction. According to a leading financial blog (Zerohedge.com), Goldman Sachs recently sent a note to its clients stating that the Fed will announce $500 billion in asset purchases at the November 2-3 meeting. Even prominent hedge fund managers are publicly proclaiming that QE is a sure thing, and that this will put a floor under equity prices."

"But will the Fed implement a sizeable QE program over the near-term? And how much is actually needed to keep equity markets humming along?"

To answer this question, Tavares examined liquidity growth and the performance of the S&P500 Index from 1998 to present in a period that covered two bear markets, the tail-end of the Internet bubble as well as the birth and death of the housing bubble.

What he found was very interesting indeed.

"Liquidity growth typically slows considerably as the S&P 500 goes into a bear phase, and surges just before its end - primarily due to the Fed's intervention. Coincidentally (or not), the current gold bull run started around the first time the Fed embarked upon this process in the early 2000s." This relationship re-asserted itself again eight years later but in reverse.

"Liquidity growth started declining precipitously after March 2008, reaching negative values around November. This was the only time negative growth was recorded in our series, which goes back to the early 1990's. To put this in perspective, in mathematical terms the index needs to grow at least by the "average" interest rate of the economy, otherwise an increasing number of borrowers will start defaulting on their interest payments (let alone amortize their loans). A negative print is thus a severe event, leading to a downright contraction in the economy."

Not long afterwards (final quarter of 2008), the Fed took "unprecedented monetary policy actions".

Note the response of the S&P500 Index (blue line) to changes in liquidity (green). There is an approximate lag of six months between liquidity changes and the response from stocks.

Chart 1 - Graph showing the relationship between percentage liquidity growth (right-hand-side in green) and the S&P500 Index (blue). Source - Will Quantitative Easing Save the Equity Markets.

Roughly six months after liquidity started to drop (April 2007), stocks began a massive correction in early November.

Traditionally, the two major liquidity providers have been banks and the Federal Reserve as we see in the next chart. Until around October 2008, bank liquidity rose.

Since the fall of 2008, bank liquidity has been a less dominant factor in stock price appreciation with the Fed's accounting for the lion's share of market liquidity. It shows the impact of government and Federal Reserve stimulus programs such as TARP - a reality clearly not lost on politicians and bureaucrats!

Chart 2 - Bank and Federal Reserve liquidity together with the S&P500 Index. Source - Will Quantitative Easing Save the Equity Markets

A closer look at chart 2 reveals that in 2007, the Fed began to cut back in a trend that continued through mid-November 2008.

"Soon after the S&P 500 peaked in October 2007, the Fed started reducing its holdings of US bonds, from $780 billion all the way down to $475 billion by March 2009," according to Tavares.

Then the Fed began to turn on the stimulus as we see by the blue histogram on the chart, even as banks continued to pull liquidity out of the system. The net result was the beginning of the powerful bull market in stocks in March 2009.

"The Fed thus effectively replaced the banks in the process of keeping liquidity growing throughout the economy, as the private credit mechanism was severely impaired (and still is, with declines not seen since the Great Depression). Otherwise banks would just keep on padding their reserves with more QE. Because the Fed does not directly lend to individuals and non-financial institutions, this could only be achieved through expanded budget deficits. Accordingly, the US government substantially stepped up its efforts to stimulate the economy."

But the lift didn't last long and barely two years later politicians are "once again contemplating doing another round of QE."

How much will be needed? According to Tavares, there is no easy answer.

"For instance, a $2 trillion liquidity injection will very likely have a different effect depending on whether equity markets are worth $8 trillion or $13 trillion, all else being equal... With this in mind, the liquidity index we used previously can provide a sense of the amount of QE required to at least sustain the status quo... The historical year-on-year growth has averaged about 8% since the late 1990's. Assuming flat bank liquidity creation, this would mean that the effect of the envisaged $500 billion QE reportedly being contemplated by the Fed would last until March 2011. Another $500 billion would be required to sustain that growth through to the end of the year."

So how much stimulus does Tavares think would be needed to do keep equity markets going?

"All in all, a QE program of at least $1 trillion may be required throughout 2011 just to sustain the status quo. Boosting the liquidity growth rate into the double digits - consistent with substantial share price gains thereafter - would require that amount to be injected under a much more compressed time frame, likely [less than] six months."

Here is the biggest risk according to Tavares in simple mathematical terms.

"More QE = more misallocation of resources = more needed for QE in the future."

Unfortunately, the biggest casualty will be the US dollar, but more on that later.

Now let's take a look at how the various types of money supply have changed in the last three years. In the next chart we see a comparison of M1, M2 and M3. Do they account for the liquidity that has driven stocks?

M3, the broadest money supply measure was discontinued by the Federal Reserve in March 2006. Thanks to John Williams of http://shadowstats.com/, we have a reasonable facsimile which he calls the M3 SGS.

As we see from the next chart, all three have fallen in the last few months with M3 suffering the biggest drop since around April 2008. Not surprisingly, given that we are now entering the pre-election year, all three are on the rise again.

Chart 3 - Charts comparing the three types of money supply since 2006. Source - http://www.shadowstats.com/alternate_data/money-supply-charts

M1-3 does not really account for the liquidity provided in charts 1 and 2. A metric called the Adjusted Monetary Base (AMB) provides a clue. Basically, the AMB is the amount of money in circulation with the lion's share of that being injected into our economy beginning in August 2008 and which had exploded 250% by April 2010. For a more detailed background discussion of the Adjusted Monetary Base complete with charts, please see our April newsletter at http://www.profitscore.com/display.aspx?articleid=OaI8Ma8jZOM=

Here is the updated chart from the St. Louis Federal Reserve showing the latest AMB. It has fallen marginally from its peak of $2.141 trillion in February to $1.981 trillion in September, but the amount of money being pushed through our economy is still 237% of what it was in August 2008.

The takeaway is that thanks in large part to stimulus and bailouts, the 2010 deficit is projected to hit $1.3 trillion, just $125 billion less than the shortfall in 2009! Any further programs that would make up QE2.0 would only add to an already crushing fiscal burden.

Perhaps the real question should be, do politicians really care about the long-term health of our economy or is the upcoming election all they really care about? A growing number of Americans are concluding that long-term economic health has become a low political priority, the victim of electoral pragmatism.

Chart 4 - Monthly Adjusted Monetary Base data charted by the Federal Reserve showing the recent explosion in the amount of money in circulation. Source - St Louis Federal Reserve.

One only has to look at the price of commodities, especially gold, to see how poorly the politicians have served their electorate.

Is Gold Too Expensive?

With gold on a tear and news stories of just how expensive it is everywhere, we decided it was time again to examine the age-old question. At its recent record high of just over $1,345 per ounce, is gold getting too expensive? In terms of the US dollar, it seems to be getting very pricey. So, is gold the problem or is it the USD?

We know from past newsletters that stocks have been hammered relative to gold over the last decade having dropped more than 80%. But just how expensive is the price of gold when compared to the most important commercial and economic commodity - oil - over the last quarter century?

As of the October 8 weekly close, crude oil (NYMEX crude oil futures) was trading at $82.66/bbl. The next chart answers the question. At a ratio of 16.28, gold is not much above the long-term average gold-to-oil ratio of 15.83.

We decided to look at a couple of other precious metals which we consider good storehouses of value - silver and platinum relative to oil. Silver was a tad more expensive than gold with a ratio of 27.95 compared to the long-term average of 23.55.

"Doctor" Copper, used by many traders to measure economic strength was also very close to its long-term average oil-priced ratio of 4.44 with an October 8 ratio of 4.57, so could not be considered overpriced.

Chart 5 - Weekly chart showing the historic ratio of the price of gold to crude oil since 1986. The long-term average ratio is 16.28. As of October 8, the ratio was close to the average at 16.28. Chart courtesy of GenesisFT.com

Of all the precious metals we examined, palladium was the most expensive with an October 8 palladium-to-oil ratio of 7.10 versus a long-term ratio of 4.72, and platinum was the least expensive with an October 8 closing platinum-to-oil ratio of 20.67 versus a long-term average ratio of 21.24.

Dollar Demoralization

As we can clearly see by examining precious metals in crude oil terms, they aren't on a tear. The problem is the dollar - politically expedient policies designed to "help" the economy have exerted an expensive "inflation" tax which has made gold and many other commodities "expensive" in dollar terms. As a result, the dollar is now worth about 16% of what it was worth a little more than nine years ago! Is it any wonder that more and more Americans are becoming dismayed with current monetary and fiscal policies?

As we see from chart 6, the greenback basically held its own from 1986 and 2001 relative to gold. As it hit its 1980's low in August 2005, it started to drop again and just kept going. Since then it has dropped an incredible 74%! No wonder we are all feeling poorer!

Chart 6 - Weekly chart showing the ratio of the US Dollar Index (DX) to gold. It clearly shows the impact of quantitative easing, and other government and Federal Reserve stimulus programs on the greenback which is down more than 84% since March 2001. Chart courtesy of GenesisFT.com

Real versus Nominal Returns - Vive le Différence!

It is easy to get lulled into a false sense of security by nominal returns. Since 2000 the Dow is up slightly. However, in real, gold-denominated terms, the index is down more than 80%. Most would agree that something had to be done to prevent further problems when Bear Stearns and Lehman Brothers collapsed. Certainly our Keynesians on Capitol Hill did! The result is that in real terms, our portfolios (and incomes) have taken a hit.

As we face another round of stimulus programs which will see the dollar further devalued, it is increasingly important to focus on the real as opposed to the nominal.

‘Foreclosure-Gate' - Implications for Housing and the Economy

We are currently tracking the unraveling foreclosure situation with some of the big banks that have powerful implications for the housing recovery. In a nutshell, there are growing concerns given the number of bundled mortgage derivative products that were developed as the housing market was taking off. Many of the mortgages may be missing crucial legal components, which has brought into question their enforceability. It is also causing buyers of foreclosed homes more than a little anxiety. We have included a number of links in Interesting Reading (below).

The part about our future that scares the heck out of me is the quality of leaders we have that are making decisions to get us out of this mess. Just because you are an elected official doesn't mean you have an above average IQ, or that you are good at anything else other than politics. Below is link to a CNBC interview with Representative Maxine Waters.

http://www.youtube.com/watch?v=a_mi1tH2opA

If you listen closely, you can actually hear someone laughing in the background.

Interesting Reading (and Viewing)...

Will Quantitative Easing [2] Save the Equity Markets?
http://www.scribd.com/doc/38803628/Will-Quantitative-Easing-Save-the-Equity-Markets-Oct10

Government Deficit for 2010 Estimated At $1.3 Trillion
http://cboblog.cbo.gov/?p=1457

Why Washington Can't Afford a Weak Dollar Policy
http://snuffysmithsblog.blogspot.com/2010/10/us-will-lose-china-trade-war-washington.html

Largest U.S. Bank Halts Foreclosures in All States
http://www.nytimes.com/2010/10/09/business/09mortgage.html?_r=2

Class Action Lawsuit Against Countrywide
http://market-ticker.org/post=168698

The Coming Middle Class Anarchy
http://www.zerohedge.com/article/guest-post-coming-middle-class-anarchy

"Foreclosure-Gate" Who Will and Who Should Pay
http://www.calculatedriskblog.com/2010/10/lawler-foreclosure-gate-who-will-and.html

"Foreclosure-Gate" - Jon Stewart's Take on the Daily Show (Video)
http://www.calculatedriskblog.com/2010/10/daily-show-on-foreclosure-gate.html

Mortgage Bankers Association - Strategic Default Isn't Funny...Or Is It? (Video)
http://www.thedailyshow.com/watch/thu-october-7-2010/mortgage-bankers-association-strategic-default

Chasing Chuckars with My Buddy Jack

As I have mentioned many times in this letter, fall is my favorite time of the year in Idaho. Days are cool and crystal clear, nights are filled with stars and it is the time of the year where I seem to spend a lot of my time exploring Idaho's back country.

Due to a torn labrum in my right shoulder, I missed my traditional 10 day September archery hunt for elk, but my bum shoulder won't slow me down from chasing Chuckars with my good buddy Jack. Chuckars are considered the mountain goats of upland game birds. They live in Idaho's steepest and rockiest slopes, mostly along the Snake River Canyon.

Most of the people I know who hunt Chuckars are a little crazy because of the difficult terrain they have to endure. Almost all serious Chuckar hunters train for the season like an athlete trains to complete. When it comes to hunting Chuckars, I know my days are numbered. I hope God will give me good knees to climb these mountains until I am at least 65.

Jack is my new dog that I have had trained into a well oiled machine over the last couple of years. This will be Jack's second season and he is already hunting like a five year old dog. Jack placed first in recent field trials and he will probably be the best bird dog I will ever own. Jack and I have been conditioning together this off season and our first day in the field will be this weekend. Jack was so excited this morning, it was like he somehow understood what I was saying and knows we are about to go chase birds.

Recent reports from good friends of mine are that this is the best population of birds we have had in years. Jack and I are hoping the reports are at least half true.

Working to grow your wealth,

John M. McClure
President & CEO
ProfitScore Capital Management, Inc.

P.S. ProfitScore provides its separately-managed accounts to individuals, advisors and institutional investors. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

Complete our Private Client Group request form by clicking here: http://profitscore.com/clientgroup.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

Size Matters When It Comes To Jobs

2010-09-20T16:23:00Z

Size Matters When It Comes To Jobs
September 17, 2010
By John M. McClure
www.profitscore.com

A Brief Performance Update
Here We Go Again
Paddling a Canoe up a Waterfall?
So Where Did We Go Wrong?
Is the 800-Pound Economic Gorilla Invisible?
Why Can't the Government Connect the Dots?
Updating the CMI Growth Index
Bronco Nation and the BCS

In last month's ProfitScore IQ, we looked at a number of forward-looking economic indicators and discussed the chances for a double dip. It was clear from the various factors we analyzed that trillions in government stimulus and bailouts have not worked, so far at least.

This month we'll take a look at the reasons why. We will then discuss the latest programs being touted by many or our politicians, which have a high probability of failure. Next we'll examine the sector that has historically generated all new jobs in our economy over the last quarter century and examine what the government is doing to help it.

The bottom line is that our economy is at a tipping point and any major policy mistakes will almost certainly take us into a much more severe recession than we are currently in. Increasing taxes or starting a trade war with China will almost certainly tip us over the edge. At this point, there are few good choices so let's hope that cooler and wiser heads can prevail in Washington in this next political cycle.

Quote of the Month
"In the first 19 months of the Obama administration, the federal debt held by the public increased by $2.5260 trillion, which is more than the cumulative total of the national debt held by the public that was amassed by all U.S. presidents from George Washington through Ronald Reagan." --- CBSNews.com September 8, 2010

A Brief Performance Update

August was a bad month for the markets but a great month for ProfitScore clients. Below are some quick performance stats. For more detailed performance analysis, click on the blue highlighted portfolio names listed in the table below.

	Jan 08 to	YTD	MTD Aug	Sharpe
Name	Present	2010	2010	Ratio
Income Builder (IB)	13.98%	5.37%	2.58%	1.33
The Guardian (GRD)	5.71%	0.85%	4.37%	1.51
Harmony Plus (HMY)	5.12%	-1.80%	5.11%	1.29
The Expedition (EXP)	1.39%	-4.88%	6.33%	1.03
S&P 500 (SP500)	-28.54%	-5.90%	-4.74%	0.54
Important Performance Disclosure

Here We Go Again - Another Stimulus Program coming to a Tax Collector near You

Job creation has been the major focus of government policies, or at least that is what we have been led to believe. Immediately after taking office, the new administration launched an aggressive spending program at a cost of more than $800 billion to keep unemployment, which at the time was below 8%, in check. It was the beginning of an impressive plethora of multi-trillion dollar stimulus programs and bailouts aimed at ‘fixing' the economy.

Fast forward to today. We learned last week that the official unemployment rate (U-3) notched higher to 9.6% (from 9.5%) in July. So with November mid-term elections rapidly approaching amid falling approval ratings, the Obama Administration is taking action again. This time it takes the form of a set of multi-billion dollar proposals, which the president has stressed is not another "stimulus" program, even though we all know that is exactly what he has planned.

The latest government program has three moving parts according to the White House.

1) A program to accelerate $200 billion in business tax write-offs which the White House has estimated will cost $30 billion.

2) A new infrastructure spending of at least another $50 billion.

3) A program to increase and extend a tax credit for research and development estimated to cost $100 billion over 10 years.

Not surprisingly, White House spokesman Dan Pfeiffer did his best this week to put a positive spin on the latest proposals.

"These measures will help create jobs while building an American economy that is more competitive and productive over the long term," in a White House blog.

With a falling approval rating and increasing opposition to the rapidly ballooning budget deficit and long-term debt, the new Obama plan is a high stakes gamble. He has to do something. With this latest iteration of Obamanomics, he is throwing everything he has left into slaying the economy's most stubborn nemesis - high unemployment.

Come hell or high water, there is one promise he seems adamantly opposed to breaking. That is his pledge to let the Bush tax cuts expire in 2011. This puts small business owners in the position of having to guess how this tax increase next year will impact them since their business profits in excess of $250,000 per year will get caught in the higher tax net. Those with investments will also get hit with higher capital gains taxes aimed at the so-called "rich."

Paddling a Canoe up a Waterfall?

Republican House leader John Boehner believes that extending the Bush tax cuts would at least give certainty to small businesses but critics say that the government can't afford to do so in the wake of trillions in recent stimulus spending. He has a point and small business owners are listening. Without certainty, small businesses, which account for the lion's share of new jobs in our economy, will put off hiring until they can assess the added tax costs.

There are other challenges to the latest Obama proposals. Harvard economics professor, Greg Mankiw, described the limitations of the new government business tax breaks.

"The impact will be relatively modest. Notice that expensing merely accelerates deductions. Thus, the value to the firm depends on interest rates. With interest rates near zero, the impetus to investment is small. Put another way, this policy can be seen as giving firms a zero-interest loan if they invest in equipment. But with interest rates near zero anyway, the value of the loan is not that great."

One of the biggest job creation agendas since the latest recession began was the government census program. At its apex in May 2010, it accounted for 564,000 workers according to the U.S. Census Bureau. To put that in perspective, there are approximately 2 million federal government full-time workers (including postal employees) according to the latest BLS data. Census hiring was a big deal.

That is now over and those jobs, most of which were temporary, are disappearing. Another 121,000 census jobs were lost in August. As the next chart shows, it provided at best a temporary blip. At worst, it may have provided a false sense of demand along with the mistaken impression that unemployment was finally on the mend. As the chart also shows, we are in the process of suffering through the worst recovery since World War II in terms of jobs lost. Now that the census hiring is over, joblosses look set to increase again.

Chart 1 - A chart comparing the recovery in employment in recessions from World War II on. Courtesy of CalculatedRiskBlog.com

Chart 2 - As this chart shows, this recession has resulted in the biggest jump in the length of unemployment in the last five decades - with little improvement in sight. Courtesy of CalculatedRiskBlog.com

So Where Did We Go Wrong?

There is scant evidence that stimulus programs have had anything other than a short-term effect, especially when it comes to helping the group hardest hit by the recession - the long-term unemployed. This recession is like no other in recent history - the length of time people have remained unemployed is unparalleled in the last 50 years and is likely as bad as the Great Depression. Unfortunately, the big changes in how unemployment figures are now calculated make realistic comparisons difficult at best. Certainly the attempts by government today are eerily similar to those like the New Deal by FDR in the 1930's. Unfortunately, the outcome we've experienced is also more similar than any current politicians in power are prepared to admit.

Chart 3 - This time is different! As we see from this chart, the number of long-term unemployed is at a 60-year high and more than 50% above that the second most severe recession in 1981-1982. Courtesy of dshort.com

Is the 800-Pound Economic Gorilla Invisible?

We have discussed the importance that small businesses play in generating new jobs. But how important are small businesses, and specifically new businesses, in driving jobs growth?

It may surprise you to learn that the government, under the auspices of the U.S. Census Bureau, has released data, called the Business Dynamics Statistics (BDS), in an attempt to address this question. One aspect of the program is to track business startups of U.S. private, non-agricultural companies.

According to a Census report entitled Jobs Created from Startups in the United States,

"The fraction of employment accounted for by U.S. private-sector business startups over the 1980-2005 period is about 3 percent per year... While this is a small fraction of overall employment, all of this employment from startups reflects new jobs. As such, 3 percent is large compared to the average annual net employment growth of the U.S. private sector for the same period (about 1.8 percent). This pattern implies that, excluding the jobs from new firms, the U.S. net employment growth rate is negative on average. This simple comparison highlights the importance of business startups to job creation in the United States." (U.S. Census Bureau report - Jobs Created from Business Startups in the United States)

Hold on a minute! There is a lot to consider in that last paragraph. If I understand this correctly, it is saying that startups accounted for ALL of the new private-sector jobs created in our economy from 1980 through 2005!

Here is a chart from the report that should help clarify the jobs picture. Take a close look because there is a lot of information presented. Also note that Micro Startups (small businesses with 1 to 4 employees) accounted for a far bigger percentage of jobs than larger firms, in fact nearly one in five (19%). This compares to an average of 3% of jobs for all startups. Unfortunately, as the next chart shows, Micro Startups have lost ground in the number of employees since the late 1980's. According to Business Dynamics Statistics, this may "reflect compositional changes in sectors such as retail trade, where there is ample evidence of substantial shifts away from small, single-establishment firms to large, national firms [box stores]."

Given the complex and diverse nature of the business market, this unfortunately oversimplifies the situation. However, there are some valuable lessons to be learned.

Chart 4 - Chart comparing the percentage of jobs created by small and large businesses.

Next we took a look at the data contained in the Census Bureau's Business Dynamics Statistics (BDS). The data dates back to 1977, but the first years that the data was collected it was incomplete. We therefore compiled data from 1995 through 2005, to try to get a more accurate picture of the impact of startups on job creation.

We've charted the results below. There is one caveat, the data for companies in the last two categories (cohorts), namely companies that are 21-25 years old and companies that are 26 years and older are incomplete, so figures represent rough estimates. Since these companies accounted for just 10% of the total number of companies, they were not a major factor in overall job creation.

Chart 5 - Chart constructed from U.S. Census Bureau Business Dynamics Statistics data compiled for the years 1995 through 2005 showing the importance of startups compared to more established companies. Only startups created new jobs. Older companies lost jobs as they matured with year 2 accounting for the single greatest annual jobs lost.

Total Net Job Creation 1995 - 2005
Firm Age (Years)	Net Job Creation
0	34,635,485
1	-260,658
2	-1,553,616
3	-1,256,543
4	-1,091,159
5	-866,540
6-10	-3,120,470
11-15	-1,344,354
16-20	-853,981
21-25*	-450,000
26+*	135,136
TOTAL	22,752,489
	US Census Bureau

Table 1 - The total number of jobs created by firms from startups to mature companies older than 26 years. * Incomplete data for these cohorts for this period.

The takeaway is that in their first year of business, U.S. startups were indeed responsible for all new private sector jobs - a total of 34,635,485 jobs were created between 1995 and 2005 according to the Census Bureau. As the chart and table show, companies shed jobs as they aged. Year 2 accounted for the greatest single-year loss at 1,553,616 jobs. Even though businesses from 1 to 26+ years lost 11,882,996 jobs, net job growth was more than +22 million for the period thanks to the huge contribution by startups.

The big picture is that on average between 1995 and 2005, startups created an average of 3,148,680 new jobs per year. That compares to an average loss for companies in the other age categories of 1,080,272 jobs per year.

Tim Kane, author of a July 2010 report entitled, The Importance of Startups in Job Creation and Job Destruction for the Kauffman Foundation summed up the BDS data succinctly.

"Startups aren't everything when it comes to job growth. They're the only thing... Without startups, there would be no net job growth in the U.S. economy."

Easy to Connect the Dots, So Why Can't the Government?

There are 154.2 million workers in the civilian workforce according to the CIA World Factbook. Add another 2 million Federal government employees and 1.5 million in the military. Lump all the government employees together at the municipal, state and federal levels and there are roughly 22 million for a total of approximately 175 million employees.

According to the BLS, there were 14.9 million unemployed as of August at the stated U-3 unemployment rate of 9.6%. That number drastically understates the real situation. A more realistic estimate is the U-6 unemployment rate which was 16.7% in August. That includes discouraged workers who have given up looking for a job as well as those that took part-time jobs after being let go. That means there are nearly 26 million civilians currently unemployed.

Can you smell what I'm cooking here? Given that new companies have been responsible for all of the hiring over the last few decades, why is so little being done in various stimulus and incentive programs to spur new businesses? Are you aware of any programs specifically aimed at encouraging new business startups? I'm not.

So is it any wonder that economic stimulus programs have so far failed to have the desired result? All government and Federal Reserve efforts introduced so far, including new proposals, essentially ignore the entrepreneur who has been responsible for all new jobs. Private employers are finding it difficult, if not impossible, to borrow money for new companies given the stricter lending rules by banks. It's pretty hard to start a new business without any support.

The government is not helping either. However, they have thrown trillions of taxpayer dollars into supporting moribund, money-bleeding entities Fanny Mae and Freddy Mac?

Something that many voters will hopefully consider when they head to the polls in November...

Last but Not Least...

I know there has been a lot to digest this month but I wanted to update the Consumer Metrics Institute's Daily Growth Index, which has been a good leading economic indicator. In the final chart this month we see what the latest CMI data is saying. The economy is still contracting and the index is pointing to a double dip recession. Let's hope it's wrong this time around, but based on past performance, I'm not holding my breath.

Chart 6 - Chart courtesy of the Consumer Metrics Institute showing the latest data for the CMI Growth Index.

More Reading...

Obama pitches road spending and tax incentives
http://www.reuters.com/article/idUSTRE67O4WF20100908

Why Obama's Stimulus Failed
http://blog.heritage.org/2010/06/07/morning-bell-why-obamas-stimulus-failed/

Why the Stimulus Failed
http://www.ncpa.org/sub/dpd/index.php?Article_ID=18404

Employers on Strike
http://online.wsj.com/article/SB10001424052748704764404575286831965692578.html

Obama's Offensive May not Charm Business of GOP
http://blogs.reuters.com/columns/2010/09/07/obamas-offensive-may-not-charm-business-or-gop/

Obama Proposes Massive Business Tax Cuts
http://www.tax.com/taxcom/taxblog.nsf/Permalink/MSUN-89343B?OpenDocument

A Small Step in the Right Direction
http://gregmankiw.blogspot.com/2010/09/small-step-in-right-direction.html

The Importance of Startups in Job Creation and Job Destruction
https://docs.google.com/viewer?url=http://www.kauffman.org/uploadedFiles/firm_formation_importance_of_startups.pdf

Jobs Created from Business Startups in the United States
https://docs.google.com/viewer?url=http://www.ces.census.gov/docs/bds/BDS_Jobs_Created_ces.pdf

BLS Employment Data
https://docs.google.com/viewer?url=http://www.bls.gov/news.release/pdf/empsit.pdf

CIA World Fact Book - United States
https://www.cia.gov/library/publications/the-world-factbook/geos/us.html

Consumer Metrics Institute
http://www.consumerindexes.com/

Bronco Nation and the BCS

I mentioned in our last letter that the Boise State Broncos were playing Virginia Tech in the ESPN game of the week. They beat them in Boise State fashion. America loves an underdog, and there has never been a football underdog as small as the Boise State Broncos. I was born and raised in east Tennessee which is located in the heart of SEC football country. Tennessee's stadium sits over 107k screaming fans and getting a ticket is not an easy thing to do - even during the bad years.

Boise State's football stadium sits 30k and change, and the full-time student population is under 10k. Boise State University is a tiny school with limited resources that has been slapping the college football world in the back of the head for the last 10 years.

This year they are ranked so high that they risk being picked to compete for the BCS championship game. If this happens, they will more than likely be the catalyst that turns the BCS ranking system on its head and forces the system to weight schools/conferences similar to larger programs. ESPN is doing everything in its power to make this a reality by bringing the Broncos as much TV coverage as possible. ESPN college game day is coming to Boise for the Oregon State game on September 25^th. Prepare to see the blue field on game day.

In one fail swoop, Boise State could win the national championship and defeat the unfair BCS ranking system in the same year! If you like underdogs, then the Boise State Broncos are your team.

Working to grow your wealth,

John M. McClure
President & CEO
ProfitScore Capital Management, Inc.

P.S. ProfitScore provides its separately-managed accounts to individuals, advisors and institutional investors. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

Complete our Private Client Group request form by clicking here: http://profitscore.com/clientgroup.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

Cash Is Less Painful Than Doing Something Stupid

2010-08-29T15:47:00Z

A Brief Performance Update
Hindenburg Omen - Riding a Lead Zeppelin?
Looking To the Presidential Cycle
Oily Omen
More Transport Weakness
Cash Collared Consumers
Housing Holdouts
Employment-Challenged Economy
So what's next?
Time to Put on My Coaches Hat & the BSU Broncos

A lot has changed since my last letter. Many aspects of worldwide markets have seemed to turn on a dime and are pointing to a volatile future. Unlike my last few letters, there is no silver lining in my tone. This letter will print longer than normal because of all the charts and graphs.

One of my favorite leading indicators on the health of the economy is the Growth Index from the Consumer Metrics Institute. It does an astonishing job of taking the pulse of the American consumer. Most other consumer based indicators are lagging by months, but this indicator gives weeks, and sometimes months of lead time - making it a very unusual and helpful indicator about the economic future. If you are not familiar with this index, below are some helpful charts and comments to jumpstart your learning curve. It is currently firing a thumbs down.

It seems like every data point we turn over we find nothing but slimy snails and worms, and my general comment after massaging the numbers is yuck! When I think about the unconscionable amount of my children and grandchildren's future that has been mortgaged to produce the worst economic recovery since the Great Depression, it makes me want to pull my waste basket out from under my desk and purge my lunch.

The tone on Main Street these days is anger and frustration. November elections will soon purge many misguided politicians back into the private sector. I can still remember the turbulent 70's - bad economy, poor job prospects, war, political strife, and an uneasy pit in my stomach. Most of my readers also remember those days too and we all survived... and later prospered as we will do again.

However, now is the time to CAREFULLY navigate the minefield we are charging into. Predicting the future is a dangerous game. 2009 proved just how powerful government intervention can be in manipulating the markets. But this time around, we have already used up most of our dry powder, so fighting off the economic boogie man (gross amounts of government manipulation) will prove impossible. One day my grandchildren are going to ask me what it was like to live through one of the worst managed, politically manipulated, self serving economic calamities in our country's history. I am sure I will have a good answer when this mess is over in about 8 more years.

Heed My Warning
The chances are high that we are about to experience a waterfall decline in global equity markets. Not a normal kind of decline, but something along the lines of September and October of 2008. If you are long equity assets, now would be a good time to sell and sit in the safety of cash. As Warren Buffett said, "sitting in cash is a painful thing to do but it is always less painful than doing something stupid".

Quote of the Month
"The economic news has turned decidedly negative globally and a sense of ‘quiet before the storm' permeates the financial headlines. Arcane subjects such as a Hindenburg Omen now make mainline news. The retail investor continues to flee the equity markets and in concert with the institutional players relentlessly pile into the perceived safety of yield instruments, though they are outrageously expensive by any proven measure. Like trying to buy a pump during a storm flood, people are apparently willing to pay any price." - Mapping the Tipping Point by ‘Tyler Durden' of Zerohedge -August 21, 2010

A Quick Performance Update

To improve the consistency of producing this letter, I am going to pull performance updates out of this letter and send a dedicated performance update out once a month to clients and interested parties. We will continue to provide links to our normal performance reports, which can be found in the top right hand column of this letter. However, our traditional performance section updates will soon take on a consolidated and enhanced format.

Are Markets Riding a Lead Zeppelin?

Much has changed since I wrote you last. The double-dip argument has grown stronger, fundamentals for the most part have continued to deteriorate and job losses mount. This month we take a look at what has happened recently through charts and indicators, some of which might surprise you.

The internet has been a buzz about the recent sell signal from an indicator with a scary name called the Hindenburg Omen. It has many data points which generally means that the data has been curve fitted to produce the desired result. With that being said, it is hard to argue against its impressive real-time track record.

