Gaffer's Portfolio 

January 29, 2010

After 10 months of climbing almost without stopping, a correction in the market was certainly due.

In January, the S&P 500 had its worst loss since last February and the portfolio had its second worst loss ever.

But there's more to it than simply being due. Washington carries a huge amount of the blame directly. Investors around the world strongly dislike uncertainty and for the past year or more (with a brief interlude for hope early in 2009) there has been nothing but uncertainty.

Progress of the attempted health bill has been nothing short of a fiasco creating, along with unfettered spending, an almost-complete lack of public faith in the government process. Just in the past week or so, two things that helped tip the market over the edge have been the extra tax on banks and the waffling over Fed Chairman Ben Bernanke's second term confirmation. That was in just one week!

When guessing games take place in the market, investors head for safety by taking profits off the table. It's a natural reaction.

Let's face it, American politics is a disgrace! Headed by a president who thought he could do what he wanted – rather than what the people wanted – with his huge majority, three elections that went against his party may have shown him otherwise. Now, instead of the cooperation and unity he promised, he cannot keep Democrats on the same page. Every major promise he made during his campaign has been broken or failed.

The problem attached to winning overwhelming support as a candidate for the White House is that he had to live up to exceedingly high expectations. That would have been a tall order for anyone.

He has delivered on one significant promise: he promised change. He has delivered that by diverting the U.S from a slippery slope to a ski slope from which an escape is difficult to see. That was not the change his enthusiastic supporters expected.

I have lived in a number of countries but the U.S is not one of them. (My daughter does, but we don't talk about politics and I have no political ax to grind.) However, anyone with an ounce of care about what goes on in the world around them cannot avoid caring about the U.S; what happens in the U.S affects us all – at least, it does for now. And it is frankly sad to see the mighty and the proud brought to their knees. The U.S people do not deserve what is happening to them right now.

What does or does not take place in Washington affects stock markets around the world – and disappointment in the Obama administration is partly responsible for the sharp reverse this month in stock markets. One can only hope the president, Nancy Pelosi and others make nice and get on with the job to which they were elected, not the farce they have been acting out.

That apart, the market was certainly due for a correction and we can expect this one to last for at least two more months if it is close to normal. Corrections of 10% or more are usual in a bull market. Think of it this time as a late January sale!

Fortunately for Gaffer's portfolio, annual rebalancing took place at the end of last month. What has happened this month is a clear demonstration of the value of periodically taking profits.

By the end of December, the holding in Freeport-McMoRan Copper & Gold was valued at $3,469.86. The position was initiated one year earlier with $1,000 and a total of $120 was added during the year at the rate of $10 each month. On December 31, shares were worth $80.29 having been bought for $24.44. Today, those same shares trade for $66.69, a drop of 16.9% in January, but more than half the holding was sold at the higher price during rebalancing. 

About one-quarter of Goldman Sachs shares were sold, too, ahead of the Administration's attack on banks that sent a mixture of messages to investors. On the one hand, recovery requires the banks to lend to small businesses instead of investing taxpayer money borrowed at 0-0.25% interest in government bonds, skimming profits in the process. And on the other hand, creaming banks for an extra tax (justified or not) during a fledgling economic recovery hardly seems to make sense.  

Goldman Sachs lost 12.23% this month, dropping from $168.84 to $148.20. 

Vulcan Materials, down 14.19% from $52.67 to $44.19, continues to disappoint – but there is no obvious reason to drop it. We paid $69.58 for it deep in the recession in anticipation that the world's leading producer of aggregates and asphalt would benefit from the U.S recovery program.

Meanwhile, Vulcan was the largest beneficiary of capital redistribution during portfolio rebalancing. Patience should eventually pay off.

Caterpillar, bought at $44.67 and down 8.33% last month from $56.99 to $52.24, is in the same holding pattern waiting for the construction industry to improve.

And another expected loser was Toyota, which announced back-to-back recall shocks last month. It fell 8.51% from $84.16 to $77.00.

Not all was doom and gloom. Korea Electric Power was up 11.76% and up close to 100% since it was bought. The number of shares held was increased during rebalancing.

Despite the overall loss this past month, rebalancing when we did (with the timing purely coincidental) was helpful to the portfolio and I am sure will prove even more helpful as the economic recovery continues. 

Now we have to wait to see if the Administration's apparent leaf-turning is real.