Wednesday, November 30, 2011

Professional Advice--Worth the Price?



Here is an excerpt from an article at CNNMoney by

"In a recent study, benefit consultant Aon Hewitt and advice firm Financial Engines looked at the 401(k) returns of more than 425,000 savers from 2006 through 2010.

The findings: The median annual return of those who got professional help was almost three percentage points higher than the return for those who invested on their own, even after taking fees into account.  (emphasis added)

One reason for that performance gap is that the investors who flew solo were far more likely to be too aggressive or too conservative (see graphic below). Emotions also played a role: Do-it-yourselfers were more apt to cash out of stocks in the 2008 crash. As a result, their returns lagged substantially when the market rebounded in 2009."

Better performance is not just picking the winning horse or horses--it is choosing the right race track and the right strategy.  We propose that history teaches that a highly diversified, value oriented, risk managed portfolio, managed by a skilled and experienced pro will produce better than average long term returns.  


Thursday, November 17, 2011

The Bond Market (re Europe) is very powerful. Beware.



Bond markets determine the interest rate that a borrower must pay to borrow.  In the 1990's, when President Clinton attempted to increase the US budget deficit, the "Bond Market" reacted negatively with such force (rising interest rates) that Clinton was forced to abandon the strategy and instead balance the budget.  His political advisor, James Carville was quoted as saying.

I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.
James Carville, political advisor to President Clinton

Rising interest rates in Italy, Spain, France and many European countries other than Germany threaten economic growth. The Bond Market sees risk of default and demands higher interest. High interest rates paid by governments lead inevitably to higher taxes, which tend to reduce economic growth. Rising interest rates and lower economic growth are bad for stocks, so stocks tend to decline. So the Bond Market does indeed have a powerful influence.

At some point, the process tends to be self compensating in that lower growth leads to less demand for credit--more cash, and lower interest rates. So far, rising rates in the weak European countries has led to LOWER interest rates in the US as money seeks a "safe haven".

Sooner or later, when interest rates go high enough, governments tend to cut spending. This reduces borrowing and interest rates fall.  Since, bond prices change in the opposite direction of interest rates--the Bond Market loves falling interest rates because bond prices go up and participants sell bonds at a profit.

Whether it be the stock or bond market, people that try to make their living speculating or trading love volatility. Perhaps that is why we are seeing so much of that lately.

Be aware that the US is not immune from rising interest rates and pressure from the Bond Market.  Right now, the Bond Market is focused on Greece, Italy, and Spain.  With continued deficits, it may not be long before we become the focus of the Bond Market with rising interest rates. Owning bonds is not much fun when interest rates rise rapidly.

Keep in mind that bonds being sold by Italian and Spanish governments are yielding close to 7% interest and they are selling about all that they need to sell. And, a lot of people are spending a lot of money buying these bonds--the majority of them assume that: A) they will get the 7% interest and a return of principal as agreed; and/or B) Interest rates will fall, bond prices will rise, and they will sell for a profit.



Tuesday, November 15, 2011

Fraidy Cat Markets



Fraidy Cat was a cartoon character first introduced in 1942 as a MGM short Tom and Jerry film, directed by the famous team of Hanna and Barbera. The character was reintroduced in an ABC TV series in the 1970’s. Seems like Fraidy Cat was afraid of everything. He had nine lives, but had used up eight of them. To Fraidy, the world was a very dangerous place, and everything he encountered was sure to end in disaster and the end of him—or so he thought. (Go to YouTube and search for Fraidy Cat and many of the shows can be viewed.)

Stock and Bond markets around the world are now what I call “Fraidy Cat Markets” where every possible threat is thought by many to surely lead to economic catastrophe. On the other hand, there is fear that perhaps the pessimism is overdone and many have inordinate fear of “missing out” on a massive upturn. Fear and Greed are always present, but we seem to have entered a period where the extremes are amplified beyond reason.

As I have said, “Mr. Market” suffers hopelessly from manic-depressive syndrome. But lately “Mr. Market” seems to be more manic and/or more depressed than usual. Volatility is the name for all this up and down. Seems like the only certainty is uncertainty.

There are many theories about the cause/s of all this. My take is that we are in an age of pessimism, much like the 1970’s. Bad, unexpected things have happened to us. Many fear that more bad things are coming.

In the age of financial entertainers like Cramer and shows like Fast Money, with major investment banks around the world gambling by “trading”, the buying and selling of stocks and bonds looks like a really crazy and dangerous activity. Yet, in my opinion, true “investors” should not see it that way.

Risk in the short term has clearly increased (MF Global proves that.) but risk in the long term for prudent investors has probably not increased much more than historical “normal” levels. In fact, true investors have a unique opportunity to use the craziness of short term volatility to their advantage. (Time arbitrage.) True investors take ownership in business enterprises that over time generate profits and increased stockholder value. When “Fraidy Cats” are selling all their holdings fearing the collapse of Europe, investors might be wise to use this as an opportunity to increase their holdings in companies likely to prosper in the long run, even if Europe does experience severe problems.

