Most current market analyses and commentary fail to take this huge fact into account in any serious way.

I believe the idea of a “new normal”, meaning a very slowly growing US economy, will be valid for many years to come. Unfortunately, the current pack of malignant bureaucrats and politicians always choose pandering or ideology over actual problem solving, so the exactly wrong regulatory frameworks are usually installed (e.g., “healthcare reform” laws, “financial reform” laws, “net neutrality”, making Fannie/Freddie even more supportive of people who cannot afford to buy a house, …). Thus, we will be stuck with the New Normal or a similar scenario, unless at least one or both of these possible events occur:

1. The current Regime becomes paralyzed and unable to pass any more dangerous laws affecting the economy, e.g., after 2 NOV 10 (an obvious speculation is available around this idea!)
2. Technology proceeds apace and radical innovations take hold….but this is a 5 to 10 year event horizon before the economy could be affected (consider the WWW was launched c1993 by Netscape and while its future impact was widely acknowledged then, it’s taken until roughly 2003 to become transformative in the economy).

Consider this figure:

Correlations among global securities

The first 14 securities are indexes and ETFs of various segments of the USA equity market. These are followed by a European and a Chinese equity ETF. The last  five are currency, fixed income or anti-inflation securities.

Note how the equity indexes are very highly correlated with each other (with most correlations over 0.8 and thus green in the matrix), but very uncorelated with the non-equity securities. GLD, the gold ETF, is truly uncorrelated with both equity and the 30 year T-Bond ^TYX.  Interestingly, GLD  and TIP (the anti-inflation US treasury security) are moderately correlated at 0.4. We would expect this since they both are used to protect against inflation, but are not equivalent in their structure.

The two rows above the matrix show the returns and volatility of each security. Note that the highest volatility is for VGK (41%/yr) and the lowest is for TIP at 5%/YR. On the other hand, only 7 of 21 securities measured have positive returns for the last 45 days. The highest return was China (FXI at 50%/YR) and the lowest was Dow Jones US Industrials (IYJ at -38%/YR).

We say this matrix, derived from the last 45 days of price action, indicates securities can best be picked based upon estimates of returns, assuming most securities will continue their very high correlations. Only asset classes, broadly categorized as equity/fixed income/anti-inflation, have negative or zero correlations for diversification.

Thus, we see yet again how the asset allocation task requires the asset class be picked before individual securities.

Budgeting skills are as important as what your portfolio is doing—probably, more important really, because budgeting is an everyday issue. If a person can scale back appropriately so that they can actually survive on a 4 percent withdrawal rate, they’re good. Any reasonably designed retirement portfolio will last with a 4 percent withdrawal rate. Eight percent? You’re going to have to get really lucky in your investments.

We love reading his work and he’s a very sharp, knowledgeable finance maven. But his claim about the 4 percent withdrawal rate seems a tad glib–there are many assumptions built-in to this claim that need explanation. Would you really like to bet on such a simple number for your retirement? We think not.

Intuitively, at 4% withdrawal rate,  if your return is 4%/YR and inflation is nil, then in fact you can simply withdraw the gain each year and never deplete the principal. But if, for example, inflation is 2%/YR and your return is 4%/YR, then we can show 4% withdrawal rate would last you 34 years. Not bad. But if your return is 3%/YR and inflation is 4%/YR, then this account will deplete after 22 years if withdrawals are at 4%/YR.  That’s probably a big difference. We show you how to handle all these “What Ifs”.

This post introduces the idea of the Safe Withdrawal Rate (SWR), a concept that has recently captured the attention of many investment advisors and publications. We introduce our own focus on this topic now. We announce two initiatives. First, we published a descriptive piece in Advisor Perspectives, a highly respected and popular website for investment professionals. This piece explains SWR ideas without math for the average investor. Second, we published our full research results in detail here, in our permanent pages (see Investing Tools drop-menu above, or click this link):

Investing Tools> Safe Withdrawal Rate

This page introduces our technical analysis and methodology to determinine your own, personal SWR. Our innovation: we capture each individual’s beliefs about his own future returns and inflation to find the expected value of his SWR, irrespective of market history. Ultimately, your personal beliefs about how future returns and inflation evolve is all that matters for your planning purposes.

I grant that low long-term interest rates could continue for months, or even well into next year. But just as easily, long-term rate increases can emerge with unexpected suddenness. Between early October 1979 and late February 1980, for example, the yield on the 10-year note rose almost four percentage points.

He generally warned us that

The United States, and most of the rest of the developed world, is in need of a tectonic shift in fiscal policy. Incremental change will not be adequate.

Do you believe the curent regime has any political courage, let alone sufficient to change course?

