Its mandate is to maintain growth and stability in the biggest economy in the world.

“Fed watchers” are economic analysts who try to forecast various economic trends by interpreting the constantly changing policies of the US Federal Reserve Board. This is what they observed in 2006:

1. The US housing market had become an arena for speculation. Prices were soaring. People were paying record high prices, buying with HUGE mortgages. It was a buying and mortgaging frenzy.

2. The Fed wanted to prevent this speculative housing boom from exploding into a bust. They increased US interest rates 17 times in a row in an attempt to cool things down.

3. Finally the Fed succeeded. [They always succeed.] US house prices are cooling down to more “normal” levels.

4. Spin-off effect. It is very difficult [impossible?] for the Fed to cool off just one segment of the economy. In the economic world, everything is connected to everything else. Now Fed watchers are worried that the stock market might cool off too. And, worse yet, the whole economy might cool off too. [A “too cool” economy is a recession: a “way too cool” economy is a depression.] Note for Canadians: if the US economy cools off, our economy cools off too – in a big way. Their problem is our problem.]

5. In January 2007 the Fed watching economists will be out in full force with their annual forecasts for the New Year. What will the economy do, and what will the stock market do? Some will forecast a “soft landing:” the economy will cool off a little, but will not slip into a recession. Other forecasters will predict a “hard landing:” the economy will cool off a lot and a recession will ensue. Both soft and hard landing forecasters will predict that the economy will recover in 2008, just on time for the presidential election.

6. Then they’ll create a forecast for the stock market based on their forecast for the economy.

7. Based on these forecasts, traditional investment managers will decide what percentage of their clients’ assets should be in the stock market, the bond market, or in cash.

8. Problem is they are thinking backwards: the stock market is a lead economic indicator. The stock market predicts the economy, not the other way around. And the economy is a lead indicator for Fed policy. The Fed uses economic indicators to decide how it should act. The Fed tries to cool down an over-heated economy and warm up an over-cooled economy.

9.The correct sequence is: [a] the stock market trends up or down. [b] The stock market’s trend is a lead economic indicator and can be used to forecast the economy. [c] Economic growth trends up or down. [d] The trend of the economy can be used to predict Fed policy. The key to it all is to have a handle on the direction of the stock market. That’s why CastleMoore manages investments based on the trends of various financial markets, not based on economic forecasts. We’re trying to keep the horse before the cart.

For example, the stock market has been going up quite strongly since early July 2006. This can be used to predict that the economy will be reasonably strong this winter and into spring 2007. If the economy proves to be too strong in this period, we may use that data to predict that the Fed will re-commence its tough money policies and interest rates may rise again.

This is the correct sequence to use when thinking about the economy. If you are running a large company, you may plan on a reasonably strong economy for at least six more months.

But, if you are speculating on real estate prices, or if you sell furniture or household appliances, you had better plan your future differently.

On the other hand, if you are trying to manage your RRSP investments, you won’t need all that economic data. Just make sure you have a good handle on the direction of the stock market.

Pitfall #1

The conflict comes when financial planning is used as a sales tool for mutual funds or insurance. What I mean by this is that the deficiencies in your financial plan are being addressed by the same person who has done the analysis. The “planner” solves your financial problem by selling you his particular financial product. Though most professional planners are probably decent, educated and hard working, they are simply part of a structure that can be flawed from the get go.

If I am the same person that highlights shortcomings in your plan AND also sells you the solutions, isn’t the planning process nothing more than a step that leads the product sale? And commissions on product sales are usually the only way planners get paid. Deficiencies are most often met by increasing one’s exposure to equities, be they mutual funds or individual stocks. Purchases of equity funds or stocks pay an advisor/ planner the highest trailers and commissions.

Pitfall #2

Another seductive tidbit to be mindful of is “dream-based.” This is acommon selling technique used by salesman/financial planners whendetermining what an investor’s wealth goals are. Just how much money will you need when you retire? If we succumb to thinking about a too-early retirement or a retirement without a reduction in income and expenditures, we play a role in this distortion. Setting retirement expectations is an entire topic unto itself. Our advice? Be realistic.

