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Good Luck Forecasting The Ukraine

On The Desk

Stock market analysts — known around here as z-vals due to the zero-validity of their 50 pct mistake rate — are busy forecasting what the turmoil in the Ukraine will mean to financial markets. Here we go again. There is no way to know, but that doesn’t stop them from posing as if there is. Let’s have a look at the absurdity of this effort.

First, a quick recap of what happened.

Freshly deposed former Ukrainian President Viktor Yanukovych was unpopular, and many believed he was unfairly elected. He has always been in the back pocket of former KGB thug and current Russian President Vladimir Putin, who wants to keep the Ukraine (now sometimes referred to as just Ukraine, without the definite article in front of it) politically and economically beholden to Russia rather than losing it to the European Union. Much of the Ukrainian population, however, wants to strengthen ties to the more progressive and sophisticated Europe and wash its hands of the backward and corrupt Russia. With Yanukovych at the top, however, Putin pulled the puppet strings.

A few months ago, citizens rose up and protested this subordination of the will of the people to foreign influence. In January, they became angrier when Yanukovych rejected a deal for closer integration with the European Union that he previously indicated he would support. There were other reasons for their anger, as well, and disposition varies by region of the country, with the Ukrainian-speaking areas in favor of European ties while the Russian-speaking areas prefer Russian ties.

Last week, the until-then mostly peaceful stand-off blew up. Riot police stormed Kiev’s Independence Square (also called Maidan in some reports, which Wikipedia can explain). The air filled with percussion grenades from the cops and Molotov cocktails from the protesters. Snipers picked off people in the crowd. Doctors operated on dining tables between incoming smoke grenades sent crashing through windows.

Politicians are nothing if not fickle fans of power, so when they sensed Yanukovych losing his they abandoned him in parliament. He also lost support of rich elites. Parliament passed a resolution ordering riot police to back off. With protection gone, Yanukovych fled his office and personal estate, leaving by helicopter as his belongings were trucked away. As protesters took over government offices and perused the fallen president’s palatial home, Yanukovych phoned in from an undisclosed location to mention that he hadn’t resigned. Parliament took care of that minor detail by dismissing him and his cabinet last Saturday. His own party called him a coward and a traitor for killing his countrymen and bankrupting his nation. Parliament bestowed interim presidential authority on speaker Oleksandr Turchynov, who said, “We have to return to the family of European countries. We are ready for a dialogue with Russia … on a new, fair, equal, and neighborly basis, acknowledging and taking into account Ukraine’s European choice.”

With that, the gauntlet was thrown and all eyes to turned to Vlad the Impaler, who finds himself in a tough spot. If he invades to win back the western-leaning Ukraine, Putin will spark an expensive war against a nation chock full of Russia lovers. If he does nothing and simply cedes the Ukraine to Europe, he’ll lose his aura of authority and vision of a Eurasian Union. Just as the Ukrainians tossed out Yanukovych the moment he looked weak, so might Russia give Vlad the boot if he looks powerless in the face of a populist uprising against a wishy-washy leader ping-ponging between Europe and Russia for more grease in each palm.

The western parts of the Ukraine want to ally westward while the southern and eastern parts are gathering people in support of Yanukovych and Russia, and calling for the sort-of-deposed Yanukovych regime to crush the rebellion decisively.

That’s where it stands now, and this is where the coin-flipping stock market analysts arrive on the scene to toss their guesses into the forecasting ring. Raising questions meant to imply trouble ahead is a time-tested way to get the attention of investors. For example, the question, “Will the Ukraine be the next black swan for financial markets?” implies that you’d better watch out because it very well could be. In fact, it’s just a question, reaching no more of a conclusion than this one: “Will the Ukraine drop off the radar screen soon, just like Greece and Syria before it, with no impact on markets or relevance to your life?” We don’t know the answer to either one, as they’re just open-ended musings on possible outcomes.