Seems like fundamental data is coming out on a regular basis confirming that the consumer is still spending, even in Germany. Corporate earnings are UP. Threats of inflation have lessened.

Life (economic and non-economic) is dangerous. There is always risk—from things we know about, and most importantly from things we do not expect. I think we can safely say that the situation in Europe is certainly dangerous (economically) and a recession or slowdown there is likely. But, it is highly probable that all but the worst case scenario is already “priced in”.

One thing for sure—the best case scenario is not “priced in”. Probability is on the side of those who believe that markets are way too pessimistic. For the long term investor, being a irrationally overcautious “Fraidy Cat” is unwise and expensive. A balanced approach with intelligent risk management is probably the surest way to prosperity for intelligent long term investors. Focus on where we will likely be in 3-5 years—not in 3-5 days or weeks.
 
The uncertainty of the past year is likely to continue for a long time. Fears about Spain will be added to fears about Italy and Greece. The upcoming controversy in the US “Super Committee” will surely generate fears that the US may “go the way of Greece”. There will be talk about military action by Israel and the US taking action against Iran. We are now in an election year—with each weekly poll creating anxiety on the part of some portion of the electorate.

Here is an excerpt from the famous poem “If” by Rudyard Kipling:

IF YOU can keep your head when all about you
Are losing theirs….

If you can trust yourself when all men doubt you

But make allowance for their doubting too;

If you can wait and not be tired by waiting…
Yours is the Earth and everything that’s in it

Written to commemorate the hero of a 1895 British military campaign in South Africa—but applicable to today’s long term investor as well.

I think it is also good to share (Again in case you missed it.) an allegory from the famous value investor Benjamin Graham about Mr. Market. http://en.wikipedia.org/wiki/The_Intelligent_Investor

Mr. Market, is an obliging fellow who suffers from a severe case of bi-polar disorder. He turns up every day at the share holder's door offering to buy or sell his shares at a different price. Often, the price quoted by Mr. Market seems plausible, but sometimes it is ridiculous. Sometimes Mr. Market is wildly overly optimistic and is willing to pay a very high price. Other times, Mr. Market is in such a depressed state that he is convinced that the future is hopeless and that the value of your shares are ridiculously low. The investor is free to either agree with his quoted price and trade with him, or ignore him completely. Mr. Market doesn't mind this, and will be back the following day to quote another price. As an investor, you need to be confident enough in the value of your investments to be able to take advantage of Mr. Market rather than being affected by his disease.

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.



































Tuesday, September 27, 2011

Risk Neutral Investing in Uncertain Times



Since July 21, we have been on a historic roller coaster ride. Down 17%, followed by a rally up of 8%, down again by 7%, followed by another rally, followed again by two more up/down cycles of 7% with markets basically oscillating wildly about the 200 day moving average. This type of action is always the result of short term thinking by speculators who travel in herds trying to predict the unpredictable. It is reinforced by investors who fail to focus on the long term and let fear overcome their logic. Sometimes the economy is affected by events and actions that are just plain unpredictable.

There are three basic themes that have produced the underlying “fear” in the market since July 21.

1) It looks less likely that the US government will, or even can, ride to the rescue of the economy if needed.

2) Economic signals related to unemployment, home sales and consumer confidence indicate the economy may be slowing down.

3) Europe is in the midst of a debt crisis that could develop into a worldwide economic shock.

The markets, in my humble opinion have over-reacted to the first two themes. But as I said in August, the risk regarding Europe is significant—a lot will depend on the resolve of Germany and how much they are willing to give up in order to bail out the banks that lent too much to Spain, Italy, Greece, and Portugal. The outcome does appear to hinge on Germany’s willingness to provide the funds necessary to be sure that trust in the European economy is restored.

The first hurdle was a decision earlier this month by the equivalent of Germany’s Supreme Court who decided that in fact it was constitutional for Germany to provide funds to bail out other countries---as long as their parliament approved such action/s. That parliamentary vote in Germany’s Bundestag is scheduled for this Thursday, September 29. The outcome is uncertain. Probably they will vote to support the “bailout”. If they do not, then market action will most probably be a real panic as NOBODY really knows what would happen next.

As an investor, times like these are pretty uncomfortable. The temptation is to exit the market, take some losses but try to avoid any more damage. This was not a bad strategy in 2008. But this is not 2008. I have told all of my clients that it is important to recognize the difference between a crash and a panic. A crash starts from an environment of high asset valuations and excess confidence. A panic feeds on excess fear and seldom starts from high valuations. Panics most usually start because of some sort of external shock or a credible fear of one. It takes a long time to recover from a crash—you can see them coming and action may be merited. 2008-2009 was a crash. Panics are usually short lived and recovery can be unpredictably rapid. 2010 was a panic—a 17% drop followed by a 33% gain. Selling after the 17% drop and sitting it out would have cost dearly.

