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.


"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.