Chart 1 - A daily chart of the New York Stock Exchange Index showing the times when the Hindenburg Omen has triggered. Red circles mark signals that triggered corrections and purple triangles mark failed signals. Look at the successful signals (circles) versus failures (triangles) since 2000. There have been 12 HO signals with only two false signals. That is a pretty good track record in anyone's book. Most recently, the indicator fired on August 12th and was confirmed when it was triggered again August 20th. Chart courtesy of Metastock.com

First, we look into what was a little known trading signal on Wall Street until August 12th. That was the date the indictor fired for the first time since June 16th, 2008. As the first chart shows, the market subsequently suffered a series of mind-numbing drops until it bottomed in March 2009.

Named for the German-made hydrogen dirigible that exploded after completing its maiden trans-Atlantic voyage on May 6th, 1937, the Hindenburg Omen has been discussed on just about every financial news channel over the past few weeks.

So what exactly is the Hindenburg Omen? It is a technical indicator that uses a combination of market breadth metrics such as the number of new highs, new lows, and unchanged issues on the New York Stock Exchange, together with the McClellan Oscillator to measure the health of U.S. stocks. When it triggers and is followed by a second signal within 36 days, it warns of an imminent stock market collapse according to theory. (For a more detailed explanation, see the first three links in More Reading at the end of this newsletter).

After the Hindenburg Omen warning on August 20th, a number of financial news programs again buzzed with discussions of the coming market meltdown. Should we be worried?

Looking to the Presidential Cycle

Two challenges exist with the latest Hindenburg Omen warnings.

First, there are a number of different versions of the code. The code we used in Chart 1 has more filters so it issues fewer signals than the original formula, or that used by Peter Eliades in 2005 (see Past Performance of the Hindenburg Omen...in More Reading). Depending on who you listen to, there is considerable debate on how many times, or even whether a valid signal has been issued.

Secondly, data between different providers is varied which causes further confusion. Our data comes from Reuters, so for the most part it is very reliable.

Another challenge to a big collapse from here is the election cycle. Michael Kahn of Barron's Online commented in Taking Stock of a Scary Market on August 18th (see More Reading section below) that we are entering a period in the election or presidential cycle in which stocks often put in major lows. That multi-year low traditionally comes near the end of September of the mid-term year. That is only a month away!

Does that mean stocks can't go much lower? Cycles are useful but shouldn't be relied upon to generate pinpoint signals. At best, they provide an overall framework as opposed to a specific time-sensitive trading strategy.

We have written about the presidential cycle frequently; there are some good reasons to suspect that the usual mid-term year lift may at best be muted this time around, if it comes at all, and here's why.

Since the turn of the twentieth century, successive administrations have become increasingly adept at getting the unpleasant job of fiscal management out of the way in the first two years of their term. This has allowed them to crank up the stimulus spigots in the last two years of their term to get the economy firing on all cylinders leading into the next election. The better they performed this task, the greater their chances of re-election.

For those not familiar with the presidential election cycle, a simple system we developed that bought the Dow at the mid-term election low and sold at the high in November of each election year 26-months later outperformed the inverse system that bought at the end of November each election year and sold in September of the mid-term year 22-months later by a factor of more than 13 to 1 between 1902 and 2006. Put another way, 93% of the Dow gains over that 102 year period occurred in the 26 months leading up to elections versus just 7% for the 22 months after elections, all thanks to a carefully orchestrated government cutback and stimulus cycle. Over time, governments have gotten better at this which skewed returns even further.

That lopsided performance began to come undone after 2004 as the Bush Administration curtailed the traditional post-election cutbacks and revved up the stimulus pumps to address the effects of the recession. Then President Obama wasted no time turning the election cycle completely on its head by spending trillions in stimulus and bailout programs immediately upon taking office.

As a result, many would argue that in lieu of some sort of monetary miracle, the stimulus spigot is now running on fumes as we enter the traditional election cycle lift. Under crushing fiscal deficits, where would the money come from to kick Quantitative Easing 2.0 into gear?

Unless they have been living under a rock, politicians should be acutely aware that voters who are also taxpayers are getting downright fed-up with a spendthrift government as Obama's recent low approval ratings would seem to indicate. Slowly but surely voters are concluding that we can't continue borrowing from the future with Uber-Keynesian abandon to finance the fiscal fiesta today.

As the economy has deteriorated, it has become painfully clear to even the most avid helicopter cash-dropping advocate that you can lead the consumer to the mall but you can't make them spend.... unless you first give them more cash. Take away the cash-copters and spending, and the economy will quickly cool. Now that the candy men (and women) in Washington have blown their stimulus-sweet voter treats, what's next?

Let's see what some of the other indicators and charts have to say.

Oily Omen

Industrial economies like ours run on oil. I wonder how many appreciate just how influential a commodity it is? I'll use this next chart to demonstrate.

Chart 2 - Chart from the late 1960's to date showing the year-over-year percentage increase in oil prices with the dates they peaked. Oil price just mixed the 100% mark in July 1987 (red arrow) but just four months later, the Dow experienced its biggest single-day drop in history. Without exception, each time oil prices year-over-year have increased 100% (horizontal red line), a recession followed.

Take a close look at when the price of oil has more than doubled year-over-year. At the far left, it first occurred in December 1973 and then again in January 1980. Oil jumped slightly less than 100% by July 1987, but then more than doubled by September 1990, February 2000, and June 2008. Do those dates mean anything?

The dates may not be significant, but what is important is what happened in each case in the ensuing months. If you said recession, give yourself a pat on the back. Without exception, every time oil prices have increased 100% year-over-year, recessions followed. Sometimes it took months, sometimes more than a year, but it happened each and every time.

When oil prices doubled in June 2008, the recession followed in December. As the above chart shows, oil prices were up 100% again by January 2010. Needless to say, it is not a ringing endorsement for a V-shaped recovery.

Cash Collared Consumers

Measures such as the consumer confidence index and the consumer sentiment index are well known. They poll consumers to gauge how they are feeling. However, a relatively new index from the Consumer Metrics Institute (CMI) measures "consumer demand on a daily basis, providing nearly two orders of magnitude more resolution than the Bureau of Economic Analysis's GDP releases."

Chart 3 - Consumer Metrics Institute Growth Index which has led GDP as well as US stocks since its inception. Chart courtesy of dshort.com, data courtesy of the Consumer Metrics Institute.

"As a result we can see timing relationships that simply can't be seen in quarterly data," according to the Consumer Metrics Institute website.

Chart 3 shows how the CMI Growth Index has led both GDP and the S&P500 Index since its inception. It is now indicating that both will be significantly lower later this year, possibly taking both GDP and the S&P500 back to early 2009 levels. But without trillions in stimulus, what will drive the next surge in the economy?

Next, we see how performance for the S&P500 from 1929 to 1945 compared to the period from 2000 to present; after correcting for inflation. The two periods are similar in more ways than just stock performance. They were both marked by unprecedented government intervention financed by the taxpayer.

The big question is whether the government approach will be any more successful than it was eighty years ago? This chart suggests that if the SPX outcome is similar, we should conservatively expect another 20 to 30% drop in the S&P500 over the next two years before economic recovery can begin in earnest. The problem is that it took World War II to finally fix the economy last time we were in a similar fix.

Chart 4 - Chart comparing the S&P500 between 1929 and 1945 to 2000 to present after correcting for the official inflation rate. Chart courtesy of dshort.com

Here is how Doug Short, creator of the above chart, explains it.

"Many people don't realize that the cyclical bear market that began in 2007 is a continuation of the 2000 bear because in nominal terms the index peak in 2007 was a couple percentage points above the 2000 high. We also see that the low in 2009 actually took the market lower than the same point during the Great Depression."

What if the real inflation rate over the last decade was higher than the "official" Consumer Price Index estimates? Since GDP is measured by subtracting CPI, it would mean that real GDP is lower than reported and may still be in negative territory. It would also mean that the inflation-adjusted S&P500 performance is even worse than shown in the above chart.

Compare the official CPI with the figure developed by ShadowStats which uses the statistical calculations used before the number was substantially altered by successive governments after 1982.

Chart 5 - Chart comparing the official CPI with actual according to the author. Chart available at http://www.shadowstats.com/alternate_data/inflation-charts

According to ShadowStats.com, the real inflation rate is nearly 6% higher than the official rate (chart 5). This means that real GDP is somewhere around -3.5%, not +2.5% that's being reported. If this is true, the recession is still in play in real terms.

More Transport Weakness

In a growing economy, transportation demand increases. Is that happening now?

Chart 6 - Chart of the Baltic Dry Index which measures the rate to ship dry goods by sea over the last five years. As we see, February through August each year (yellow rectangle) has historically been a period of growth for transport demand. This was not true in 2008, and it has not been true in 2010.

Our first metric is the Baltic Dry Index, which measures the cost of transporting dry goods by sea. As the next chart shows, demand has traditionally been strong from February through August; that was until 2008. Demand appears to resurge in 2009, but it was short-lived, and has now dampened again in 2010.

Based on year-over-year percent change in the next chart, this trend is showing little sign of improving. Demand is softening in the same way it did in the fall of 2008.

Chart 7 - Chart showing year-over-year percent change in the Baltic Dry Index with the recent weakening trend in transport demand.

There is a similar trend in rail traffic according to the latest data from the Association of American Railroads (chart 8). Chart 9 shows the latest LA Port traffic figures.

Chart 8 - Comparison of US rail traffic for all commodities showing that 2010 is looking similar to 2008, but at significantly lower levels. Demand is on track to return to 2009 levels. Chart courtesy of http://www.aar.org/

Chart 9 - Chart of monthly LA Port import and export traffic. According to the latest data, imports are up but exports are down 4% since May. Chart courtesy of CalculatedRiskBlog.com

On the positive side, port traffic has rebounded, but most of the improvement is inbound traffic (imports). If economic growth is to be sustained and our manufacturing sector to grow, we need to see growth in exports, and that hasn't happened.

Housing Holdouts

Housing was an important factor in economic growth until 2007. How is the industry fairing now?

Building Permits, housing starts, and new home sales have traditionally led existing home sales and prices. For starters, according to the National Association of Home Builders, builder sentiment measured by the Housing Market Index (HMI) is still deteriorating. Builder sentiment fell to 14 in July and again in August to 13, the lowest level since March 2009 (chart 10).

Much of this is due to falling new home sales, which in May dropped to the lowest level since the data was first recorded in 1963. May sales were revised down from 300,000 to 267,000 units. New home sales in June did improve marginally, but the initial estimate of 330,000 made it the worst June on record. Now the question is how much will this figure drop in future revisions?

Both existing and pending home sales also showed more weakness in June, and preliminary estimates of existing home sales in July of 3.95 million (annually) would make it the lowest level since 1996 according to Thomas Lawler (Realtor.com).

Chart 10 - Chart comparing the NAHB Housing Market Index (HMI) Builder confidence declined again in August to the lowest level since March 2009.

Chart 11 - Chart showing official Unemployment Insurance Weekly Claims from 2000 to present courtesy of CalculatedRiskBlog.com

Chart 12 - Chart showing three unemployment estimates; the official U-3, the higher U-6, and the highest estimate courtesy of http://www.shadowstats.com/alternate_data/unemployment-charts

Employment-Challenged Economy

In spite of what the government claims in that millions of new jobs have been created, reality simply does not bear that out. Jobs are still being lost and unemployment remains near Great Depression levels by some estimates.

On August 19, we learned that weekly jobless claims hit 500,000 which is the highest number since November 2009. The official unemployment rate (U-3) shows unemployment of 9.5% with the U-6 estimate that includes the official discouraged and underemployed workers, at 16.5%. But the true unemployment rate could be even higher if the data from Shadowstats.com are to be believed (see chart 12). These data that are arrived at by using unemployment calculations prior to the changes to remove various categories of unemployed from official estimates in an effort to make the number look less negative (read: to help incumbent parties get re-elected) over the last two decades.

Employment is a lagging indicator, but the rate of change lags far less, if at all. However, the problem is that the very steps being taken by government to address unemployment and fix our economy is risking doing more damage than good.

Let me explain. Trillions have been spent since 2004 in attempts to re-ignite long-term demand in an economy that is roughly 70% dependent on consumer spending. The government claims to have created millions of new jobs, but unless I am missing something, what they have created for the most part, is government jobs. I have yet to see any data indicating any significant improvement in private sector employment.

Government jobs and the wages they pay compete with small businesses, which have created the lions' share of new jobs over the last decade. The more jobs the government creates through various "infrastructure" make-work projects, the fewer workers there are that are willing, or available, to work for private enterprises. To compete, private employers must pay higher wages: a situation that puts small businesses under greater stress in a weak economy.

This course of events is not new. It was why it took nearly a decade and a world war to fix it last time we were in such a pickle.

So What's Next?

There are many who still believe that spending our way out of trouble is the best solution: some are even Nobel Laureates. This approach belies the results to date and an accurate assessment of history. How can anyone with an understanding of history believe that spending more money and creating more debt can cure a debt problem, and break our obsession with debt? It failed to work in the 1930s and it's not working now.

If that is the case, why do politicians continue to doggedly pursue this solution? There are a number of reasons. They include a poor understanding of what really drives economies by both elected and non-elected officials, combined with selective myopathy when it comes to lessons in history. But most of all, the fault can be traced to giving into populist political pressure.

A poor understanding of economics combined with a misguided attempt to adopt an ultra-Keynesian solution supported by popular opinion has taken us in the wrong direction while saddling us with unprecedented levels of debt in the process.

As traders and investors, we can't control what politicians do any more than we can dictate crowd behavior. All we can do is take appropriate action to preserve what we have and profit where possible. Stock markets continue to move erratically partly due to low volumes and partly due to a growing mistrust by investors about where economic policy is taking us. Regardless of the reasons, we must take action commensurate with what our common sense and indicators are telling us.

So what is Jim Miekka, creator of the Hindenburg Omen, doing right now? According to the Wall Street Journal on August 16th, although he isn't exactly bullish about stocks following the first signal, Miekka didn't say it was time to head for the exits just yet. However, he did offer the following comment.

"I'll be dancing close to the door."

No doubt he'll be dancing even closer to the door following the second Hindenburg signal August 20th.

More Reading...

Taking Stock of a Scary Market Signal
http://online.barrons.com/article/SB50001424052970203651904575437701553249446.html

Past Performance of the Hindenburg Omen 1985 - 2005
http://www.safehaven.com/article/3880/the-past-performance-of-the-hindenburg-omen-stock-market-crash-signals-1985-2005

Hindenburg Omen Flashes - Yahoo Finance
http://finance.yahoo.com/banking-budgeting/article/110355/hindenburg-omen-flashes

Consumer Metrics Institute website
http://www.consumerindexes.com/

Time to Put on My Coaches Hat & the BSU Broncos

My youngest daughter, Annabelle, began soccer practice this week and I am not sure who was more excited, me or her. I love to get involved and coach my girls in the sports they play. As they get older and play in more advanced leagues, my ability to coach them will be more limited, so I cherish the time we get to spend together now.

Sarah has decided to hang up her cleats so she can concentrate on basketball. It is crazy how competitive kid's sports have become. Kids are now choosing one sport to specialize in while they are in elementary school. When I was a kid, you didn't even think about specializing until high school. I start coaching Sarah's basketball team in October so my fall schedule is about to become crazy busy.

In case you haven't already heard, the Boise State Broncos, ranked third in the country in the AP, will be playing Virginia Tech on Monday, September 6^th in a game arranged and heavily promoted by ESPN. It is being called the game of the week by ESPN and it promises to be a barn burner. Compared to other top 10 schools, Boise State is tiny. It would be like the smallest college football team in your state being ranked in the top 10. Despites the schools size and limited resources, their coaching staff are second to none and as a result their players have speed and ability that few teams can match. If you like rooting for the small guy who has a habit of beating up on over ranked competitors, then Boise State is your team.

I am very serious about the warning I gave on global equity markets in the introduction of this letter. Risk is very high these days, so protect what you have and don't let this market get the best of you.

Working to grow your wealth,

John M. McClure
President & CEO
ProfitScore Capital Management, Inc.

P.S. ProfitScore provides its separately-managed accounts to individuals, advisors and institutional investors. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

Complete our Private Client Group request form by clicking here: http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

Is Our Nation's Largest Creditor Telling The Truth?

2010-06-10T15:51:00Z

Our Monthly Performance Update
China: The Economic Elephant in the Room?
Chinese Fool's Gold
Smoke and Mirrors
Superbubbling Over?
Trade Earnings of the Impossible Kind?
A Drop in the Bucket
Interesting Reading
Portfolio Performance Analysis
Why Pigeons Walk Instead of Fly in Boise Idaho

Was the flash crash a market related fluke, or could it be telling us something about our future? When most investor's think back to the most recent bear market, many remember Bear Stearns, Lehman Brothers, and the gut grinding months of September, October, and November. The event was so traumatic that it is easy to forget how it all got started.

The first shot across our bow was in August of 2007. As it turned out, most of the larger quantitative based market neutral long/short hedge funds had become correlated with their positions and didn't know it. Each thought they had developed some super secret alpha generating model, but actually these funds had developed similar models that were making the same trades. Everyone's super secret computer model had found the same edge in the data.

In August of 2007, the perfect storm hit causing these funds to unwind their trades at the same time causing huge losses for their clients. When there is no one to take the other side of your trade, it is painful. The losses were so large that it caused many hedge funds to close their doors. Even Goldman Sachs had to close down some of their billion dollar funds, so it must have been completely unexpected. Genius failed again.

What happened in August of 2007 and the flash crash in May of 2010 seems eerily similar. Do you recall what happened next?

In September of 2007, the talking heads/market cheerleaders talked down Augusts' volatility saying it was a one-time glitch in the markets trading dynamics that caused the increase in volatility and that everyone should start buying stocks again. Strangely, the market got wacked again in October and November as cracks in the dam started to appear. Ninety-five plus percent of economist stated that everything was fine. It was commonly mentioned that corporate earnings were at record numbers, and that future economic growth is up and to the right. "I sure wish I would have known how to short sub-prime back in 2006 when I sold my house".

As of today, the SEC still doesn't know how, or what, caused the flash crash in May. So what do they do? Pass rules and institute policies that are not based on fact. I am 99.99% sure I know the reason. It is called fear.

The average investor got ravaged in 2008 and simply does not want to give back the gains they made in 2009. Many of these same investors are still underwater from their 2007 equity high, not to mention underwater since March of 2000. It is because of 2008 that many investors had to change their retirement plans to adjust to their new net worth reality.

Europe's impending collapse had everyone's nervous finger on the trigger. The flash crash was caused by fear, plain and simple. Program trading may have made the drop a little worse and the recovery faster, but it was not the cause of the event. As it turned out, August of 2007 was the canary in the markets coal mine warning of future volatility. May 2010 was down 8.2%, and was one of the worst months in the markets history. Was the flash crash a warning sign of future volatility? I believe it was.

This letter is based almost entirely on China. Why you may ask? Because I feel that China's equity markets are leading U.S. equity markets out of and into bull and bear markets. At least that is the recent pattern.

China's equity markets advanced 4 months ahead of developed markets in the last bear market rally to lead equity markets higher. Again leading, China's equity markets topped out in July of 2009 and are now down over 35%. Industrialized countries appear to be slower out of the recovery gate, and late to roll over. Many economists feel that China's consumption has become the economic driver of the world. Are they leading equity markets as well? Recent activity clearly shows that they are and if China's bubble is about to pop it deserves our attention.

In my humble opinion, China is lying through their teeth about their economy. Like Russia at the end of the cold war, we will soon get to see, and unfortunately experience, the bursting of the greatest bubble in human history.

There are investors much smarter than me who have been saying this for quite some time. Most of my thinking about China has come from their research findings. In this letter, we are going to dig into their research and see if we can find clues for what China doesn't want anyone to know. Hopefully this will give you a better understanding about our nation's largest creditor.

Quote of the month
"It is a sad reality when a trillion dollars [in Euro-zone stimulus] can only buy you 400 points on the Dow. What can the politicos do for an encore?" - David Rosenberg

"The fate of the world economy is now totally dependent on the growth of the U.S. economy, which is dependent on the stock market, whose growth is dependent upon about 50 stocks, half of which have never reported any earnings." - Paul Volker

Our Monthly Performance Update

Baptism by fire! In our last letter, I mentioned that we just pulled the trigger on a more adaptive way to trade equity markets. We went live with this methodology on April 23rd, which turned out to be the very peak of the market. So, how did we do? We were flat in May and are up a little over 1% MTD June. Since the launch of our new heat seeker methodology on April 23rd, the S&P 500 has declined -12.76% and we are flat to slightly up, depending on the portfolio.

So far, I have to give our new adaptive heat seeker methodology a big thumbs up. Below are our updated numbers through MTD June.

Below are recent performance returns on the four portfolios we currently offer:
ProfitScore provides its separately-managed accounts to individuals, advisors and institutional investors. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

	Jan 08 to	YTD	MTD June	Sharpe
Name	Present	2010	2010	Ratio
Income Builder (IB)	8.39%	0.20%	0.57%	1.33
The Guardian (GRD)	3.20%	-1.54%	0.97%	1.51
Harmony Plus (HMY)	4.49%	-2.39%	1.50%	1.29
The Expedition (EXP)	3.50%	-2.90%	1.74%	1.03
S&P 500 (SP500)	-23.48%	-3.96%	-2.50%	0.54
Important Performance Disclosure

Complete our Private Client Group request form by clicking here: http://profitscore.com/clientgroup.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info@profitscore.com.

Someone will contact you within 24 hours of receiving your information.

China: The Economic Elephant in the Room?

It has been an incredible decade and much has changed. One of the biggest marvels has been the economic revolution in China. It has gone from a poor third-world nation with one of the lowest per capita GDP's, to the fastest growing economy in the world in a few short years.

From an investment perspective, once a follower of western markets, Chinese markets are now leading the globe in more ways than one. Chinese GDP growth, estimated to be in the double-digits this year is the best in the world with India running a close second, making both the envy of every industrialized nation struggling to repair the scars the recession left behind. This is more than three times the International Monetary Fund estimated GDP growth for the U.S. and Canada in 2010. In addition, roughly ten times the estimated growth for major Euro-zone economic drivers Germany, U.K., and France.

China had no recession if the numbers are to be believed, growing at 8.7% last year while the global economy contracted 2.2%, according to CSMonitor.com.

According to Economist, the IMF reckons that by 2015 almost 75% of global growth will come from China and other developing countries. This compares to a contribution averaging 40% during the 1990's, rising to 58% between 2000 and 2007.

The Shanghai Composite Index peaked in October 2007 with other national stock markets, but then bottomed out more than four months before the other major indexes providing the first hints that the economic recovery was underway. However, since peaking in July 2009, Chinese stocks have struggled.

So which indicator is right? The correct answer is that it is too early to tell with much certainty. Economic estimates are somewhat subjective, whereas equities markets reflect investors making real financial bets. We tend to give more stock (no pun intended) to the latter, especially considering the abysmal record economists have demonstrated in the last decade. (Ninety-five percent of economists surveyed in March 2001 got it wrong when asked by Economist if they thought a recession was imminent, even though as we later learned, we were already in one at the time!)

Figure 1 - Weekly chart of four major market indexes showing the Chinese Shanghai Shenzen Composite peaking along with the rest of them in October 2007 but bottoming well in advance of the others in spite of impressive Chinese economic numbers. So which indicator is right? Chart courtesy of GenesisFT.com.

We have also described in past issues the tendency for governments to exaggerate the positive (GDP, new jobs), and downplay the negative (unemployment, inflation), when reporting economic numbers. They have a huge vested interest in making voters think the situation is better than it really is.. After all, their jobs depend on it. This is a science that has been carefully nurtured and perfected over decades, if statistical trends are any indication.

Chinese Fool's Gold?

No one can seriously dispute the fact that demand in China is strong based on the amount of commodities they are buying from countries like Australia. Much of this demand is based on export growth. According to the World Trade Organization, China exported more than $1.2 trillion in goods, overtaking Germany in 2009, making it the world's leading exporter even after accounting for a 16% drop in Chinese exports.

How much of the Chinese ‘marvel' is smoke and mirrors? How much of the growth is the result of the totalitarian government accentuating the positives and burying the negatives so that anyone on the outside world, as well as those in the country have a distorted view of what is going on?

We've all heard that well-worn maxim, "Power corrupts and absolute power corrupts absolutely." If a totalitarian communist government with iron-clad censorship and no independent oversight, the largest standing army in the world combined with zero transparency isn't absolute power, then I don't know what is.

Why should we care? As well as being the fastest growing economy and the largest dollar-volume exporter in the world, China now has the second largest financial system and the second largest stock market according to Economist. It is the single largest holder of U.S. Treasuries and holds the largest current account surplus. It also holds the greatest foreign reserves in the world, estimated to be somewhere between $2 and $3 trillion.

With one-fifth the population, China consumes half the cement, a third of the steel and a quarter of the aluminum produced in the world. Perhaps more importantly, is the rate at which the demand is growing. Demand for iron ore for example, has risen by an average 27% a year in the last four years. Since 1999, crude oil imports are up 3500% and soybean exports are up a similar percentage. Copper ore and concentrate are up 2500%. (See article Ravenous Dragon). These parts of the Chinese growth story seem real enough.

If economic growth in this dragon economy has been exaggerated by government statistics, or if the nation is in the throws of a superbubble, the global economy will be seriously impacted when the inevitable correction comes and reality sets in.

Smoke and Mirrors

Two presentations make the case that China is not only obscuring the real economic situation, but it is in a superbubble. In his April presentation entitled China - The Mother of All Black Swans, Investment Management Associates portfolio manager and director of research, Vitaliy Katsenelson breaks Chinese growth into three stages: Late-Stage Obesity (1998-2008), You Lie!, (2008 (Q4) - 2009 (Q2), and Super Steroids R-Us (2009 (Q2) - present day).

He says that the 10% growth China experienced over the last decade is unsustainable for one big reason. It is clear that western nations, and especially North America, have overleveraged themselves and now must go through a period of painful deleveraging. This has created vast overcapacity in Asia, and especially China.

For example, South China Mall opened in 2005 and is the second largest shopping mall in the world with 1500 stores and 7.1 million square feet. It was built in anticipation that the Chinese middle class would have more disposable income. According the Katsenelson, 99% of the space sits empty. The middle class in China is only 10% of the population according to investment advisor Gary Shilling. This compares to a middle class in the U.S. of roughly 80% of the population. Such ambitious mega building projects in China are only accessible by a small percentage of the population.

Another white elephant is the City of Ordos, built in Inner Mongolia for one million residents on speculation. It too, remains empty - an expensive ghost town.

According to Katsenelson, with global exports down 25% in 2009, tonnage shipped by Chinese railroads down double digits, and electrical consumption declining, how could Chinese GDP expand 10% in 2010, and slightly less in 2011 as projected by the Chinese government? It can't, and he believes these figures are a blatant lie.

We've all heard about the massive stimulus the Chinese government pumped into their economy in the last year. Stimulus which Katsenelson says amounts to 14% of Chinese GDP, which is the largest in the world in percentage terms. Perhaps worse, is the fact that lending by the Chinese government (via state-owned banks) to keep the economy going, was up 250% in 2009 or by another 29% of GDP. Most of lending was for projects similar to ones mentioned above as well as bridges, highways and skyscrapers: projects not built based on need, but to keep workers employed.

As a result of massive spending programs, national real estate prices are up 40% in the last 18 months according to the New York Times, and floor space constructed jumped 100% while the rest of the world was in recession in 2009.

Here is another example of a huge project being built in China according to the New York Times.

"In the City of Tianjin, in North China, developers have created a $3 billion "floating city," a series of islands built on a natural reservoir, featuring villas, shopping malls, a water amusement park and what they say will be the world's largest indoor ski resort."

This resort city in North- Eastern China is expected to be home to 350,000 residents but the $64,000 question is: who is the project being built for? Certainly not average Chinese. There is no way they could afford such luxuries.

Superbubbling Over?

Frothy asset prices and growth look eerily like Japan in the late 1980's before its bubble bust. Although there are similarities, the big difference between the two Asian powers is demographics. One of the reasons Japan's malaise has lasted for more than two decades is the low birth rate and rapidly aging population; a major positive for China. All this really means though, is that any bubble burst will heal faster thanks to demographics, it won't prevent it.

James Chanosis president and founder of Kynikos Associates, an investment company that scopes out companies that are overvalued and sells shares short to profit when they drop. This strategy made millions shorting companies such as Enron Corporation. In many ways, Chanos agrees with Katsenelson.

Chanos expressed his concerns about China in a February presentation. He sees classic pockets of overheating in the economy combined with overcapacity in a number of sectors.

Chanos believes the very tight range of GDP growth estimated, that have hovered around 9% for years, is statistically "staggering." He likened the phenomenon to Soviet reports of 6-8% GDP growth, which caused many to believe it was only a matter of time before the Soviet Union overtook Western Nations. We all know what happened there.

Chanos discussed the fact that new factories are being built in China while some factories "across the street" sit idle. He says the real estate boom is due to the fact that Chinese people see property as a store of value causing wealthy Chinese to buy 3 or 4 apartments for similar reasons investors bought property in the U.S. in 2005 - 2006. The roughly 30 billion square feet of office space under construction works out to a 5x5 foot cubicle for every man, woman and child in China.

Is it any wonder why Chinese officials have been so reluctant to let their currency, the renminbi, appreciate in response from demands from the U.S. and China's other trading partners? If the economy is in a bubble, the last thing it needs is a strengthening currency to exacerbate the problems.

It is a stark reminder to what happened in Mexico in 1994 when investors realized that the peso had been artificially propped up and it subsequently collapsed causing an economic ripple around the world. A pop in the Chinese bubble will have widespread impact. The result could well be collapsing commodity prices and global demand for goods and services that have buoyed commodity-dependent economies in countries like Australia, and to a lesser extent, Canada, especially right now while the economic recovery is fragile.

Chinese stock performances confirm Chanos' concerns, but more importantly have disturbing implications for U.S. stocks. As Figure 1 shows, from the bottom in the Shanghai Shenzen Composite in October 2009, to the peak in July 2010, the index rose nearly 100% before rolling over. This compares to an appreciation for the S&P500 of nearly 80% to date. A further drop in Chinese stocks would exert an even stronger pull on their U.S. counterparts. But even without the Chinese bubble bursting in the near term, further declines in global stock markets is only logical given the growing influence the Asian Tiger is having on other markets.

Trade Earnings of the Impossible Kind?

Three days after the Dow suffered what many believe was a mysterious one-day waterfall of nearly 1000 points, the world learned that four big banks, namely Goldman Sachs, JP Morgan Chase & Company, Bank of America and Citigroup, had a near-perfect trading quarter in Q1-2010. We thought it was worthwhile to put the 63 day winning streak - a period during which these giants did not lose money in a single day - in perspective. Just how statistically likely is this to achieve?

According to our very own Dr. Howard Bandy, this type of ‘luck' is far less likely than getting struck by lightning. Here is how he explains it for Goldman Sachs that enjoyed 63 winning days in the quarter.

"The probability of that, assuming each day was equally likely to be a win or a loss, was near zero. The actual number is (0.5)^63, or, 1.08 x 1019, or 0.000,000,000,000,000,000,108." (One in more than a thousand trillion?)

Here is how he explains the chances of this happening.

"Give every one of the 6 billion people on earth a unique identification number. Have each person pick a number between 1 and 10 billion and write it down. Have a disinterested party select a single special person who holds the winning number and write down that person's number. Now close your eyes, turn around three times, and name both the correct person and the number he or she picked. That is an easier task than 63 straight winning days when winning is equally as likely as losing.

"At least three other banks/traders achieved the same result -- 63 straight -- Bank of America, JP Morgan, and Citigroup.

"So a better question to ask is: At what level of probability for a win is it equally likely to get 63 wins in a row versus 62 or fewer wins out of 63? The answer is 0.989. The interpretation is that Goldman and the others each independently have a 98.9% probability of having a winning day.

"If you need to have a probability such that it is a coin flip whether the first four banks you ask all had 63 winning days out of 63, then the probability that any random day is a winning day is 99.7%."

"Certainly having low cost money to bankroll both the trading and lending operations helps."

As Dr. Bandy points out, every trader and investor, whether trading his own account or a multi-billion dollar institutional account, has these guys as competitors and counterparties.

Is it any wonder that there is a growing perception that major Wall Street firms are playing with a stacked deck? And the Federal Reserve thought it was necessary to bail these guys out to the tune of billions of dollars last year? Kind of boggles the imagination, doesn't it?

A Drop in the Bucket...

