By the year 2000 my T theory forecast had concluded the era of great growth during the 1980s and 1990s had reached a dangerous over extended condition with great risk to equities for some years to come. In response, I spent the following years devising a new, more conservative bond investment strategy which has become unique to our company. It is derived from the Confidence Index, devised and maintained by Barrons Financial and has been published for many decades as a basic indicator of investor confidence in the future economic outlook. We call ASIC's interpretation of its logic the "Best Bond Strategy". Its annual back performance since 2000 is summarized in the table below.
The Barrons Confidence Index is derived from the bond investors basic need to choose between a higher yield, but riskier, low quality bond that promises a greater income return, or alternatively, choosing a safer, higher quality bond that promises default protection in hard times but which necessarily provides a lower yield. The Confidence Index monitors ongoing investor preference between these two options. Thus the trend of this indicator provides an insight as to investor confidence as the bond market judges the relative future prospects for these alternatives. This process is constantly being re-evaluated by bond investors in light of ongoing economic developments, thus a dynamic and insightful indicator can result.
In our program we simplify these two basic choices to either the Fidelity Capital and Income fund, a high yield, well managed bond fund of lower quality, but which the fund manager thinks can ultimately survive economic setbacks, or alternatively to a very high quality Vanguard US Government long term bond fund that places safety above current yield. My business partner Paula Burke spends much of her time evaluating the relative performance of these two alternatives and her conclusion is that Fidelity Capital and Income provides the best low quality high yield fund for our program while the Vanguard organization provides the best and most efficient, safe alternative with either the Vanguard Long Term or Vanguard Intermediate Term US Government bond fund.
Its basic operation is to own the safer, lower yielding Vanguard US Government Bonds when confidence in the economic outlook is declining, then switching to the higher yielding Fidelity Capital and Income once the Federal Reserve makes it clear they are committed to pulling the economy out of a crisis situation.
*Data compiled from Morningstar,Inc. a leading provider of independent investment research world. Vanguard Long Term US Fund fund symbol VUSTX
As noted in the Table above the Total Return for the S&P 500 benchmark, which includes gains/losses plus dividends has over the last decade, returned a disappointing average return (1.1%). This has resulted from the recent gross over valuation of equities, the failure for regulator to limit past speculative practices, the general inability of the US economy to compete with Asia, and the US preoccupation with running up ever increasing debts which it can ill afford.
In contrast, we see the average returns over this same period for the either of the two bond alternatives to be far more attractive. If one had implicit faith in the management of Fidelity's Capital and Income (whose symbol is FAGIX) to prosper long term no matter what the negative economic consequences going forward, then the average performance of FAGIX since 2000 looks to be quite attractive (9.9%) relative to equities (1.1%). On the other hand if one were ultra conservative, the Vanguard Long Term US government Bond fund would have provided an alternative superior average return (7.9%) although not as high over this period as the lower quality fund Capital and Income return.
This divergence is not unexpected. As a general rule it is always true, when viewed over sufficient time, that if one seeks safety and security above all other considerations, one must accept a lower return as the price for "sleeping at night". Our first principle is that not that one kind of bond is superior to the other going forward, as there is room for both considerations because both look to be superior. Rather the over-riding consideration is that there is an alternative approach to the common equity investment for growth that we used in our early decades. Our program makes use of these two types of bonds. It is not a simple income approach as can be seen by the best Bond Total Return (21.6%) when the better of the two alternatives is selected retrospectively for any one year.
There are important points to note for the 10 year average total return for the Best Bond. First is a retrospective view, second its results are not guaranteed, and third it does not require trading within a one year holding pattern. Because it is retrospective it should be noted that the selection of which fund we use in our program is dictated by my T Theory which involves time symmetries in the chart below of Fidelity Capital and Income's price movements over the last 12 years. These time symmetries are represented by the graphical Ts which essentially conclude the the period of maximum price appreciation of the fund coming out of any major low has to be equal to the period of prior decline.
So for example, T#1 has its graphical pattern fixed by the decline from the early 2000 peak down to the late 2002 bottom pattern. This defines the time span that becomes the left side of the T. In 1973 I discovered that the duration of the subsequent advance must last an equal time period to the point of maximum appreciation rate. So the Time symmetrical T forecasts a peak in the funds price in early 2005. It is true the fund price moved higher into late 2007, but the maximum rate of price appreciation was completed in the equal time requirement of T Theory.
T # 2 develops along similar lines except the duration of the decline was shorter, so the projected up time ends rather quickly in August 2010. In our program that means by the end of this coming summer we will have sold our Fidelity Capital and Income holdings after capturing the maximum price appreciation that T Theory sees as likely. By September 2010 we will be invested primarily in the highest quality US Government bonds until the next attractive opportunity presents itself.
In general, the direction of this fund price tracks the Barons Confidence Indicator reasonably well. That is, a declining trend in the price FAGIX parallels a decline in investor confidence as bond investors, fearful of the economic future, move more of their income investments away from the riskier low quality bonds to the relative safety of the higher quality alternatives. In the event of a serious loss of confidence, such as occurred at the center of both Ts, extreme concern can depress the fund to the point that its indicated yield rises above 10% per annum to 15% per annum or so.
At these major price lows the fear of lower quality bond default keeps bond investors at bay, but in time all recessions end, and at some point these very high yields can be captured in our program by converting the high quality US bond assets which have appreciated during this period of declining confidence, into a very high yielding investment which has high capital appreciation potential once the crisis blows over. This process is basically how our "Best Bond" program operates over the very long term assuming an ongoing systemic bond default risks exist.
To learn more about our Wealth Management program please click our link to amshar.com.
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