The worry most presented is that the Ukraine will devolve into a civil war between its European-leaning factions and its Russian-leaning factions, that such a civil war could draw in support from the West and Russia, and that such an escalation could ultimately pit the United States against Russia in a hot war for the soul of the Ukraine. Because we’re discussing the view from stock market analysts, the further fear is that such a blow-up would cause worldwide stock prices to collapse.

Look at the layers of uncertainty involved here to the point of rendering forecasts silly. We don’t know:

  • Whether Ukrainian factions will fight.
  • If they do, whether it will be a big fight.
  • If it is, whether it will draw outside support.
  • If it does, whether it will escalate further.
  • If it escalates, whether financial markets will care.

Within this collection of shoulder shrugs, consider that past wars have been good for stock markets, not bad; that any outside support for factions fighting in the Ukraine would probably arrive in the usual manner of weapons, drones, intelligence, and so on rather than with Russian troops and American troops meeting directly on the battle field; that talk from the White House about consequences carries the weight of a helium balloon after the current president threatened them without follow-up in Syria; oh, and that the Ukraine matters about as much to financial markets as your napkin matters to the quality of your dinner. Sure, it’s part of the picture, but not exactly critical.

Just how minor is the Ukraine’s economy? It doesn’t even crack the top 50 by various world GDP rankings. Let me put it this way: Nigeria’s economy is bigger than the Ukraine’s. So is Thailand’s. Heck, even Glorious Nation Kazakhstan has cobbled together an economy bigger than the Ukraine’s.

Am I saying that the Ukraine’s strife will mean nothing to financial markets? No. Am I saying it will become a black swan? No. I’m not saying anything because I don’t know — and neither do the analysts, or the presidents, or the guys down at the bar, or you. Nobody knows, so why bother listening to forecasts?

As with all things related to the financial markets, intelligent reaction trumps folly-filled forecasting every time. Contrary to the image analysts love to put in popular media, it’s not necessary to know the future in order to do well in the stock market. This is good news, since nobody can know the future, not even the talking heads in fine suits. Keep your methodical investment plans on track through whatever scare angle they serve up next. Yes, someday something will send stock prices down again, but they don’t know when or what, so there’s no point tuning in to these coin-flipping exercises. Just react intelligently to what actually happens, not blindly in advance of what some z-val says might happen.

The Ukraine matters, of course, socially, politically, and in other ways. It might even matter to financial markets. There’s just no way of knowing in advance.

Back to it. Have a good day,
Jason Kelly

See this two-minute video to learn more about reactive rebalancing.


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Posted in Geopolitics, On The Desk | 2 Responses

Special Report: Assessing China Risk

Last Sunday’s Kelly Letter featured a special report on the growing concern about financial risk out of China, given warnings from Charlene Chu and Jim Chanos about the $15T in lending capital China created, which powered its infamous property bubble, which the analysts warn is ready to pop. Many subscribers asked me for permission to share the report with their friends and colleagues, which I granted.

I’m also offering the report to non-subscribers as an invitation to try the letter. It delivers far more useful content every Sunday morning than most once-per-month services deliver in four weeks. See how the letter is managing China the way it manages all scares of the moment as it steadily follows its methods to long-term profit with little stress.

To receive the report, Assessing China Risk, please subscribe to the letter today so we can get you set up in the database to receive the next new letter this Sunday morning. We’ll send a welcome note with the site password, and attach the report to the email.

Please subscribe here. I hope to see you on the list this Sunday!

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Top 40 Dividend Growth Stocks for 2014

My friend, Dave Van Knapp of SensibleStocks.com, publishes an annual overview of the dividend-paying stock scene for $40. This year’s edition, the seventh, came out last month and Dave was kind enough to send me a copy of Top 40 Dividend Growth Stocks for 2014.

Right upfront, these are the new features for 2014:

  • A new selection of 40 Top Dividend Growth Stocks, including complete analyses and valuations
  • Performance table to show how 2013′s Top 40 did
  • New and expanded coverage of:

    • A variety of terms and definitions in the glossary
    • Risk and how to manage it
    • How to get started
    • Dividend growth stocks in retirement and retirement planning
    • Dave’s own demonstration Dividend Growth Portfolio
  • Text and investment guide now covers over 180 pages
  • At request of readers, the book uses a new, lower minimum yield requirement (2.0%) for those who look forward to decades of compounding.

