Strategy Update plus Victoria Falls

David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to CNBC programs. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).


May 20, 2009

Some bullets on different asset classes follow.

US Stocks

It appears that the March 9 low is seriously established. Since then, the market has powered higher with broadened participation. The market has confirmed a determined upward bias. We can see evidence of this broadening by examining the S&P 500 Index and its component parts four different ways. Let’s look at four ETFs to support this view.

RSP is the stellar performer among them; it is the equal-weighted version of the S&P 500 stocks. From March 9 through May 18 it delivered a total return of 50%. Compare this with RWL, the revenue-weighted version of the same S&P 500 index; it delivered a total return of 43.5% for the same period. SPY is the ETF that tracks the cap-weighted S&P 500 index; it was up 35%. OEF is the cap-weighted largest 100 stocks within the S&P 500 index; it was up 32.7%. Conclusion: market leadership has been broadening, which is why the specially designed ETFs are outperforming the standard cap-weighted ETF. Disclosure: RSP is Cumberland’s largest ETF position and a current core holding in US ETF portfolios.

Contrast the above with the performance of these same four ETFs during the period of January 1, 2009 through March 9. Then the market was in steep decline. Selling was uniform and impacted all four ETFs nearly equally. RSP declined 28.4%, RWL was off 29.3%, SPY fell 26.7%, and OEF declined 26.8%. Conclusion: during the sell-off nearly all stocks fell; after the bottom was formed on March 9 the market leadership changed, which is why the highly correlated performance during the decline morphed into the diverse and less-correlated outcome of the recovery.

International Stocks

Emerging markets have been the stellar performers in the rally since March. Brazil and China have been leaders among them. Many believe that China’s stimulus response to the global financial crisis has been and remains more effective than that in the US. Cumberland has been overweight China and overweight the emerging markets in international ETF accounts. Bill Witherell will be writing about the details. Cumberland continues to overweight this sector.

Tax-Free Bonds

It is safe to say that the Muni market has caught fire. Interest rates in Muniland are falling rapidly from extremely priced levels. The 7% high-grade tax-free Muni at the peak quickly gave way to 6% and then to 5%. Accounts that were funded were rapidly invested and have been able to participate in this rally. This tax-free bond sector is still cheap. The ratio of taxable fixed-income to tax-free suggests that the fall in Muni yields (rise in bond prices) is only partially over. John Mousseau will have more details to offer about this sector and about the demise of the bond insurers. Cumberland’s tax-free accounts are nearly fully invested and favor longer durations and a selective focus on refunding candidates. This asset class is still very attractive.

Taxable Municipal Bonds

With the introduction of the Build America Bonds (BAB), this asset class has taken on a life of its own. BAB issuance is replacing traditional tax-free new issues in many jurisdictions. Nearly all new municipal bonds are constructed and priced on both a traditional tax-free and a BAB structure. The issuer is then able to choose which is more economical. The effect has been to compress the spread to the tax-free new-issue yield and also orient the spread between taxable and tax-free so that it approaches the tax arbitrage of 35%. We expect that to continue. Peter Demirali will have more details on this exciting new issue. Cumberland has been active in taxable municipal bonds for years and is able to apply that experience to this new and rapidly expanding asset class.

Certificates of Deposit

The temporary FDIC insurance limit of $250,000 is scheduled to expire on December 31, 2009. Pricing in the CD market reflects the risk that it may revert to $100,000. Some CD investors are altering their behavior when they consider CDs with maturities into 2010 and beyond. Congress knows this. The Senate version of the FDIC limit bill extends the insurance to 2013. The House version makes the insurance limit of $250,000 permanent. We expect that the $250,000 limit will be extended beyond December 31. Fast Congressional action would relieve fearful investors in the CD sector. Getting it from Congress is problematic. Because there is some political risk, albeit small, we are limiting longer-term CDs to $100,000 until Congress actually passes the extension.

Victoria Falls

We are flying to Africa this Saturday and will participate in the Global Interdependence Center (GIC) conference in Livingstone, Zambia next week. Details at We look forward to the central banking discussion workshop, which will focus on how smaller open economies apply monetary policy options when faced with exogenous price shocks. The genesis of this discussion was in Cape Town over a year ago when GIC learned firsthand of the problems that US ethanol policy was causing in Africa and elsewhere. Washington’s ethanol subsidy drove corn prices higher, and maize-based small economies like Zambia experienced high food inflation. About 70 countries in the world were impacted to some degree. GIC has partnered with the Zambian central bank and other central banks and institutions around the world in an effort to develop dialogue about this issue, which harms about 2.5 billion people in the world and has caused about half of them to be “food insecure.” We will report on our findings.

David R. Kotok, Chairman and Chief Investment Officer, email:

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