One approach to retirement planning is to do something you like doing until they bury you. Instead of imagining how much money you might need, imagine what you’d really like to do. Retirement might mean starting a new job that you do for love, not for money. Well, maybe you could bring home a little income. This approach helps to mitigate the effects of the “dream-based” selling angle. It helps you think of your life first, then your money.

Me? I’d love to be a golf course marshal with a bit of drill sergeant in him. The marshals now-a-days seem like they just drive around the course looking for golf balls instead of moving along the slow pokes. Another way to avoid conflict is to try and separate the two functions: financial planning and portfolio management.

Most accountants can provide a good financial plan. Or, there areprofessionals solely dedicated to financial planning. Both will charge a flat-fee for their service.

We don’t talk about individual securities in our newsletters because there can be a lot of risk in any individual security. We don’t encourage our readers to take risk. And besides, we don’t want to known as great stock pickers. Talking about an individual stock doesn’t really help investors. It entertains investors.

Having said this, income trusts as subset of the TSX have been whacked pretty hard these past few weeks. They have come under some significant upheaval and price depreciation. To say it’s topical is an understatement: many investors were caught off guard by the news that taxation of income trusts was being changed. Thousands of individual investors lost money.

What income trusts to jettison and what to keep? A good starting point is to classify your trusts. Are they an Energy, Real Estate (REITs), or Business income trusts? Once you know this you will then be able to properly see how the tax changes affect each type as a category.

When you look at the “business” trusts, they are all over the map. These trusts represent all the sectors of the whole equity market: financials, utilities and materials etc. Some have broken down and others are merely experiencing a correction within a longer term up trend.

Properly classifying your trust in general terms—energy, REIT or business–is relatively easy. Many investors understand this point already. The next step is to find where your trust falls within the sub sectors of income trusts. Once you are there, you will be able to see some remarkable differences. Do like we do: keep the ones in up trends, jettison the ones in down trends.

For the record CastleMoore has never purchased an income trust for our clients. Our clients may own them vicariously through their small percentages in some Exchange Traded Funds [ETF’s.] As an industry group, the income trusts have been underperformers for a year. One of our investment principles is to identify those industries and sub-industries that are outperforming the overall stock market. If the overall stock market goes up, say 10 %, we hope our portfolio of out-performers will go up, say 15%. During the past year, the income trusts have gone up less than the overall stock market: they were under-performers for a long time before the recently announced taxation changes.

True Story:

Before the outcome of that battle was announced, investors knew that it would have a profound impact on the values of their “consuls”: a victory by Wellington would send the market to unprecedented heights; the plunge would have made cockney flower girls out of duchesses.

This was the thinking as well of a certain investor—let’s call him Mr. W.—whose shrewdness as an investor was so well known that others investors would use his actions as the sole bases of their own investment programs.

And Mr. W knew it.

Of course, back then, there was no CNN, and thus pertinent information tended not to be disseminated to all interested parties simultaneously. Thus, the earlier one obtained information, the greater his or her advantage in the business of buying or selling on the London Exchange.

These prices were not about to rebound, since there was no underlying value to them.

A panic sell of stocks can be viewed as a transfer of ownership in millions of shares from speculators to investors, the latter group driven by the knowledge that stock will always make new highs sooner or later. This is an important point to consider in the aftermaths of such events.

At CastleMoore we manage our clients’ investments through a methodical and disciplined set of systems that virtually removes any individual bias and emotion from the investment process. What we do works. We rely heavily on loss avoidance techniques when making investment decisions.

Our clients are investors that pay particular attention to asset prices, have little tolerance for investment losses, and strong expectations of getting their money’s worth. Clients appreciate CastleMoore's all-inclusive, comprehensive fee schedule. If we are required because of volatile markets, to be more active within our client accounts CastleMoore bears all the costs associated with more frequent transactions.