In looking ahead, Dave writes that he feels “good about the general dividend outlook for 2014. I think that most companies have regained their footing since the Great Recession. It took some of them a few years to get there, but I think that most of them are there now.”

Here’s the table of contents:

Top 40 Dividend Growth Stocks For 2014 TOC

In the introduction, Dave writes, “The principal goal of dividend growth investing is simple: To build a sufficient, reliable, steady stream of rising income.” There are three phases in his process, each explained in a separate chapter:

Phase one is to identify the best dividend growth companies. By Dave’s way of thinking, they:

  • Are financially solid
  • Have great business models with sustainable competitive advantages
  • Offer a good initial yield at time of purchase
  • Consistently raise their dividends
  • Are relatively low in risk by dividend and stock price

On the last point, he clarifies that stock market risk can never be fully eliminated. Within the risk of the market, however, we want relatively stable companies, not firecrackers.

Phase two is valuation of companies so that you can purchase them at favorable prices. “You literally shop for stocks that are on sale,” he writes.

Phase three is portfolio management. It includes everything not covered in the first two phases: How to make timely decisions to buy, sell, hold, or replace stocks; maximize dividend streams; exercise sound risk management; manage dividend cuts; and avoid outright loss of capital wherever possible.

After a terrific primer on the benefits of dividend income and buying companies that produce it, Dave outlines the characteristics of the best dividend stocks and then introduces the 2014 Top 40 with “sufficient variety” to “create a well-rounded portfolio” as shown in the following breakdown by sector, with the numbers at the front of each row taken from the Global Industry Classification Standard (GICS):

Top 40 Dividend Growth Stocks for 2014 Sectors

Each of the 2014 Top 40 gets a one-page Easy-Rate Scoresheet for simple comparison, and those follow various lists of the 40 sorted in different ways. Given the many ways of viewing the winners, you’ll have no trouble choosing which are right for your portfolio. The highest dividend yield is 7.6 pct and the lowest is 2.0 pct.

Dave has preloaded all 40 of the stocks into F.A.S.T. Graphs and linked the page directly from within the eBook. Readers just click the link, then select the stock they want to see from a dropdown on the resulting page in their browser. The up-to-date graph for the selected stock will load. This is a convenient feature for readers that will remain timely all year.

Here are seven observations about this year’s 40 from Dave. Note that DGR stands for dividend growth rate:

Top 40 Dividend Growth Stocks For 2014 Observations

Per the sixth observation, the stocks to watch did indeed get cheaper in the recent market dip. Many remain at better valuations now than at the time of the book’s publication.

Dave closes with thoughts on how to use dividend-growth stocks in retirement planning, relying on a helpful cistern metaphor. He suggests picturing that your retirement assets “reside in a cistern, with pipes bringing assets in and taking them out.” He says your retirement cistern has two goals:

  1. You must be able to draw enough from the cistern to fund your retirement adequately.
  2. The cistern must never go empty. In fact, it must never get even close enough to empty that you lose sleep or worry about the possibility.

With the help of this book, it won’t.

Another year, another fine addition to the annual series. Dave is selling Top 40 Dividend-Growth Stocks for 2014 in PDF form for $40 (a buck a stock). I receive no compensation if you buy it.

I wrote four years ago that this is the best dividend stock book I know. It still is, and it keeps getting better.

Like this? Email the link to your people:

Posted in Books, Dividends | Tagged | Leave a comment

The Sad Reason Keystone XL Doesn’t Matter

The Kelly Letter Excerpt
The following is from this year’s Note 5 of The Kelly Letter, which went out to subscribers last Sunday morning.

The State Department on Friday released a final environmental study of the Keystone XL pipeline that increased the odds of the Obama administration approving it, providing pro-environment former Obama backers with yet another reason to regret sending him to Washington.