President Obama proudly announced a few months back that his politically motivated administration was committed to reducing government spending by $100 million in the next 90 days. Here we present a short video that explains exactly what that means in terms of overall government spending and the current size of the fiscal deficit. I hope you enjoy this presentation as much as I did.

Federal Budget Explained
http://www.wimp.com/budgetcuts/

Interesting reading:

Special Report; China
http://www.economist.com/countries/China/

IMF Economic Forecast
http://www.economist.com/markets/indicators/displaystory.cfm?story_id=15954583

Forecasted Growth
http://www.economist.com/daily/chartgallery/displaystory.cfm?story_id=15947057

China overtakes Germany to become the biggest exporter of all
http://www.economist.com/daily/chartgallery/displaystory.cfm?story_id=15836406

Risks and rewards of doing business in China
http://www.economist.com/displaystory.cfm?story_id=15807417

Ravenous Dragon
http://www.economist.com/surveys/displaystory.cfm?story_id=10795714

Not just another fake - The Chinese economy.
http://www.economist.com/displayStory.cfm?story_id=15270708

What does China's unloading of US securities mean?
http://www.china.org.cn/opinion/2010-02/23/content_19459041.htm

Presentation - China - The Mother of All Black Swans
http://www.zerohedge.com/article/china-mother-all-black-swans-updated#comment-305765

China: the coming costs of a superbubble
http://www.csmonitor.com/Commentary/Opinion/2010/0316/China-the-coming-costs-of-a-superbubble

Jim Chanos's lecture on China
http://www.businessinsider.com/jim-chanos-china-is-overheating-and-overindulging-2010-2

Goldman winning streak 2009
http://www.huffingtonpost.com/nathan-lewis/the-gs-files-4-always-a-w_b_253856.html

Portfolio Performance Analysis

Risk & Reward
Each of our portfolios is strategically allocated across one or more of the Investment Pillars of Strength discussed below. Each Pillar is managed by multiple, uncorrelated, absolute-return investment managers to produce a return stream that is consistent, negatively correlated with the major market averages in down markets and non-correlated with each of our core Pillars of Strength. Commentary found in this newsletter is for informational purposes only and does not effect how our portfolios are traded.

Managing risk is our most important consideration and it is reflected in the way our portfolios are built and managed each and every day.

In our last letter, I wrote the following:

"March looks like July 2009, producing multiple up days in a row. We actually experienced 10 up days in a row in the S&P 500 futures market. This many consecutive up days in financial futures hasn't been seen since 1987, so you might say that March is another historical reference point in a long list of statistical outliers encountered in this incredibly strong bear market rally."

It is well known that markets are hard to predict, but volatility is relatively easy to predict. Low levels of volatility are normally always followed with high levels of volatility, and vice versa. It is also well known that markets go down much faster than they go up. Gains that have taken months to accumulate can vanish in a matter of weeks. This predictive cycle has played out over and over again in the markets history. Once the last investor has been suckered into the rally, it collapses under its own weight. For reasons covered in the introduction to this letter, investors are in a heighten state of alert, so it makes trading this market increasingly difficult but engaging.

Index Advantage:

Overall, I have to give our new adaptive heat seeker methodology a high five. It took about two scary weeks for it to adjust to radically different market conditions than we experienced over the last 12 months, but once it got locked on target our trading accuracy has been exceptional. Our exposures have been smaller than normal, but gains have been normalized by increased levels of volatility. We are pleased so far but need more time to statistically evaluate our results in real-time, so we are watching closely.

MTD June performance 1.91

Strategic Balance:

These traders came to life in May and MTD June has been productive as well. We recently added a new strategy trading emerging markets that has excelled at capitalizing on the trading opportunities present in this volatile market.

MTD June performance 1.44

Dynamic Income:

High yield bonds are once again sitting on the side lines waiting for another opportunity to materialize. From the looks of things, it may be a while before they establish new positions. Government bonds continue to trade well and are adding gains to this important allocation.

MTD June performance .34

Our portfolios are built using varying distributions to the strategic allocations discussed above. To view detailed performance and risk statistics information about our investment portfolios for the month, please click on the links below:

If You Are a Client, Don't Be Confused.
Actual management and performance fees are incurred monthly but are deducted from client accounts in the first month of every quarter (January, April, July, and October). For performance reporting purposes, we deduct fees monthly as they incur and not quarterly, as they are reflected in client statements. It all washes out in the end, but this may cause your account performance to deviate from our published performance reports on a month-to-month basis. To be conservative, we also deduct the maximum fees we charge from our performance reports and your actual overall fees paid may be less than our maximum.

Why Pigeons Walk Instead of Fly in Boise Idaho

ProfitScore's office used to be located at the top of one of Boise's tallest buildings. Working downtown had some nice perks. Great restaurants were everywhere, it was close to some really cool stuff, and I got to watch first hand the aerial attack of Peregrine Falcons as they consume downtown Boise's pigeon population. Peregrine Falcons are serious predators, and thanks to a Professor at Boise State University, who discovered that the pesticide DDT was causing their destruction, these birds and many other birds of prey have made an impressive comeback.

Boise is home to the World Center for Birds of Prey. This center has been ground zero for reestablishing birds of prey around the world. My kids love to go there, so if you are in town, I highly recommend a tour. A few years ago they had an eagle there from Panama called the Harpy Eagle that preyed on monkeys, sloths, and other large mammals. The size of these birds made our eagles look like a school kid. Its talons were the size of my fingers.

It was not uncommon for me to be looking out my window in downtown Boise and see pigeon parts fall to the ground. Peregrine Falcons rule the sky in Boise and thanks to the efforts of a lot of hard working people, they rule the sky in many cities across the US and elsewhere.

Below is a webcam from a building in Boise showing a nest with three hungry chicks being fed by a mother who is thinning down Boise's pigeon population:

http://www.peregrinefund.org/falconcam/

Peregrine Falcons are unique in that they are the only bird that kills in the air. All other birds of prey attack their prey on the ground. Being a pigeon in Boise Idaho is a dangerous occupation.

Summer is here again, so I hope you have big plans with family and friends. We are leaving next week to tour the Redwood National Forest of Northern California and spend a week on a huge houseboat on Lake Shasta with dear friends. I can't wait.

Working to grow your wealth,

John M. McClure
President & CEO
ProfitScore Capital Management, Inc.

P.S. ProfitScore provides its separately-managed accounts to individuals, advisors and institutional investors. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

Complete our Private Client Group request form by clicking here: http://profitscore.com/clientgroup.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

Why It Is Good Not To Be First

2010-05-03T15:09:00Z

April 30, 2010
By John M. McClure†
www.profitscore.com

Our Monthly Performance Update
Dr. Howard Bandy Has Joined Our Team
An Important Change to Our Equity Allocations
The Most Important Charts of the New Century
Surfing the Money Tsunami
Bubbles of the Far Away Kind
Making Everyone Else Rich...
If You Can't Beat the Fed, Join Them
Interesting Reading
Spokane, Reno, and Orlando

The United States is very fortunate to have a front row seat to Europe's, and soon Japan's, sovereign debt crises. Going through the second phase of the credit crisis will be difficult short-term, but learning hard lessons from our neighbors will soon turn our ship out of harm's way and ensure the long-term economic viability of the United States. It's not that we're smarter than our comrades across the pond, it's just that our economic cycle is five to ten years behind theirs.

When this sovereign debt crisis finally plays out, socialism as currently defined by Europe, will no longer exist. As the book, The Fourth Turning clearly documented, humans have a nasty habit of hitting the reset button every 80 to 100 years. The Romans and Greeks recognized and documented this destructive and rebuilding phenomenon in their own culture.

This consistent cycle has been going on so long in human history, it appears that social recalibration is just part of human society. It is almost like we can't help ourselves as we strive to throw out the old and bring in the new. The last three 80-year cycles in American history are the Great Depression and World War II era, the Civil War and the Revolutionary War. I sure hope this cycle doesn't involve people shooting at each other.

Simply watching events play out in Europe is not enough on its own to cause the United States to change our debt-laden ways. There are a lot of very painful changes we must make to get us on the right track. We are as guilty as the next deficit-induced country. Change will occur only when there are no other choices, and watching Europe's demise just might motivate us to fix our problems.

Here is a recent update from the United States Government Accountability Office (GAO): "Roughly 93 cents of every dollar of federal revenue will be spent on the major entitlement programs and net interest costs by 2020."

When looking for clues to figure out a difficult problem, I try to find undeniable facts in the data. With 93% of every tax dollar paying for entitlements and interest payments, our country cannot survive, so we have to change. Don't be surprised if the Tea Party becomes its own political party.

The problem is so enormous that we can't simply tax our way out. We must cut spending to the bone and raise taxes. It will require both to survive as a country. In government, it seems to require difficult circumstances to force change because politicians naturally avoid choices that are unpopular with their constituents. Passing health care legislation will seem like a walk in the park when you have to sanction laws that reduce Medicare and Social Security payments to people who are just barely getting by. The next 10 to 15 years are going to be history in the making.

I am encouraged by what I am seeing because of our front row seat. The United States is going to benefit by not being first. The process we are about to go through is going to be difficult, but in the end, these changes will make the United States stronger than we have ever been in the past. I have pondered for months what the other side was going to look like and I now feel for the first time I understand how it is going to play out. In the end, we either change or we become Greece. Knowing America's glass half full culture, we will not become Greece!!!

Welcome Dr. Bandy!
Before we jump into our fact-filled letter, I wanted to bring to your attention that I have recently hired Dr. Howard Bandy as Director of Research at ProfitScore. Dr. Bandy is one of the best and brightest quantitative analysts in our business. Dr. Bandy has been working with ProfitScore for months on a proprietary project used to adjust our portfolios based on regime changes in the market. If you are curious, and want to learn more, please read the section below discussing Dr. Bandy and the recent changes to our equity allocation techniques.

Quote of the month
"We used to think that you could spend your way out of recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists and that in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step."
- Jim Callaghan, UK Labor Prime Minister in the 1970s (Economist, April 8, 2010)

Our Monthly Performance Update

This letter is later than normal due to the launch of our new equity allocation trading strategies. Since I will be sending out April's letter in 15 days, I am going to scale down the performance section of this letter. In summary, March and April were down months for our equity portfolios but positive for our fixed income strategies.

For those that are interested in our portfolios monthly performance, please click on the portfolio links found in the top right hand margin of this letter. The normal detailed performance reports will pull up once you click on the link.

Dr. Howard Bandy has Joined Our Team

Dr. Bandy is very unique in this business because he is as bright as the sun but passionately believes experience trumps intelligence. Working with excessively smart people can be a real challenge because they are overcome with confidence. Dr. Bandy has been developing quantitative strategies since the early 90's and has learned how humbling this business can be. When it comes to developing trading systems, he believes nothing and doubts everything until it can be statistically proven to be very significant. His disciplined rigor is both refreshing and tiring for my brain.

Dr. Bandy has written several books on quantitative investing, gets asked to speak around the world, and has a pedigree as long as your leg. In working closely with Dr. Bandy, I have come to the conclusion that it's simply unfair to put all that intelligence in one person's brain. If you want to learn more about Dr. Bandy, you can read more of his Bio by clicking on this link:
http://profitscore.com/management_team.aspx

Dr. Bandy is in the process of moving to Eagle, Idaho where he will lead our research efforts, developing better ways to use quantitative mathematics to manage risk and harvest profits for our clients.

An Important Change to Our Equity Allocations

2009 was a disappointing year for our equity returns. The market changed course in March and we did not participate in the move higher because our models and traders were trading a different market regime. Looking at the charts in hindsight makes it seem obvious, but adjusting in real-time is anything but easy. Dr. Bandy has helped us create processes to identify these changes and adjust our allocations accordingly. Between Dr. Bandy, Mike Mann, and me, we have over 1000 man hours in this project and many sleepless nights. The research got so intense, that it was not uncommon to wake up in the middle of the night to write down an idea you had in your dream, or simply get up because your mind wouldn't let you sleep.

When your strategies are underperforming against the benchmarks you track, it is easy and dangerous to rush to conclusions. As a quantitative money management organization, everything must be run by the numbers. If it can't be quantitatively proven, then no changes are made! This rigor, and Dr. Bandy's discipline, extended our time lines to make sure every possible scenario was considered. In the end, we developed something more robust than I thought possible.

Implementation of our equity allocation model went live late last week. Our core discipline has not changed. We will continue allocating to multiple strategies and traders, but our methods for making these allocations have become much more adaptive. Hindsight is always 20/20, so you can probably guess I wish I would have started this project much sooner so we could have participated in last year's powerful rally.

Historical walk forward returns are impressive and the equity line charts are a thing of beauty, but the most exciting aspect of this new allocation methodology is the way it adapts to changes in the market. By focusing our research on adaptation, we have built something that should stand the test of time.

The system is not perfect and will of course have losing months. Given our equity underperformance over the past several months, I am hoping Europe doesn't implode next month and cause an overnight collapse of the market in the first full month we go live.

Heads Up
ProfitScore will be partnering with a Canadian-based portfolio manager to offer an exciting new quantitative-based stock portfolio. More details will follow shortly on the strategy, including a white paper and information on how to invest. I began trading the strategy in April, and it has significantly outperformed the indexes. This project has been in the works for several months and I can't wait to offer this exciting new product. Please expect more details on this strategy soon.

The Most Important Chart of the New Century

Figure 1 - Updated chart of the Money Multiplier (MULT) from the Federal Reserve. As of our last newsletter, the MULT was 0.788, which is the lowest reading on record so far. It has since come up, if ever so slightly, hitting a reading of 0.817 as of March 24, 2010.

Last month we discussed the incredible surge of the money in circulation, thanks to Federal Reserve efforts to reflate the economy, and examined the impact it is having on the economy. The money multiplier (MULT) measures how much the money supply (in this case M1 money supply) increases or decreases in relation to the monetary base (money in circulation as measured by the Adjusted Monetary Base or AMB - see Figure 1A).

Figure 1A - Bi-weekly chart of the Adjusted Monetary Base (not seasonally adjusted) showing explosion in the amount of money in circulation.

As we discussed last month, the Adjusted Monetary Base has expanded nearly 250% over the past 18 months, but as the MULT chart above shows, this money is not being lent by banks to get it circulating into the economy.

This month we examine this relationship in more detail in an attempt to see how this trend is impacting the economy as a whole. It is a topic that the more relevant economists like David Rosenberg, Senior Economist for Gluskin Sheff, and Marc Faber, author of the "Gloom, Boom & Doom" report, have been watching carefully for good reason. It also tells us how well our economy is working.

This next chart from Nathan's Economic Edge blog was labeled "The Most Important Chart of the Century" for good reason (see link below). Marc Faber presented a similar chart at a Vancouver seminar in March 2009 with the same trend target for zero debt benefit by 2015. This chart and the money multiplier (Figure 1) are two parts of a similar puzzle.

Figure 2 - Chart showing diminishing productivity of debt. Chart courtesy of http://www.swarmusa.com/
Here is how Nathan explains Figure 2 on his blog:

"This is a very simple chart. It takes the change in GDP and divides it by the change in Debt. What it shows is how much productivity is gained by infusing $1 of debt into our debt backed money system.

"Back in the early 1960's a dollar of new debt added almost a dollar to the nation's output of goods and services. As more debt enters the system the productivity gained by new debt diminishes. This produced a path that was following a diminishing line targeting ZERO in the year 2015. This meant that we could expect that each new dollar of debt added in the year 2015 would add NOTHING to our productivity.

"Then a funny thing happened along the way. Macroeconomic debt saturation occurred causing a phase transition with our debt relationship. This is because total income can no longer support total debt. In the third quarter of 2009 each dollar of debt added/produced NEGATIVE 15 cents of productivity. At the end of 2009, each dollar of new debt now SUBTRACTS 45 cents from GDP."

So, what has caused this GDP/Debt ratio to come off the tracks six years ahead of schedule? Clearly, it is the result of skyrocketing public debt that has been taken on in a Keynesian attempt to reflate the economy. But if Nathan and Faber are correct, instead of helping out the economy, these efforts are hindering it. And without herculean efforts to reduce public debt, we should expect below trend economic growth at best, continued high unemployment levels, and a deteriorating standard of living - in other words a situation similar in many ways to the conditions that have plagued the Japanese during their last two "lost decades."

Surfing the Money Tsunami

Reaching the goal of having sustained economic growth could be as challenging as shoveling water. However, that doesn't mean there won't be investment opportunities. While the Fed and government have been doing their level best to devalue the greenback in the name of quantitative easing, some asset classes have been surfing the reflation tsunami.

If what mainstream economists are saying about deflation being the greater threat were true, commodities (and commodity-rich economies) would be experiencing deflationary pressure too. However, as commodity-rich economies such as Canada and Australia clearly show, deflation is certainly not the problem if the values of their currencies are any indication. Take a close look at the next chart of the US Dollar-Canadian Dollar currency pair ($USD-CAD) versus the S&P500.

Figure 3 - Weekly chart of the $USD-CAD currency pair and its relationship to the S&P500 Index including the correlation (red) between the two. Chart courtesy of http://www.genesisft.com/

This chart also reveals another very interesting relationship. Over the last two years, the relationship between the USD-CAD and the S&P500 Index has grown strong, hitting negative 0.95 in April (a perfect negative correlation of -1 means that for every point drop in the USD-CAD, the SPX moved up a point). As the US dollar has dropped in relation to the Canadian dollar, US stocks have soared. On the flip side, periods of Canadian dollar weakness against its American counterpart were accompanied by falling stock values. A similar relationship exists between the $AUS-USD and the S&P500, which enjoyed a positive correlation of close to 0.95. Strong Canadian and Australian dollars have been good for US stocks.

Yes, US stocks have been rallying, but they were doing so at the expense of the USD to commodity-based currencies. It was another clear indication of the diminishing marginal productivity of debt.

What would happen if the US dollar was able to manage a rally? Would stocks pay the price?

Bubbles of the Far Away Kind

First, there was the Internet bubble. Next, was the property bubble. Although home prices across much of the US have since experienced their worst declines in history, there are troubling signs that another correction may be in the cards (see Shiller - "Don't bet the farm on a housing recovery" article below). In other words, the US bust is still very much in play.

I wonder how many of us in the USA are aware of what is happening to home prices in commodity-rich countries? Prices in a number of major Canadian cities are now higher than they were before dropping in the face of the approaching recession. In Toronto and Vancouver, the two hottest cities in Canada, average home prices recently hit new all-time highs. Just like the real estate bubble that happened here, they are courtesy of quantitative easing policies led by the Federal Reserve.

By April 2010, Vancouver's detached home prices had risen nearly 20% from their recession low in May 2009, and prices in Toronto are up nearly 15% over the same period. In the exclusive Vancouver West Side, the average price of a detached home surpassed $1 million in March for the first time ever. It has gotten to the point that qualifying for a standard low ratio mortgage (75% loan to value) on the average home in Vancouver requires 75% of the average income - worse than just about any US market at the peak in 2007! This has prompted action by both banks and the government to try and cool the market by cranking mortgage rates more than 60 basis points and increasing sales taxes on everything from new homes to real estate fees in Ontario and British Columbia.

Home prices in a number of Australian cities are similarly buoyant, prompting the Reserve Bank of Australia (RBA), the nation's central bank, to raise the key lending rate again to 4.25%. Brazil, another commodity-rich country (that has also been fuel self-sufficient since the 1970s), is in a similar situation.

Inflation is not just a problem in a few commodity-based economies; it is a world-wide concern. According to the latest Economist's commodity-price index (April 8), commodities around the globe have risen 29.9% from a year ago in US dollar terms. A basket of industrial commodities is up 78.3%, the Sterling (UK) all items commodity index is up 26.1%, the Euro index up 28.8%, gold is up 29.2%, and a barrel of West Texas intermediate has gained 76.8%.

If deflation were truly a problem, why have commodity prices risen so strongly and why are some nations being forced to raise interest rates to fight inflation? If inflation is dead, why are precious metals like gold, silver, and platinum again rallying with a vengeance? Technical traders will tell you that these charts all look very bullish indeed. Answer - inflation isn't dead, it's just been sleeping here. But in some parts of the world it has awoken and taken flight.

Making Everyone Else Rich...

Why, after spending trillions in stimulus, increasing the money in circulation 250%, and enacting a host of new laws that punish outsourcers and importers while rewarding companies that create jobs at home, are the greatest beneficiaries outside the USA? After so much effort from so called "experts" trying to fix our broken economy, how is it that we now find ourselves in a position in which our very recovery depends on an ever weakening dollar to drive it?

The answer to both questions may be simple, but the solution is anything but. These problems have been created by a combination of the unprecedented issuance of new debt and Fed-driven inflation. While the Fed has been furiously pumping out fresh minted cash and trillions in new debt instruments, stronger economies have been exploding. No matter what any Ivy-League economist may try to tell you, printing money and issuing debt is inflationary. Like a lurking monster in the deep, it will one day raise its ugly head and have to be slain.

The most obvious solution is debt reduction. But, the solution will take years to fix, assuming the powers that be see it as a priority. The problem is that given the Keynesian epidemic sweeping Capitol Hill these days, debt reduction is off the table. Nature has a nasty way of eliminating those who cling to worthless and irrelevant theories when the reality calls for pragmatic action. Nature can only be ignored for so long before the pain of not taking the correct action becomes too great to ignore any longer.

If You Can't Beat the Fed, Join Them

We've all heard the saying, "Don't fight the Fed." But many, including yours truly, have found it a hard lesson to internalize. In March 2009, while earnings were still plummeting and the Fed had the quantitative easing lever on full-forward, most investors were selling. In spite of evidence more than a year ago that printing presses had been kicked into turbo drive, gut instinct would be to get your money out of the market. But those who trusted in the power of money (even the devalued kind), were buying along with some of the pros who had a better sense of what the Government and Fed were doing.

Now, the Fed (courtesy of the FOMC) is telling us that due to the continued weak economy, quantitative easing is still the flavor of the month and there are still no plans to change it for the foreseeable future.

Long-term PS-IQ readers have heard me mention one of my favorite trading quotes from currency trading giant George Soros. It is one I repeat to myself at least once a week.

"Economic history is a never-ending series of episodes based on falsehoods and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend, and step off before it is discredited."

I'm as patriotic as the next guy. The problem is that money isn't. It does best where it, or the assets in which it's invested, are appreciated (and appreciating) the most. Yes, US stocks very well could continue to rally, but the gains will come at a price. While stocks rise, their real value will be diminished by a falling greenback.

Here is the challenge from a trading perspective. How many will know when the current trend is being discredited in time to step off?

One useful strategy is to look further a field. Stocks in Canada and Australia (as well as other commodity-rich markets) have also been rallying. Thanks to rising currencies, vis a vis the US dollar, their value in real terms is rising faster.

So by all means, ride the cash tsunami courtesy of the Fed and government, but be sure to do so in a way that gives you the greatest chances for success. Like any market, it's important not to overstay your welcome!

Interesting Reading

Shiller - "Don't bet the farm on a housing recovery."
http://www.calculatedriskblog.com/2010/04/shilller-dont-bet-farm-on-housing.html

Waiting for the other shoe to drop - Fears of a second dip in the housing market grow - Economist
http://www.economist.com/world/united-states/displaystory.cfm?story_id=15772789

New and Existing Housing Gap Updated... Wow!
http://www.calculatedriskblog.com/2010/03/home-sales-distressing-gap.html

CRE Cataclysm! Moody's/REAL Commercial Property Price Index
http://paper-money.blogspot.com/2010/03/commercial-cataclysm-moodysreal.html

Office Vacancy Rate hits 17.7% in San Francisco
http://www.calculatedriskblog.com/2010/04/office-vacancy-rate-hits-177-in-san.html

Another housing market concern - Residential fixed investment (RFI) has stalled
http://www.calculatedriskblog.com/2010/03/residential-investment-stalled.html

Canadian real estate market in a word - Overheated!
http://www.canequity.com/mortgage-news/archive/2010/2010-04-08_LEPAGE-markets_cities_overheated_others.stm

Public Debt/GDP Worldmap
http://paul.kedrosky.com/archives/2010/04/debtgdp_worldma.html

Krugman spouts more pro-Keynesian inflationary policy drivel
http://www.financialsense.com/fsu/editorials/schiff/2010/0409.html

Future of Public Debt - This BIS paper is a must read
https://docs.google.com/viewer?url=http://bis.org/publ/work300.pdf%3Fnoframes%3D1

Can the world's biggest debtor nation remain an economic superpower for long?
http://www.cbsnews.com/stories/2010/04/08/eveningnews/main6377088.shtml

Absolute Return Partners - Beware of Echo Bubbles
http://pragcap.com/beware-of-echo-bubbles

Taxpayers to pay thru the nose for Obama's ‘gift' to autoworkers
http://www.businessinsider.com/remember-that-huge-gift-obama-gave-to-the-auto-unions-now-were-about-to-pay-for-it-dearly-2010-4

Recessions and the birth rate. An interesting correlation
http://www.calculatedriskblog.com/2010/04/us-births-per-year.html

FOMC - Doubts on housing recovery and stimulus?
http://www.calculatedriskblog.com/2010/04/fomc-minutes-on-housing.html

"The Most Important Chart of the Century"
http://economicedge.blogspot.com/2010/04/guest-post-and-more-on-most-important.html
http://www.swarmusa.com/vb4/content.php/282-THE-Most-Important-Chart-of-the-CENTURY

Incomes Decline, Debt Increases: Why the Credit Bubble Cannot Be Reflated
http://www.oftwominds.com/blogapr10/income-debt04-10.html

The impact of housing on GDP growth...
http://www.calculatedriskblog.com/2010/04/frbsf-economic-letter-housing-drag-on.html

Personal Bankruptcies Hit a High and May Keep Rising - Time
http://www.time.com/time/business/article/0,8599,1977728,00.html#ixzz0kGPAElqS

Rising Mortgage Rates: The End of the Refi mini-Boom?
http://www.calculatedriskblog.com/2010/04/rising-mortgage-rates-end-of-refi-mini.html

More on the recent law on US capital controls - this can't be good...
http://www.marketskeptics.com/2010/04/americans-becoming-international.html

A better view of the unemployment picture
http://www.calculatedriskblog.com/2010/04/unemployment-rates-and-duration-of.html

A made in Japan recovery - Is this what we can look forward to?
http://www.bloomberg.com/apps/news?pid=20601039&sid=aBmgJSstDl74

New jobs post gains in March but so did personal bankruptcy filings...
http://www.calculatedriskblog.com/2010/04/personal-bankruptcy-filings-surge-in.html

One very big reason banks are reluctant to foreclose and kick the owners out...
http://www.latimes.com/business/la-fi-hemet30-2010mar30,0,7301923.story

Latest Case-Shiller Home Price Index reading
http://www.calculatedriskblog.com/2010/03/case-shiller-house-price-graphs-for.html

Latest Fed economic charts for what they're worth...
http://www.clevelandfed.org/research/data/updates/index.cfm

24-hour time elapsed graphic of global air traffic
http://holykaw.alltop.com/world-air-traffic-time-lapse-video

Spokane, Reno, and Orlando

My oldest daughter, Sarah, is in the 5^th grade and plays club basketball for a nationwide organization called Hoop Dreams. You have to tryout to make the team because there is only one 5^th grade girl's team in Boise. Sarah has a tough-as-nails coach fresh out of Boise State. The level of instruction that young kids get today in sports is incredible. I was never trained as well as Hoop Dreams is training her today. No wonder so many kids are leaving high school and going straight to the pros!

Boise has an exceptional Hoop Dreams organization. They are focused on fundamentals and building skills. By the time these kids get to the 7^th and 8^th grade, they look like a smaller version of Duke or Gonzaga. I saw their 6^th grade boys team beat a 7^th grade team at a recent tournament 87 to 28, and 40 of their points were three-pointers. If their coach saw a player dribble the ball more than 3 times and not pass, he would pull them out of the game. Their objective was to dribble the ball as few times as possible to score. The pace of the game looked like the Lakers when Magic played. Heck, I don't think my old high school team could beat their 8^th grade boy's team.

Sarah's team will travel to three tournaments this spring. We just got back from Spokane and we leave for Reno at the end of May. It is a lot of fun for the kids. We all stay in the same hotel, so the there is a big pool party every night for the kids. Instead of flying, we have been driving to give them the experience of a road trip.

The trip to Spokane took us through three magnificent canyons, Payette River Canyon, Salmon River, and Clear Water Canyon. We also crossed through the Camas Prairie and the Palouse, where the top soil is 300 feet deep in some places. The Palouse is famous for growing more wheat per acre than anywhere in the world. On the trip back, we stayed in a hotel located on the banks of the Salmon River. We left the window open all night and let the river put us to sleep. I haven't slept that good in a long time.

I leave for Orlando on Saturday to attend the annual meeting for the National Association of Active Investment Mangers (http://naaim.org/). I always pick up several ideas to throw into our research queue, so I can't wait to see what I learn this year.

Working to grow your wealth,

John M. McClure
President & CEO
ProfitScore Capital Management, Inc.

P.S. ProfitScore provides its separately-managed accounts to individuals, advisors and institutional investors. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

Complete our Private Client Group request form by clicking here: http://profitscore.com/clientgroup.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

The Great Experiment - Will It Work Long-Term?

2010-03-30T12:35:00Z

Our Monthly Performance Update
Doing Things Better
Welcome to Keynes' Grand Petri Dish
Money, Money Everywhere...
Why Isn't the Money Getting to Where It's Needed?
Treasury International Capital Flows
Interesting Reading
Portfolio Performance Analysis
A Boise View on Commercial Real Estate

So much changes in the economic picture from month to month that it is hard to write about it in one letter. I have tried to send out letters more often, but research demands have made it almost impossible. In order to communicate with my readers more often, I will soon be joining the blogsphere and begin publishing my thoughts in smaller bites through my blog, and then follow up with a monthly summary of my thoughts in this newsletter.

So for those of you who like smaller, more focused content sent out more often, you can subscribe to my blog. If you enjoy reading a summary of my thoughts once a month, we will still be publishing this newsletter for our long-term readers. For those who like both, then you will have access to both. I will keep you posted on the launch of our blog.

In last month's letter, we mentioned that our intense research over the past several months had turned up some encouraging quantitative edges in the data we use to run our models. The first implementation of our findings was put to work a few days ago. I will explain more about what we are doing to improve our consistency in the section below titled Doing Things Better.

We will also be discussing the greatest economic experiment of all time. Will it work out over the long-term, or will we fall into a Japanese-style deflationary spiral? No one knows for sure and there are passionate arguments on both sides. As long as demand for our country's debt continues, then the experiment can go on and will hopefully work out. If demand subsides, then very painful decisions will have to be made.

As we demonstrate below, demand for our nation's treasuries is decreasing, but still high enough to buy us time. This downward trend has got to be making the Treasury a little nervous as they continue to pump in what were once unimaginable amounts of stimulus into our economy.

Making our largest purchaser of our debt, China, mad at us over currency manipulation cannot help the situation. The talk of currency manipulation and finger pointing at our nation's largest creditor has most everyone scratching their head. If a trade war does ensue, I can guarantee you that this economic experiment will go up in flames and we will surpass the economic calamity experienced during the Great Depression.

Quote of the month
"Short of digging Karl Marx out of his London grave, and putting him in charge, it is hard to see how the state could get more involved in the economy." - Matthew Lynn, Bloomberg

Our Monthly Performance Update

Stocks are roughly 30% overvalued and housing data is rolling over. Am I too cautious or is there a real disconnect between reality and value? February was a good month for our portfolios, but unless we make up a lot of lost ground, March is going to sting for our equity portfolios. Below are our updated numbers through February.

Below are recent performance returns on the four portfolios we currently offer:

	Jan 08 to	YTD	Feb	Sharpe
Name	Present	2010	2010	Ratio
Income Builder (IB)	8.50%	0.30%	0.25%	1.37
The Guardian (GRD)	5.32%	0.48%	0.87%	1.53
Harmony Plus (HMY)	7.28%	0.22%	1.20%	1.39
The Expedition (EXP)	6.67%	0.08%	1.63%	1.10
S&P 500 (SP500)	-20.81%	-0.61%	3.10%	0.66
Important Performance Disclosure

ProfitScore provides its separately-managed accounts to individuals, advisors and institutional investors. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

Complete our Private Client Group request form by clicking here: http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

Doing Things Better

In last month's letter, I mentioned that we had added to our research staff a battle-hardened PHD with over 20 years experience developing quantitative models for the hedge fund industry. In June of 2009, I decided to allocate an additional percentage of ProfitScore's gross revenue to hire seasoned consultants in our industry to challenge everything we do. Our investment is about to pay off.