The problem in Europe as a whole appears to be more related to liquidity rather than solvency, although it does appear that Greece as an individual country is probably insolvent. One cannot be sure, but estimating the long term effects of whatever happens in Germany on Thursday, the probability of gain is probably very close to the probability of loss. So for smart investors that neither seek or avoid excess risk (Risk Neutral Investors)—a short term hold is probably wise. Keep your mind on what you believe the companies you own, or want to own will be worth in 2-3 years from now—that is what investors do. Let the foolish speculators spend their energy on what the markets will do in the short term. Keep in mind: long term investors make money; speculating is a zero sum game.

I think it is timely to share an allegory from the famous value investor Benjamin Graham about Mr. Market. http://en.wikipedia.org/wiki/The_Intelligent_Investor
  
Mr. Market, is an obliging fellow who suffers from a severe case of bi-polar disorder. He turns up every day at the share holder's door offering to buy or sell his shares at a different price. Often, the price quoted by Mr. Market seems plausible, but sometimes it is ridiculous. Sometimes Mr. Market is wildly overly optimistic and is willing to pay a very high price. Other times, Mr. Market is in such a depressed state that he is convinced that the future is hopeless and that the value of your shares are ridiculously low. The investor is free to either agree with his quoted price and trade with him, or ignore him completely. Mr. Market doesn't mind this, and will be back the following day to quote another price. As an investor, you need to be confident enough in the true value of your investments to be able to take advantage of Mr. Market rather than being affected by his disease.

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.








Thursday, September 15, 2011

Income Groups over 40 Years



Note that if average tax rates have remained the same for the top 10%, and their income has risen--they are paying a higher proportion of the total tax burden now as compared to what they paid in 1970.

The debate is not so much that higher income earners should pay more---the issue is how much "more" is enough. 


This has real impact on markets. Fear that "surplus" income will be taken away in the future causes the investor class to take fewer risks--hence lower stock prices and lower interest rates.

This economic commentary is related to politics (political economy) and is the sole responsibility of the author and no other. It is not to be considered financial advice or a solicitation for political support.

Wednesday, September 14, 2011

Federal Income Tax Burden by Income Group



This info is from the Federal Reserve Bank of St. Louis. Link: Tax Burden at FRED for entire article. It, and the "Jeffersonian" quote from 1817 highlights the debate about "fairness" that underlies the other debate about the size of government currently raging in the USA. It is this debate and struggle that is the root of the uncertainty that is one major cause of the slowness in our economy.  Debt can only be eliminated with inflation or taxes. Spending in the long term therefore can only be offset by inflation or taxes. In either case, when government takes from one to give to another--it should be no surprise that the one who is burdened by the "taking" resists and is reluctant to "invest".

Note that the tax rate % for the highest 5% and the highest 20% has remained about the same since 1980.

Note also that the tax rate % for the other (lower) 80% has declined signficantly--with the lowest 20% actually getting more $ back from the government than they paid in. Nearly 40% are paying nothing.



Thomas Jefferson (1817) A TREATISE ON POLITICAL ECONOMY

"To take from one, because it is thought that his own industry and that of his fathers has acquired too much, in order to spare to others, who, or whose fathers have not exercised equal industry and skill, is to violate arbitrarily the first principle of association, ‘the guarantee to every one of a free exercise of his industry, and the fruits acquired by it."

Until this uncertainty is eliminated or reduced by a clear message sent by a national election, it is quite possible that economic activity may be sub-optimal.

This economic commentary is related to politics (political economy) and is the sole responsibility of the author and no other. It is not to be considered financial advice or a solicitation for political support.

Monday, August 22, 2011

Fear of Deflation/Depression do not consider All potential Fed Actions



Bernanke's 2002 Speech

http://www.federalreserve.gov/boardDocs/speeches/2002/20021121/default.htm

In 2002, Ben Bernanke told us that a diligent Federal Reserve has all of the tools necessary to stop deflation.  Many have forgotten his speech. They think the Fed is "out of ammunition".

The most familiar stimulus is low interest rates. The Fed has used and continues to use that tool.

The next, the purchase of Treasury Bonds, known as QE2 has been used--it is being maintained, but not expanded.

Low rates and QE are like rocks and slingshots. The Fed has a large arsenal of many other, MUCH MORE POWERFUL tools.

Less familiar, but much more powerful tools remain to be used. I believe the next most powerful is the purchase of private debt securities and foreign debt securities. Finally, in my opinion, the most powerful: purchase of domestic and foreign equities.


No doubt, these tools will be used reluctantly. Given Rick Perry's warnings, monetary stimulus for "political" reasons would not be acceptable. However, the Fed's mission is "price stability" which includes controlling BOTH boom induced inflation and recession induced deflation. This has nothing to do with politics--it has to do with The Fed following their mandate. 

No doubt, all of this is "printing money" and is inflationary. That's the point. To kill deflation or fears of it, the Fed uses tools to create an offsetting or counteracting inflationary force.  The Money Supply is only part of the equation. Increasing the supply of money in an economy where money is "lazy" may only offset the deflation caused by the slow movement (velocity) of money through the economy.  Failure to print more money in such an environment would be the same mistake the Fed made in the 1930's.  They are not likely to make the same mistake this time--no matter what the politics.