The study concluded that the pipeline would not materially exacerbate climate change because it will simply move fossil fuel that would end up being moved by some other means anyway. If the fuel doesn’t move through the pipe, it will move by rail or highway. Stopping the pipeline is not synonymous with lessening climate pressures, because it will neither boost demand for fossil fuel nor encourage production. It will merely transport product already being produced to meet already rising demand.

The report also said the project will not create a meaningful number of jobs. Following some 40,000 jobs during the two-year construction phase, the pipeline will offer a mere 35 permanent positions.

Those for and against the pipeline reacted along their usual lines. Tar sand backers in Canada and pro-oil lawmakers in the US rejoiced. Environmental groups ignored the findings of the study and reiterated that the pipeline will worsen the planet’s carbon pollution issue.

Congressman Raul Grijalva (D-AZ) called the study a “sham” and said it “featured multiple documented conflicts of interest, corporate failure to disclose relevant business ties, and a State Department more interested in greasing the skids than doing due diligence. We thought we’d seen the last of this in the George W. Bush era, when profits came before science and wealthy corporate interests called all the shots.”

TransCanada CEO Russ Girling retorted that opponents are grasping at straws regardless of the evidence on the table. “No matter how much noise they make or how much misinformation they spread, the science does support this project.”

It’s not so much the science as the reality of global politics that supports the project. Science says fossil fuel usage is changing the climate. Global politics says, “So what?” Canada is committed to extracting its tar sand crude and getting it to market one way or another. The real disappointment to environmentalists should not be that this one pipeline will likely get approved, but that momentum across the board is for more fossil fuel production and consumption. The problem is not just Keystone XL.

Both sides missing the point is the most disheartening aspect of Friday’s report and reaction. The State Department did not say that fossil fuel does no harm to the environment, so pro-pipeline groups should take a moment to realize that their industry may not cause more damage to the climate due to the pipeline, but no less, either. Environmentalists should face facts that whether this one pipeline happens or not is beside the depressing point that the climate is a goner regardless. Essentially, the State Department said, “The climate is cooked one way or another. All we’re discussing is how to get the cooking fuel from the ground into the air.”

The science referred to by Grijalva wasn’t the science of the pipeline per se, but rather the bigger picture science around what fossil fuel is doing to the planet, and there’s little doubt that corporate interests continue calling the shots in that department. Too bad they always will. Too cynical? Just look at how meaningless hope and change turned out to be, on all fronts.

Yours truly,
Jason Kelly
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Posted in Kelly Letter Excerpt | Tagged , | 10 Responses

Kelly Letter Subscriber Roundtable

The Kelly Letter Excerpt
The following is from the subscriber discussion with me regarding this year’s Note 4 of The Kelly Letter, which was sent on Sunday, January 26, 2014. It showcases typical interplay within this intelligent investment community, which is a helpful benefit of becoming a subscriber.

STEVE, posted 1/26/14

Regarding the Signal Strategy:

Many readers are probably investing in a taxable account. Frequent selling is going to trigger taxes, often at higher short-term rates. This is going to drag on results, and the money to pay the taxes may have to be withdrawn. All of this also incurs transaction costs as well.

Taking this into account, I wonder by how much this Strategy’s potential advantage will be mitigated? How might it compare to simply holding a tax efficient ETF for the long term, with less frequent rebalancing. Transaction costs would be minimized; and any taxes due could be delayed indefinitely into the future, allowing the investment to compound all the more, and finally paying the lower long term rate.

Have these two approaches been compared?

JASON, posted 1/26/14

No doubt, Steve, the quarterly trading schedule of the plan makes it more suitable to tax-advantaged accounts, such as IRAs and 401(k)s. However, tracking lots makes it fairly simple to sell those held for more than one year, thereby reducing the tax burden to 15 pct rather than the short-term rate, which is usually higher than 25 pct for investors. This helps, but remains a burden.

The plan has outperformed buying and holding an efficient index ETF, even when taking taxes into account. However, I’m not sure the plan as it’s being run in Tier 3 will do so, and probably can’t be sure because it will differ in all environments given the many moving pieces involved in the tier’s portfolio. I’ll keep an eye on making sells worthwhile by skipping signals that don’t lock in significant strength that brings high odds of a reversal, etc.