This research has taken us in a lot of different directions as we dissected the quantitative-based strategies we use, the managers we employ, and the asset classes we manage. It has also taken us down many dead-end paths in our pursuit of alpha, but every now and again we have uncovered a significant edge in the data. Some of our computational research has been so intensive, that we have had to rent mainframe time to do our analysis.

Quantitative-based investment research is grueling business. A hit rate of 1 out of 100 is considered good. To make matters more difficult, the edge you find is a moving target, so adapting to change is critical to your success. Hundreds of hours turn into thousands of hours of research to squeeze out an ounce of alpha juice.

Some of the smartest people in the world are in the absolute return business, and as a result, outsmarting the other guy has turned into a never-ending chess match. What worked last year rarely works today, and the pace of change seems to be increasing monthly. Adjusting to changing market regimes has become the most important part of producing consistent return streams over time.

After eight months of intensive research, we finally implemented round one of what will be an adaptive adjustment to what we do. We literally just went live with this process a few days ago, therefore you won't notice a substantial change in our return numbers for a few months. At that time, I am confident that our performance charts will begin to move up and to the right.

Due to my careful conservative nature, we will implement slowly as we introduce this adaptive process into our management techniques. This first change will be focused on our long/short equity exposure, with other asset classes to soon follow.

Expect a stock and ETF portfolio from us in the very near future.

Welcome to Keynes' Grand Petri Dish

Few would argue that we are currently involved in the biggest economic experiment in history. On the hot-seat are the economic policies of economist John Maynard Keynes, first put forward in the early twentieth century and which gained widespread political support post World War II. In a nutshell,and at the risk of oversimplifying, Keynes proposed that decisions made by the private sector sometimes lead to macroeconomic inefficiencies, thereby requiring government intervention to stabilize capital markets. He postulated that during times of economic slowdown, it was the government's responsibility to spend public money to create jobs and to stimulate public demand for goods and services to re-energize the economy-ideas that were taken to heart by the administration of Franklin Delano Roosevelt in the late 1930s and early 1940s.

Figure 1 - Our updated chart of total credit market debt (debt at all levels of the economy) to GDP. As we see, this ratio has dropped (from a high of 375% in early 2009) for the first time since the early 1980s, which is a good thing. The problem is that government (public) debt has grown much faster (see next chart).

Although many present day economists would argue that FDR's policies were successful in bringing the Great Depression to an end, that conclusion is debatable. The reality is that economic performance remained strained at best, until the onset of the second World War and it was the demands of the war, not economic policies that were responsible for bringing the economic debacle to a final end. Be that as it may, this is clearly not the conclusion of policy makers today around the globe who have taken Keynes' ideas and propelled them and the printing presses into overdrive.

Figure 2 - Chart showing changes in Federal debt and annual rate of change (red). As of February, the debt stood at $12.4 trillion.

Money, Money Everywhere...

As Bloomberg's Matthew Lynn points out in his article, "Deathbed of Keynesian Economics Will Be in U.K.," most industrialized nations have taken Keynes' ideas to heart, but none have done so to the degree that the British have. Lynn makes a convincing argument that spending their way out of recession, ideas that have been vociferously endorsed by economists such as Joseph Stiglitz and Paul Krugman, are now attracting a growing cadre of opponents who are alarmed at the state. The Keynesian-driven U.K. budget deficit is already at 12% of GDP - on par with that of Greece. But as Lynn points out, as the Greek deficit is narrowing, that of the U.K. is ballooning.

Here at home, the situation isn't much better. Based on the real budget shortfall of $1.84 trillion in 2009, our budget deficit is approaching 13% of GDP and the economy remains challenged at best, in spite of gargantuan stimulus programs and the more than doubling of the money in circulation (as evidenced by the Adjusted Monetary Base) in the past 18 months.

So at what point will we be forced to admit that the current Keynesian-driven approach is not working? Before I attempt to answer it, let's get an update on the financial situation in the U.S.

Figure 3 - Comparison of the annual rates of growth for total debt versus government debt. Total credit market debt declined in nominal terms in 2009 for the first time since the 1950s, while public debt soared at the greatest rate in twenty-six years.

As others have pointed out, in spite of trillions in stimulus being pushed into our economy, it's not getting to those who need it most. Figure 4 is the current chart of the money multiplier on the Federal Reserve's website. As the chart shows, the multiplier in the mid-1980s was above 3. But it has been declining since 1987, and according to the most recent data (February 24, 2010) is now just 0.786.

So Why Isn't the Money Getting to Where It's Really Needed?

In other words, despite the fact that the money in circulation is nearly 250% of what it was 18 months ago, it is not being effectively circulated into the economy. Banks and lending institutions are not lending it out or putting it into the hands of consumers. And when consumers do get money, they are instead opting to save it, due to the uncertain employment situation (see The Geography of a Recession Chart in the links below). Both responses are understandable given the economic environment, but this creates a big problem given that two-thirds of our economy depends on consumer spending!

Undoubtedly one of the biggest challenges we face is the state of the housing market. The foreclosure situation is fragile at best. According to Realtytrac, more than 300,000 American families are still getting foreclosure notices every month. Mark Zandi of Moody's Economic.com believes that foreclosures will come in at 2.2 million for the year versus 1.7 million last year. There were 2.09 million vacant homes in Q4-02; up from 1.99 million in Q3-09, according to the U.S. Census Bureau.

So although there are house deals galore, the sales of existing homes fell 7.2% in January, according to the National Association of Realtors. The new home market is understandably worse. According to the latest data, housing permits dropped again in February. Home builder sentiment dropped to 15 in March from 17 the month before, according to the National Association of Home Builders. Any reading below 50 is considered negative, as it means that respondents believe the market will continue to decline.

Figure 4 - Chart of the money multiplier (ratio of M2 money supply to bank reserves) has fallen steadily since 1987 through February 2010. Chart - Federal Reserve.

My point is that in spite of TARP, TALF, HAMP and a host of other stimulus programs totaling trillions of dollars, the economic situation remains tough. Yes, things are improving slowly in some sectors, while others have stopped getting worse. But how long is it supposed to take for these Keynesian efforts to take effect? Or will the outcome be the same as in the 1930s in the U.S. and the 1990s in Japan - they simply did not work at all, leaving behind mountains of debt?

One possible reason for the failure for Keynesian economics to provide a lasting solution is that it has the tendency to put added pressure on small and medium sized businesses, which are the real jobs generators in an economy, by making them pay more for labor, materials, and now health insurance. Another more insidious effect is the scapegoat approach the government is taking-blaming the meltdown on private enterprise and large corporations.

Are the economic optimists falling prey to Albert Einstein's definition of insanity - expecting that by doing the same thing they will see a different result? If so, we had better be prepared for years of challenging economic times. Stocks are doing well now, so we better enjoy it while it lasts. When the stimulus programs finally wind down, we will all be left with one heck of a bill to pay! Since a 1% increase in tax decreases GDP by 3%, it is mathematically impossible to not have this debt be a burden to America's long-term growth prospects.

An In-Depth Look at Treasury International Capital Flows

The Treasury recently updated the international capital flow data for January 2010 and here are our charts to reflect the changes. Although the complete report is an interesting read, we have found line 30 to be the most accurate overall number to track to get a sense of the general capital flow trend.

The next two charts reflect monthly and yearly changes. Monthly net TIC flows is the most comprehensive category contained in the U.S. Treasury's reporting data set and includes nonmarket flows, short-term securities, and changes in banks' dollar holdings. Line 30 of the report is the sum of net foreign acquisition of long-term securities, increase in foreign holdings of dollar-denominated short-term U.S. securities, and the change in banks' own net dollar-denominated liabilities divided by net equities. In other words, it reflects whether foreign net investment in Treasuries is increasing or decreasing.

In January there was a net outflow of $33.4 billion versus an inflow of $53.6 billion in December 2009, according to the U.S. Treasury. Of this amount, net foreign private flows were $0.6 billion and net foreign official flows were negative $34.1 billion. As the next chart shows, the trend (yellow line) since 2005 has been down. Foreign holdings of dollar-denominated short-term U.S. securities, including Treasury bills and other custody liabilities, decreased $30.9 billion. Foreign holdings of Treasury bills decreased $44.4 billion. Banks' own net dollar-denominated liabilities to foreign residents decreased $3.5 billion.

Figure 5 - Monthly Treasury capital flows (line 30) showing trend since 2005. Also shown is the monthly Federal budget deficit (red).

Figure 6 - Annual Treasury international capital flows (line 30) showing that with the exception of outlier years 2004 and 2006, the trend has been down since 2002 and strongly negative in 2009 for the first time since 1982.

What about the annual trends? As the next chart shows, capital flowed out of the country in 2009 to the tune of $285.9 billion, as foreigners cashed in U.S. Treasuries and securities. Although we need to wait for the data to "settle" after future revisions, this trend is a concern, especially for a nation saddled with so much debt. This situation has the potential to strongly undermine economic growth in the years to come - a conclusion supported in the work of Ken Rogoff and Carmen Reinhart in their most recent book This Time is Different, published by Princeton University Press.

Interesting Reading:

Deathbed of Keynesian Economics Will Be in U.K.
http://www.bloomberg.com/apps/news?pid=20601039&sid=a5t.xQdllnbo

The Geography of a Recession
http://cohort11.americanobserver.net/latoyaegwuekwe/multimediafinal.html

U.S. FORECLOSURE ACTIVITY DECREASES 2 PERCENT IN FEBRUARY
http://www.realtytrac.com/contentmanagement/pressrelease.aspx?channelid=9&itemid=8695

Realtytrac take on slowdown in foreclosures in Bloomberg interview
http://www.youtube.com/watch?v=kY1LvCo7SiI

Soros Signals Gold Bubble as Goldman Predicts Record
http://www.bloomberg.com/apps/news?pid=20601103&sid=aFszao23VDGA

U.S. debt overview by Bloomberg in charts
http://www.bloomberg.com/insight/america-tied-up-by-record-debt.html

Most recent Monetary Trends publication from the Fed
http://research.stlouisfed.org/publications/mt/20100401/mtpub.pdf

Latest economic charts from the Fed
http://www.clevelandfed.org/research/data/updates/

Housing Real-Estate Recovery Signaled as Fed Unwinds
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aR8gttX52VgE

U.S Treasury International Capital Flow report for January
http://www.treas.gov/press/releases/docs/Press%20Notice%20for%2010Mar15.pdf

BusinessWeek review of This Time is Different by Rogoff and Reinhart
http://www.businessweek.com/the_thread/economicsunbound/archives/2009/09/this_time_is_di.html

Portfolio Performance Analysis

Risk & Reward

Each of our portfolios is strategically allocated across one or more of the Investment Pillars of Strength discussed below. Each Pillar is managed by multiple, uncorrelated, absolute-return investment managers to produce a return stream that is consistent, negatively correlated with the major market averages in down markets and non-correlated with each of our core Pillars of Strength. Commentary found in this newsletter is for informational purposes only and does not effect how our portfolios are traded.

Managing risk is our most important consideration and it is reflected in the way our portfolios are built and managed each and every day.

Five steps forward and one step backward has resumed with March's rally.   March looks like July 2009, producing multiple up days in a row. We actually experienced 10 up days in a row in the S&P 500 futures market. This many consecutive up days in financial futures hasn't been seen since 1987, so you might say that March is another historical reference point in a long list of statistical outliers encountered in this incredibly strong rally.

Index Advantage:

February was a good month for our long/short index traders, but March has been a challenging month. As discussed above in our "Doing Things Better" section of our letter, we have implement changes to this important allocation that should start to show dividends in the second quarter. I am confident that this critical allocation will soon be a performance enhancer and not a drag for our portfolios moving forward.

February performance was 2.03

Strategic Balance:

Trading activity continued to pick up in this allocation as opportunities materialized. More good things will soon be added to this allocation in the near future.

February performance was 1.23

Dynamic Income:

To my surprise, high yield bonds are once again on the move, and this portfolio is a direct beneficiary. After producing eight consecutive winning months and a loss in December, this important alpha driver continues its upward move. As of today, this important allocation is now sitting at new equity highs.

February performance was .50

Our portfolios are built using varying distributions to the strategic allocations discussed above. To view detailed performance and risk statistics information about our investment portfolios for the month, please click on the links below:

If You Are a Client, Don't Be Confused.
Actual management and performance fees are incurred monthly but are deducted from client accounts in the first month of every quarter (January, April, July, and October). For performance reporting purposes, we deduct fees monthly as they incur and not quarterly, as they are reflected in client statements. It all washes out in the end, but this may cause your account performance to deviate from our published performance reports on a month-to-month basis. To be conservative, we also deduct the maximum fees we charge from our performance reports and your actual overall fees paid may be less than our maximum.

A Boise View on Commercial Real Estate

I have recently been kicking around the idea of buying an office building with some other like-minded business owners. In this letter I often discuss the demise of commercial real estate and negative headlines that are common in the financial press. But, until you go out in the market and start negotiating with the banks who own these foreclosed properties, it is difficult to gauge how serious the problem has actually become.

The metropolitan statistical area (MSA) of Boise, Idaho currently has approximately 55 months of vacant commercial inventory on hand. This monthly metric of consumption is based on normal consumption patterns, so no one really knows what the new consumption metric should be during this recession/depression. Is it fair to estimate that consumption is half of what it was during the manic years (2 x 55 = 110 months)?

Boise is not unique to America's view of commercial real estate. Our market is in the top third of all MSA's for foreclosed residential real estate, so the real estate economy is a little worse than normal. In other words, you would probably find similar statistics in your local market. The bank we are negotiating with has a Texas Ratio greater than 125% and just got a love letter from the FDIC. Small local and regional banks made their living lending to small businesses and making loans on commercial real state. I estimate that over half of the small banks in our area will be gone by the time the dust settles.

The building we are interested in was constructed about 2 years ago. Land cost was $400k, with construction costs running around $1.2 million. It appraised at $1.8 million after it was built. After the foreclosure in January, the bank is underwater about $600k.

We offered $400k in an all cash deal, and the bank is holding out hoping to cover their loan cost of $600k. To date they have no offers in that range so we may be getting a phone call. It is almost unimaginable that you can buy a Class A office building for one third of the construction value, including land. Wow! The press is stating that commercial real estate values are down over 40% from their peak. In our market, the forecasts are overly optimistic-I would say the number is closer to 60%.

There is nothing prettier than the fresh green grass of spring contrasted by snow-capped mountains. Idaho is breathtakingly beautiful this time of year. My fly fishing hand is getting anxious with this warm weather, so I hope I can report back on a successful fishing trip in next month's letter.

Working to grow your wealth,

John M. McClure
President & CEO
ProfitScore Capital Management, Inc.

P.S. ProfitScore provides its separately-managed accounts to individuals, advisors and institutional investors. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

Complete our Private Client Group request form by clicking here: http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

Would Someone Please Press The "Easy Button"?

2010-02-18T01:50:00Z

Our Monthly Performance Update
My Decision on Buying My Next House
Cocaine, Profits & Your Brain
Top Ten List of Risks to Watch Out For
Interesting Stories
Portfolio Performance Analysis
Basketball, Dancing and Mom's Scavenger Hunt

In this letter, I have produced my top 10 list of risks I see in the immediate future. Several months ago, Greece would have been lower on my list. However, economic conditions are very fluid and seem to be changing at increasing speeds. I will also discuss my decision on when I plan to buy my next house. For those not familiar with my housing saga, I sold my house in May, 2006 because I fortunately saw this housing crisis approaching. I have been renting a home since then, and now my rental contract is due for renewal in March, so I need to decide whether to buy a house or continue to rent. I'll outline my research on this decision.

There is some fascinating research on investing and your brain. This research removes all doubt on the importance of controlling your emotions when making investment decisions. Since most Americans are on a cocaine-induced investment high from 2009 gains, it may be time to carefully plan out your next investment steps so your emotions don't destroy the gains from such an impressive year.

It has been about two months since my last letter. Recent investment research projects have had me working 60-plus hour weeks and I simply haven't had time to update you on my thoughts. As a money management firm, my priorities must always be focused on making money for our clients.. To help shoulder some of the research responsibilities, I have recently retained a PHD who is extremely capable and battle-hardened, with over 20 years of quantitative system development expertise.

Our portfolios will soon benefit from this research. I can honestly say that I have never been more optimistic about our ability to produce consistent, absolute returns for our clients. In 2010, we will be launching stock and ETF portfolios to compliment our current offerings.

A disproportionate share of ProfitScore's budget is spent on research and development. The world is constantly changing, and thus, asset flows are in a state of flux to adjust to these changes. Many in my industry would argue that 2009 was a government-manipulated flux, but a flux nonetheless. Since the launch of our multi-manger portfolios in March of 2007, we have remained in the top deciles of our manager peer groups. Staying at the top of our game takes considerable effort and expense, as we chase down many dead end rabbit trails in our never ending pursuit of alpha. Our bounty looks rewarding for our investors in 2010!

Here is probably my all time favorite quote:

"Economic history is a never-ending series of episodes based on falsehoods and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend, and step off before it is discredited."
George Soros

Our Monthly Performance Update

U.S. equity markets have seen increased volatility since the first of the year. This probably has to do with the fact that volatility is being produce from outside the United States and is more or less out of our government's manipulating hands. Troubles in Euro land promises to keep the risk of flash point events high for the remainder of 2010. YTD, we are showing green across the board for our equity portfolios and a small loss for our fixed income focused strategy.

Below are recent performance returns on the four portfolios we currently offer:

	Jan 08 to	YTD	YTD Feb	Sharpe
Name	Present	2010	2009	Ratio
Income Builder (IB)	7.91%	-0.29%	-0.24%	1.37
The Guardian (GRD)	5.36%	0.52%	0.52%	1.53
Harmony Plus (HMY)	7.48%	0.40%	1.38%	1.39
The Expedition (EXP)	7.59%	0.94%	2.51%	1.10
S&P 500 (SP500)	-23.09%	-3.45%	0.15%	0.66
Important Performance Disclosure

Complete our Private Client Group request form by clicking here: http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

My Decision on Buying My Next House

As long-term ProfitScore subscribers may remember, I sold my house in Boise in May 2006 once I realized that the hot market was simply not sustainable. In retrospect it was the right decision - home and property prices in my area have been cut in half since then.

My original plan was to get back into the market this year but I have re-evaluated that decision. Let me share with you my reasons why I don't believe this is the time to buy.

Without a doubt, the huge foreclosure number is the 800-pound gorilla dominating the market right now - another 315,716 were reported in January. Although this is a decrease of nearly 10% from December, it is still 15% above the level reported in 2009 according to RealtyTrac.

As this next chart shows, mortgagors who are 90 or more days behind on mortgage payments soared over the last year. History tells us that these folks have a better than 90% chance of defaulting so this is a good leading foreclosure indicator. As long as foreclosures are increasing, there will be continued downward pressure on real estate prices. Increasing layoffs and weak employment number (discussed above) certainly don't help.

According to RealtyTrac CEO James Saccacio, "January foreclosure numbers are exhibiting a pattern very similar to a year ago: a double-digit percentage jump in December foreclosure activity followed by a 10 percent drop in January. If history repeats itself we will see a surge in the numbers over the next few months as lenders foreclose on delinquent loans where neither the existing loan modification programs or the new short sale and deed-in-lieu of foreclosure alternatives works."

Like any other market dominated by the laws of supply and demand, prices rarely appreciate in the face of increasing supply and falling demand. And the greatest risk to putting off buying as I see it is increasing mortgage rates but here is the dilemma.

Sure, mortgage rates could be quite a bit higher in 2011 or 2012. But if rates rise, it will be another lead weight on real estate prices. There is an old adage in real estate - for every 100 basis-point rise (1%) in interest rates, roughly 10% of the buyers get knocked out of the market. And the lower the interest rates, the greater this negative impact (since a 1% rise from 3 to 4% interest rates translates to a 33% increase in payments all things being equal).

Currently the average price of an higher end home in my area is $300,000, down from $600,000 three years ago. Assuming prices drop to $200,000 but rates rise from 5 to 10%, my payments will still be a higher (at least until rates come back down again) but the principle will be a lot lower. On the flip side, if I buy at $300,000 and prices fall to $200,000 that means I will have to come up with another $100k (plus commission and expenses) when I want to move!

Thanks but no thanks. It is just not a risk I am prepared to take. And while we are on the topic if risk and reward, I wanted to mention a very interesting book I read recently that I think you will find fascinating.

Cocaine, Profits and Your Brain

"The neural activity of someone whose investments are making money is indistinguishable from that of someone who is high on cocaine or morphine... Financial losses are processed in the same areas of the brain that respond to mortal danger." - Your Money and Your Brain by Jason Zweig

Why are most of us so challenged when it comes to investing? In his 2007 book, Jason Zweig delves into the science of neuroeconomics to explain how smart people can become stupid when it comes to markets.

Take Sir Isaac Newton, who postulated the three laws of motion (every action has an equal an opposite reaction) and is credited with discovering the law of gravity. In 1790, he was wiped out in a stock market crash. How could a genius like him make such a classic mistake? One can have the best laid plans but when it comes to the practice of investing, the vast majority of us including the likes of Newton are unable to follow through on the theory.

In his book, Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich, Zweig proffers some ideas regarding why investors go astray when it comes to applying their investment plans. Here is the problem according to Zweig. "The neural activity of someone whose investments are making money is indistinguishable from that of someone who is high on cocaine or morphine," which makes greed such a powerful motivator. On the other side of the psychological ledger is fear causing investors to become equally illogical when losses occur. According to Zweig, "financial losses are processed in the same areas of the brain that respond to mortal danger."

In other words, the emotions of fear and greed can and usually do override the most carefully developed investment plans.

The challenge for most of us is separating the evolutionary factors, like gorging when food was plentiful and running from a predatory animal during our caveman days, are counterproductive when it comes to investing. Those, like Warren Buffett who are ultimately successful, only do so because they are able to control these powerful emotions and let logic dictate their investment decisions.

The other option is to find a professional money manager to handle this challenging task for you...

;-)

Top Ten List of Risks to Watch Out For

Here is our top-ten list of risks today, both short and long-term, as we see them in 2010 and beyond.

1.) Ballooning debt (and deficits) - This is our most discussed challenge that currently faces stocks (and our economy), which has been the case for a number of years. But unlike past recessions which served to reduce debt levels, this time around debt has soared. Debt was at the heart of the credit meltdown that was in a large part caused by the housing market collapse and the biggest reason for the stock drop between October 2007 and March 2009.

For more on this please see last month's ProfitScore IQ at: http://www.profitscore.com/display.aspx?articleid=YroVUlgCkd8=
In a nutshell, total credit debt is now well above $50 trillion, or more than 370% of estimated 2009 US GDP. Throw in unfunded liabilities from such programs as Medicare, Medicaid and Social Security and the total rises to more than $115 trillion, or more than $1 million per US household. This risk takes us immediately to the next biggest challenge.

2.) Rising interest rates - As debt levels rise, interest rates become increasingly important. As we discussed in our last newsletter, the fact that interest rates haven't risen faster is somewhat surprising. But it will only continue as long as bond investors continue to accept real losses in exchange for the perceived safety of US dollar-denominated assets like US Treasuries. As past crises have taught us, once investors begin to lose faith in a currency, interest rates soar and that creates a whole new set of economic challenges. This risk is currently exemplified by growing sovereign debt risk in such countries as Iceland, Ireland, Spain and former Eastern block countries like Latvia, Lithuania and Estonia. And who seriously expected sovereign defaults in oil-rich Dubai? These risks will expand rapidly as interest rates rise.

The European Union will either bail out Greece or its economy, and government will fail within the next 6 months causing systemic risk around the world. Germany would argue against bailing out Greece because they are only 2.7% of the EU and then systemic risk can be controlled. As a point of reference, Bear Stearns was less than 2% of the US banking assets and look at what happened to our banking system and the rest of the world when they failed. Given the EU differences of opinion and Europe's history of getting along, I project that Greece has a greater than 50% chance of falling into a deep depression that will take them decades to recover.

3.) Aggressive central bank quantitative easing (QE) - Another name for this risk could be "Misguided Monetary Policy." Put simply, quantitative easing is an attempt by central banks, led by the Federal Reserve, to reverse popping asset bubbles. But what policy makers are doing in effect is more of what got us into this mess in the first place. The idea that we can create more debt to cure our debt dependency is absurd, at best. At worst, it is the penultimate definition of insanity - doing the same thing, while expecting a different result. Unfortunately, the public and policy makers are unwilling to do what is necessary - let a correction rid the system of the excesses that have built up over the decades through bankruptcies, debt defaults and foreclosures.

The unfortunate side-effect is that the longer this painful but necessary catharsis is in coming, the more severe and protracted it will be. As the lessons from Japan have taught us, there are two ways of curing economic excesses-denial or quantitative easing. The way they dealt with it was by denying the severity of the problem, which only compounded it, along with the pain of the ultimate cure. Quantitative easing efforts in the U.S. too closely mimic the Japanese solution for my liking, but somehow too many believe that this time will be different. More likely it will serve to lengthen the time it takes for full, sustainable recovery. (See next point.)

4.) Government bailouts - There is little doubt that government stimulus programs and policies have catapulted stocks higher - so much so that some analysts have leveled charges of market manipulation (see article TrimTabs, suggests government manipulated stocks). These programs have the same goal as quantitative easing. This is accomplished by throwing more money at the problem in an effort to repair popping bubbles. And even if quantitative easing were to end tomorrow, government programs could continue indefinitely or until either bond holders or taxpayers finally rebel, since the former must finance on the hopes they will be paid back and the latter ultimately pays for such efforts.

Like quantitative easing efforts, government bailout programs could eventually prove counterproductive and while they may lessen the short-term pain, ultimately extending the time it takes for full recovery. (See the October 28 ProfitScore IQ http://www.profitscore.com/display.aspx?articleid=gB2mbJnjm0o= ). As President Gerald Ford declared to a joint session of Congress, "A government big enough to supply you with everything you need, is a government big enough to take away everything that you have..." Unfortunately, this outcome does not come due to deliberate malicious intent, but is the unfortunate aftermath of policy decisions.

5.) Housing effect - As Mr. Bernanke (and everyone else who followed his lead) learned the hard way, ignoring the importance of the housing market can throw a real wrench into anyone's plans for continued economic success. But true underlying residential real estate health has been obscured by government bailout programs such as TARP (Troubled Asset Relief Program), HAMP (Home Affordable Modification Program) and a continuous supply of cash to troubled lenders Fannie Mae and Freddie Mac, resulting in an apparent improvement in the housing market. In our December 17, 2009 ProfitScore IQ ( http://www.profitscore.com/display.aspx?articleid=YroVUlgCkd8= ), we discuss the troubling gap between new and existing home sales. Here is an updated chart showing that the gap is still widening, thanks in large part to expanding government and Fed programs to stimulate home sales. Unfortunately, it has not worked very well for new home sales. And what happens to both when these programs finally run out?

Chart - http://www.calculatedriskblog.com/

6.) Commercial real estate - So far, the Obama administration has committed trillions to try to fix the residential housing market. The most expensive of these fixes is the purchase of approximately $1.25 trillion in residential mortgage-backed securities issued by Fannie Mae and Freddie Mac. Then there was the $8,000 first-time home buyers' rebate that was not only extended but expanded to include prior home buyers (with a smaller rebate). There have been no such stimulus or bailout programs for commercial real estate, nor should we expect this. Therefore, commercial real estate (CRE) will provide a true insight into real estate demand in the future which is why it is important to follow. The article entitled, "Ugly CRE Charts" says it all...go to http://blogs.reuters.com/rolfe-winkler/2010/01/06/ugly-cre-charts/

Below, we include a chart comparing residential and commercial prices. As we see, while residential home prices appear to have begun to respond to government programs with prices bouncing off bottom in March and April, commercial property prices continue to drop. Other troubling CRE trends include rising commercial defaults, falling prices and rising vacancy rates in everything from strip malls to office space (see articles in Commercial Real Estate links section).

Chart - http://www.calculatedriskblog.com/

7.) History of recoveries - In economic circles, David Rosenberg has become a household name. Never one to get caught up in irrational exuberance, he has been providing sobering commentaries for years. But his approach has caused many, especially the bulls, to discount what he has to say and this was a fatal oversight leading up to the October 2007 market collapse. Rosenberg was in the small minority of economists who saw it coming (see Economists Explain Why Hints of the Economic Crisis Eluded Them below).

Since stocks bottomed in March 2009, Rosenberg has continually pointed out the risks in this recovery and the observations in his first client newsletter of the year (including the second quote of the month) are no exception. Below is the chart demonstrating his point. As we see, in all past recoveries GDP growth was nothing short of exceptional, that is with the exception of the current one triggering the logical question, in spite of trillions in stimulus spent and the most aggressive quantitative easing program in history, why has economic growth been the weakest since at least 1950? Although the answer to that question will take some time to answer, it demonstrates that efforts so far to inflate the bubbles have proven disappointing. A 32% surge in personal bankruptcies isn't helping (see article Personal Bankruptcies... below).

Chart - http://www.gluskinsheff.com/

8.) Jobless decade - This next chart appeared in a January 1, 2010 Washington Post article entitled, "The Lost Decade for the Economy" (see link below) and compares job growth in the previous seven decades. As we see, the latest decade was by far the worst with zero job growth. If we are to see any measurable improvement in our economy, job growth is pivotal, especially considering that about 70% of economic growth is dependent on consumer spending, begging the obvious question: If consumers aren't confident about job prospects, why would they increase spending?

Chart - http://www.washingtonpost.com/

9.) Stock valuations - This has been another favorite topic discussed in the ProfitScore IQ. Both bulls and bears cite valuations to support their case - the bulls say they are attractive and bears tell us they are too high. So who is right? In recoveries, expectation leads to reality - investors have purchased stocks on the expectations that earnings will rise, hoping that they will be proven correct. At the beginning of the 2003 recovery, the Price/Earnings ratio for the nearly 8000 stocks tracked by VectorVest soared to more than 60 times earnings (see first blue arrow in next chart). Bulls were eventually proven to be correct as earnings caught up in 2004.

In March 2009, the average PE for the roughly 8000 stocks in the VectorVest index soared to an unprecedented 155 (see second blue arrow in next chart). Will the bulls again be proven correct or do the bears really have a point that this time expectation is running much too rich to pan out? By year-end 2009, the PE for the nearly 8000 stocks of the VectorVest index had returned to a more normal number at 40, as the next chart shows. But even after a large decline, the PE is still high by historic standards. There is a risk that stocks have gotten too far ahead of themselves and although earnings have recovered from their March 2009 lows, they are still anemic in historic terms. This premise is further supported by long-term PEs published by Robert Shiller, who has shown that on a trailing ten year basis, PEs are still high at 20. In past recessions, long-term PEs have generally dropped below 10 before a sustained recovery occurred. As discussed above, the big difference between past and present recoveries is government stimulus and no one knows for sure what comes next.

Chart - http://www.vectorvest.com/

10.) The "this time is different" mentality - This is not so much a challenge as it is a curse. There is no clearer example of this thinking than from our government and banking leaders, who throughout this malaise, have adhered to the belief that doing more of what got us into this problem will solve it. As long as the majority believes that the problems that presents us will have a different outcome than in the past, look out. In their latest book, This Time is Different, economists Ken Rogoff and Carmen Reinhart trace financial folly back eight centuries and clearly show that this belief has dominated each economic catastrophe, but each time it was eventually proven false, usually with tragic results. Unfortunately the error in this assumption was only realized after the population had endured considerable pain through a series of false bear market rallies and ensuing economic and market retrenchments.

If you are a serious student of markets and the economy, the book published by John Wiley & Sons in 2009 is an essential read. This list of portfolio risks is by no means complete. Will markets continue to scale the wall of worry and when will the next correction strike? These are the $64 million questions today.

As one gets closer to retirement, the more conservative and risk-phobic a portfolio should be. But a portfolio for someone in their 50s has traditionally included government and bonds deemed low risk. But if the government is in reality treading the path to financial calamity, bonds become a questionable choice, especially if rising yields and inflation are in the cards longer-term.

If there was ever a time for help in keeping your eye on your financial goals and sticking to your plan, this is it!

