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.

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.