Also, bear in mind that the higher a person’s income tax, the harder it is for this or any plan to clear the tax consequenes on short-term trades. It’s possible that a high-tax-bracket investor making all short-term trades could fail to achieve enough outperformance to offset the tax burden in a future market. It’s probably unlikely, however, because the 3 pct hurdle each quarter is actually fairly demanding of the market. Particularly if a person is adding more cash every month, most signals will be buys, not sells, and the sells will almost always be worthwhile eventually when their proceeds are reinvested at lower prices on later buy signals.

Luckily, most people manage the bulk of their lifetime savings in tax-advantaged accounts. In their taxable accounts, the Signal Strategy will almost certainly outperform any active approach they’re taking, which would incur tax consequences of its own, and has in the past provided enough extra performance to more than offset the tax burden.

CJ, posted 1/29/14


First I want to say I love the 3% plan. I’ve been applying it in my IRA for a few years now.

I was wondering if the tax implications could be limited by shorting the individual stock or ETF instead of selling them. This way you would build a short and long position over time with the net amount equaling the required hold position. Then as you build over time you could theoretically sell for taxable losses. Please let me know what you think.


JASON, posted 1/31/14

Thank you for the positive, real-world report, CJ!

You could indeed mitigate taxes with a shorting strategy, but I think suggesting so would be inviting danger into the lives of people who, for the most part, are interested in the strategy for its stress-reducing aspects. For more sophisticated investors, however, shorting could work better than selling for the reasons you cited. It might even produce the series of tax write-offs you mentioned, all the while growing the account balance — quite a coup!

See you Sunday,

ARON, posted 1/26/14

I need clarification about specific points on the new 6% signal strategy for Tier 2. Is this a fair interpretation: 50% of Tier 2 capital is going into BOND and 50% is going into MVV?

What Jason means by: “60% as the percentage of safe capital at which a rebalance back to 50% is triggered” is that once your Tier 2 capital in BOND grows to be 60% of the total capital in Tier 2 you’re going to sell enough to bring it back to 50%?

Should we keep that money as cash or invest it into MVV? Also, why did Jason choose BOND (Tier 2) and CMBS (Tier 3) as safe investments?

JASON, posted 1/26/14

Good questions, Aron, and I’ll be sure to run them by Jason when I see him next. Oh! Here he is now…

Yes, the target allocations in Tier 2 are 50/50 MVV/BOND. When the BOND balance hits 60 pct of the tier’s capital, we’ll move all of the excess into MVV on the next quarterly buy signal, not before and not when there’s a sell signal.

The three bond funds offer different expense ratios, different yields, but similarly competitive resilience in stock sell-offs. From the feature article of last year’s Note 53 sent Nov 3:


Our portfolio consists of three tiers, and we’re going to use BND, BOND, and CMBS for the respective cash balances in them.

BND is broadly diversified and very cheap, consistent with the goal of Tier 1, which is to achieve steady growth over time by rebalancing the stock portion of its value averaging plan to a quarterly 3 pct signal line by either buying or selling. Rather than using a zero-interest cash fund for the proceeds of the sales, we’ll begin using BND next year.

Tier 2 is more aggressive than Tier 1, though you wouldn’t know it recently given its holdout in cash. It does not worry as much about expenses nor as much about long-term yield. The plan wants to be entirely in ProShares Ultra MidCap 400 (MVV $117) most of the time, and should have been in recent times. My overly cautious outlook prevented it from happening. To remedy that, we’ll move cash into BOND, which is Bill Gross’s famous Pimco Total Return mutual fund in an exchange-traded product. The expense ratio is high for this category, but Gross is a superb bond trader and Tier 2 is a place for active management and higher fees in pursuit of higher ending performance.

Tier 3 is another active management zone, where we least expect capital to stay on the sidelines for long. Therefore, price stability is more important than yield here, and CMBS looks about perfect. Its price has held up well in the recent bond market volatility and it pays a decent yield while charging a modest fee.