Recessions are caused by collapsing asset bubbles or fear driven collapse in demand. They result in the slowing of money velocity. Before the Fed, the only thing you could do is hope that people would get over their fear sooner than later. The Fed's tool box gives it the ability to counter this slowing with a larger supply of money--either preventing the recession or making it shallow and of short duration.

Mr. Bernanke is well aware of the politics of 1937 and 2011--I think those who bet against him doing the right things are making a bad bet.

More analysis of the this subject is available by reading:


This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.







Friday, August 19, 2011

What Next? Is it like 2008 or 2010?




Over the past 60 days, it has been hard to predict the direction of markets for the next day, let alone forecast where markets will be 30 days in the future. Uncertainty and volatility has been extreme. The S&P 500 has fallen 17% from it’s peak in April.

Last year, in 2010, we saw a similar pattern, with uncertainty about European debt and continued high unemployment in the US driving fears of a double dip recession. The S&P 500 fell 17% from it’s peak in April 2010 before rising 33% to the April 2011 peak.

So are we going into a recession or can we expect another 33% gain in the next few months?

In June, I introduced you to the Citigroup Economic Surprise Index. It can be viewed at Bloomberg http://www.bloomberg.com/apps/quote?ticker=CESIUSD:IND#
(under the ticker CESIUSD:IND ) A negative reading of the Economic Surprise Index suggests that economic releases have on balance failed to meet consensus expectations and have “disappointed”. This indicator reached an extreme low on June 3, improving since, but still with a negative reading. The debate about the debt ceiling and brinksmanship of the US government was shocking. The downgrade of the US by S&P was also shocking.  It seems like every talking head and prognosticator has felt the need to go on the record predicting a "possible" recession: 20%, 30%, 50% Chance.  NONE OF THEM KNOW!  (Remember, news media maintains your attention with stories meant to stir your emotion.)

The Federal Reserve QE2 stimulus ended in June. The debt ceiling debate reduced the likelihood of any government fiscal stimulus. In other words, this time, it looks less likely that the US government will, or even can, ride to the rescue of the economy. The really big deal is Europe.

In the US, banks lent too much money to individuals with mortgages. In Europe, banks lent too much money to governments. The individuals had at least some collateral.  Loans to governments are more dangerous--sort of like signature only loans with no collateral.  Too much “tough love” and “austerity” in Europe to reduce this government debt may result in a economic contraction there—a real recession that then might spread all over the world. Concurrent reduction of stimulus by the US Government actually increases the risk.

What many fail to appreciate is that while the end of QE2 ends the increase of Fed stimulus, the Fed is not withdrawing stimulus. Zero Interest Rate Policy (ZIRP) is in place for two more years and the QE balance sheet is being “maintained”. And, while clearly there will be reduction in deficit spending, the US will still be stimulating the economy with deficit spending higher than any time in history except for 2009-2011.  Franklin Roosevelt would never have even dreamed that it was possible for the US Government to throw so much money at the problem. Those that claim the war brought us out of the Great Depression should remember that the US is presently waging two wars.

As most of my clients already know, I study and monitor certain economic data that I call Reasonably Reliable Leading Indicators. While there are some economic indicators pointing to a slower economy, AT THIS TIME, none of what I deem to be Reasonably Reliable Leading Indicators are showing a pending recession. Retail Sales do not show signs of a pending recession. Industrial Production data does not show signs of a pending recession. Corporate Earnings Guidance indicated an expected slowing, but not a pending recession. The Interest Rate Yield Curve is still very steep. Unlike almost every recession in history, corporate bonds are rising or maintaining value as stocks have fallen—a bullish sign that indicates the recent market action is probably just an old fashioned panic and crisis of uncertainty.  When a real recession is likely, people typically sell corporate bonds and stocks at the same time.

Certainly the risk regarding Europe is significant—a lot will depend on the resolve of Germany and how much they are willing to give up in order to bail out the banks that lent too much to Spain, Italy, Greece, and Portugal. Let's hope the ECB stops raising interest rates and learns how to implement intelligent monetary policy.

Again, markets are determined by fundamentals and sentiment. Fundamentals (corporate earnings) are strong. (See graph) We invest in companies. Not only are companies profitable—they have accumulated cash and most have real “staying power” to survive downturns. This is not 2008. It is also probably not 2010 either.

Please remember that sentiment changes rapidly based on current news and information. What we don’t yet know, we don’t know. As I have stated “Life has been uncertain, difficult and dangerous. Uncertainty, difficulty and danger will continue to exist.”

It is very possible that the worst case scenario is already priced in. A 17% drop is a significant correction. (We are also down 28% from the 2007 highs. Some would argue that we are still in a recession--it hasn't ended yet.) History teaches, and indicators tell us that there is a possibility of further declines; But, there is a higher probability that markets will turn back up or at least stabilize. The biggest danger is probably fear itself where fear and resulting collective actions to avoid potential losses actually creates the economic slowdown that people fear and are tryiing to avoid. Emotion is the economy's (and your money's) worst enemy.