Interesting Reading

I Know What Keeps Obama Awake at Night
http://www.zerohedge.com/article/i-know-what-keeps-obama-awake-night

TrimTabs Suggests Government Manipulated Stocks
http://www.marketwatch.com/story/fund-flows-firm-suggests-government-bought-stocks-2010-01-05

Timothy Geithner Meets Vladimir Lenin - John Hussman
http://www.hussman.net/wmc/wmc100104.htm

A Testing Year - Buttonwood
http://www.economist.com/blogs/buttonwood/2010/01/a_testing_year&sa_campaign=twitter

Housing Animal Spirits to Be Banished by Prime Foreclosures
http://www.businessweek.com/news/2010-01-04/housing-animal-spirits-to-be-banished-by-prime-foreclosures.html

U.S. Growth Prospects Bleak in New Decade, Government Bailouts Create Illusion of Profitability
http://www.reuters.com/article/idUSTRE6021LK20100103

Economists Explain Why Hints of the Economic Crisis Eluded Them
http://www.pbs.org/newshour/bb/business/jan-june09/economists_01-09.html

U.S. Loan Effort Is Seen as Adding to Housing Woes
http://www.nytimes.com/2010/01/02/business/economy/02modify.html

Sprott - Is It All Just a Giant Ponzi Scheme?
http://pragcap.com/sprott-the-sp-will-fall-below-its-march-09-lows-u-s-economy-is-a-ponzi-scheme

Personal Bankruptcies Surge 32% in 2009
http://expectedreturns.blogspot.com/2010/01/personal-bankruptcies-surge-32.html
http://online.wsj.com/article/SB126263231055415303.html?mod=WSJ_hp_mostpop_read

The Lost Decade for the Economy
http://www.washingtonpost.com/wp-dyn/content/graphic/2010/01/01/GR2010010101478.html

Commercial Real Estate links
Ugly CRE Charts
http://blogs.reuters.com/rolfe-winkler/2010/01/06/ugly-cre-charts/

Commercial Real Estate Poses Risk to U.S. Recovery, Ryding Says
http://www.businessweek.com/news/2010-01-04/commercial-real-estate-poses-risk-to-u-s-recovery-ryding-says.html

Strip Mall Vacancy Rate Hits 10.6%
http://www.calculatedriskblog.com/2010/01/reis-strip-mall-vacancy-rate-hits-106.html

US Apartment Vacancy Rate Hits 23-Year High-Report
http://www.reuters.com/article/idUSN0539889920091006

Moody's: CRE Prices Off 1.5% in October
http://www.calculatedriskblog.com/2009/12/moodys-cre-prices-off-15-in-october.html
http://web.mit.edu/cre/research/credl/rca.html

Moody's: CRE Prices Off 41 Percent from Peak, Off 3% in August
http://www.calculatedriskblog.com/2009/10/moodys-cre-prices-off-41-percent-from.html

Portfolio Performance Analysis

Risk & Reward
Each of our portfolios is strategically allocated across one or more of the Investment Pillars of Strength discussed below. Each Pillar is managed by multiple, uncorrelated, absolute-return investment managers to produce a return stream that is consistent, negatively correlated with the major market averages in down markets and non-correlated with each of our core Pillars of Strength. Commentary found in this newsletter is for informational purposes only and does not effect how our portfolios are traded.

Managing risk is our most important consideration and it is reflected in the way our portfolios are built and managed each and every day.

2009 was a bumper year for just about every asset class that got destroyed in 2008. As I have mentioned before, there have only been 2 other rallies in the history of the US stock market that have increased 50% or more in 24 weeks - both happened during the Great Depression and both ended in tears. It will be interesting to see if history repeats itself or at least rhymes. To help you visualize how seldom powerful rallies like 2009 occur, below is a graph from http://dshort.com/ to give you a point of reference.

Our quantitative investment style is based on taking higher probability trades. If probabilities are low, we will invest against them occurring. If they are high, we position assets accordingly. Twenty-four-week rallies increasing 50% or more happen so rarely, they are practically impossible to anticipate. In my world, these events are considered a statistical outlier, or a fat-tailed event, because they fall outside the normal distribution curve. Historically, these events have been followed by increased volatility, which usually, but not always, means declining markets. Since fair value on the S&P is around 850, the edge is to the downside.

Part of our research recently has been to help us determine when events like this are occurring. They are very difficult to anticipate, but when they are occurring, we have uncovered an edge that will help us identify these abnormal markets and adjust our positions accordingly. In our research discussions, we describe these markets as when the train is on the tracks, because positioning assets against them is like standing in front of a train. Our recent findings should help us step out of the way the next time our indicators here this powerful whistle blowing.

Index Advantage:

2010 is off to a good start. Our long/short equity traders have capitalized on recent volatility. The biggest change in our profits is due to the fact that markets seem to have normalized, so short positions are once again equally contributing to trading gains.

YTD this pillar gained 1.98.

Strategic Balance:

Trading activity has picked up as these very risk adverse traders have begun to increase the frequency and size of there trading positions. We will be adding allocations to this important pillar in 2010.

YTD this pillar earned .53.

Dynamic Income:

2009's powerful rally compressed high yield spreads reducing the opportunity to make profits in high yielding assets. I anticipate that the majority of our profits in 2010 for this investment pillar will be produced by our government bond and currency traders. If markets accelerate to the downside, there could once again be opportunities to harvest high-yielding profits later in the year.

YTD this pillar earned -.24.

Our portfolios are built using varying distributions to the strategic allocations discussed above. To view detailed performance and risk statistics information about our investment portfolios for the month, please click on the links below:

If You Are a Client, Don't Be Confused.
Actual management and performance fees are incurred monthly but are deducted from client accounts in the first month of every quarter (January, April, July, and October). For performance reporting purposes, we deduct fees monthly as they incur and not quarterly, as they are reflected in client statements. It all washes out in the end, but this may cause your account performance to deviate from our published performance reports on a month-to-month basis. To be conservative, we also deduct the maximum fees we charge from our performance reports and your actual overall fees paid may be less than our maximum.

Girls Basketball, Dancing and Mom's Scavenger Hunt

My daughters have developed a love for the game of basketball. As their coach, I get to spend quality time, sharing a game which we both love to play. Coaching has helped me become a better dad, because it pulls me away from the office and focuses my attention on the family. The experience has taught me how to be a better coach and them to be better basketball players. You might say we are teaching each other. This year, both Sarah (10) and Annabelle (7) are the leaders on their team. Annabelle's team is undefeated and Sarah's team has lost only one game by one point.

This past Sunday was Valentine's Day and with two daughters and a wife, it has become an increasingly important holiday around the McClure household. On Friday, the girls and I celebrated by attending their school's Daddy Daughter Valentine's Dance. It has become an annual tradition that I hope I get to enjoy until they are 18. Since Annabelle has grown too big to hold in one arm and dance with Sarah in the other, the girls have had to start taking turns dancing with Dad on the slow songs. It is fun to watch them fuss about who gets to dance with Dad next.

On Saturday night we created a scavenger hunt for their mom, hiding 10 gifts around the house with clues for finding the next gift. Mom didn't expect a thing until we sprung it on her during my famous, big Sunday morning breakfast. Mom had a blast trying to find all the gifts. Annabelle was so excited to help Mom that she would give her a few extra hints on where the next present might be. Sarah was not too happy with Annabelle's extra hints. I am truly blessed to have such a wonderful family.

Best of wishes to you for a happy, healthy, prosperous and risk-aware 2010!

Working to grow your wealth,

John M. McClure
President & CEO
ProfitScore Capital Management, Inc.

P.S. ProfitScore provides its separately-managed accounts to individuals, advisors and institutional investors. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

Complete our Private Client Group request form by clicking here: http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

Squeezed Between A Budget Rock And A Fiscal Hard Place

2009-12-18T13:05:00Z

Our Monthly Performance Update
The Golden Rule - Does It Still Apply?
Gold vs. Treasury Bills
Treasury International Capital Flows Jump
Real Estate Update
Who Pays the Taxes?
No Recovery in Tax Receipts
Portfolio Performance Analysis
My Boise State Broncos

Is the real economy truly turning up or are recent upward ticks in the data caused mostly by government stimulus programs? One thing for sure is that betting against the American consumer has historically been a very bad idea. Are gross amounts of government spending trying to make this a better trade?

Left to their own devices, free economies, with minimal governmental intervention, typically solve most problems they face. This is not to say that we should let people go hungry in the streets or minimize the effects of systematic risk, but when it comes to successful economies and governmental intervention, less definitely means more. Governments-even those governments with the best of intentions, have a bad habit of getting in the way of the natural economic process. They either make problems worse or they extend the amount of time it takes for a damaged economy to heal its wounds, or both. I can't think of a situation where this is not the case.

In recent academic literature, it has been clearly documented that tax increases have a negative effect on GDP and that government stimulus has a short-term, but no long-term positive effect on economic growth. Here is the latest working paper on this topic http://papers.nber.org/papers/w15369.pdf.

What recent academic research clearly demonstrates is that taxes have a 3X multiplier on GDP and that government spending works short-term, but has no long-term positive effect on the economy. More specifically, a 1% tax increase decreases GDP by 3% and vice versa. Since government spending produces short-term positive effects but no long-term positive gain, any short-term gains caused by government spending has to have a negative intermediate-term effect to take long-term gains back to zero. In other words, a positive lift in the economy caused by government spending must revert below the mean intermediate-term to take the long-term effect back to par.

Since excessive amounts of government spending almost certainly cause tax increases, it looks like the good intentions of the government will either make our current situation worse or extend the length of time it takes for the natural economic process to heal itself.

Quote of the month:

"It is far too natural for us humans to make socially acceptable choices in life. We are punished via negative reinforcement for making decisions that are not conventional. As it is often said - it is better to fail conventionally than fail unconventionally, for the blame will be placed on the individual versus the circumstances when taking the path less traveled. If you buy and hold, you can always blame a poor market for your losses, in contrast you will typically get credit for skill in good markets. In contrast, the trader will face intense scrutiny for underperforming in good markets and receive credit for performing well in a poor market. Trading is no different from any other endeavor that is crippled by our primitive decision-making facilities. For all the intelligence that exists in the world, few of us wish to be different, and the logical few are only too aware of the severe costs of making unconventional decisions that fail-even when they know it is the right choice."
David Varadi - CSS Analytics

Our Monthly Performance Update

November was yet again another positive month for global equity markets. Due to our cautious stance in these markets, our hedged and net short positions kept us from participating in the market's advance. Fixed income continues to be our shining star, eking out its 8^th winning month in a row.

Below are recent performance returns on the four portfolios we currently offer:

	Past 12	YTD	November	Sharpe
Name	Months	2009	2009	Ratio
Income Builder (IB)	12.29%	13.20%	0.12%	1.46
The Guardian (GRD)	11.43%	9.08%	-0.25%	1.70
Harmony Plus (HMY)	11.45%	6.55%	-0.47%	1.44
The Expedition (EXP)	11.47%	3.12%	-0.53%	1.13
S&P 500 (SP500)	25.39%	24.07%	6.00%	0.67
Important Performance Disclosure

Complete our Private Client Group request form by clicking here: http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

The Golden Rule - Does It Still Apply?

With Black Friday 2009 now in the history books, markets have become jittery of late. Not only have stocks encountered increasing headwinds, precious metals are under pressure as well. Does it mean the rally is over?

In his 1977 book, The Golden Constant, Roy Jastram traced the price of gold from the Middle-Ages in Britain and in the U.S. during the 1800's. He concluded that gold tended to return to an historic rate of exchange or purchasing power parity with other commodities in an index that bears his name.

In a paper entitled "Gold as a Store of Value" for the World Gold Council in 1998, Stephen Harmston updated this gold measure and offered the following long-term view of the yellow metal:

"If gold is to function successfully as a store of value it must either maintain its rate of exchange with other goods and services or, at least, be expected to return to an historical rate of exchange. It is said that an ounce of gold bought 350 loaves of bread in the time of Nebuchadnezzar, king of Babylon, who died in 562 BC. The same ounce of gold still buys approximately 350 loaves of bread today. Across 2,500 years gold has in other words retained its purchasing power, relative to bread at least, and has had a real rate of return of zero."

Where a number of critics get hung up is in the short-term fluctuations that tend to render this argument flawed. For example, a loaf of bread cost 33 pence in the UK in 1980. Today, that same bread costs roughly three times more, around £1. Gold sold for around $800/oz in 1980, but still has a ways to go to reach $2400/oz.

So does this render the historic gold value measure invalid?

Today, a loaf of whole wheat bread starts around $1.60 on up to more than $3.00. Using the 350 loaf measure above, at a price of around $1150, 350 loaves would cost $3.28 each, so the ancient measure is not far off.

But Rastram's work and the research by Stephen Harmston confirm that over the long haul, by smoothing out the volatility, gold has been a good measure of inflation. For example, the Jastram gold index set the value at 100 in 1717 when Britain went on the gold standard. The index was also 100 in 1930, three years before FDR temporarily took the U.S. off the gold standard to devalue the dollar. And although the index has enjoyed some wild rides since its first measure in 1343, it remains a good standard of value, a conclusion again confirmed by Harmston.

"Gold functions as a long-term store of value. That is the key finding of this report. This analysis may not have established the veracity of the claim that gold has held its value since the time of King Nebuchadnezzar, but it has proved that gold has maintained its real purchasing power in terms of commodities and intermediate products since the early days of the United States of America, since the reign of Queen Elizabeth I, and since shortly after the end of the First Republic in France. It has also maintained its value since the late 19th century in Japan and since the time of the political unification of Germany in the early 1870s."

Gold vs. the Other Safe Haven - Treasury Bills

There is little doubt that the rapidly rising price of gold and other precious metals is a vote of no-confidence in current global fiscal policy, especially in the U.S. But, owning gold is a double-edged sword, as those who held it from 1985 through 2001 learned the hard way. The metal may be a good way to protect against inflation, but it also offers no real return.

However, over the last three years, it certainly has been better than owning Treasury bills or T-bonds. They pay nearly zero nominal return, and a very big minus real return, as the next chart shows comparing gold performance with the inflation-adjusted T-bill returns since 1960.

Figure 1 - Chart of the price of gold since 1960 versus real interest rates.

This chart clearly shows that during tough times when real inflation rates wreaked havoc on real bond returns, gold performed very well. During the last two big recessionary periods (late 1970 to early 1980s and today), gold had done best when T-bills lost money.

There are some very compelling reasons to suspect that the worst may still lie ahead. This next chart shows the incredible explosion in U.S. debt and how this tendency has impacted government receipts (black line) versus expenditures (red line). As debt levels soar and tax revenues decline, governments are increasingly squeezed between a budget rock and a fiscal hard place.

Figure 2 - Growth chart from SocGen report showing U.S. debt versus GDP from 1947 to present.

Unfortunately, this greatly enhances government (Fed) temptation to print its way out of the mess, and the bigger the debt gets, the greater the print temptation becomes.

By the way, the above chart comes to us courtesy of Société Générale from a sobering Q4 report to clients entitled, "Worst- Case Debt Scenario." The report opens with a chart that shows the new fiscal "inconvenient" reality - global debt has jumped 250% in the last decade. But then in a rather puzzling twist, the report recommends selling the dollar (ok that makes sense) and buying government bonds (buy at historic low yields with only one direction left to go? we must assume this does not include U.S. bonds following recommendation # 1) and cherry picking equities and commodities. It then drew some compelling similarities to the Japanese malaise that has plagued that country since the early 1990s. Could it really be all that bad here? Certainly the charts included in the report suggest more headwinds to come.

This next chart, on page 8 of the report, of the price of gold versus the monetary base (amount of money in circulation) shows that even at its current, rather lofty nominal price, gold is undervalued compared to the amount of printed money sloshing around the financial system.

Figure 3 - A useful chart showing monetary base divided by the price of gold.

Treasury International Capital Flows Jump - Yeah!

After eight months of outflows, punctuated by the occasional anemic inflow, US treasuries appear to be back in favor with foreigners, as the net inflows jumped $133.5 billion in September versus a revised gain of $25.3 billion in August. However, this still amounts to an average monthly decline of $39 billion in 2009, but at least it's up from the average decline of $60 billion as of August.

Figure 4 - Monthly Treasury international capital flows with latest data from September.

What remains puzzling is the apparent strong demand from indirect bidders in government bond auctions. Bid-to-cover ratios continue to hover around three (three times as many bids as there are bonds available), which is utterly amazing considering that bonds are paying almost nothing in interest. So here is the question of the year: Why are investors running for the cover of bonds denominated in a falling currency for an effective return of zero? Answer: They must believe it's a safer place to be than in equities or any other asset class! I don't know about you, but I ‘m having a hard time buying that argument.

Real Estate Update

We also got some reasonably good news on the property front with the latest Case-Shiller report showing a September gain of 0.33% over August for the 20-city composite price index. Annually, prices are still down more than 9% and as the above chart shows, this marks the fifth consecutive month of gains.

However, all is not well in Camelot as the next chart shows. Government stimulus programs, especially the first-time and new existing home owner (homeowner) tax credits, have caused a run on existing homes, many of which are distressed sales or bank default short sales. But the new home market, which has traditionally moved nearly hand in glove with existing homes, is now trailing the existing market badly. This is an unhealthy situation as long as it persists.

Figure 5 - Chart showing growing gap between existing homes sales in response to the stimulus programs compared to new home sales.

Trillions in stimulus is having a much more powerful reflation impact in other nations as the article from Vancouver, Canada entitled, "B.C. home affordability takes a hit as prices rise in tightened, hot market," demonstrates (see Interesting Reading). Is this yet another example of a bubble in the making as a result of the never-ending stream of global quantitative easing programs?

Figure 6 - Case-Shiler Home Price Index and the year-over-year rate of change in housing prices for the 20-city index. Although the worst in home price declines appear to be over, home prices are still dropping.

Our next chart (Figure 6) shows the relationship between builder sentiment, according to the National Association of Home Builders Housing Market Index (HMI), and single family housing starts. The HMI (red) has clearly led housing starts, but after a number of months of gains, the index fell in October, as did housing starts in October.

This drop is a concern given the extension of the first-time home buyer tax credit and initiation of the grant for existing homeowners. There is even talk on Capital Hill about a new program called Cash for Caulkers (see link below) to issue grants to homeowners to reduce energy bills and make the homes more environmentally friendly.

If all this tax money is having an impact on the construction industry, this effect has so far been muted as Figures 5 and 7 demonstrate.

Figure 7 - Chart showing the National Association of Home Builders survey of the housing market index (red) leading single family housing starts (blue).

Who Pays the Taxes?

The next graphic that comes to us courtesy of the U.S. Mint shows the breakdown of who paid what portion of the tax bill last year. As we see from the pie chart on the right, income earners in the top 10% pay 71.2% of all taxes while the bottom 46.9% with incomes below $10,000 pay no federal income taxes.

A conversation about of the fairness of our progressive tax system is sure to generate a rousing debate at any cocktail or dinner party. But no matter what your opinion on the matter, one thing is sure, the combination of an aging population and rapidly accumulating federal and state debt will mean that tax rates will go up and the burden borne by those in the upper tax brackets will continue to get more onerous.

Graphic courtesy of the U.S. Mint.

Tax Receipts under Pressure

Exactly how the taxes are paid and who pays it is interesting. But what has been happening to tax receipts? There has been much ado about how the economy has improved and the stock market has rebound thanks to continued government quantitative easing and trillions in government stimulus programs. However, tax receipts tell another, more troubling tale.

As this next chart from ZeroHedge.com shows, individual withholding taxes have fallen nearly 8% in the last year and corporate withholding taxes are down a whopping 64% in the same period.

Here is a synopsis from ZeroHedge.com that brought this report to the public's attention.

"On a rolling 12 month basis, individual tax withheld has dropped by nearly 8% YoY, from $1.42 trillion to $1.31 trillion, while company withholdings are down a walloping 64%, from $274 billion to just under $100 billion! This is money that will never be used to pay down the skyrocketing U.S. deficit, because the U.S. consumer and average U.S. corporations are simply not collecting the required cash to line the Treasury's pockets with the one traditional way to pad the deficit: taxes. Expect much, much, much more debt issuance in America's short, medium and long-term future."

Interesting Reading:

Gold is rallying because...
http://www.nakedcapitalism.com/2009/11/guest-post-gold-is-rallying-because.html?

Why is the price of bread important?
http://news.bbc.co.uk/2/hi/uk_news/magazine/6240619.stm

Gold as a Store of Value, Stephen Harmston
http://www.spdrgoldshares.com/media/GLD/file/research_study_22.pdf

Does the price of gold rise or fall in a deflation?
http://goldnews.bullionvault.com/gold_deflation_062520092

A parable on gold from Jim Grant
http://www.zerohedge.com/article/parable-gold-jim-grant

Lessons on Monetary Reform
http://www.polyconomics.com/ssu/ssu-000428.htm

SocGen Report Worst-Case Debt Scenario
http://www.scribd.com/doc/22756491/SocGen-Worst-Case-Debt-Scenario

B.C. home affordability takes a hit as prices rise in tightened, hot market
http://bit.ly/8ybrFn

Dollar's Demise Traces Roots to U.S. Tax Trap
http://www.bloomberg.com/apps/news?pid=20601039&sid=aWwPrRxeEoyk

Japan's Deflation Concern Mounts Even as Growth Accelerates
http://www.bloomberg.com/apps/news?pid=20601101&sid=an8bsmHmjb0U

Cash for Caulkers?
http://www.calculatedriskblog.com/2009/11/cash-for-caulkers.html

Who Pays the Taxes?
http://www.mint.com/blog/trends/who-is-paying-taxes/

Collapse in Tax Withholdings Refutes Improvements in Unemployment/Profitability
http://www.zerohedge.com/article/collapse-tax-withholdings-refutes-improvements-either-unemployment-or-corporate-profitabilit

More about withholding taxes from the recent Financial Management Service report
http://fms.treas.gov/publications.html

Portfolio Performance Analysis

Risk & Reward
Each of our portfolios is strategically allocated across one or more of the Investment Pillars of Strength discussed below. Each Pillar is managed by multiple, uncorrelated, absolute-return investment managers to produce a return stream that is consistent, negatively correlated with the major market averages in down markets and non-correlated with each of our core Pillars of Strength. Commentary found in this newsletter is for informational purposes only and does not effect how our portfolios are traded.

Managing risk is our most important consideration and it is reflected in the way our portfolios are built and managed each and every day.

Generating absolute-returns is a double-edged sword. Your first job is to mitigate risk and your second job is to make money in all market environments. Clients generally love you when the market is falling and wonder what the heck is wrong with you when it is going up. The math works in our favor long-term, but it is just hard to explain to an emotional investor who has powerful heard instincts to chase the hot hand. Because markets generally drop about 3X faster than they increase, it is just not possible to achieve both of our risk and return objectives at current nose bleed valuation levels. Risk remains high and so we remain vigilant in our effort to mitigate this risk in client accounts.

Our equity trading accuracy remained north of 50% for the month, but trading losses incurred from taking short positions continue to outweigh our overall portfolio gains. Interest rate sensitive allocations continue their upward march higher.

Index Advantage:

Although you can't tell it from our equity curve, our long trading accuracy has been north of 70% for the last three months. Our short trading losses keep eating away at our gains, causing our overall gains to drop or remain flat. In more normal market conditions, current trading accuracy would produce outsized gains, so we continue to be patient in our approach as we tightly managerisk in our portfolios.

For the month, this pillar gained -1.0.

Strategic Balance:

Very little trading is occurring in this tactical allocation, as our traders wait for better risk-adjusted trades to materialize.

For the month, this pillar earned -0.09.

Dynamic Income:

Eight winning months in a row and we are closing in on our ninth. I can still remember the problems we had trading this important allocation in our early days. Its non-correlated properties have made it a perfect fit for our equity portfolios, producing Sharpe ratios above 1.4 for our blended portfolios.

For the month, this pillar earned .37.

Our portfolios are built using varying distributions to the strategic allocations discussed above. To view detailed performance and risk statistics information about our investment portfolios for the month, please click on the links below:

If You Are a Client, Don't Be Confused.
Actual management and performance fees are incurred monthly but are deducted from client accounts in the first month of every quarter (January, April, July, and October). For performance reporting purposes, we deduct fees monthly as they incur and not quarterly, as they are reflected in client statements. It all washes out in the end, but this may cause your account performance to deviate from our published performance reports on a month-to-month basis. To be conservative, we also deduct the maximum fees we charge from our performance reports and your actual overall fees paid may be less than our maximum.

My Boise State Broncos

America has always pulled for the underdog, and when it comes to college football, my Boise State Broncos have become America's favorite underdog football team. College football rankings have been hotly debated for as long as I have been a football fan. And today, it seems more debated than ever.

Historically, smaller teams have had practically no chance of being picked as the number one team. Boise State's famous win over Oklahoma in the 2006 BCS Fiesta Bowl may have changed the BCS selection process for a long time to come. For those unfamiliar, here is an ESPN article on the Cinderella game http://sports.espn.go.com/espn/columns/story?columnist=forde_pat&id=2716979. In my humble opinion, the Oklahoma Sooner's still haven't mentally recovered from this loss. The game was voted by ESPN fans as the second greatest game in college football history, so Oklahoma will probably have to relive this game for longer than they care to remember. I could go on, but you get the picture.

Being from Tennessee, I am still an SEC Tennessee Volunteer at heart, but my Tennessee orange now comes in a shade of Bronco blue. It saddens me to say this, but my Tennessee Volunteers would get trounced if they matched up against my Boise State Broncos this year. How can a smaller school with smaller players consistently beat the major schools? Big programs like the SEC typically recruit larger players. Boise State typically recruits players that are a little smaller, but have an extra step in their stride. What Boise State has proven to the rest of the college football world is that David can beat Goliath, especially when he is faster on his feet.

This year Boise State faces off against Texas Christian University (TCU), another highly ranked, mid-major team, in the BCS Fiesta bowl. It promises to be a fast-paced, hard-charging game. If Boise State beats TCU and Oregon can beat Ohio State in the Rose Bowl, my Broncos will probably get ranked third in the country. Not bad for a smaller, underdog team that few major programs want to play for fear of getting embarrassed.

Working to grow your wealth,

John M. McClure
President & CEO
ProfitScore Capital Management, Inc.

P.S. ProfitScore provides its separately-managed accounts to individuals, advisors and institutional investors. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

Complete our Private Client Group request form by clicking here: http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

Two Steps Forward and Three Steps Backward

2009-11-20T14:19:00Z

Our Monthly Performance Update
Dollar Reality Check
Are Valuations Justified?
The Mother of All Carry Trades
Market Summary
Portfolio Performance Analysis
Can I Do It This Year?

Timing is everything and being early with your investment decisions can be almost as painful as being late. Since most investors lost significant sums of money in 2008, they feel a deep-seated fear of getting left behind. It is called the herd instinct. This important emotion kept us alive when we hunted with knives and spears, but today it runs investors off a cliff. In dealing directly with retail clients, the herd instinct is the most prevalent emotion I see.

Over the past several months, the markets powerful advance has made me feel like I have been standing in front of a train. I had this same feeling back in May 2006, when I sold my house to move into a rental home because I felt the real estate market no longer made any sense. I feel the say way today about the stock market. The Fed and the Treasury have many tricks up their sleeves to buy short term relief. But, what long-term price will future generations have to pay?

The dollar has been bouncing off its all time low for the past couple of weeks and the market continues to rally. As you will learn from reading this letter, a weak dollar is feeding leverage and liquidity into the market. Over the past 90 days, there has been an inverse correlation between the dollar and the S&P 500 of approximately 75%. So when the dollar goes up, the market goes down, and vice versa. It feels good when asset prices go up, but when these assets are compared in dollars or gold, there has been no gain at all. As a matter of fact, there have been further declines in the United States global buying power.

In this newsletter, I have decided that a picture is worth a thousand words, so we have provided lots of charts and graphs. The picture these charts paint about our economy is not pretty, yet the market continues its advance. Hopefully, our research at least makes you pause and ask why?

"Whether you are investing in real estate in China, equities in Peru, or indexing the S&P 500, you are putting your faith in the ability of the U.S. Government to pull off a miracle. Expectations will be tough to meet, and the risk of the Administration losing a handle on the situation is a constant threat. Over the next five years, investors should focus on capital preservation and avoid getting swept up in the inevitable credit-fueled bubbles."
Boeckh Investment Letter, October 30, 2009

An Update on Our Performance

Interest-rate sensitive strategies continue to lead in 2009. Shorting the U.S. dollar and being long high-yield bonds has been the easiest trade of the century. Actively trading government bonds has also rewarded our investors handsomely. In 2008, fixed-income investments were grossly manipulated by the Fed and Treasury, and in 2009, equities seemed to make no sense. No one ever said it would be easy, but they sure didn't say it would be this hard either.

Below are recent performance returns on the four portfolios we currently offer:

	Past 12	YTD	October	Sharpe
Name	Months	2009	2009	Ratio
Income Builder (IB)	9.50%	13.06%	0.73%	1.47
The Guardian (GRD)	4.33%	9.33%	0.43%	1.73
Harmony Plus (HMY)	0.54%	7.05%	-0.12%	1.46
The Expedition (EXP)	-2.53%	3.67%	-0.60%	1.14
S&P 500 (SP500)	9.80%	17.05%	-1.86%	0.66
Important Performance Disclosure

Complete our Private Client Group request form by clicking here: http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
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Someone will contact you within 24 hours of receiving your information.

Dollar Reality Check

Much has been written about the value of the dollar since the stimulus bonanza began in 2007 and before. Pundits have worried that our cheap dollar policy ("Quantitative Easing") has had a clear impact on the dollar, and not in a positive way. As we see from the next chart, they have a point showing the dollar value erosion began in 2000, as the tech bubble began to break in a trend that continues to this day.

Figure 1 - Weekly chart of the US Dollar Index priced in gold. Chart GenesisFT.com

Stocks Priced in Gold
Economic growth that occurred during the 1990s was accompanied by a confidence in the dollar, which led to some very real gains in asset prices, stocks and commodities (that are priced in US dollars). But in real terms using the gold standard, stocks have been significantly hurt by the falling greenback, thanks to a nearly 85% drop in the value of the buck compared to gold. Next let's look at how stocks fared in gold terms.

Figure 2 shows that the Dow, priced in gold, peaked in mid-1999-almost a year before the index peaked in nominal terms and a big part of the more than 80% drop in real stock prices due to dollar weakness. Stocks have been doing well lately in the face of a weakening dollar, but this has had an overall net negative effect in real terms.

Figure 2 - Weekly chart of the Dow Jones Industrial Average priced in gold. Chart GenesisFT.com.

Stocks in a Euro and Canadian Dollar Perspective
The next two charts show the Dow priced in Euros and Canadian dollars to provide a different value perspective. As we see, the Dow peak in 2007. It was well below its 2000 peak and remains more than 50% depressed from a European investor's point of reference. This may explain why dollar denominated assets held by foreigners (as well as the interest in Treasuries) has fallen in the past few years.

Figure 3 - Weekly chart of the Dow Jones Industrial Average priced in Euros. Chart GenesisFT.com.

Figure 4 - Weekly chart of the Dow Jones Industrial Average priced in Canadian dollars. Chart GenesisFT.com.

Stocks and Commodities
Do you think gold has rallied based on hype and speculation, not real demand? To test this idea, let's examine how stocks have fared compared to commodity prices. As we see, compared to a basket of 17 commodities, the Dow Jones Industrial Average is down nearly 65% from its commodity-adjusted price peak in 1999.

Figure 5 - Weekly chart showing the Dow priced in commodities as represented by the CRB Index. Chart GenesisFT.com.

Are Valuations Justified?

Now that we have a more global perspective on how stocks have fared in the new millennium, where are stock valuations in nominal US dollar terms? If they are historically cheap, they will become more attractive to investors looking for long-term value who believe that stocks have the potential to appreciate in real terms, even if the dollar continues to weaken. This of course assumes that economic growth from here will be sustained and that the dollar does not collapse in value compared to other major currencies.

In late October, ContraryInvestor.com performed an interesting comparison between stock values (S&P500), after stocks rallied 60% between the March lows and October highs, with the 60% rallies that occurred in 1972, 1976, 1983, 1994, 2006. As the following table shows, the numbers were interesting. Based on these metrics, stocks are anything but cheap!

Here is a summary of the 10 indicators following past 60% rallies compared to this one.

