The Problem with Wild PIIGS

For years, we at THOR have talked about the potential problems with the European Union (“EU”). As long as there are no stresses on the system, the system works relatively well. However, our real concern with the EU was if and when one of the weaker countries ran afoul of the rules and put a strain on the entire system. Would the stronger countries like Germany and France come to the rescue? Anyone with a sense of economic history knows that the weaker countries (the PIIGS – Portugal, Italy, Ireland, Greece and Spain) have a long history of overspending and devaluing their currencies to spark economic growth when they fell into a recession. Today’s problems in Greece should not come as a surprise to the strong countries in the EU. The PIIGS have lived off the trough of lower interest rates as a result of the credibility EU entry brought them, which compounded their spendthrift ways with easy money. Those days are now over as interest rates have risen in the PIIGS.

The question is what should Greece do now? It must stop spending and change people’s reliance on the government. If the government unions and general population fail to change their ways, then Greece should be kicked out of the EU. Otherwise, any other rescue plan will only “kick the can” further down the road and cause the entire EU system to fail, with a much higher cost. This also would be a powerful statement to the other PIIGS and hopefully force them to discontinue their profligate ways. If Greece is kicked out, it represents a mere 2.6% of Europe’s total economy. Such action would likely strengthen the remaining countries in the EU. Greece would be the country to suffer (as it should) while the other countries in the EU that have abided by the rules would be saved.

How does this issue affect your portfolio? Our model continues to have us underweighted in international securities. In addition, most of our international funds are currently overweighted in the Pacific Basin (especially Japan). If the Euro continues to falter, we will look for an opportunity to increase our international exposure, especially our European exposure. This could be a similar situation to 1998 when Asian currencies collapsed and we were able to buy international companies at a fraction of their value compared to their US counterparts. Whichever way the Greece story plays out, we will be looking for an opportunity to benefit from it.

Sincerely,

Your THOR Team

The January Effect Revisited

In our last market update, we talked about “the January effect”, a phenomena in which a positive market in January has a high correlation to a positive market for the entire year. Below is a copy of that e-mail:

“The January Effect

This is an anomaly where the stock market rises during the first week of January. The explanation to why this occurs is that those investors that sold off in late December to capture gains/losses in their portfolio reinvest those assets back into the market at the beginning of the following year. The anomaly occurred again this year with the Dow rising +1.8% and the S&P 500 rising +2.7% during the first trading week of 2010.

The first week anomaly is interesting; however, what is more important is how the stock market performs for the whole month of January. Positive January market performance sets the stage for the entire year. Since 1950, there has been only two years (1966 and 2001) when the stock market (S&P 500) was up in January and ended down for the year. If the market remains positive for the month of January, the odds are in favor that the market will perform well in 2010.”

What happens when January is Negative?

Many stock market indicators are good barometers in one direction, but not in the other. For example, having a large percentage of insiders buying their own company stock is almost always a very good signal to buy that stock. Why? “Insiders” typically are privy to information about the future prospects of their own company that is not widely known and if they are willing to put their money into buying shares, then this may be a good indication to an “outsider” to invest in the same company. Many investors automatically believe insider selling is bad for a company. This is not necessarily true. Many times, insiders sell for other reasons (portfolio diversification, planned sales, tuition payments, new purchases, etc.) than just the share price. Insiders buy for one reason – they believe the stock is undervalued where as there could be a host of reasons for selling. That is why insider buying is a better indicator than insider selling. The same thing occurs with the January Effect.

The January Effect works over 90% of the time (these are very good odds and better than any you could get in Las Vegas). The question is: does it also work in reverse when stocks fall in January? The answer is no. Since 1950, the stock market has produced negative returns for the month of January a total of 23 times. Of those 23 negative January months, stocks were lower in 12 of those years and positive in 11. In other words, there is only a 52% (12/23) chance that the market will be negative at year end because stocks were negative in January. Statistically, this is not a good indicator to tell you how stocks will perform for the whole year. It truly is a coin flip on whether they will be positive or negative. A perfect example is 2009. The S&P 500 was down -8.43% in January and ended the year up 26.5%. Those that sold off in February because stocks were negative in January missed a significant money-making opportunity the remainder of the year.

Sincerely,

Your THOR Team