In times like these, it is important that any money invested is truly long term—then these short term up/down movements are much less important to you. It is also important to keep the emotions of fear and greed out of your thoughts as these emotions generally lead to bad decisions. Keep your mind on what you believe the companies you own, or want to own will be worth in 2-3 years from now—that is what investors do. Let the foolish speculators spend their energy on what the markets will do in the short term.  Keep in mind: long term investors make money; speculating is a zero sum game.


This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.























Friday, June 24, 2011

Worried about Greece?


I don’t often write commentaries on a daily basis, but the developing saga and fear based market moves related to the current Greek credit crisis deserves your attention and a bit of understanding.

It is estimated that the total amount of Greek debt is well above $300 billion. That would make a default there one of the largest in history for one country. Larger than Argentina in 2002. And, Greece is not the only European country that has more debt than it can repay. It is a big deal.

Defaults like this (but not necessarily this large) however are not as uncommon as the average person thinks. Between 1998 and 2004, there were 15 governments that defaulted on their debt. Between 1976 and 1989, there were more than 40!

One of the things that I thought we learned in the past is that in most cases, by the time default is contemplated, the situation is usually so bad that a large part of the loans need to be written off. Here are some quotes from the EMTA’s site (link below) “The Brady Plan, the principles of which were first articulated by U.S. Treasury Secretary Nicholas F. Brady in March 1989, was designed to address the so-called LDC debt crisis of the 1980's…..From 1982 through 1988, debtor nations and their commercial bank creditors engaged in repeated rounds of rescheduling and restructuring sovereign and private sector debt, in the belief that the difficulty these nations experienced in meeting their debt obligations was a temporary liquidity problem that would end as the debtor nations' economies rebounded. However, by the time the Brady Plan was announced, it was widely believed that most debtor nations were no closer to financial health than they had been in 1982, that many loans would never be entirely repaid, and that some form of substantial debt relief was necessary for these nations and their fragile economies to resume growth and to regain access to the global capital markets.” Read more at the site:


What I thought we learned from past was that some sort of market based solution is necessary. Repackaging and reselling the debt. Something similar to the Brady Plan has been proposed by Daniel Gros, Director of the CEPS and Thomas Mayer, Chief Economist of Deutsche Bank. You can download their plan at the link:


One thing that is different this time is that those same pesky Credit Default Swaps we learned about during the mortgage bond credit crisis here in the US are involved in this crisis too! Seems like the French and German banks bought “insurance against default” on Greek, Irish and Portuguese debt—from US banks! So, it gets a bit more complicated. And, it is logical that a possible and probable default in Greece is creating a “not this again” fear in stock markets. i.e. 2008 all over again.

What is probably different however is that companies have prepared for this storm with strong balance sheets. And, hopefully, the US banks have prudently “reserved” for losses from their CDS "insurance" they have issued, with more capital. The Greek people vote on June 29 and June 30 on whether they will accept more “austerity”—a condition placed by lenders for more “bailout” money. It appears that markets are getting ready for the possibility that they will refuse and the crisis escalates. (Think Wisonsin.) Be prepared for volatility, risk and great uncertainty in this case. My best guess is that a temporary solution will be implemented, and then, sooner or later, the losses will be recognized and the crisis will end. We are at the end of the beginning of a resolution. I think this issue will be in the news for quite some time. I do not think that this week’s actions will merit any major portfolio changes, yet, as markets are likely to snap back very quickly. Be sure all of your present investments are long term oriented--the bottom of this may be a very good entry opportunity.


This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.

















Thursday, June 23, 2011

Borrowing Money is Fun! Paying it back--Not so much.



Graph of Household Debt Service Payments as a Percent of Disposable Personal Income
Ben Bernanke (06/22/2011).......“We don’t have a precise read on why this slower pace of growth is persisting,” Bernanke said. Referring to “frustratingly” slow job growth and weakness in the financial and housing industries, Bernanke said “some of these headwinds may be stronger and more persistent than we thought.”

You have got to hand it to a man who is honest and straightforward, but markets get spooked when the man who “should know what to do” tells us that the Fed does not know why growth is so slow and that they underestimated the headwinds holding back the economy. Add this to continued worries about the fiasco in Greece and it is no wonder that markets trend down.  (Remember that markets are driven by fundamentals and sentiment.)  Mr. Bernanke is a good man and a great economist--perhaps he is not the best at inspiring confidence.

The chart above is one illustration of the biggest problem: Too much debt and the consequences of debt reduction. Borrowing money is fun—paying it back—not so much fun. (Sort of like gaining and losing weight.) Households in the US took on too much debt—in fact you might say we went on a debt binge from 1994 until 2008. Since then, we have been paying off debt—fast and furiously! The good news—we are rapidly approaching a “sustainable” level of 10-11% of our income.

