December 28, 2013 Alpha

Risk/Reward Vol. 201

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

"What's it all about Alfie?/Is it just for the moment we live
What's it all about/When you sort it out Alfie?"---lyrics from "Alfie" by Burt Bacharach

"When this old world starts getting me down/And people are just too much for me to face
I climb way up to the top of the stairs/And all my cares just drift right into space
Up on the roof."---lyrics from "Up On The Roof" sung by The Drifters

"For we can fly up, up and away/In my beautiful, my beautiful balloon
The world's a nicer place in my beautiful balloon
It wears a nicer face in my beautiful balloon."---lyrics "Up, Up and Away" sung by The Fifth Dimension

In the financial world, "Alpha"measures the risk adjusted return on an investment. 2013 has been an incredible year for Alpha as the Dow Jones Industrial Average hit another weekly high on Friday. But, "when you sort it out/what's it all about, Alpha?" Is Alpha sustainable or "is it just for the moment?" Financial commentators certainly don't know "what it's all about", with some predicting a continued rosy picture for stocks and others forecasting a steep decline. Personally, I don't know if the stock market can continue to set records, but I do not see a precipitous fall. As I have written previously, with interest rates so low, There Is No Alternative to equities if one wants a decent return. (See a discussion of the "TINA"factor at Vol. 164 www.riskrewardblog.blogspot.com )

Speaking of interest rates, the yield on the 10 Year Treasury Bond broke through the 3% ceiling, an event that back in September I predicted would not happen even if QE3 tapering began. (See Vol.186 www.riskrewardblog.blogspot.com ) I may have been wrong, but the consequences of rates "Up on the Roof" "are not too much for me to face." Indeed, from what I can tell, with interest rates having "climbed way up to the top of the stairs" (the other side of 3%, that is) "this old world isn't getting me down" at all. I'm not saying "all my cares are going to just drift right into space." But, so long as the rise in interest rates is gradual, the impact on the stock market in general and my holdings in particular should be negligible.

Not that I would object to a general rise in interest rates (otherwise known as inflation). Indeed, this is what I wrote in Vol. 1 ( www.riskrewardblog.blogspot.com ):

"As I have explained to each of you, I am in search of a 6%, pre tax return. Throughout most of my life, this would have been a layup. From 1969 through 1997, the 10 Treasury rates rarely fell below 6%. From 1980 through 1985, they never fell below 10%. So, at this stage in my life all I need is a little inflation."

Unfortunately, I do not foresee inflation any time soon. Indeed, the recent minutes of the Federal Reserve bespeak a concern that we are headed into a period of sustained deflation despite the Fed's accommodative monetary policy. Deflation has plagued Japan for nearly 20 years and the conditions that have caused it ( e.g. an aging population, productivity gains and globalization of supply) plague us as well. For an interesting discussion on this topic, Google "Stephen Conwill Japan deflation." (Mr. Conwill is an actuary and President of Milliman of Japan.) The threat of deflation doesn't mean that we cannot earn a decent return (look at this year's Alpha!), but it does mean that we cannot do so simply by investing in low risk securities such as Treasury bonds.

I wish you all a very Happy New Year and may 2014 bring you continued prosperity. A special thanks to those who have responded to my posts. Investing is difficult in today's low interest rate environment. So take some advice from Burt Bacharach and "Make It Easy on Yourself." If you ever feel like "Raindrops Keep Fallin' On Your Head", drop me a line. I'm not "On My Own," and you shouldn't be either. After all, "That's What Friends Are For."
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