RocketCap Smart Grid Stock Index: Annualized ROI Through 5-28-10

The chart above shows our index since inception on 3-13-09. The chart also shows the sub-indexes for vendors and utilities, the PUI utility ETF and the S&P500 Index for comparison. Our vendor index remains the leader. Note that our IP leaders for smart grid technology are well represented in our index.

Dr. Ruth Fisher, who’s a specialist in IP analysis and competition, and I decided to find out. This is one of those deals in which one says “If I had any idea what this would lead to….”  We compiled an initial list of 23,000 US patents from an online, subscription database called WIPS. We filtered them down to 3000 patents which we further analyzed. We (mainly Ruth)  literally read the summary page and first claim for all 23,000 patents. By our readings we placed each patent into at least one NIST standard technology category. Then we sliced and diced the categories, patents and owners.

All of this work was designed to identify the IP leaders in smart grid technology.

The results will surprise you. Read the report here:

Who Is the Smart Grid Technology Leader?

Performance of RocketCap Smart Grid Stock Indexes

We see that all these performance measures are highly correlated, but RSGSI_V  has had superior ROI over the time period from 3-13-09 through 3-31-10 (266 trading days).

Today, Bloomberg News makes a very strong and creatively presented case for deflation. We now have some serious validation….but no joy.

• Extrmely low probability
• Extremely high impact
• Unimaginable a priori

Given this BSE, we have had a massive “pivot” from the health care fiasco in the making to focus on USA economy and jobs. The reason for this change is simply the one new Republican vote that can stop disastrous congressional economic policies.

OK, so how can this BSE save us? Bear with us for a bit.

We recently came upon this quote and find it quite descriptive:

“A democracy is always temporary in nature; it simply cannot exist as a permanent form of government. A democracy will continue to exist up until the time that voters discover that they can vote themselves generous gifts from the public treasury. From that moment on, the majority always votes for the candidates who promise the most benefits from the public treasury, with the result that every democracy will finally collapse due to loose fiscal policy…”

by Alexander Fraser Tytler, Scottish lawyer and writer, 1770.

Now, consider this fact:

~50% of USA workers pay $0 taxes, while the rest of the workers (the “rich”) pay all the taxes.

We think it fair to conclude:

Half the population has incentive to free-ride on the others and will cheerfully vote for increasing burdens on those “rich”.

Our country is in peril from financial catastrophes and very poor political decisions. Most pertinently, the Scott Brown BSE may enable the inevitable lunge by Democrats for more taxation and thus massive class warfare to be avoided.

We think the stock market is a good system for measuring value. We also know our RSGSI includes both power utility companies publicly committed to smart grid investing, and also vendors to those utilities. But we thought there might be a difference between utility and vendor valuations, reflecting a market estimate of who will “win” in future. So we refined our index into two component indexes to dive deeper. We now have these indexes to compare:

• RSGSI     = Rocketcap Smart Grid Stock Index
• RSGSI_U= Rocketcap Smart Grid Stock Index of utility companies
• RSGSI_V= Rocketcap Smart Grid Stock Index of vendor companies to the utilities

The utility and vendor indexes are simply comprised of the utilities and vendors which make up the RSGSI, so that

RSGSI=(9/21)*RSGSI_U  + (12/21)*RSGSI_V

• ^GSPC   = S&P 500 Index ETF
• PUI= PowerShares Dynamic Utilities ETF consisting of power utility firms. The top 10 holdings of this ETF, which comprise 46% of it’s whole market value, has only one utility from our own RSGSI (SRE-Sempra Energy). Those top 10 holdings range from 3.02% to 5.33%, with SRE at 5.25%.

Consider this graph, which shows the annualized returns for each of these indexes since 3-13-09, a 206 day time period.

The beginning of this time period corresponds with the market bottom last March (would we have invested then!). The graph shows the wild volatility of returns for the three months ending in June. The returns settled down after June 09. Now let’s consider the various cross correlations:

From the graph of returns and the correlation matrix, we can make these informal conclusions:

• RSGSI is highly correlated with S&P500, and their ROIs have tracked well.
• RSGSI_U and PUI are highly correlated and RSGSI_U has had superior ROI
• RSGSI_V and PUI are weakly correlated and RSGSI_V has had superior ROI to PUI
• RSGSI_V has best overall ROI of all the indexes, particularly superior to the utility indexes, RSGS_U and PUI

These vendors have so far gotten the greatest market valuations, yet have minimal implementations (sales) of Smart Grid systems! Thus, this value may reflect the market’s future valuation, including that of the vendors’ Smart Grid intellectual property.

This is not rigorous analysis, but it is suggestive. The innovation value of the Smart Grid vendors may be key to Smart Grid evolution.