Oil prices had been rising rapidly for a year. But, recently they changed direction and have been falling. Today, the US and other nations agreed to release a lot of oil from strategic storage reserves. This will tend to accelerate the drop in the price of oil and is a big stimulus to global economic growth.

The one thing out there that is not necessarily “about to turn the corner” with certainty is the debt problem in Europe. Banks lent too much money to homeowners in the US. In Europe, banks lent too much money to governments. When a homeowner can’t pay the loan back, there is at least some collateral that can be sold in a foreclosure. Lending to governments is like a signature only loan or credit card debt—you can’t exactly foreclose—your only collateral is government revenue from taxes. When governments continue to run deficits, spending more than they take in from taxes, there is no surplus left to pay back the loans.

So, the problem in Greece specifically and with European government debt in general is yet to be resolved. I have no sure idea what the final outcome will be, but my understanding of history (specifically in Latin America) tells me that a great deal of the debt in Greece, Ireland and Portugal will have to be written off and restructured. Will that hurt the stock market? In the short run—you are seeing it today as this scenario is being “priced in”. In the long run, reducing debt and getting back to being “fit and trim” economically is probably very good for the economy and the stock market.

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.
























Saturday, June 11, 2011

Who Moved My Cheese?



Who Moved My Cheese? An Amazing Way to Deal with Change in Your Work and in Your Life, A best-selling motivational book by Spencer Johnson in 1998 was written as allegory. The moral: Change Happens (They Keep Moving the Cheese); and Anticipate Change (Get Ready for the Cheese to Move).

After many months of better than expected economic news, accompanied by a rising stock market, there has clearly been a recent spate of “disappointing” economic news. Over the past week, we have seen a significant reaction by stock markets to that “worse than expected” data. Somebody moved the cheese!

As most of my clients already know, I study and monitor certain economic data that I call Reasonably Reliable Leading Indicators. One of those indicators is particularly applicable to the present situation. It is known as the Citigroup Economic Surprise Index. It can be viewed at Bloomberg: http://www.bloomberg.com/apps/quote?ticker=CESIUSD:IND# (under the ticker CESIUSD:IND) A negative reading of the Economic Surprise Index suggests that economic releases have on balance failed to meet consensus expectations and have “disappointed”.

As I have indicated in the past, markets are determined by fundamentals and sentiment. When the Citigroup Economic Surprise Index falls, sentiment falls. When the Citigroup Economic Surprise Index is negative, sentiment is negative. When sentiment reaches an extreme (within it’s normal cyclical up/down range) it usually indicates a turning point. The Citigroup Economic Surprise Index reached an all time high (100+) around the first of March, and then fell like a rock to near an all time low (100-) this past week. The bottom line—in general, people had become too optimistic. Reality has returned. A quote from 2010 that we display on our website:

“Ever since Adam and Eve were cast out of Eden, Life has been uncertain, difficult and dangerous. Uncertainty, difficulty and danger will continue to exist. Some will be able to recognize opportunities despite such danger and difficulty and will prosper mightily. Others will simply adopt proven strategies to survive and prosper reasonably in a changing world where the future will always be uncertain. In the longer run, the future is seldom as bad as the pessimist believes, nor as good as the optimist predicts.”

Another Reasonably Reliable Indicator is the Investor Sentiment Survey published by the American Association of Individual Investors. http://www.aaii.com/sentimentsurvey  It is considered a contrarian indicator as the vast majority of individual investors misread the markets. (According to historical data.) The normal “bearish” prediction is 30%. Last week it was a much higher than normal 47.7%.

Again, markets are determined by fundamentals and sentiment. Fundamentals (corporate earnings) are strong. Sentiment (expectations about future earnings) is very negative. When sentiment reaches an extreme (within it’s normal cyclical up/down range) it usually indicates a turning point. It is impossible to predict market movements so it is possible that we could see continued market declines as sentiment falls further and fear begins to spread. On the other hand, fear and pessimism is pretty high and history teaches that we are most probably near a turning point. Or, at least a “treading water” period, waiting to see what the next round of earnings reports tell us about fundamentals.
 
Please remember that sentiment changes rapidly based on current news and information. What we don’t yet know, we don’t know. As I have stated “Life has been uncertain, difficult and dangerous. Uncertainty, difficulty and danger will continue to exist.” In times like these, it is important that any money invested is truly long term—then these short term up/down movements are much less important to you. It is also important to keep the emotions of fear and greed out of your thoughts as these emotions generally lead to bad decisions.

Although unemployment and housing information has been disappointing, other information is quite good, or at least not bad. A) According to a government advisory panel in Japan: “Spending to rebuild Japan's tsunami-hit northeast will spark an economic boom later this year”; B) The US Commerce Department reported: “American companies sold more computers, heavy machinery, and telecommunications equipment in foreign markets in April--exports have finally returned to pre-recession levels"; C) The Institute for Supply Management said its services sector index rose to 54.6 last month from 52.8 in April. The reading came in just above economists' forecasts for 54.0, according to a Reuters survey. (Service Sector employment according to ADP is much larger than the Good Producing Sector.); D) According to the Association of American Railroads: “U.S. Freight Rail Traffic: Not Seasonally Adjusted: intermodal in May 2011 up 7.5% over May 2010, Seasonally Adjusted: intermodal in May 2011 up 0.8% over April 2011.”