Year-over-year retail sales: 9.3% average in prior 60% rallies versus -5.3% currently
Consumer Confidence Index: 95.5 average; 53.1 now
Capacity utilization: 79.9% average; 66.6% now
Year-over-year industrial production: 4.1% average; -10.7% now
Institute of Supply Management (manufacturing) : 53.9 average; 52.6 now
Payroll employment gains over period: 2.2% average; -2.0% now
Decline in continued unemployment claims from cycle peak: -26.3 average; -11.6% now
Year-over-year growth in total credit market debt: 9.3% average; 3.0% now
Year-over-year growth in household debt: 8.8% average; -0.1% now
P/E multiple (trailing 10-year earnings): 16.8x average; 20.0x now

Figure 6 - Weekly chart showing prices, average P/E (blue line) and earnings growth (GRT) for 7,995 U.S. stocks tracked by VectorVest. As the chart shows, the average P/E for the broad range of publicly trading companies entered uncharted territory in 2009 and is still well above any previous year's high. Chart VectorVest.com.

But what happens when we examine valuations for a much broader basket of US stocks, like 8000 (see Figure 6) instead of the cherry-picked, and constantly modified, S&P500 or Dow Jones Industrial Average? The results of this exercise were equally interesting.

On June 5, 2009 the average price-to-earnings ratio for the 8,011 US stocks of the VectorVest Composite Index (VVC) hit an all-time high of 155.58, thanks to rising prices, but no increase in average earnings. Earnings had fallen to their lowest level since the VVC was initiated in 1995 of $0.13/share. But then earnings for a broad range of companies began to show their first real signs of improvement since March 2007, rising from $0.13 to $0.15 per share. P/Es have continued to fall, albeit slowly, to just over 100 on October 30, 2009 as earnings rose.

The same can't be said about earnings growth (GRT). After peaking in May 2005 at 11%, earnings growth (GRT) continued to deteriorate falling to 10% in 2006. By the second week in October, earnings growth had fallen to 0% and the average EPS for the roughly 8000 companies had grown to just $0.22/share, still well below their new millennium peak of $1.04/share in January 2007.

How do these numbers compare to the last recovery? As the rally was getting underway in March and April 2003, earning growth (GRT in red) was a much healthier 8%, and earnings growth had begun improving nearly a year before hitting a low of 3%. Within two months of the bottom in stock prices and the beginning of a 56-month bull market, VVC P/Es peaked at 60.51 (May 2003). Looking even further back to the lofty prices in March 2000, we see the P/E, although high, was a much more benign-32 times and earnings growth was running at 11%.

The Mother of All Carry Trades

Since late 2006, the financial world has become all-too-familiar with the carry trade (selling a low-yield currency to buy assets in high-yield currencies). Then, the Japanese yen was the fuel of choice, thanks to basement costs of borrowing. But with the credit crisis and rapid collapse in the values of high-yield currencies, like the Icelandic krona with commensurate losses, the carry trade appeared to go the way of the dodo bird-extinct.

However, the very factors discussed above have given global investors with a penchant for risk a new carry trade target - that's right, the USD. As Figure 3 shows, one popular currency pair, the New Zealand dollar and US dollar (NZD-USD) has helped fuel the recent stock rally. It means that global investors can borrow dollars at record-low rates, sell them to buy New Zealand dollar denominated bonds and other assets, and reap the interest rate difference as profit. A further weakening dollar/strengthening NZD is a bonus. Their major risk is the possibility of a rapid USD appreciation/NZD depreciation.

As Figure 3 shows, this carry trade was somewhat popular before the credit crisis began in late 2007, but has recently surpassed its 2007 peak popularity, as investors sell USD to buy NZD. Currently, the correlation between the two is nearly 0.94 (a correlation of 1 is perfect correlation).

Figure 7 - Weekly chart of the New Zealand dollar - US dollar currency pair in the upper sub-graph, the S&P500 in the mid-subgraph and the 20-week correlation between the two (red).

As the economist known as Dr. Doom, Nouriel Roubini, pointed out in an article last week, the conditions that have driven the USD carry trade have created what he believes is the "mother of all carry trades."

Here is how he outlined the power behind the key risks that this trade presents in his Financial Times article, "Mother of All Carry Trades Faces an Inevitable Bust."

"So what is behind this massive [stock/commodity] rally? Certainly it has been helped by a wave of liquidity from near-zero interest rates and quantitative easing. But a more important factor fuelling this asset bubble is the weakness of the US dollar, driven by the mother of all carry trades. The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates - as low as negative 10 or 20 per cent annualized - as the fall in the US dollar leads to massive capital gains on short dollar positions."

These conditions, "a zero Fed funds rate, quantitative easing and massive purchase [monetizing] of long-term debt instruments is seemingly making the world safe - for now - for the mother of all carry trades and mother of all highly leveraged global assets."

If Roubini is right (and let's face it, his track record in calling the market leading up to and through this crisis so far is impressive), investors are surfing a global cash tsunami which could still be some time from reaching its zenith. However, any potential for gain is offset by the reality that the bigger this bubble gets, the more destructive its ultimate collapse will be, so caution is a requisite.

But even Dr. Doom is careful about calling the end of the financial world as we know it in his final paragraph.

"This unraveling may not occur for a while, as easy money and excessive global liquidity can push asset prices higher for a while. But the longer and bigger the carry trades and the larger the asset bubble, the bigger will be the ensuing asset bubble crash. The Fed and other policymakers seem unaware of the monster bubble they are creating. The longer they remain blind, the harder the markets will fall."

Market Summary

I will be the first to admit that one of the biggest challenges in the current credit crisis and apparent recovery has been estimating the impact of various policy decisions by the Fed and other central bankers around the globe. Few, including yours truly, appreciated just how powerful this stimulus could be in the face of massive debt. In my defense, job one is to protect principle, and debt creates serious risk, especially when it gets as big as it is today.

As history has taught us, bubbles generally build longer than expected, with the biggest gains coming nearer the end than the beginning. Enter too late or exit too early and you underperform your less risk-averse peers.

We at ProfitScore will continue to take a cautious approach to this market and trade it with great care, with both eyes on money management. We will continue to take profits out of the markets without putting serious capital at risk. This is certainly not a market for the weak of heart!

Based on current economic reality, the U.S. still has some time to go before it can follow nations like Australia and be weaned from the punch bowl. And as long as the punch bowl offers libation, there will be money to be made, as long as one doesn't imbibe to the point of losing an appreciation for what happens when the punch is gone.

Interesting Reading:

International Monetary Fund - Principles for Stimulus Exit
http://www.imf.org/external/np/g20/110709.htm

Detail IMF document - Global Economic Prospects and Principles for Policy Exit
http://www.imf.org/external/np/g20/pdf/110709.pdf

Why Some Countries Are Stopping Their Stimulus
http://www.time.com/time/business/article/0,8599,1936585,00.html

The American Economy in One Chart
http://www.safehaven.com/article-14999.htm

Mother of All Carry Trades Faces Inevitable Bust - Roubini
http://www.ft.com/cms/s/0/9a5b3216-c70b-11de-bb6f-00144feab49a.html?nclick_check=1

Portfolio Performance Analysis

Risk & Reward

Each of our portfolios is strategically allocated across one or more of the Investment Pillars of Strength discussed below. Each Pillar is managed by multiple, uncorrelated, absolute-return investment managers to produce a return stream that is consistent, negatively correlated with the major market averages in down markets and non-correlated with each of our core Pillars of Strength. Commentary found in this newsletter is for informational purposes only and does not effect how our portfolios are traded.

Managing risk is our most important consideration and it is reflected in the way our portfolios are built and managed each and every day.

Based on our internal valuation estimates, fair value on the S&P 500 is approximately 850. Our long-term dismal GDP growth calculations over the next five years, combined with the fact that equities are currently 30% overvalued, have our five year forecast on the S&P 500 as a negative return. I have had only limited success forecasting equity markets based on fundamentals because investors simply don't care. Fear and greed drive the markets and they always will. Due to volatility contraction and P/E expansion into nose bleed territory, we remain vigilant in our efforts to carefully manage risk.

Our equity trading accuracy remains above 50%, but our average losing positions during October were larger than our average winning trades, producing small negative returns for equities in October. MTD November, we are currently showing small gains for equities across the board. Interest rate sensitive allocations continue their upward march higher.

Index Advantage:

Trading accuracy has stabilized north of 50%, after our low in July. Large monthly moves seem to find us on the wrong side of trades, which causes us to fight back to pull our returns back into positive territory. November is showing small gains for the month. Managing risk in a hard-charging market can be a difficult job.

For the month, this pillar gained -1.28.

Strategic Balance:

We continue to tread water in this allocation, as our risk-adverse traders patiently wait for higher probability trades to materialize.

For the month, this pillar earned -0.67.

Dynamic Income:

Our interest rate sensitive strategies combined to once again produce positive returns for what is now the 7^th-winning month in a row. Given the over-extended positions in asset classes traded in this allocation, we are growing more cautious about changing dynamics and increasing volatility. If the economy once again falters, I fully expect the government to once again manipulate the long and short end of the yield curve, making our job managing these positions almost impossible. Until then, we plan to make hay while the sun is still shining!

For the month, this pillar earned .98.

Our portfolios are built using varying distributions to the strategic allocations discussed above. To view detailed performance and risk statistics information about our investment portfolios for the month, please click on the links below:

Complete our Private Client Group request form by clicking here: http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

Currency Manipulation – Has It Helped Your Net Worth?

2009-10-30T13:08:00Z

Discussion on the Hill
Dollar Crisis Averted, But at What Cost?
The Cost of Global Dollar Reliance
A Year After TARP -- Was It Necessary?
Attaboy Jack!

In this letter, we are going to spend some time digging into the recent volatility of the U.S. dollar. In case you haven't noticed, the U.S. dollar roared back in 2008 only to resume its free fall in 2009. There are advantages and disadvantages to having a strong/weak dollar and some passionate arguments for/against various dollar policies. Historically, every great power in history has used a weak dollar to inflate their way out of paying off large amounts of debt.

Below is a recent discussion between Chairman Bernanke and Congress on the use of currency swaps as an apparent tool of the Fed to manipulate the currency market. It appears that the recent financial crisis and the fact that the U.S. dollar is the reserve currency of the world, gave the Fed a perfect opportunity to have its cake and eat it too. The recent drop and increased volatility in the U.S. dollar may mean that the Fed got more than it bargained for.

Question?
If you are invested in the S&P 500 in 2009 and it goes up 15% in value and at the same time the U.S. Dollar drops 16% in value, has your global net worth increased?

"Swap" Discussion on the Hill

A hearing in Congress on July 21, 2009 provided a unique insight into the Federal Reserve's actions at the beginning of the credit crisis. Here is a noteworthy exchange between Congressman Alan Grayson (D - Florida) and Fed Chair Ben Bernanke.

Grayson:
"Chairman Bernanke, I'm looking at the report you handed out this morning... There's a table on page 26 [of your report] that consists of [the Federal Reserve] balance sheet and one of your entries called central bank liquidity [currency] swaps shows an increase from 2007 from $24 billion to $553 billion ...by the end of 2008. What's that?"

Bernanke:
"Those are swaps (derivatives) done with foreign central banks, many [of which] are short dollars and [that would have had to] come into our markets looking for dollars, drive up interest rates and create volatility in our markets. What we have done... [is to] swap dollars for currencies [of 14 central banks']; they take the dollars and lend it out to banks to bring down interest rates in those jurisdictions." (What he didn't say was that such action also helped keep US interest rates down.)

Grayson:
"We looked at one of the arrangements, [one of which was] $9 billion for New Zealand, which works out to $3,000 per person [New Zealand resident]. Wouldn't it have been better to extend that kind of credit to Americans?"

Bernanke:
"...we are extending that kind of credit to Americans."

Grayson:
"...look at the next page which shows... a 20% increase in the nominal USD exchange rate at exactly the same time that you were handing out a half a trillion dollars to foreigners. Do you think that is a coincidence?"

Bernanke:
"... [Pause]...Yes."

It's an interesting question, despite how Bernanke answered it. Action contradicts his answer but in his defense, strengthening the dollar was probably not the goal of the Federal Reserve in taking this action - it was an unintended consequence.

Dollar Crisis Averted, But at What Cost?

In August, September and October, the US Dollar Index (USDX) appreciated 21% after falling 24% from late 2005 into early 2008. But if taming volatility was a motivator for the Federal Open Market Committee to sell swaps as Mr. Bernanke claimed, the strategy failed abysmally. The dollar shot up from 72 in early August 2008, before peaking at 90 in March 2009, after which it then lost 16%.

And the aftermath isn't pretty. The dollar is still falling and recently broke key support at 75, and there is little on the horizon to indicate that this trend will change anytime soon, especially given the moves by foreign central banks to shift away from the dollar (see articles in Related Reading below). Can anyone blame them? Current Federal Reserve and government policies and responses have been anything but dollar positive.

This month, the Bank of International Settlement (BIS) published a paper that attempted to answer this and other questions surrounding central bank actions entitled "The US Dollar Shortage in Global Banking and the International [read: Federal Reserve] Policy Response."

The paper wasted no time in getting down to brass tacks and asked some probing questions of its own.

The global financial crisis has shown just how unstable banks' sources of funding can become. Throughout the crisis, but particularly following the collapse of Lehman Brothers in September 2008, many banks faced severe difficulties securing short-term US dollar funding. In response, central banks around the world adopted extraordinary policy measures, including international swap arrangements with the US Federal Reserve, to enable them to provide US dollars to commercial banks in their respective jurisdictions. What caused this global shortage of US dollars? Which banking systems have been most affected? How could a shortage develop so quickly after dollar liquidity had been viewed as plentiful?

In a nutshell, when the crisis hit the dollar a shortage was the result caused from a trend that had become popular with foreign banks of taking increasingly larger US dollar positions, thereby creating significant short dollar positions among foreign banks. In Europe's case, "[the] banks' need for short-term US dollar funding was substantial at the onset of the [credit] crisis, at least $1.0 -$1.2 trillion by mid-2007."

And that was just Europe.

The Cost of Global Dollar Reliance

The origins of the US dollar shortage during the crisis are linked to the expansion since 2000 in banks' international balance sheets. The outstanding stock of banks' foreign claims grew from $10 trillion at the beginning of 2000 to $34 trillion by end-2007, a significant expansion even when scaled by global economic activity (Figure 1, left panel). The year-on-year growth in foreign claims approached 30% by mid-2007, up from around 10% in 2001. This acceleration took place during a period of financial innovation, which included the emergence of structured finance, the spread of "universal banking", which combines commercial and investment banking and proprietary trading activities, and significant growth in the hedge fund industry to which banks offer prime brokerage and other services.

So how big was the risk of the credit crisis on these foreign dollar positions?

Were all liabilities to non-banks treated as short-term funding, the upper-bound estimate would be $6.5 trillion.

Many of these dollar short positions held by foreign banks was the result of participation in complex derivatives in a market that had grown to around $600 trillion. This short-term funding liability was little more than one percent of the derivative total.

Figure 1

And it is this amount and potentially more that the Federal Reserve was attempting to cover in the action taken by the FOMC. In other words, the Federal Reserve became the buyer of last resort in an effort to avert further crises with the taxpayer, ultimately being on the hook for the tab!

The BIS paper highlighted just how little was known about the structure and complexities of international bank balance sheets and their dependence on one another thanks to financial globalization. It also exposed the risks that grew from this trend and growing use of foreign exchange swaps and other derivatives.

When the credit crisis hit and Lehman Brothers collapsed, short-term currency funding sources were seriously compromised, which many believe required that a buyer of last resort step into the fray. These problems became most acute in smaller countries like Iceland, that had become heavily reliant on complex derivatives and foreign banks to provide a funding backstop in case something went wrong. And in 2008, that is exactly what happened.

But what happens when the next crisis strikes? Will the Federal Reserve be ready and able to again act as buyer of last resort and provide necessary liquidity? And who assumes the risks of this action? As we have learned in the past year, it will be the US taxpayer.

This was just one event in a series of events that were part of a larger global crisis that some experts would have us believe threatened our financial system.

A Year After TARP - Was It Necessary?

Another quickly improvised solution to the 2008 crisis was the $700 billion Troubled Asset Relief Program (TARP), introduced by Secretary Treasurer Hank Paulson in September 2008. Without it, we were told, the financial fabric of our country would have been irrevocably torn with untold consequences. Given this supposed threat, Congress quickly approved TARP on October 3, 2008.

A year after TARP, what has it accomplished? A paper by Florida State University Professor Randall Holcombe published recently sought to address this question.

Figure 2 - Chart from the Federal Reserve showing the effect of TARP, a reduction in commercial and industrial bank lending by commercial banks, which is the opposite of the intention (we were told at the time) of the program. Based on the amount of money spent to date, this chart should make you sick to your stomach.

So what risks did the credit crisis pose based on these foreign dollar positions?

In his opinion, TARP was neither necessary nor has it worked (see Figure 2).

To look at the first question, consider what TARP was designed to do. Secretary Paulson said interbank lending had dried up because banks had toxic assets (mortgage-backed securities) clogging their portfolios. Because nobody knew what they were worth, banks were uncertain of the financial security of other banks. This uncertainty caused a reluctance to lend and prompted the financial markets to lock up.

The solution, Paulson argued, was to approve TARP and use $700 billion to buy the toxic assets. Replacing the assets with Treasury securities would fortify bank balance sheets and interbank lending would resume.

Dr. Holcombe pulls no punches in his synopsis.

It is easy to say the program wasn't necessary, despite Paulson's arguments, because the TARP money wasn't used to buy toxic assets. TARP money was instead used to buy preferred stock in banks, shoring up their balance sheets by giving the federal government part ownership of the banks.

Nine of the largest banks were forced to issue stock to the Treasury, paid for with TARP money, even though several of the banks tried to opt out. Secretary Paulson said that if some of the big banks participated and others didn't, it would identify their varying levels of weakness, which Paulson believed was undesirable.

Instead of buying up toxic assets, the TARP money was used to partially nationalize the banking industry. It was also used for a federal takeover of AIG (after it was initially rescued by the Fed) and the bailout of Chrysler and General Motors.

He admits that without this sizable taxpayer infusion some banks would have failed, but he believes that wouldn't have been so bad.

When firms take risks, they must balance the potential profits from success against the potential losses from failure, and the TARP support removes the last part of that balancing act. There may have been some dislocations in the short run from bank failures, but in the long run allowing them to go under preserves the incentive structure that fuels a market economy. Banks are financial intermediaries that match up borrowers and lenders. When a bank goes under, it does not reduce the amount of money available to borrowers, or prevent savers from providing money that can be lent. Other financial intermediaries are available to borrowers and lenders to replace the activities that failed banks would have performed.

We contacted Professor Holcombe this week to discuss his article with him. His comments provide an excellent TARP overview and epilog.

As to the stimulus package and bailouts, they are both counterproductive. As the economy now enters a recovery, the "stimulus" spending will divert resources from the private sector into government spending, which will slow the recovery.

In hindsight we can see the folly of the auto industry bailout. The justification was to give them a source of temporary funding so they could avoid bankruptcy, but they went into bankruptcy anyway. Now, GM is 61% owned by the federal government, which will make it harder for the company to survive long-term than if it had just gone through a regular bankruptcy proceeding last December rather than getting its first distribution of bailout money.

His comment that stimulus spending "will divert resources from the private sector (and real jobs creator) into government spending, which will slow recovery" is significant. That is exactly what happened during the Great Depression with FDR's New Deal (and other programs). It has also proven to be true as a result of the official response from the Japanese government following the breaking of its asset bubble in 1990 over the last two decades in Japan.

The huge difference in the economies of the U.S. in the 1930s and Japan in the 1990s is that complex derivative ticking time-bombs did not exist at the time, which will make the next crisis far more "interesting."

Definitions

Currency Swap
A currency swap is a financial derivative and an arrangement in which two parties exchange specific amounts of different currencies initially and a series of interest payments on the initial cash flows are exchanged. Often, one party will pay a fixed interest rate, while another will pay a floating exchange rate (though there may also be fixed-fixed and floating-floating arrangements). At the maturity of the swap, the principal amounts are exchanged back. Unlike an interest rate swap, the principal and interest are both exchanged in full in a currency swap. http://www.investorwords.com/1244/currency_swap.html

Derivatives
Warren Buffett describes them as "financial weapons of mass destruction" for good reason. A derivative is a financial contract whose value is derived from the performance of underlying market factors, such as interest rates, currency exchange rates, and commodity/equity prices. Derivative transactions include a wide assortment of financial contracts including structured debt obligations and deposits, swaps, futures, options, caps, floors, collars, forwards and various combinations thereof.

Related Stories and Links:

Alan Grayson and Ben Bernanke Video
http://www.youtube.com/watch?v=n0NYBTkE1yQ

US Dollar Shortage in Global Banking and the International Policy Response
http://www.bis.org/publ/work291.pdf?noframes=1

How the Federal Reserve Bailed Out the World
http://www.zerohedge.com/article/how-federal-reserve-bailed-out-world

A Year After TARP: $700 Billion Down the Drain - Holcombe
http://blog.mises.org/archives/010873.asp

Economist - Down with the Dollar, Why the Dollar Is Falling
http://ow.ly/15W3ht

Dollar to Hit 50 Yen, Cease as Reserve
http://ow.ly/v6hS

Russia Ready to Abandon Dollar in Oil, Gas Trade with China
http://ow.ly/v5Ru

Iran Joins List of Nations in Moving Away from the Dollar...
http://ow.ly/v5QZ

Attaboy Jack!

I put my dad on a plane back to Tennessee on Monday after enjoying another successful bird hunting trip with him. We had great weather, which made for incredible hunting. We recapped the entire experience with friends and family, while enjoying incredible southern cuisine. My new hunting dog Jack made it all possible by exceeding my wildest expectations and performing like an experienced dog well beyond his years. I owe a special thanks to my good friend Brian King for helping me plan a special pheasant and chukkar hunt for us on his ranch.

On our last day, I took my oldest daughter Sarah so she could share this special time with her Papaw. Below is a picture of Sarah and me as we stop for a rest.

I don't think I could have wiped that smile off her face.

My dad and I have been going on this hunt for 12 years and it seems like I enjoy each hunt more than the last. My father turns 70 in March and I know our bird hunting days are numbered, so I am blessed to spend this special time with my dad. For next year, I am in the planning stages of a two-week hunt across Idaho, Montana, North and South Dakota. If you are a bird hunter and can help me plan some stops along the way, I would welcome your call.

Working to grow your wealth,

John M. McClure
President & CEO
ProfitScore Capital Management, Inc.

P.S. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

Complete our Private Client Group request form by clicking here http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

How Our Home Prices Compare To The Rest Of The World

2009-10-20T16:39:00Z

Global Home Price Comparison
Lessons from the Forgotten Depression
Resisting the Intervention Urge
Chaining the Tiger
More Difficult Than Timing the Market

Quote of the week
"Institutional equity investors fear missing out on the rally. Bond investors fear deflation and the stock market is way overdone and is ripe for a steep correction. The gold bugs fear that the fiscal and monetary largesse globally will lead to inflation and fear that the U.S. dollar is on the verge of collapse. Never before has fear felt so reassuring - pick an asset class, and it's going up in price."
David Rosenberg in a recent newsletter to clients

Global Perspective - What's a Home Worth?

In an effort to address deflating stock prices, the Federal Reserve began lowering interest rates in January 2001. Within 18 months it had dropped to multi-decade lows. The strategy eventually worked, but it also fueled a housing boom, propelling home prices to unprecedented highs even after adjusting for inflation. But the strategy had a high price tag and since 2007 we have suffered the all-too-predictable bubble break and property depression.

But how have home prices fared around the globe? Did prices appreciate as significantly? Have other markets been as severely impacted as those in the U.S. over the past two years?

The answers surprised us. A series of charts recently published by The Economist magazine compared home prices from 1990 to present (Q2-09). In the next chart, we see nominal home price changes for Hong Kong, Britain, Spain, New Zealand, Canada and Japan, as well as two estimates for U.S. home prices - the generous Federal Housing Finance Authority (FHFA) and the more conservative Case-Shiller Home Price Index.

Notice the unique jump for Hong Kong in the late 1990s followed by the major correction and market re-ignition. Every other market in the chart, with the exception of Japan, experienced rapidly rising home prices starting in the early 2000s, with peaks in late 2007. Top of the list was Spain followed then by New Zealand (and Australia which closely tracked the path of its smaller neighbor), then Hong Kong, the U.S. followed by Canada and finally Japan, where home prices dropped over the two-decade period.

The takeaway is that although a lot of press was given to the situation in the U.S., there has been a relative dearth of articles comparing international housing markets on this side of the Atlantic and Pacific. In Spain, where home values jumped nearly 400%, prices are still 350% above where they were two decades ago, suggesting that this market has the greatest potential for further price declines. New Zealand and Australia aren't far behind on the "bubble-scale."

Notice that home prices in Canada significantly underperformed their global counterparts through the 1990s and into the new millennium, which may explain why the housing market there has remained more robust of late. And Japan, where prices are still little more than one-half of what they were two decades ago, continues to experience weak housing demand - a result of a combination of an aging population, punitive government stimulus and bankruptcy prevention policies that have frustrated any lasting recovery chances. These are lessons lost on U.S. policy makers.

Figure 1 - International home price comparisons. Source - Economist.com

One thing is clear from this chart. Chances are that the worst is not over for the countries in which housing prices were launched into the stratosphere. It will take more time before economic gravity pulls them back to earth. And even if U.S. property markets stabilize, what impact will falling prices in other parts of the world have on our economy?

Lessons from the Forgotten Depression

Past issues of the ProfitScore IQ have examined the wisdom of a policy to bailout struggling companies and industries in the face of an economic meltdown in historic terms. And in no period in history is the difference between present and past starker than it is today, compared to the 1920 depression.

Then the government and Federal Reserve stayed out of the way and let free market forces deal with the fallout and recovery. Will it become a blatant example of how failing to learn the lessons of history doom us to re-learn them the hard way?

Analysts and economists continually harken back to the period from 1929 to 1933, at the beginning of the Great Depression to laud the example set by Franklin Roosevelt and how he sought to cure the ills of the period with massive government spending and New Deal programs.

Opinions could not be more polarized. On one side supporters of John Maynard Keynes credit government intervention and deficit spending with saving our nation from economic ruin. On the other, opponents of corporate socialism argue that government intervention only served to prolong the economic pain and recovery which ultimately took the second great war to complete.

Why are other periods of economic contagion so rarely discussed? In a recent paper entitled Warren Harding and the Forgotten Depression of 1920, Thomas E. Woods Jr. of the Von Mises Institute explores the Great Depression of 1920 and examines the official response.

"The economic situation in 1920 was grim. By that year unemployment had jumped from 4 percent to nearly 12 percent, and GNP declined 17 percent. No wonder, then, that Secretary of Commerce Herbert Hoover-falsely characterized as a supporter of laissez-faire economics-urged President Harding to consider an array of interventions to turn the economy around. Hoover was ignored."

From 1920 to 1921, foreign trade was cut in half and prices in the U.S. fell by more than 20%.

Today, Hoover's advice would have been gladly accepted and instituted. But a different ethic prevailed in the Harding Administration in 1920.

"Instead of ‘fiscal stimulus,' Harding cut the government's budget nearly in half between 1920 and 1922. The rest of Harding's approach was equally laissez-faire. Tax rates were slashed for all income groups. The national debt was reduced by one-third. The Federal Reserve's activity, moreover, was hardly noticeable. As one economic historian puts it, "Despite the severity of the contraction, the Fed did not move to use its powers to turn the money supply around and fight the contraction."

Resisting the Intervention Urge

Today, policy makers would denounce such a policy as economic suicide and they'd have the backing of the majority of economists and voters. Tightening the purse strings and letting companies and consumers fend for themselves without the help of government cash would not be politically popular.

But then a strange thing happened.

"By the late summer of 1921, signs of recovery were already visible. The following year, unemployment was back down to 6.7 percent and was only 2.4 percent by 1923," according to Woods.

"In 1920-21," writes economist Benjamin Anderson, "we took our losses, we readjusted our financial structure, we endured our depression, and in August 1921 we started up again. . . . The rally in business production and employment that started in August 1921 was soundly based on a drastic cleaning up of credit weakness, a drastic reduction in the costs of production, and on the free play of private enterprise. It was not based on governmental policy designed to make business good."

As Thomas Woods explains, "The federal government [of 1920-21] did not do what Keynesian economists ever since have urged it to do: run unbalanced budgets and prime the pump through increased expenditures. Rather, there prevailed the old-fashioned view that government should keep spending and taxation low and reduce the public debt."

Even in 1920, Harding's laissez-faire approach attracted significant opposition from economists who believed intervention was the right approach, according to Woods. And few presidents before or since have been subjected to the degree of ridicule that President Warren Harding had to endure. His 1920 Republican Presidential Nomination Acceptance Speech provides some clues as to why.

"We will attempt intelligent and courageous deflation, and strike at government borrowing which enlarges the evil, and we will attack high cost of government with every energy and facility which attend Republican capacity. We promise that relief which will attend the halting of waste and extravagance, and the renewal of the practice of public economy, not alone because it will relieve tax burdens but because it will be an example to stimulate thrift and economy in private life.

Let us call to all the people for thrift and economy, for denial and sacrifice if need be, for a nationwide drive against extravagance and luxury, to a recommittal to simplicity of living, to that prudent and normal plan of life which is the health of the republic. There hasn't been a recovery from the waste and abnormalities of war since the story of mankind was first written, except through work and saving, through industry and denial, while needless spending and heedless extravagance have marked every decay in the history of nations."

Figure 1 - Chart of the 46% drop in stock prices from 1919 through 1921 to the nearly 500% boom that followed over the subsequent eight years. Chart by GenesisFT.com.

Can you imagine a political leader giving a similar speech today? But as much as this approach counters the prevailing conventional wisdom, the recovery that it elicited in the early 1920s was nothing short of phenomenal.

Chaining the Tiger

From 1922 through 1929, the U.S. gross national product rose 40%, from $74.1 billion to $103.1 billion and the federal government ran a surplus budget. Unemployment remained low, between 3 and 4%, and per capita income rose from $641 in 1921 to $847 in 1929. As we see from Figure 1 above, after shedding 46% in value between 1919 and 1920, the Dow managed an incredible 500% gain over the next eight years that dwarfs any subsequent eight-year rally.

Such a recovery was possible only because the market had been allowed to work and the economy cleared of uncompetitive companies run by inept managers and debt levels had been significantly reduced. This created an environment that stimulated new business and economic growth, in addition to generating rapid job growth and fueling consumer confidence.

But there was one undeniable side-effect of this and every other sustainable recovery. While the average per capita income rose 35.3% from 1920 and 1929, it jumped 75% for the top 1% income earners. And it is this reality that present-day policy makers find so intolerable. Today's politicians would rather risk national economic health than allow the rich to benefit unfairly. It is the same intervention ideology that would see the tiger fettered with chains to give the gazelle a better chance during the hunt.

Don't get me wrong, I'm all in favor of helping the poor. But how does keeping moribund companies on government mandated life-support and indenturing our children and children's children with debt to help the poor, especially if it increases their number longer-term? And even if these policies did work, how many would prefer to live in a world dominated by government committees that have the power to decide which businesses should survive and which should fail using your tax dollars to play Santa Claus?

Related Stories and Links:

House Prices Are Creeping Up, But It May Not Last
http://www.economist.com/businessfinance/displaystory.cfm?story_id=14462419

Safe as Houses - Interactive home price graph
http://ow.ly/rSoG

Warren Harding and the Forgotten Depression of 1920 by Thomas E. Woods Jr.
http://www.firstprinciplesjournal.com/articles.aspx?article=1322&theme=home&loc=b

Economy of the 1920s
https://www.wou.edu/las/socsci/kimjensen/ECONOMY%20OF%20THE%20TWENTIES.htm

Former Fannie Chief Credit Officer Says FHA Is $54 Billion Underwater
http://www.zerohedge.com/article/former-fannie-chief-credit-officer-says-fha-54-billion-underwater

Measured in Euros, U.S. Per Capita GDP Is Down 25% Since 2000
http://online.wsj.com/article/SB10001424052748703298004574458923186941870.html

How Currency Devaluation Can Be a Bad Thing
http://www.zerohedge.com/article/how-currency-devaluation-can-be-bad-thing

Foreclosures Mark Pace of Enduring U.S. Housing Crisis
http://www.reuters.com/article/domesticNews/idUSTRE59705J20091008?sp=true

Foreclosure Sales in Limbo Over Title Issue
http://www.boston.com/business/articles/2009/10/09/title_troubles_leave_some_foreclosure_sales_in_limbo/

More Difficult Than Timing the Market

My wife left for a well-deserved vacation to Puerto Rico last Tuesday, so I have been playing both Mom and Dad. My kids are very involved in athletics and love to play basketball and soccer. The month of October is just nuts because Sarah has three different teams that overlap during the month, so she is currently playing on 2 different basketball teams and one soccer team. Annabelle is fortunately only playing on one soccer team at the moment.

