What’s a girl to do?

The year is half over and the Dow Jones Industrial Index is down 1% from the start of the year. There are lots of people who are worried about that – savers, investors, economists, portfolio managers for pension funds and mutual funds, insurance companies, politicians, and so forth – and not one them can do anything about it or tell us about the future.

So, what are we going to do for the rest of the year? The past is done and the future is unknown and murky and nobody knows whether the Dow can recover in the next six months. Hopefully, it will but how much can we expect in so short a time, so soon? Is the cup half full (and we’ve seen the worst) or half empty, and the worst is yet to come?

The “smart money” is talking about defensive stocks, consumer discretionary stocks, US industrial stocks, cyclical stocks, China, Europe, and the “Election Factor” – since 1896, the Dow Jones Industrial Average has ended higher in 14 out of the 19 presidential elections in which the sitting president was on the ballot – but all that we really know (in the words of one expert) is that “it’ll be one side of the economy or the other – we don’t know which but it won’t be both – and historical precedent suggests the market may end higher for the year giving investors the confidence to assume greater risk in their portfolios.”

Are you kidding me? What, exactly,  can we buy as investors who are risk averse – we want to keep our money and obtain a hopeful return above inflation – or should we just stay in cash and at least make no money at all? That’s for sure and guaranteed.

In January, we showed you The Perpetual Bond® and how it can be applied to the companies of the Dow Jones Industrial Index. We call it a “bond” because the capital is provably 100% safe – 100% Capital Safety™ – but it has other properties as well that are better than “bond-like” – it is demonstrably “Alpha-smart”™ (that is, it behaves like a “deep discounted” bond) and obviously, “100% Liquid”™ – if we need some cash, just sell some stocks (please see these Letters, The Perpetual Bond (B), June 2012).

We’ve been running this portfolio (as well as several others  in other markets) since early 2009 and the only thing to say about it, unlike the “smart money”,  is what’s in (B) and what’s in (N), now, and there’s  no need to prognosticate or worry about the future (nor does it help):

Exhibit 1: The Perpetual Bond (B) – DJI – 2009 through 2012 – (B)(N) There And Done That.

For example, in early 2009 we were willing to buy twenty-nine of the thirty companies in the Dow, but that number changed as new information became available  on a quarterly basis. In late December of last year and early January of this year, we held fourteen companies and have both bought and sold two to four companies in the last six months, and currently hold fourteen (please the column for 2012Q2 and what we reasonably expect, but don’t know yet, for the third and fourth quarters).

Nearly half of these companies, such as Chevron, Home Depot, IBM, McDonald’s, Merck and Verizon, have been in our portfolio without change for more than two years! And we could care less what the pundits are saying about any of them today. The picture is a little clearer if we show you the “cash flow” statement as a graph:

Exhibit 2: The Perpetual Bond (B) – Cash Flow – 2009 through 2012

The dark line is the total value of The Perpetual Bond (B) at the end of each quarter since early 2009 and it is the sum of the value of the  “equities portfolio” defined by the (B)’s (light bars) and the cash account (dark bars). The chart says that $1,153,000 was enough money to buy 1,000 shares in each of the thirty companies of the Dow at the end of 2008 and early 2009, but we didn’t buy them all for The Perpetual Bond – only twenty-nine which was soon trimmed to twenty-seven and so forth. The cash account is the result of buying and selling stocks on (N)- to (B)-transitions (we buy) and (B)- to (N)-transitions (we sell) and, for transparency, does not include earned dividends that we earned as a result of owning the portfolio of stocks.

The light line is the actual value of all thirty companies in the Dow bought on the same basis (1,000 shares of each company) at the same time. The Perpetual Bond (B) also earned $83,000 in dividends over the three years ending in 2011, and the Dow Portfolio (consisting of all the stocks) earned $127,000 during that time, although neither number is included in the cash account that is shown because we wanted our buying and selling activity to be completely transparent (those facts can be verified from the tables in our previous Letter).

We published this portfolio in early January of this year and it is natural to wonder how we’re doing at the half-time and what are we going to do next?

Exhibit 3: The Perpetual Bond in the First Half of 2012

The Perpetual Bond (B) which we started in 2009 with $1,153,000 in cash of which $169,000 was left in cash by the end of the first quarter and $985,000 was allocated to the purchase of 1,000 shares of each of, initially, twenty-nine companies in the Dow Jones Industrial Companies, ended up (on January 1, 2012) as $936,000 in cash and a portfolio of fourteen companies (please see Exhibit 1) worth $852,000 at that time, and a further earned dividend of $83,000 over three years (which is available but not used here). Those results are summarized as Plan A, January 1, 2012 in the above table, Exhibit 3.

The Total Return on the portfolio amounts to 16% per year compounded over three years, but we also note that had we done nothing subsequently except for the required change in the portfolio composition during the past six months (for example, we bought American Express in the first quarter and still hold it, held Caterpillar for three months, sold Exxon in the first quarter, and so forth – please see Exhibit 1), that portfolio earned dividends of $13,000 and has additional cash of $860,000 and a portfolio worth $956,000 at this time (Plan A June 22, 2012) for a Total Return of 2% during the past six months.

In contrast (the Plan Dow), had we sold Plan A on January 1 and used the receipts and the cash account to buy 1,000 shares each of all thirty companies in the Dow, the cost was $1,604,000 and left a residual cash account of $184,000. That portfolio earned dividends of $22,000 and is presently worth $1,875,000 for a gain of 5% during the previous six months – which is more than our Plan A!

Ah, but hold on, what about Plan B, C, and D? Why are we holding so much unallocated cash, $936,000, in Plan A when the Dow Plan is all equities? If we don’t need the cash right away, then (without any thought at all) we can buy more of what we already have, as in 60%, 80% and 90% equities in Plan B, C, and D, respectively, for Total Returns of 5%, 9% and 11% during the previous six months.

Yes, indeed, the market is down 1% and, based on the demonstrated volatility, could go down another 6% or up 6%. But we’re not down and the issue is whether we should protect our prices (using stop/loss or three-month dated bought puts and sold calls based on our long position) and go to the cottage until September, or keep on working?

What would you do?

Disclaimer

Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”.

Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability.

We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are, now.

The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”) . The Canada Pension Bond®™ and The Medina Bond®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”,  “price of risk”, “risk price”, and the symbols “(B)” , “(N)” and N*.