History teaches, and indicators tell us that there is a possibility of further declines; But, there is a higher probability that markets will turn back up or at least stabilize. One should always remember the moral: Anticipate Change (Get Ready for the Cheese to Move).

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.
















Monday, April 18, 2011

Is Silver (or Gold) a Safe Investment?


Silver was not a very good investment for one billionaire in 1980. Here’s the story...

Nelson Bunker Hunt is best known as a former billionaire whose fortune collapsed after he and his brother William Herbert Hunt tried, but failed to corner the world market in silver.

Beginning in the early 1970s, Hunt and his brother William Herbert Hunt began accumulating large amounts of silver. By 1979, they had nearly cornered the global market. In the last nine months of 1979, the brothers profited, on paper, by an estimated $2 billion to $4 billion in silver speculation, with estimated silver holdings of 100 million ounces of silver.

During the Hunt brothers' accumulation of the precious metal, the price of silver during 1979 and 1980 rose from $11 an ounce in September 1979 to $50 an ounce in January 1980. Silver prices ultimately collapsed to below $11 an ounce two months later.

Hunt filed for bankruptcy under Chapter 11 Bankruptcy laws in September 1988, largely due to lawsuits incurred as a result of his silver speculation.

According to TV Investment Commentator, Jeff Macke, investing in Silver now is a strategy akin to “being reckless without getting killed… The fact is that charts like silver's 5-year (2006-2011) don't occur in nature. They are functions of a mob. Being part of a mob can be fun and lucrative as long as you don't get arrested or killed.”

It should always be remembered that during the last time the US had a bout with high inflation, the price of Gold fell by over 50% from 1980 to 1982. Precious metals are investments for people that are gambling or who are afraid. They have not done well in recent periods with high inflation and high interest rates.

Human nature is fascinating.  Some people will make a concentrated and speculative “high risk investment gamble” that they know has the potential of an almost permanent 50-78% loss in just a few months, yet a potential but temporary 10-15% drop in their diversified stock portfolio causes them to lose sleep at night.

Concentrated “investment gambles” like Silver (and Gold) sometimes pay off,  but the potential for sudden and great loss makes them an unwise choice for your serious money that you are saving for future income. There is no substitute for prudence and patience with a highly diversified portfolio.

 
This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.

Market’s Reaction to S&P Rating is probably Melodramatic


Three days ago I wrote: “Conservative and Liberal elements of our society are so diametrically opposed that the path forward regarding government’s role and spending are uncertain. What happens when government spending stimulus is withdrawn? What happens if government deficits continue?” 

Today, changing the outlook for US debt from stable to negative, Standard and Poors (S&P) said "We believe there is a material risk that U.S. policymakers might not reach an agreement on how to address medium- and long-term budgetary challenges by 2013; if an agreement is not reached and meaningful implementation is not begun by then, this would in our view render the U.S. fiscal profile meaningfully weaker than that of peer 'AAA' sovereigns”
Excerpt  from Bloomberg, August 31, 2007 :
“S&P and Moody's Investors Service failed to downgrade bonds backed by loans to borrowers with poor credit until July, when some had already lost more than 50 cents on the dollar. …U.S. Senate Banking Committee Chairman Christopher Dodd said yesterday credit rating companies must explain why they assigned ``AAA ratings to securities that never deserved them.''

The irony of S&P’s ratings today, warning about AAA rated US Treasuries, given Senator Dodd’s comment  3 ½ years ago,  is notable. Sort of in line with "be careful what you wish for".  
Given the track record of rating agencies and their own limitations/warnings regarding their comments, one must wonder why markets would react in any major way to anything they say.  Click on the below for warnings from S&P itself regarding what ratings are and are not.
           http://www2.standardandpoors.com/aboutcreditratings/

What we know after the S&P outlook change is the same as what we knew before.  We knew we had a deficit problem. We are expecting higher interest rates.  So why have world markets lost almost $600 billion in value, in one day, in reaction?
People act irrationally when they become fearful.  Sometimes being reminded about risks that they know already exist just makes people panic from fear.  
The value of the US $ in currency trading generally  rose after the S&P report today—exactly opposite the direction it should have gone if the US is less credit worthy—it went the direction you would expect during a general rise in the level of fear and uncertainty  in markets.

As I said on Friday, the Wall of Worry Gets Taller as potential risk and opportunity both grow.  

The important news will be what we don’t already know.

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.

Saturday, April 16, 2011

The Wall of Worry Gets Taller



The “correction” we expected as mentioned in our February 26, 2011 article did in fact occur in March.  Corrections can be likened to a room with gasoline spilt on the floor—the potential for fire exists—it only awaits the match.  In March, the “match” that lit the fire was a combination of a natural disaster in Japan, increasing tensions in the Middle East, and a new “limited” military adventure in Libya.  The correction did not last long.  After a 5% drop, the S&P500 ended March at the same level that it began.