The day that my wife left for Puerto Rico, Annabelle began vomiting and running a high fever, so I had a kid at home most of last week. Needless to say, I didn't get a lot done working from home, but have worked the entire weekend trying to catch up. I have no idea how single parent families function. Being a single parent in this day and age makes my job of making money in up and down markets seem like a walk in the park. The next time I complain about how hard it is, please remind me to reread this letter.

Working to grow your wealth,

John M. McClure
President & CEO
ProfitScore Capital Management, Inc.

P.S. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

Complete our Private Client Group request form by clicking here http://profitscore.com/clientgroup.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

Why We Appear To Be On The Down-Hill-Side Of Unemployment

2009-10-13T22:08:00Z

A New Strategic Alliance
Our Monthly Performance Update
Incomes - A Four-Decade Long Report Card
Will the Real Unemployment Rate Please Stand Up?
It's ROC That Matters
Will They Keep Buying Our Bonds?
Rocket-Riding Stimulus Junkies (Part II)
Paying the Piper
Are You in "Old-Man Shape?"

I often write about the facts in this letter with little or no emotion. However, peeling back the layers of the onion of economic data over the past 18 months has brought tears to my eyes. I have close friends that have lost their jobs, houses, and even their families during this great recession. It is a humbling experience to watch it affect real people trying to live real lives.

In this week's IQ, we dig into the unemployment numbers and find some encouraging signs that hopefully point to more jobs. This recession has affected a lot of hard-working people who are desperately looking for a way to put food on their family's dinner table. I hope the recent slowing of unemployment will soon turn into new jobs and provide them to people who need them most.

We sat at this very same place back in the mid 1930s when the economy came stumbling back from the first leg of the depression until bad political decisions of higher taxes and restricted trade sent the economy into another deeper decline. It was this second decline that turned a sever recession into the Great Depression. We are seeing some recent trade spats with China and the Obama Administration. It is still planning on eliminating Bush's tax cuts. Despite these warning signs, I am still cautiously optimistic that cooler heads will prevail and we will not make the same poor decisions that will cripple our economy and send us back into a deep recession.

A New Strategic Alliance

Before jumping into our research, I have some exciting news about an important new strategic alliance. As you are probably aware, ProfitScore Capital Management is in the business of managing money for individual and institutional investors. Institutional investors can take many forms such as Registered Investment Advisors, hedge funds, family offices, broker dealers, corporations, pension funds, etc.

Because of overwhelming regulation, one of the most challenging investors to serve are broker dealers. To better serve this market and to give these important clients the respect and service they deserve, ProfitScore has signed an exclusive distribution relationship with Flexible Plan Investments to serve the broker dealer channel.

In this relationship, ProfitScore will begin offering its portfolios through Flexible Plan Investments and Flexible Plan will set up and oversee the client account and manage the broker dealer relationship. In other words, each firm will concentrate on what they do best. I have known Jerry Wagner, CEO of Flexible Pan Investments, for many years and feel fortunate to partner with Jerry to serve the broker dealer marketplace.

Flexible Plan has served the broker dealer channel for over 25 years and is currently approved at over 500 broker dealers. ProfitScore will benefit by being immediately available at hundreds of broker dealers and thousands of their representatives over night. Flexible Plan and ProfitScore are on track to start offering these portfolios by November 1. I promise to keep you posted as we get closer to making these portfolios available.

If you are a broker dealer or a representative of a broker dealer and are interested in learning more about how ProfitScore and Flexible Plan Investments can help you manage your clients' assets and to provide you with the tools to grow your assets under management, we would love to hear from you by sending us an email to: advisor @ profitscore.com.

An Update on Our Performance

The main reason for writing hundreds of pages of commentary and sharing our research is to keep our current clients updated on our thoughts and to shamelessly promote our investment portfolios to investors that may need our help managing their assets. Below is a brief performance update on our investment portfolios.

Fixed income continues to shine as the bright spot in our performance. I get asked often what this portfolio is comprised of, so I thought I would take this section of the newsletter for the next few monthly letters to describe our portfolios in a little more detail.

The Income Builder portfolio is a multi-manager portfolio that is 100% invested in interest rate sensitive assets. Because we strive to produce absolute returns, this is not your traditional fixed income investment. All of our portfolios are considered absolute return investments because we take both long and short positions in all the assets we trade. Income builder is comprised of high yield bonds, government bonds, and the U.S. dollar, each traded actively to benefit from changing market conditions. The portfolio's assets are currently allocated to six investment managers who are trading eight quantitative-based investment strategies.

The design of this portfolio truly gives an investor an opportunity to earn equity-like returns with fixed income volatility. To see more performance statistics on the Income Builder portfolio or some of our other investment strategies, please click on the blue-lettered links in the performance table below.

Below are recent performance returns on the four portfolios we currently offer:

	Past 12	YTD	September	Sharpe
Name	Months	2009	2009	Ratio
Income Builder (IB)	9.67%	12.24%	3.84%	1.46
The Guardian (GRD)	4.69%	8.88%	1.62%	1.73
Harmony Plus (HMY)	2.32%	7.18%	0.25%	1.48
The Expedition (EXP)	-0.27%	4.29%	-1.31%	1.16
S&P 500 (SP500)	-6.91%	19.26%	3.73%	0.67
Important Performance Disclosure

Complete our Private Client Group request form by clicking here http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

Will the Real Unemployment Rate Please Stand Up?

It is clear that employment is increasingly impacting stocks as investors fret over the ability of our fragile economy to generate jobs and boost consumer confidence.

With a release that was worse than expected, the Bureau of Labor Statistics (BLS) reported that there was a monthly loss of 263,000 jobs in September lifting the official U-3 unemployment rate to 9.8%. And, although the number was depressing, it was a mere flesh wound compared to the BLS household survey that showed a September decline of 710,000 jobs.

Some analysts charged that the household survey "vastly" underestimated the loss of jobs (see article September Unemployment... below). How could two estimates from the same government agency be so different? And, did it mean that the chances for a double-dip recession had just increased? Clearly the market was confused.

The chart below adds more confusion. It shows three different unemployment estimates (not including the household survey). Notice the difference between them. The government uses the most benign unemployment measure (U-3) that removes discouraged workers, or those who have given up looking for work (9.8%). This number also doesn't include those who have been forced to go from full-time to part-time employment as part of job cutbacks.

Next, is the U-6 unemployment number which was 17% in September that includes these two groups. Finally, there is the ShadowStats.com estimate that calculates unemployment, including all the groups that have been removed over the years to make the numbers (and the government) look better, was 21.4% in September. That is as bad as it was during the dirty thirties! Which number was most accurate?

Examine Figure 1 and you will notice that although the numbers are different, they are nearly identical in one respect. The three lines move exactly together - they increase and decrease at about the same rate (rate of change). So, no matter which estimate you believe, the rate at which they are getting better or worse is the same.

Geek Note:
Please keep in mind that because the government has changed the way they calculate unemployment, it is mathematically impossible to compare today's official government unemployment numbers to other times in U.S. history. That is why we use unemployment numbers from Shadowstats.com, who uses the same calculation methodology that was used during the Great Depression.

Figure 1 - Chart showing three different unemployment rates. First, the official U-3 rate (green), generally discussed, which rose to 9.8% in September. Next, the broader U-6 unemployment rate (yellow), which includes discouraged and part-time workers that came in at 17% in September. And, finally the alternate unemployment or Alt rate published by ShadowStats.com, which was 21.4% (red) in September. Shadowstats.com

It's ROC That Matters

In an effort to show the true picture, we have constructed a rate of change (ROC) chart (using the U-6 unemployment number). We also placed vertical dashed lines at the beginning and end of the last recession and at the beginning of the current one. In both cases, the unemployment rate had begun to increase fairly rapidly before the recession was officially declared by the National Bureau of Economic Research (NBER), the agency entrusted to tell us when recessions begin and end. It is interesting to note that the 2002 recession officially ended in November 2001 (although we had to wait until July 2002 to be told that fact by the NBER), a full month before that rate at which jobs were being lost peaked. But December 2001 was also sixteen months before the market ultimately bottomed and the rally began (March 2003).

Figure 2 - Rate of change chart showing the speed at which the U-6 unemployment rate changed between 1995 and September 2009.

Two things stand out in the chart. Not only do we see how unemployment peaked well ahead of the recovery and the fact that the rate jobs were being lost soared much higher this time around, but what becomes clear is the that the rate at which jobs are being lost peaked in April 2009. So unless jobs losses accelerate again, this is more proof that even if this rally proves to be a bear rally and retraces, it has strong potential to be a market bottom. Not only that, if things are more or less the same, there is a good chance that the NBER could eventually declare this recession officially over in March (or thereabouts).

Many economists have voiced their opinion of how unemployment is a lagging indicator. However, take the derivative or rate of change and the rate looks to be a pretty good leading indicator. The important caveat here is something we have all read in investment prospectuses - past performance does not guarantee future results.

There is always the chance that this is just a temporary improvement before the next employment rate decline and one of the most probable catalysts for this kind of reversal is the risk for rapidly rising interest rates.

Will They Keep Buying Our Bonds?

What happens when the government has a bond auction and nobody comes?

In 2006, the world got its first taste of what could happen to an industrialized nation when investors decided, en masse, that the interest rate the government was offering on its bonds simply wasn't worth the risk. It wasn't pretty. Saddled with a current account deficit north of 15% of GDP and fast rising foreign debt, Iceland, an OECD member and one of thirty most-developed countries in the world, desperately needed to sell its bonds.

But government bond auctions failed to attract investors even though the rate was a healthy 8%. Even an increase to 14% wasn't enough to entice investors.

Fast forward to October 2008 - in an effort to stem rapid declines in the value of the Icelandic krona, which had its value cut in half on October 8 alone - the government was forced to raise the nation's overnight lending rate 600 basis-points to 18% in one day!

And now a similar situation is unfolding in EU-member Latvia. Like Iceland, it has been a crisis-in-the-making for a while.

Flash back to June 3, 2009, the day that the Latvian government managed to sell just 5% of the more than 50 million lati (about $100 million in US) in bonds. Like a number of nations around the globe, Latvia is drowning in debt. With a GDP down 18.6% in the past year, its public debt as a percentage of GDP swelled from 19.5% in 2008 to a projected 34.1% in 2009. But this amount of debt pales in comparison to many of its European neighbors. Public debt in Italy, Greece, Belgium, Hungary and Ireland are projected to swell to 113%, 103.4%, 95.7%, 80.8% and 61.2% in 2009.

The failed bond auction reflects growing tensions in the Eurozone. Two other eastern European nations, Lithuania and Estonia, have seen their GDPs drop 10.9% and 15.6%, respectively, over the last year prompting a number of analysts to wonder if they are next.

Figure 3 - Monthly chart showing net Treasury international capital flowing into and out of U.S. Treasuries between 2005 and present.

Ballooning debt and falling economies is not a problem unique to the Eurozone. Federal debt in the United States is projected to be in excess of 100% for 2009 and that is a drop in the bucket compared to unfunded liabilities such as Medicare and Social Security. Our point is that governments in the most industrialized nations around the globe are becoming increasingly reliant on investors to finance rising debt levels.

In our recently updated U.S. Net Treasury International Capital Flows Chart (Figure 3), we see that the net foreign demand for our bonds has been steadily dropping since 2005. From the beginning of this year, there has been only one month in which there was not a net redemption of Treasuries by foreigners and the gap between government budgetary needs every month (red line) and foreign capital has steadily widened. Also notice that the long-term trendline (yellow) fell into negative territory in May.

If you listen to weekly government bond auction results, there continues to be a strong demand for Treasuries even though the rates of interest are near historic lows. This is good news as long as it lasts, but just how long can we expect investors to keep buying bonds and be paid back in dollars that have almost steadily dropped in value over the last year?

Could Iceland and Latvia be early canaries in a global bond contagion? And perhaps even more important, how will it impact us all?

Rocket-Riding Stimulus Junkies (Part II)

"You cannot spend your way out of recession or borrow your way out of debt."
Daniel Hannan, Member of the European Parliament

Back in December we discussed the rate at which the adjusted monetary base or money in circulation in the U.S. had rapidly increased in the past few months. According to the Federal Reserve website, the adjusted monetary base (AMB) is the sum of currency in circulation outside Federal Reserve Banks and the U.S. Treasury, deposits of depository financial institutions at Federal Reserve Banks, and an adjustment for the effects of changes in statutory reserve requirements on the quantity of base money held by depositories.

By November, year-over-year growth in the monetary base was an incredible 97%; a rate of growth unprecedented in our history as the next chart shows. You will be interested to know that the printing presses have remained in overdrive since then, hitting another new level of year-over-year growth of 112% in April. If you are looking for the fuel behind both the economic recovery and the stock market rally, look no further.

I like to think of the recovery this way. You know those ceramic fake logs you see in a gas fireplace that start to glow a few minutes after it has been ignited? Comforting isn't it, especially when it's cold outside. However, it isn't so comforting to know that Washington has created a gas fireplace economy and the fuel they are using is freshly printed cash. What happens when the gas to our ceramic log economy is turned off?

The question is, have the trillions in stimulus money fueled real economic growth, started new businesses and allowed existing businesses to become profitable enough to survive on their own once the stimulus gas is turned off? This is one reason for caution and why we need more confirmation before we'll know if the unemployment rate discussed above is truly subsiding or just taking a break before soaring to new heights.

Figure 4 - Data from the Federal Reserve showing the adjusted monetary base or money in circulation going through the roof over the last year. So what happens when the presses get turned off?

Paying the Piper

But the bigger problem lies ahead. When the presses do eventually get turned off, the money still has to be paid for (that is unless the nation files for Chapter 11 bankruptcy). As it stands, this money is simply being added to the books as debt.

An interesting paper written by Kyle Bass, Managing Partner of Hayman Associates, the man who allegedly made billions shorting the subprime market, sheds some more light on the true unemployment and hyperinflation threats.

According to Bass, "There have been 28 episodes of hyperinflation of national economies in the 20^th century, with 20 occurring after 1980... all of which were caused by financing huge public deficits through money creation."

Bass discusses the work of Peter Bernholz, Professor Emeritus of Economics in the Center of Economics and Business at the University of Basel, Switzerland, whose 2003 book Monetary Regimes and Inflation: Historic, Economic and Political Relationships, retraces past episodes of hyperinflation and provides an insightful look into the intertwined worlds of politics and economics, with special attention given to money.

Professor Bernholz studied these failed economies and made a startling conclusion - the hyperinflation tipping point occurred when the government deficit exceeded 40% of its expenditures.

So where does that leave us?

"According to the current Office of Management and Budget (OMB), U.S. federal expenditures are projected to be $3.653 trillion for financial year 2009 and $3.766 trillion for FY 2010 with unified deficits of $1.5802 trillion and $1.5 trillion respectively. These projections imply that the U.S. will run deficits equal to 43.3% and 39.9% of expenditures in 2009 and 2010, respectively. To put it simply, roughly 40% of what our government is spending has to be borrowed," a level of debt that Professor Bernholz's research has shown is unsustainable.

Bass believes that, "global currency printing will inevitably lead to high levels of inflation - outright currency debasement. Historically, it has taken 18 months to two years to take hold, but we believe it could be sooner due to the size of both monetary and fiscal stimulus as well as the coordinated global nature of the actions."

How they are investing in anticipation of such a scenario makes it very interesting reading and is available in the first link below. But it is very fascinating to note that Professor Peter Bernholz's conclusions are frighteningly similar to those of Ralph Foster is his 2008 book, Fiat Paper Currency: The History and Evolution of our Currency, which I also highly recommend.

In the meantime, it's a trader's market and riding this rally requires keeping one hand firmly on the exit button.

Interesting Reading

Deep Thoughts from Kyle Bass
http://www.zerohedge.com/article/deep-thoughts-kyle-bass-0

Review of Monetary Regimes and Inflation: Historic, Economic and Political Relationships
http://eh.net/bookreviews/library/0649

September Unemployment: ACTUAL LOSS 995k
http://market-ticker.denninger.net/archives/1485-September-Unemployment-ACTUAL-LOSS-995k.html

Household Survey vs. Non-Farm Payrolls
http://www.bls.gov/web/ces_cps_trends.pdf

BLS News Release Page
http://www.bls.gov/bls/newsrels.htm

A House Regulated Cannot Stand - How regulation helped devastate the housing market
http://mises.org/story/3757

Hotel defaults, foreclosures rise in California - Defaults, foreclosures up five-fold in ‘09
http://www.latimes.com/business/la-fi-hotels-foreclosure7-2009oct07,0,6655066,full.story

Link to Ralph Foster's Fiat Paper Currency: The History and Evolution of Our Money
http://home.pacbell.net/tfdf/

Ailing Fast - Latvia on Life Support
http://www.economist.com/world/europe/displaystory.cfm?story_id=14582771

Iceland, in Nod to IMF, Boosts Rate to Kick-Start Crown
http://www.reuters.com/article/topNews/idUSTRE49R30Q20081028?sp=true

Portfolio Performance Analysis

Risk & Reward
Each of our portfolios is strategically allocated across one or more of the Investment Pillars of Strength discussed below. Each Pillar is managed by multiple, uncorrelated, absolute-return investment managers to produce a return stream that is consistent, negatively correlated with the major market averages in down markets and non-correlated with each of our core Pillars of Strength. Commentary found in this newsletter is for informational purposes only and does not effect how our portfolios are traded.

Managing risk is our most important consideration and it is reflected in the way our portfolios are built and managed each and every day.

The S&P 500 continues its momentous climb higher, piling on another 3.73% in September. The S&P 500 is currently priced for perfection, so a negative earning session would almost certainly cause a sharp drop in current prices. As we pointed out above, positive signs in the economy are starting to appear. So, unless something critical happens to the economy, it may start to provide some fundamental justification for stabilizing the market.

Without question, this rally has gotten ahead of itself and will almost certainly have a meaningful correction to stabilize recent gains. If the economy continues to improve, then we should see the second leg of this advance take shape. If not, then there will have been no justification for this advance and equities will get crushed. In other words, if the economy begins to justify this recovery then there is room for more upside. If economic and earnings data begins to fall short of expectations, then there is lots of downside risk.

As I pointed out in last month's letter, our equity trading accuracy fell below 30% in August. The last four weeks have us battling back over 50% and our charts are up and to the right. Since March's low, the market has been steadily shifting from a short term mean reverting market to trending for several days to weeks in a row. It has taken our quantitative models time to adjust to this regime change in the market, but recent improvements in our equity trading accuracy are encouraging.

Our fixed income traders operate and function in a completely different world than our equity traders, so it is common for one equity curve to go up while the others go down. In 2008, equity outperformed fixed income, but our fixed income portfolio has quickly made up for lost ground and now leads all portfolios for the year and past 12 months. Our equity models appear to have stabilized to recent market changes, so I anticipate our equity strategies to take the lead over the next several months.

Index Advantage:

All of the losses experienced in this important allocation occurred in the first two weeks of September. Trading accuracy has steadily improved from what we expect was the equity low for this allocation. October is currently showing small gains and trading accuracy continues to improve.

For the month, this pillar gained -1.71.

Strategic Balance:

We again experienced a small loss trading U.S. sectors and international markets for the month. Our overall investment exposure remains historically low as these traders patiently wait for higher, rewarding, low-risk trades.

For the month, this pillar earned -0.42.

Dynamic Income:

This now makes the 6th winning month in a row for our fixed income allocation. Month-to-date October is also showing green across the board lead by our allocation to government bonds.

For the month, this pillar earned 4.09.

Our portfolios are built using varying distributions to the strategic allocations discussed above. To view detailed performance and risk statistics information about our investment portfolios for the month, please click on the links below:

If You Are a Client, Don't Be Confused.
Actual management and performance fees are incurred monthly but are deducted from client accounts in the first month of every quarter (January, April, July, and October). For performance reporting purposes, we deduct fees monthly as they incur and not quarterly, as they are reflected in client statements. It all washes out in the end, but this may cause your account performance to deviate from our published performance reports on a month-to-month basis. To be conservative, we also deduct the maximum fees we charge from our performance reports and your actual overall fees paid may be less than our maximum.

Are You in "Old-Man Shape?"

As I have gotten older, I realized how important it is to stay physically fit. It takes months to get into shape, and only a few weeks to fall off the wagon. My definition of being in shape has changed over the years. When I was in my late teens and early 20s, I thought being in shape meant I needed to bench press 300 pounds. The thought of lifting that kind of weight these days makes every joint in my body ache.

Nowadays being fit means I am in good enough shape to ride my mountain bike in the foothills, hunt for chukkar along the Snake River Canyon, or ski Idaho's many slopes. After a while, my mind's eye actually starts to make me feel like I am in the kind of shape I was in during my early 20s. Well, that is until I do something silly like play a game of soccer against my daughter's soccer team.

I didn't grow up playing soccer, but have grown to have a lot of respect for the game. I am an assistant coach for my oldest daughter's team. Sarah has a great coach named Corey, who makes practices both fun and challenging. During our last practice, Corey wanted the two of us to play on one team against Sarah's entire undefeated team so we could spread the field and teach the girls how important it is to stay in their correct position. In hind sight, let me advise you against doing this when you only have one other person on your team and the field is 100 plus yards long.

What I didn't know until after practice is that Corey is a marathoner and runs between 5 and 18 miles a day. He thought this would be a great way to teach the girls some important fundamentals and good exercise for us.

Corey didn't even have sweat on his brow as he encouraged me to run faster to get open for the pass. For a brief moment, I thought I might actually pass out from a lack of oxygen to my brain caused by my bleeding lungs. It was hard to hear the laughing of the girls zooming by me to steal the ball because of the ringing in my ears. What a wake-up call! There is a big difference between running on a treadmill and running 100-yard sprints up and down a soccer field.

This kind of reality check seems to happen to me about every couple of years. My mind tricks me into thinking that I am in good shape just because I work out on a regular basis. My daughter has coined the phrase as "old-man shape." It is a shame that they wasted all of that strength and agility on the youth.

Halloween is just around the corner and my kids are finalizing what they want their costumes to be. Annabelle was dressed up as an angel last year, but this year she wants to look like a Hershey Bar. Her mom is really struggling on figuring out how to make a costume shaped like a candy bar. Sarah and her buddy have decided to dress up by dressing down to their PJs. I can't wait to take the pictures.

Working to grow your wealth,

John M. McClure
President & CEO
ProfitScore Capital Management, Inc.

P.S. ProfitScore provides its separately-managed accounts to individuals, advisors and institutional investors. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

Complete our Private Client Group request form by clicking here http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

So What Is Warren Buffett’s Desert Island Indicator Saying?

2009-10-09T14:58:00Z

Warren's "Desert Island" Indicator
So What Is It Telling Us?
The Weekly Rant - The Rocket-Riding Stimulus Junkies
Moose for Dinner

Last week, we discussed the Baltic Dry Index as a leading economic and market indicator. We showed how it had performed during the recent highs and lows of the market. This week we continue our discussion on leading indicators as we examine the indicator that Warren Buffett would rely on if he were on a desert island and could only use one to make his investment decisions.

Warren's "Desert Island" Indicator

The data that powers Warren Buffett's desert island indicator, or more appropriately, set of indicators, are produced by the Association of American Railroads (AAR). They publish data every Thursday morning (East coast time). These indicators are useful because they show real demand for the raw materials and finished products for a broad spectrum of commodities and merchandise shipped by rail, which is still the most cost-effective way of shipping around the U.S.

In their latest monthly report for August, the AAR reported that total U.S. freight rail traffic was down 16.4% (to 1.116 million freight carloads) from August 2008. In addition to that, intermodal (truck freight trailers on rail cars) was down 16.7% and Canadian rail traffic was down 20.5% (reflecting a drop in commodity demand). Cyclical traffic (autos, steel, lumber, chemicals, etc.) was down even more on a year-over-year basis at 44.6% in Q3-2009.

We examined various data sets provided by the AAR and on a quarterly basis, all figures are down from the same quarter the year before. This next chart of intermodal traffic shows an interesting relationship to the stock market. As we see from the green "V" pattern (Figure 1) in Q1-2002, intermodal traffic hardly suffered during the recession of 2001-2002 and began to recover more than a year before the stock market recovered in March 2003. If there was a recession in transport, you would have never known it from intermodal traffic.

Figure 1 - Quarterly intermodal rail traffic report comparing the impact of the recessions in 2001-2002 and now. TOFC stands for (truck) Trailers On Rail Cars. Data - railfax.transmatch.com

Intermodal traffic also peaked out in Q4-2006 (magenta inverted "V"), well in advance of the stock market peak in Q3-2007. But then something interesting happened. Instead of recovering in advance of the stock market rally, traffic fell in Q4-2008! Traffic dropped 37% between Q3-08 and Q3-09.

According to Drew Robertson of Atlantic Systems, the drop in intermodal traffic demonstrates the decline in U.S. manufacturing (and increase in reliance on foreign imports that don't ship intermodally) combined with the effects of the recession. Atlantic Systems produces proprietary transport and stock indicators for investors. Robertson believes that as the recovery takes root, intermodal traffic will rebuild as U.S. manufacturing picks up again. But that probably won't happen until at least next year.

Figure 2 - Transmatch chart showing year-over-year weekly changes in total rail and intermodal traffic. Both charts show a bottom around the end of June, but total traffic looks to have bottomed first. A positive sign? Source - railfax.transmatch.com

Figure 3 - Another perspective on rail traffic showing a rolling four-week average of both total and intermodal rail traffic showing a bottom in Q1-2009. Source - railfax.transmatch.com

So what is Warren's desert-island indicator saying?

There is little doubt that this time is most certainly different than past recessions when it comes to rail traffic, and especially intermodal truck/trailer rail traffic. Down by more than one-third in the past year, traffic will have to increase by nearly 60% just to get back to where it was last year. Given the trend of increases in imports, that won't happen anytime soon. But is a recovery in U.S. manufacturing back to prior recession levels necessary before the economy can recover this time around? Probably not, however an increasing dependence on imports is certainly not positive for long-term national prosperity.

This does not mean that the current rally can't continue for a few more months. More importantly. from a shorter term investment perspective, the latest weekly data suggests we have seen a bottom of sorts in rail demand and that is positive for both markets and the economy as long as it persists...which brings us to our next topic.

The Weekly Rant - Rocket-Riding Stimulus Junkies

"Our nation is suffering from ‘stimulus addiction,' and the path of least resistance is to continue feeding the habit." - Dr. Chris Martenson in a September 28, 2009 report

Last week, a friend of mine told me that a Canadian bank was offering five-year variable-rate mortgages at 2.25%. I checked and sure enough, rates for our pampered neighbors to the north are at their lowest in more than 30 years, according to the ad. A five-year fixed rate was advertised at 3.89%. Is it any wonder that the Canadian real estate market is again rising faster than a Roman candle on Canada Day? And a number of sectors of the U.S. market are enjoying a similar resurgence if the latest real estate statistics are any indication.

ProfitScore readers are by now familiar with the forces that drove real estate prices to unheard of heights (even after adjusting for inflation). And as discussed in our last monthly report, this growth was certainly not due to any measurable rise in real wages or household incomes. It was made possible thanks to a seemingly endless supply of cheap money. No one seems too concerned about the rather unpleasant side-effect of rapidly rising debt levels (see Figure 8 in last month's report).

It could be argued that the availability of cheap money created demand that spread like wildfire and eventually enveloped the nation. But was this demand real or artificially created?

In a "normal" market, no matter what the product, demand is driven by the ability of potential customers to buy it. That means that they must have a job and the disposable income necessary to pay for the product.

But as we all know, unemployment is still rising and the average work-week was just one-tenth of an hour above its all-time low at 33.1 hours in August (see Figure 1). Real unemployment measured by the more realistic all-inclusive BLS U6 unemployment rate hit a six-decade high of 16.8% in August.

And as we also learned last month in Figure 2, real wages are still lower than they were in 1982.

So, if real wages are lower than they were 27 years ago, unemployment is at a multi-decade high (and rising) and the number of hours worked per week is near an all-time low, just how are people buying homes?

In his latest weekly newsletter, Chris Martenson makes an interesting case for the argument that in an effort to re-inflate the housing bubble, the federal government and Federal Reserve now have become the housing market. Is this possible and if so, how?

Thanks to Federal Reserve "generosity," interest rates are at or near a half-century low, but that alone was not enough to re-ignite this housing market without a bigger push. The next step was trillions in stimulus that included programs to take over and refloat[O1] the failed GSE mortgage giants Fannie Mae and Freddie Mac with billions in new cash; agencies that failed because they had too many non-performing loans. So what does the government do? Instead of decreasing the size of the amount of loans it issued as would be the responsible thing to do, they increased the maximum loan limit! The plan also included forcing banks to "renegotiate" billions in risky mortgages, instead placing this risk squarely on the shoulders of the taxpayer.

The latest federal housing stimulus program is a credit of up to $8,000 (or 10% of the value of the home whichever is less). This allows new home buyers to purchase their first home (in three years) and get a tax refund. A total of 1.8 million buyers are expected to take advantage of the program. There is now a bill (introduced by Senator and former realtor Isakson) before the Senate that would raise this credit to $15,000.

Martenson calculates that through August 2009, a total of $686 billion in new mortgages were issued. Compare that to mortgage-backed securities (MBS) purchased by the Federal Reserve over the same period totaling $624 billion, plus another $98 billion of agency debt for a total of $722 billion injected into the housing market through Fannie Mae, Freddie Mac and the Federal Home Loan Bank (FHLB).

"In other words, the Federal Reserve alone bought $722 billion of mortgages and agency debt when only $686 billion in new mortgages were issued. So, through August, the Fed bought more than 100% of the entire supply of mortgages in 2009," according to Martenson (emphasis are mine not his).

Here is the obvious conclusion. National demand has created a political machine that is doing the voters' bidding. That overriding demand is to cure economic and housing ills, no matter what the cost and no matter who has to pay for it. Put in simple terms, we have become a nation of debt junkies who demand our fix no matter what the cost and the majority of our politicians are only too happy to comply.

But, as any junkie who has recovered and lived through it will tell you, the bigger and more deep-rooted the habit, the more painful and costly it is to cure. I wonder how long it will take our nation of debt junkies to figure out that we can't live beyond our means. That will be a tab left to our children and children's children to pay.

Some legacy!

Related Stories and Links

Warren Buffett's "Desert Island" Economic Indicator
http://manualofideas.com/blog/2009/09/warren_buffetts_desert_island.html

American Association of Railroads Monthly Report
http://www.aar.org/NewsAndEvents/~/media/AAR/RailTimeIndicators/Rail%20Time%20Indicators%20September%202009.ashx

Atlantic Systems Weekly Railfax Report
http://railfax.transmatch.com/

Chris Martenson's Website
http://www.chrismartenson.com/

First-Time Homebuyer Tax Credit Claims Soaring
http://finance.yahoo.com/news/Firsttime-homebuyer-tax-cnnm-973908072.html?x=0&.v=5

Banks Are Forcing Homeowners to Keep Paying After Short Sales
http://www.businessweek.com/the_thread/hotproperty/archives/2009/09/banks_are_forci.html?ref=patrick.net

U.S. Mortgage Delinquencies Set Record
http://www.reuters.com/article/gc03/idUSTRE58K29E20090922

Almost One-Third of Home Loans Under Water
http://www.marketwatch.com/story/almost-one-third-of-home-loans-are-under-water-2009-08-13

"Banking system like South Sea bubble," says senior Bank of England official
http://www.guardian.co.uk/business/2009/jul/01/bank-england-south-sea-bubble

FDIC Weighs Extraordinary Steps to Shore Up Fund
http://finance.yahoo.com/news/FDIC-weighs-extraordinary-apf-3266069115.html?x=0

FHLB Website
http://www.fhlb.com/

Moose for Dinner

It doesn't get any better than spending time with good friends and family in Idaho's backcountry. Doug's camping accommodations continually get better year after year, and this year was no exception. His new pellet stove burned warm the entire night, knocking the edge off of the cold mountain air. It was a refreshing change to not have to build a fire on a cold, dark morning to warm the tent.