We’ll make this transition at year end for a fresh start in 2014. I’ll also introduce other changes on the way for the new year in later issues.

Over time, keeping our cash balances in these bond funds should boost overall performance with only a mild increase in risk.

JUDSON, posted 1/26/14


Great letter.

I just wanted to say that I DO enjoy the international perspective your letter offers. I live in Houston, Texas and read your letter with delight every Sunday. China is the second largest economy in the world, so what happens there matters to the rest of the world. I am consistently amazed at the blissful ignorance of my fellow Americans to the world outside our borders. China had a century of humiliation because it turned inward and ignored threats and changes outside, thinking itself the center of the world. Japan, on the other hand, did not and modernized with the Western powers. We must not fall into that same seduction, and I keep a constant eye on different members of the global community. I can say one thing, the citizens of China know more about us than our citizens care to know or learn about them.


JASON, posted 1/26/14

Thank you, Judson.

I agree that a global perspective is needed these days, and it would help America’s internal debates if more of its citizens were aware of best practices elsewhere on the planet. The health care reform discussion, for instance, would have gone far differently if a greater percentage of the electorate knew how most of the developed world provides citizens with health care. The amount of disinformation that’s possible in America is breathtaking, and would be mostly avoidable if more people got a visa and hopped on a plane once in a while. I realize that stretched incomes make this hard for many, but you get the point. Barring the ability to travel to other countries, people could at least study up on them.

I’ll keep the international perspective coming. I find it very useful in understanding pressures on the US market, and it will only become more needed as the rest of the world steadily contributes more to global economic activity.

EARL, posted 1/27/14

“If you see something, say something.” This week’s letter was great! My respect and thanks to Jason for his hard work and economic analysis.

At the same time, I find it disturbing to see Climategate fraud participant and fabricator of the infamous “hockey stick graph,” Michael Mann, sourced in this letter’s “sphere of research.” This climate alarmist, IMO, doesn’t add value or credibility to the letter, he detracts from it.

JASON, posted 1/27/14

Thank you for the kind words about Sunday’s letter, Earl! On Mann and climate, however, I have to respectfully disagree.

Climategate turned out to be nothing, and the relevance of Mann’s hockey stick graph is proven. The controversy created by the graph is the very subject of his new book, The Hockey Stick and the Climate Wars: Dispatches from the Front Lines, which you might enjoy even as one of those who dismisses Mann. You’ll find equal time in the book because therein lies its dramatic tension.

FactCheck.org found Climategate claims that man-made global warming is a fabrication “to be unfounded.” Among the reasons: “E-mails being cited as ‘smoking guns’ have been misrepresented. For instance, one e-mail that refers to ‘hiding the decline’ isn’t talking about a decline in actual temperatures as measured at weather stations. These have continued to rise … The ‘decline’ actually refers to a problem with recent data from tree rings.”

SHERYL, posted 1/28/14

Mr. Kelly,

Thank you for today’s newsletter. I have a question regarding your new “signal” approach. In Tier I for instance, you mention that you want 20% of safe capital in BND and a max of 30% at which time you will rebalance it back to 20%. However in today’s newsletter I see that there is 33% in BND ($235,836 divided by $715,031). Do you just consider 33% close enough to 30% and I am being too literal?

Thank you very much,

JASON, posted 1/29/14

Excellent observation, Sheryl.

No, 33% isn’t close enough. The situation is that the plan hasn’t issued a buy signal since summer 2012. When the bond balance reaches 30%, the plan waits for the next buy signal to move in all excess back to a 20% bond allocation. It does not move it in on the next quarter necessarily, but on the next buy signal. The plan has been selling on the way up, as it’s designed to do. In most environments, this is fine as the proceeds are later put back into the growth vehicle at lower prices. In a long bull market, however, the 30% is hit and then later rebalanced.

Once we get a buy signal, you’ll see all of the excess bond balance move in at once. In the short term, this looks wrong and it certainly isn’t perfect, but over many years of running the plan this works best.


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Posted in Kelly Letter Excerpt | 1 Response