The list of risks, any of which might derail our recovery seems to be growing.  European sovereign debt issues continue.  We are now engaged in three military conflicts in a Middle East that seems on the verge of revolution. Some believe the revolution is with the goal of democracy—others fear it is with the goal of radical theocracy.  Inflation caused by rising oil prices is threatening to permeate our entire economy. Unemployment is falling, but it is still very high. The residential real estate market continues to be weak, threatening a continuing problem of debt defaults and foreclosures.  Conservative and Liberal elements of our society are so diametrically opposed that the path forward regarding government’s role and spending are uncertain. What happens when government spending stimulus is withdrawn? What happens if government deficits continue? What happens after the world’s third largest economy experiences perhaps the most serious natural disaster in modern history? Fear regarding the future value of paper money seems to be creating a new bubble in the price of commodities and precious metals. As my title suggests: the Wall of Worry seems to have gotten taller.
As I have said in the past, a Wall of Worry is an absolute requirement for a continued bull market. It means that there is still a large bank of “potential” buyers.  While any of the risks mentioned could cause a fall in markets, it is important to remember that the values of equities depend on the psychological perception about corporate earnings in the long term as compared to interest rates, and a perception of the direction of corporate earnings in the short term.   
We are now just at the beginning of “Earnings Season”. Earnings and outlooks from Alcoa, Google, Bank of America and JP Morgan last week produced a bit of anxiety.   Be prepared for a great deal of volatility as the markets try to “read” the true meaning of the corporate announcements over the next few weeks.  What has been driving the markets up, despite worries, is the belief that the economy is recovering. This is supported by facts.  The fear is just about whether this trend and recovery continues.
I am most optimistic about one key indicator. CEO Confidence as measured by the Conference Board is quite high. Says Lynn Franco, Director of The Conference Board Consumer Research Center (April 7): “CEOs’ confidence has improved, yet again, and expectations are that the economy will continue to expand in the coming months. As for the employment outlook, CEOs are more bullish than last year, with half now saying they intend to ramp up hiring.”
Our advice is to remain cautious in the short term.  However, we are also convinced that tremendous opportunity exists for those with a long term view.  Stay the course, remain conservative and diversified—but keep your eyes peeled for trouble and opportunity—we are likely to see both.
This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.

Wednesday, March 16, 2011

Nuclear Situation in Japan and the Markets-Don't Join the Panic


Nuclear Situation in Japan and the Markets


News coverage from many sources has tended to exploit fear with sensational headlines and innuendo based on myth and rumor. Government officials have been pontificating, again with the goal of gaining attention to themselves, or perhaps an agenda that they support.

Here is an excellent source of factual information: http://www.nei.org/

The 50 heroes that are tending to the nuclear power plant did not abandon it like the press reported: They were evacuated for about an hour but returned to the site to continue efforts to restore safe conditions at the plant. A fire reignited at Tokyo Electric Power Co.’s Fukushima Daiichi 4 reactor. The fire was extinguished after about two hours and was not related to the spent fuel pool, but rather an oil leak.

Certainly the situation in Japan is serious. Pray for all of the Japanese people. (On behalf of our clients, we made a recent contribution to the Salvation Army who has a long term presence and tradition of helping people in Japan.) In regards to the nuclear power plant, a worst case scenario could be very bad. But, facts indicate that things are not quite as bad as is being reported.

The most recent stock market performance in Japan that closed today was UP 5.6%. A comment by European Energy Commissioner, Guenther Oettinger caused a big drop in US markets this morning when it was reported he told a European Parliament committee, according to news reports. “In coming hours there could be further catastrophic events which could pose a threat to the lives of people on the island.” He had no real knowledge about the subject, other than what he had read in the press. When a bureaucrat thousands of miles from the real picture can move markets with careless comments--you know the markets are spooked.

As an investor, it is important to remember that there is a big difference between a panic selloff and a crash related to a bubble deflating. As I mentioned in previous commentary, stock markets were a bit ahead of themselves. We were overdue for a normal correction. So far, the S&P500 is down 5.8% from the peak on February 18. We are essentially back to December 31 levels. Reasonably Reliable Leading Indicators are beginning to look positive. This is a simple panic selloff—and other than the stock of Tokyo Electric Power, the owner/operator of the troubled nuclear power plant , long term intrinsic values of well managed companies have not really changed. We may be closer to a buying opportunity than a selling one. Seems to me the biggest risk continues to be inflation and higher interest rates.

My advice is to never make major changes in reaction to a panic sell off. They can happen at any time. Your portfolio should already be prepared for them. You can see bubbles (2007-08) and therefore the resulting crashes that will come—making major changes to protect yourself. This does not appear to be a crash.

I am focused on the news in Japan to determine if any action is justified. So far, no major changes are recommended. If circumstances deteriorate—not based on hyperbole, but real facts, then you should give me a call for further discussion.

This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.