As usual, we got a big snow storm. This storm came on Wednesday and dumped 8 inches in the valley and 12 inches in the higher elevations. I call these big storm days "pancake days" because we normally get a late start and get to enjoy a big country breakfast before braving the cold.

I was fortunate to fill my moose tag on the 2^nd day of our hunt before the snow came, so we were blessed to have filled our freezers with Idaho's finest. Hunting moose in Idaho's backcountry will be one of my all-time fondest memories. As I have aged, it is more about the experience and the special times with friends and family and less about the hunt.

My father is due to visit in a couple of weeks for our annual bird hunt with my new dog, Jack. My wife is a spectacular southern cook, so I can't wait to eat our traditional quail dinner with all the fixings, topped off with homemade pumpkin pie. Talk to you next week.

Working to grow your wealth,

John M. McClure
President & CEO
ProfitScore Capital Management, Inc.

P.S. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

Complete our Private Client Group request form by clicking here http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

Are Shipping Rates Trying To Tell Us Something About This Recovery?

2009-09-28T14:02:00Z

www.profitscore.com

Consumer Crush
To Lead or Not to Lead?
Got a Market Headache?
The Weekly Rant-More BLS CPI Sleight of Hand
Idaho's Back Country

In September's ProfitScore IQ, I mentioned that we would begin publishing a smaller, fact-filled weekly newsletter called the ProfitScore Weekly Market Watch. As promised, here is our first publication of that newsletter. I hope you enjoy its content and that it helps you become a better investor.

In last IQ, we discussed household wealth and debt and how the growth rate of debt at all levels has rapidly outpaced both incomes and wages. As debt becomes a larger burden on our economy, it will increasingly strangle consumer spending and that is a problem when we consider that approximately two-thirds of our economy depends on it.

This week we take a final look at the health and financial staying power of the consumer. Then we begin the search for some useful, leading market and economic indicators.

Consumer Crush

This next chart shows just how seriously consumers have cut back their borrowing; cuts that have come for two reasons. First, when there is a real chance that you could lose your job, it is only natural (and financially wise) to curtail your debt load. To put this drop in perspective, the $108.7 billion drop was both the largest on record and the largest percentage drop since the time of the D-Day invasion in 1944 when allied forces were landing in Normandy in the largest military offensive in history.

Unfortunately in economic times like these, what is good for the economy (increasing spending) is simply bad for the consumer. Now squeezed between rising unemployment and tighter bank lending practices, consumers are hunkering down. Savings levels rose to a 14-year high of 6% in May, before dropping back to 4.2% in July, compared to just 1.3% at the beginning of 2008.

Figure 1 - Monthly chart of consumer credit closely tracking the business cycle over the last twenty years, showing the $109 billion drop so far in 2009.

To Lead or Not to Lead?

So will programs like the $3 billion cash-for-clunkers draw shoppers back into stores and get them spending again in an economy that has lost approximately 7 million jobs since the recession officially began in December 2007? As our charts of real time incomes (in 1970 dollars) showed last week, its not as if consumers have access to bigger pay checks to help them ‘grow' the economy.

If anything was clear from those charts, it's that the latest bubbles were not fueled by increasing incomes. Median incomes peaked in 1999 at $50,641 and were still below that level at $50,233 in 2007, according to the latest data available. There is little doubt that median incomes fell again in 2008 and will likely fall in 2009. Spending to fuel these bubbles was made possible by a large jump in debt levels, thanks to central bank cheap-money policies.

So how will we know when the worst is truly behind us? That's the trillion-dollar question.

One approach is try and stay one step ahead of the economic data. And, to accomplish this daunting task, it requires a combination of indicators, some well-known and some that are more obscure.

Got a Market Headache? Take a BDI and Call Me in the Morning...

One of the more widely used indicators is the Baltic Dry Index (BDI). The BDI represents the cost for shipping dry bulk goods like iron ore, coal, grain, etc., by sea around the world (not by tanker or in containers). When international demand for goods is high, shipping rates go up, and when demand is low, they fall and so this is a good leading economic indicator.

What makes the BDI interesting is that there is virtually no speculation and very little opportunity for manipulation, since the price of shipping is not traded on an exchange. It is driven by real demand, so it is therefore not subject to trader fear and emotional greed swings. It also supports the theory that the bubbles in commodity and stock markets were not significantly driven by speculators as many politicians and regulators have charged.

This index climbed from around 4,000 in early 2007 to over 11,000 in May 2008, thanks to strong economic demand in a booming global economy. Last Monday (September 21^st), the index was sliding toward 2,300, down nearly 50% in just three months from its June 2009 high. It is interesting to note that the BDI bottomed on the same day that the 17 commodities of the CRB Index did - December 5.

Figure 2 - Chart of the Baltic Dry Index showing the significant double top in September 2007 and in May 2008 above 10,000, after which the index cratered to a low of 663 on December 5, 2008-lows in the index not seen since August 1986. As this chart shows, the six-year average is just under 4,300. Its most recent peak briefly topped above it in early June, then reversed again. Data - Capital Link Shipping.

So how good is the BDI as a leading market indicator? It took some digging to answer this question. First, we had to match data points for both the S&P500 Index (SPX) and the BDI. As we learned the hard way, both indices had quite a large number of gaps (even though both were supposed to be daily), which means we had to fill them in with the previous daily data, since charting programs don't work well with holes in the data. The Baltic Dry Index dates back to the beginning of 1985, so that is as far back as we could go.

Figure 3 - Daily chart of the S&P500 compared to the Baltic Dry Index showing the BDI peaking later, but bottoming earlier. Is this latest drop a warning of things to come?

The chart revealed an interesting relationship. First, the correlation between the two before 2000 was low, but increased from 2005 into 2009. But as we see from Figure 3, although both peaked around the same time (October 2007), the SPX dropped after putting in a lower high and the BDI rallied again to a higher high in June 2008. However, it then dropped off before hitting bottom in early December, a full four months before the SPX (and a number of other global stock market indices) bottomed.

More importantly, is the recent drop from its 2009 high in June a warning of market trouble ahead? This argument becomes more compelling when we look at China's Shanghai Composite Index that has been in a bear trend since peaking in August and can therefore not be ignored.

Because of its importance in measuring global trade demand, the BDI has the potential to provide advance warning of both increasing and decreasing demand. But, as any good trader knows, one indicator does not a trading (or investment) system make.

Next week we'll take a closer look at the indicator that Warren Buffett would choose if he was stranded on a desert island and could only use one to make his investment decisions.

The Weekly Rant-
More BLS CPI Sleight of Hand

Longer-term PS IQ subscribers are familiar with our views on government-generated statistics. At best, they leave much in the way of impartiality to be desired. At worst, they are little more than propaganda tools to make incumbent governments look better at dealing with economic challenges than they really are and have become crucial aids in keeping governments in power come election time.

In the September 16^th Consumer Price Index (CPI) August news release from the Bureau of Labor Statistics contained the following terse statement:

"In contrast to these increases [in food and other prices], the index for new vehicles fell 1.3 percent in August, partly due to ‘cash for clunkers' incentives." (For the complete report, please see Related Stories below.)

Excuse me? Since the description was very brief, it left a lot of room for interpretation. But, if I understood correctly, it meant that the $3 billion in taxpayer assistance was treated as non-existent. Did the BLS just do what I think it did - reduce the cost of all the cars purchased under the program (which by the way works out to 666,666.66 cars sold if you divide $3 billion by $4,500)?

If so, it sets yet another interesting "moral hazard" precedent. Not only does it make inflation look tamer than it really is because car prices weren't in fact reduced by $4,500, they used your money to help buy them and then treated the cash as non-existent. Since inflation is subtracted from GDP growth to get real economic growth, this sleight of hand also has the effect of making GDP look better than it really is. But that pales in comparison to the $787 billion TARP program and all the trillions in business, bank, mortgage and other bailouts that have been handed out so far.

So how will the statisticians treat all the stimulus cash? Will it also be treated as non-existent? The answer to that question is that the government will treat it pretty much any way it pleases, thanks to hedonics, which gives these minions the ability to treat any statistic any way they please and to make the government look more effective than it really is.

And these methods don't have to be consistent, which means we will likely see a mess in the way this cash turns up on government balance sheets and in the "official" government statistics.

Related Stories

Baltic Dry Index Dives as Chinese Coal, Iron Ore Demand Slumps
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aFnXgNO6O._U

Record Plunge in U.S. Consumer Credit Signals Weakened Spending
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=avvF5aNtrCfc

U.S. Economy May See Its Slowest Recovery Since 1945
http://www.bloomberg.com/apps/news?pid=20601068&sid=aBj5AeyQqun8

Is the Government Using Cash for Clunkers to Supress Inflation?
http://www.businessinsider.com/is-the-government-using-cash-for-clunkers-to-suppress-inflation-2009-8

Link to BLS Cash-for-Clunkers September 16 news release
http://www.bls.gov/news.release/pdf/cpi.pdf

Idaho's Back Country

I was notified this summer that my archery hunting buddy Doug Bolen and I were drawn for one of Idaho's special Moose Permits. I say "special" because you have less than a 1% chance of getting drawn and if you are drawn you won't get to put in for this hunt again for the rest of your life. If you grew up enjoying hunting like I did, getting picked for this hunt is the equivalent of winning the lottery.

Doug is one of the most capable guys I know in the woods and the best part is that his camping gear is second-to- none. Camping in Doug's sheep herder's tent is like living in a small, cozy cabin with about every accommodation you could ask for besides indoor plumbing. Being comfortable is a good thing because running around in Idaho's rugged back country is not for the weak of heart.

In a typical day, we will walk 10 to 15 miles, starting our day around 4:30 AM and getting back to camp an hour or so after dark. I wore a device that tracked my calories burned in a day a few years ago hunting elk and I burned around 5,500 calories a day. That is about the same as Navy Seals burn in training camp.

Doug and I have trained hard for this trip, so hopefully our preparation and hard work will reward us by filling our freezer for the year.

Working to grow your wealth,

John M. McClure
President & CEO
ProfitScore Capital Management, Inc.

P.S. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

Complete our Private Client Group request form by clicking here http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

Why Are Americans Earning Less Than They Did In 1982?

2009-09-22T19:06:00Z

www.profitscore.com

An Update on Our Performance
Incomes - A Four-Decade Long Report Card
The Incredible Shrinking Work Week
The Curious Case of Hourly Earnings
What a Difference a Week Makes
What's a Buck Worth?
Incomes Just Don't Buy What They Used To
Wow, I Didn't Know That!
Questions and Comments
Definitions
Take My TV Challenge

Tuesday, September 14^th marked the first anniversary of the collapse of Lehman Brothers. This historic event almost brought our financial house down and exposed a multitude of inherent Wall Street vulnerabilities in the process. Only time will tell if the government response of throwing trillions at the problem to bail out industry giants like Fannie Mae, Freddie Mac, Citigroup, Bank of America and AIG, deemed "too big to fail," was the right move.

In this ProfitScore IQ, we will continue our inflation/deflation argument and we will examine real employment incomes, and the growth in household wealth compared to debt growth rates. How have wages fared during the inflationary times of the 1970s, on through the eighties and nineties, and into the new millennium?

What we found astounded us and will surely surprise you!

But first, I have some exciting news for our current subscribers and would like to welcome our new subscribers to the ProfitScore IQ. If this is your first letter, I want you to know how much I appreciate your valuable time and that my staff and I put our heart and soul into publishing this letter. We hope our thoughts help to make you a better and more knowledgeable investor.

Over the past several years, we have gained a large and growing readership. This is in a large part due to our loyal, long-term subscribers. We recently added a new distribution partner for this letter. This new relationship will push our readership over 1 million. Thanks to all of our readers who have made this possible!

Major economic changes are now happening at the speed of light. To keep abreast of these rapidly changing circumstances, we will now start publishing our thoughts weekly. We will call this weekly publication the ProfitScore Weekly Market Watch. You will start receiving this weekly letter on September 28^th. I, of course, will take a few weeks off for holidays, but you can expect to hear from me much more often.

These weekly letters will be shorter, yet focused and full of thought-provoking content. Once a month, we will also produce our traditional ProfitScore IQ containing more details about topics produced for the weekly letters and our regular update on our portfolios and other ProfitScore specific news.

An Update on Our Performance

The only bright spot in last month's performance was once again our fixed income portfolio, which continues to make consistently positive returns and now sits at a new equity high. In the long-term, we will be rewarded for these high probability decisions, but short-term, they can damage our equity curve.

Below are recent performance returns on the four portfolios we currently offer:

	Past 12	YTD	August
Name	Months	2009	2009
Income Builder (IB)	5.85%	8.09%	0.83%
The Guardian (GRD)	6.32%	7.15%	-2.06%
Harmony Plus (HMY)	9.42%	6.91%	-4.16%
The Expedition (EXP)	9.32%	5.68%	-6.36%
S&P 500 (SP500)	-18.25%	14.97%	3.61%
Important Performance Disclosure

ProfitScore provides separately-managed accounts for individuals, advisors and institutions. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

Complete our Private Client Group request form by clicking here http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

Incomes - A Four-Decade Long Report Card

According to the latest non-farm payrolls data from the Bureau of Labor Statistics (BLS), the number of jobs being lost fell to 216,000 in August. But before celebrating, we need to look more closely at the employment numbers and time spent working. BLS reported that the average hours worked was 33.1 hours in August, up marginally from a multi-decade low of 33 hours in June.

We also learned that the unemployment rate jumped to 9.7% in July, the highest rate since 1983. A statistic not widely discussed was BLS's all-inclusive U6 jobless rate, that includes those working part-time. It showed the loss of 336,000 full-time jobs in August, sending the U6 rate to an all-time high of 16.8% since the data was first recorded (and does not include the Great Depression).

What about incomes? This begs our first question of the week - Are we better off than we were four decades ago? If so, how much better? And have real incomes kept up with the rate of inflation? In order to answer that question, we need to look at a BLS statistic called personal consumption expenditures (PCE), together with changes in average hourly incomes will determine an inflation-adjusted number.

PCE represents the cost of goods and services used for individual personal consumption and are measured differently by each country. This statistic is designed to provide a representation of the cost of living for the individual. (For a more detailed definition, please refer to the end of this newsletter.)

We will then adjust average hourly earnings by both the official and unofficial CPI to figure out how our incomes have changed.

The Incredible Shrinking Work Week

Our next chart shows average hourly earnings since 1970 adjusted for PCE inflation. In January 1970, the average hourly income was $3.31, and by December it had increased to $3.50, according to the U.S. Bureau of Economic Analysis (BEA). Contrast this with an average hourly wage of $18.43 in January 2009 and $18.56 by July in 1970 dollars.

Figure 1 - Chart showing average hours worked with big drops in the past 18 months of multi-decade lows.

In other words, since 1970 wages have increased 430%, which works out to an average annual compound increase of 4.3% per year. Here are my calculations.

Total return (for n years) (TR)                                4.30 or 430.0%
Number of years (n)                                               40.0
Average annual return (AR) =((1+TR^(1/n))-1 =    0.043 or 4.3%

But as we see from our next chart, this growth rate was anything but linear each year. Between 1970 and the early 1980s, PCE inflation-adjusted wages soared from $3.31 to a high of $5.58 by June 1982. However, over the next two decades real average hourly earnings growth stagnated and by July 2005, it had dropped to $4.93/hour, a 12% decline from the peak in the early 1980s.

In other words, real incomes actually dropped during the greatest bull market in history (1982 - 2000)!

The Curious Case of Hourly Earnings

Figure 2 - Monthly chart of real average earnings (1970 dollars) showing a fast rise between 1970 and 1983, after adjusting for PCE inflation. As of the most recent data (July), real earnings are down 0.1% from their 1983 peak. In nominal terms, average hourly earnings were $3.50 versus $18.56 in July 2009.

As the above chart shows, in July 2009 real average hourly earnings were still below where they were in the summer of 1982.

But is this a realistic income picture since monthly incomes are determined by multiplying average hourly incomes by the number of hours worked? To answer that question, we gathered data from both the BLS and BEA to calculate average weekly PCE inflation-adjusted incomes.

This next chart shows our findings.

What a Difference a Week Makes

Figure 3 - Annual chart of real average weekly earnings that factors in the drop in average hours worked in a week. It recently hit an all-time low of 33. Real earnings are down 6.1% since the peak in 1982.

We again see that average weekly earnings rose rapidly during the inflationary years of 1970 through 1982 from $125.80 to a high of $186.93 in 1970 dollars. However, due to a trend of falling hours being worked each week, incomes in 2009 are still 6.1% below where they were when the biggest bull market began in 1982. This is a 6% greater drop than in hourly earnings (Figure 2).

What's a Buck Worth?

Next, we calculate buying power for the average hourly income by deflating nominal hourly earnings by CPI. As a brief review, our next chart from our last monthly newsletter compared three different inflation estimates, the most benign of which is the official government consumer price index (CPI-U). It showed that the dollar is now worth about 18% of what it was in 1970, the alternate CPI (CPI-Alt) that calculates inflation before statistical changes were made post-1982, showing a drop in dollar buying power of 94%. According to the price of gold, the dollar has dropped more than 96% since 1970.

Figure 4 - Chart of three different estimates on how the value of a dollar has changed since 1970. In 1982, government statisticians began making changes to the way inflation was calculated that had the effect of minimizing it. The official CPI (CPI-U) puts the value of a 1970 dollar at $0.18 today compared to $0.059 using the Alt-CPI (original CPI calculation) and $0.04 using gold. Source data - Bureau of Labor Statistics and ShadowStats.com

Next is a chart that adjusts average hourly incomes by both the official CPI (CPI-U) and John Williams' alternate CPI (CPI-Alt) in 1970 dollars. The graph of average weekly earnings adjusted for both CPI-U and CPI-Alt is not included here shows an even greater drop in CPI adjusted earnings!

What also stands out is the difference between the Personal Consumption Expenditures and the Consumer Price Index. As we saw above, wage inflation (the total increase in wages) was 430% between 1970 and 2009. According to the PCE, inflation amounted to 338% over the same period while the official total CPI (CPI-U) was 450%. That's a big difference in inflation!

Incomes Just Don't Buy What They Used To

Figure 5 - Chart of average hourly incomes deflated by both the average annual official consumer price index (CPI-U) and the alternate consumer price index (CPI-Alt), showing the purchasing power of the average wage after adjusting for inflation.

Figure 5 provides us a long-term look at the buying power of the average hourly wage. If you are feeling more poor than you felt in the 1980s, you now know why!

Even before the big plunge in household incomes as a result of the credit crisis that started mid-2007 fueling a record loss of $13.7 trillion in household wealth (see article Shock May Put Global Relapse... below), incomes have failed to keep up with inflation. And if you use the alternate CPI, which calculates inflation as it was before all the changes made to the statistic post 1982, the drop in real incomes has been significant.

Wow, I Didn't Know That!

In 1970, the Dow Jones Industrial Average ended the year at 828.40. On Friday (September 18) it closed 9820.20, an increase of more than 1086% in nominal terms compared to a nominal (non-inflation adjusted) increase in wages of 430%. Why have real wages fallen as the stock market gains so much ground?

Did households become increasingly dependent on stock market gains to provide income or was some other factor responsible for the growth in household wealth over this period?

And through this period, how quickly has debt grown - debt which one day will have to be repaid?

Here is what we found.

First we looked at the growth of household net worth between 1970 and 2009 (green) and then examined the annual change (red line). Net household wealth peaked (annual basis) in 2007 at $63.9 trillion, according to data from the Federal Reserve. By December 2008, it had dropped to $52.9 which was a 17.2% drop before recovering slightly to $53.1 trillion by Q2-2009. That was the biggest percentage dropping by a wide margin since the Fed first began recording the data in 1945 (see Figure 6).

Figure 6 - Annual household net worth and the yearly rate of change.

Figure 7 - Household debt and annual rate of change showing the first year-over-year decline in 2008 of 0.71% followed by a 1.05% drop in 2009 (to Q2-09), which were the first annual declines since 1945 according to the Fed.

Now let's put it all together and compare the overall growth rate in household debt, average wages and the Dow Jones Industrial Average versus three types of debt - household debt, total credit market debt (debt at all levels in the economy) and Federal government between 1970 and 2009. (For a more detailed discussion of Federal government and total credit market debt and a chart showing how quickly each has grown, see Figures 3 and Figure 4 in last month's newsletter.)

Here is what we found. As the chart shows, government and credit market debt have grown more than twice as quickly as household wealth and more than three times faster than the Dow in the 39-year period. Federal government debt grew seven and a half times faster than wages between 1970 and 2009!

Figure 8 - Comparison of the growth rates of wealth, the Dow and average wages compared to three types of debt from 1970 through Q2-2009.

We performed the same calculations for the last decade (1999-2009). Not surprisingly, Fed government debt grew the fastest at 130% over the decade with both credit market and household debt close behind (105% and 108% respectively). Wages were next at 41%, followed by household wealth (24%) then the Dow, which dropped 16% between December 1999 and September 18, 2009.

We watched an interview that featuring perma-bull Ken Fisher. His big message was that he wished we had more debt! Using what we consider rather twisted logic, he said that with an economy of approximately $13 trillion annually and debt where it is today (the latest estimate comes from Sprott Management puts total debt and unfunded liabilities at $118 trillion), means that the country in Fisher's opinion is returning 11% on its debt (investment).

It is important to point out that he made the same claim in June 2007 and also claimed that our economy AND homeowners needed more debt at the time, advice which those who took it to heart probably seriously regret today. Warning - relying on Fisher's logic to run your own financial affairs would be very harmful to your financial well being! However, somehow it's okay for a nation to be reckless in its financial affairs. (See both the recent and June 2007 articles below in Stories of Interest.)

Here is a little known fact. Ken Fisher has a mutual fund called Purisima Total Return (PURIX). You can look it up at Yahoo or any similar website. I calculated how it performed during the current bear market and here is what I came up with:

Equity High was on November 1, 2008 - $23.93 per share
Equity Low was on March 9, 2009 - $9.99 per share
Loss in dollars: $13.94 per share
Loss in percentage terms: -58.25%
Increased required to get back to break even: (100% / 41.75% = 240%)

I will let you be the judge if Ken is a better marketer or a better money manager.

But whether we like it or not, based on the growth rates in debt, Fisher will most certainly get his wish. The current debt level of $118 trillion works out to exactly $1 million per U.S. household, which most economists would argue is completely impossible to pay off anytime soon (more like within the next three or more decades).

Next week we continue with this discussion to see how you can protect yourself and even profit from the challenges we face. Stay tuned!

Questions and comments

Do you have a question or comment? Please email us at info @ profitscore.com. Paste this email address but remove the blanks before sending. (We have to do this to reduce spam emails.)

DEFINITIONS

Personal Consumption Expenditures (PCE)

Personal consumption expenditures (PCE) are all funds spent on goods and services intended for individual consumption or use. It includes such items as food, beverages, clothing, and utilities. The PCE price index takes into account actual prices paid by households for durable goods, as well as non-durables and services. Even though the personal consumption expenditures price index makes constant adjustments for changing consumer spending habits, its conclusions are considered somewhat predictable and therefore has little impact on the markets. Source - InvestorGlossary.com

Consumer Price Index (CPI)

The (official) Consumer Price Index (CPI-U) is released monthly by the US Department of Labor. It measures the price changes in a fixed basket of consumer goods in an attempt to measure economic inflation. A Consumer Price Index reading that excludes volatile food and energy prices (core CPI) is also published monthly. The basket of goods and services used to calculate the Consumer Price Index includes medical services and drugs, food, energy, recreation, clothing, education, housing and communications. The Consumer Price Index is widely viewed as a leading economic indicator. Cost of living adjustments in programs such as Social Security are based on the Consumer Price Index. GDP calculations also use the Consumer Price Index as an input. Because of its wide implications, the Consumer Price Index can affect interest rates and foreign exchange rates. Source - InvestorGlossary.com

Stories of Interest

Too Much Debt? Please. We Need MORE Debt, Says Ken Fisher!!
http://finance.yahoo.com/tech-ticker/article/334648/Too-Much-Debt--Please.--We-Need-MORE-Debt-Says-Ken-Fisher?tickers=tlt,tbt,spy,dia,%5egspc,udn,uup&sec=topStories&pos=8&asset=&ccode

Same sort of funny advice from Fisher in June 2007 with his numeric rationale...
http://globaleconomicanalysis.blogspot.com/2007/06/in-love-with-debt.html

Gain in U.S. Household Wealth Will Help Ease Strain on Spending
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=apwSioYuG_cI

Revealed: The ghost fleet of the recession anchored just east of Singapore
http://www.dailymail.co.uk/home/moslive/article-1212013/Revealed-The-ghost-fleet-recession-anchored-just-east-Singapore.html

Shock May Put Global Relapse Odds as High as 1-in-3, Roach Says
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a9odwc3.kFwM

Poverty Deepens as Recession Cuts U.S. Incomes, Census May Say
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aw6DvG14bU6s

U.S. Economy May See Its Slowest Recovery Since 1945
http://www.bloomberg.com/apps/news?pid=20601068&sid=aBj5AeyQqun8

Global Economic Crisis to Continue: IMF Chief
http://www.reuters.com/article/GCA-Economy/idUSTRE58B0K620090912

Record Plunge in U.S. Consumer Credit Signals Weakened Spending
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=avvF5aNtrCfc

U.S. Economy: Trade Deficit Widens Most Since 1999 on Imports
http://www.bloomberg.com/apps/news?pid=20601087&sid=aZcN_BCvBsAE

Consumer Sentiment Improves, Inventories Drop
http://www.reuters.com/article/GCA-Economy/idUSTRE58A3EM20090911?sp=true

Portfolio Performance Analysis

Risk & Reward

Each of our portfolios is strategically allocated across one or more of the Investment Pillars of Strength discussed below. Each Pillar is managed by multiple, uncorrelated, absolute-return investment managers to produce a return stream that is consistent, negatively correlated with the major market averages in down markets and non-correlated with each of our core Pillars of Strength.

Managing risk is our most important consideration and it is reflected in the way our portfolios are built and managed each and every day.

I would be lying to you if I could have imagined that the S&P 500 would be 60% above its March lows 6 months later. Then again, the world has never seen so much liquidity pumped into the markets by governments around the globe. During the past six months, the S&P has leaped from 20% below its 200 day moving average to 20% above it. Has it come too far to fast? Yes! Here are some interesting statistics I pulled from Bespoke Investment Group the other day:

"Since 1928, it's happened three times--1932, 1938 and 1975--and each time, the S&P was lower one, three and six months later every time but--and this is a big 'ol but--the average return, one year later, was 13.3%, with positive returns two out of three times."

It is hard to argue against the liquidity effects of trillions of dollars, but I think those dollars are getting tired. At this point, I am not sure how the next six months will play out. With so much government intervention, it is hard to tell. The only thing I am fairly confident in is that volatility is about to be reintroduced back into the equity equation.

The other day I was playing a game called "Trouble" with my oldest daughter, Sarah. The game is pretty simple and fun for younger kids to play. The game has one die in the middle enclosed by a hard plastic see-thru shell. When you press the shell, the spring in the bottom pops the die, which is the equivalent of rolling the die to determine your number. To do well at the game, you need to roll a six. Rolling six gets your man out of home and allows you to travel to your destination. By rolling a six, you also get to roll again. Tolerate me for a moment, because this helps me explain our performance in August.

While Sarah and I were playing, I rolled 12 sixes in a row. It was quite amazing-and boy do I wish I could have had that kind of luck playing craps. I obviously won the game. The very next night, the whole family played the game and unfortunately my luck had changed. In this game, I wasn't able to roll one six. I never got one man out of home before the game was over.

If you flip a coin and it lands on heads 20 times in a row, the chances of it landing on heads on the 21^stflip is still 50%. Unlike investing, with flipping a coin, the chances of lading on heads or tails is always 50%. It is common to experience long winning or losing streaks, but your chances are always 50%. Trading is different in that you can win more than 50% of your trades. Our overall average is around 65%, but in the past 16 months we have seen some months better than 80%.

In August, our equity trading accuracy dropped below 30%. It felt like we couldn't buy a positive equity trade. There are more reasons for this besides just statistics, but probabilities do play a big role in return distribution. This is one of the reasons that we trade so many different asset classes.

Our fixed income models had another impressive month, helping to offset our difficult month trading equities. Month-to-date, we are still a little shy of 50% with our equity trading accuracy, but our distribution is starting to skew back to the positive side of our historical averages.

Below is a performance summary for the indices we track and benchmark our portfolios to:

	Cumulative Return			Average Annual Return
Indexes	Mth.	YTD	1 yr	3 yr	5 yr	10 yr

CSFB L/S *	1.42	13.03	-3.59	3.36	7.30	7.73
CSFB Multi-St. *	1.42	17.03	-5.00	1.52	4.91	7.05
Barclay F-of-F *	1.22	7.04	-10.69	-1.70	2.25	5.15
S&P 500	3.61	14.97	-18.25	-5.78	0.40	-0.79
Barclay HY	1.86	40.94	6.50	3.87	5.27	5.59
Barclay Agg.	1.04	4.63	7.95	6.35	4.96	6.31

* Note:	Estimated monthly performance

Index Advantage:

As explained above, we experienced a larger than normal loss for the month with the majority of our trades experiencing losses.

For the month, this pillar gained -9.94.

Strategic Balance:

We also experienced a small loss trading U.S. sectors and international markets for the month. Our overall investment exposure remained low and thus our losses were muted.

For the month, this pillar earned -0.61.

Dynamic Income:

This makes our 5th winning month in a row for this important diversifying allocation. September is also showing impressive gains currently leading all investment allocations.

For the month, this pillar earned 1.08.

Our portfolios are built using varying distributions to the strategic allocations discussed above. To view detailed performance and risk statistics information about our investment portfolios for the month, please click on the links below:

If You Are a Client, Don't Be Confused.
Actual management and performance fees are incurred monthly but are deducted from client accounts in the first month of every quarter (January, April, July, and October). For performance reporting purposes, we deduct fees monthly as they incur and not quarterly, as they are reflected in client statements. It all washes out in the end, but this may cause your account performance to deviate from our published performance reports on a month-to-month basis. To be conservative, we also deduct the maximum fees we charge from our performance reports and your actual overall fees paid may be less than our maximum.

Take My TV Challenge

When I grew up, the only time to watch cartoons was once a week on Saturday morning. There just wasn't much on TV for kids back then, so we did what most kids did - go outside and play. Well that was when my dad gave us time from our farm chores to play with our friends. Remember what your parents used to say when you went outside to play, "Be home by dark." Ah, those were the good old days. Now-a-days there are multiple channels for kids to watch. Some of them are good; Discovery, History Channel, etc. However, many are bad.

After much discussion with my wife, we decided to unplug cable TV about two years ago. I can say today that it has been one of the best family decisions we have made. It has taught my kids how to entertain themselves and they play with each other and their friends all the time. Our neighbor's kids are the same age and they don't allow their kids to watch much TV either, so it has been a perfect situation for both of our families.

In June, we decided to unplug the TV altogether. I have been getting all my news from the internet for years, so I had no business reason other than entertainment to watch TV. In Idaho, there are lots of ways to be entertained without watching TV, so staying busy and entertained is not a problem. I can say for certain that we have grown closer as a family because we simply spend more time together. In America, fathers spend on average 15 minutes a week talking with their daughters. I now spend at least an hour a day. It hasn't been easy missing Monday Night Football or missing my favorite college football team, but it has been one of the most rewarding family decisions we have made.

I encourage you to take my challenge and try turning off the tube. If you are like me, you have grown so addicted to TV that you can't simply turn it off. You'll have to have your cable turned off to kick the habit. My guess is that the thought of turning off your TV is unimaginable, even scary to you. I know because I felt the same way. Sadly, there's no other word for the feeling other than addiction. Your friends will think you are weird because they can't imagine their life without TV. I now enjoy watching the expression on peoples face when they find out I don't have a TV. Now that I have kicked the habit, I actually feel sorry for other people who haven't.

I will make a deal with you if go without watching TV for three months, I will manage your money free of charge for three months (this will apply to new clients only). If you need help kicking the habit, send me an email and I will talk you down off the cliff.

Working to grow your wealth,

John M. McClure
President & CEO
ProfitScore Capital Management, Inc.

P.S. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

Complete our Private Client Group request form by clicking here http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
Call us directly at (800) 731-5690.
Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.